S&P 500 Volatility-Based Price Probability Range

Historical volatility projection suggests the range of probable S&P 500 prices from around 1750 to 2050 by year-end

Major trend indicators suggest high probability of prices ending in the lower half of the probability range

GAAP P/E and forward operating P/E ratios reverting to 5-year and 10-year averages suggest prices in the 1700’s

GAAP earnings have turned down and prices tend to follow

But GAAP earnings yield relative to current and near-term prospective 10-year Treasury yield is supportive of current index price

As you might imagine, the phone has been busy these past few days with nervous inquiries.

The prevailing questions are about direction of the US stock market and the magnitude of likely price change.

DIRECTION
I have written to you before with a negative outlook, based on objective data mostly about breadth; simple price chart behavior and patterns; and recent declines in quarterly earnings — but tempered by the continued market supporting aspects of the Treasury yield curve.

Our 4 factor major trend reversal indicator is suggesting a major trend change to a downward direction.

None of that attempts to fathom events and conditions around the world, but merely examines the final result of all that is going as expressed in earnings, price changes and trading volume.

So, my conclusion is that the probabilities (not certainty) is for the Correction to continue into a Bear.

A Correction is a 10% price decline from the trialing 1-year high. A Bear is 20% price decline from the trailing 1-year high, which decline is sustained at that level or worse for at least 2 months.

MAGNITUDE
Let’s look at that two ways:

out 3 months based on historical volatility

valuation level reverting to a “normal” valuation (not an overshoot) based on historical price GAAP and forward operating earnings estimates; and GAAP earnings yield relative to historically normal 10-year Treasury yields.

These are all projections, but based on reasonable and historically justified calculations.

Volatility-Based Price Probability Projections
This daily S&P 500 chart plots three horizontal cones projected three months into the future (to 12/28/2015) based on the 1-month, 3-month and 12-month historical volatility of the S&P 500 index, and using a 67% probability range.