The Northern Trust Company Economic Research Department Positive Economic Commentary “The economics of what is, rather than what you might like it to be.” 50 South LaSalle Street, Chicago, Illinois 60675 Web Page -- http://www.northerntrust.com (See Economic Research) Paul Kasriel (312)-444-4145 Fax (312)-444-4132 February 05, 2004 Stocks Fairly Valued According To “Kasriel” Market Valuation Model It has been almost a year since I have updated the “ Kasriel”stock market valuation model. To refresh your memory, I calculate a theoretical market capitalization for the stocks of nonfinancial corporations. Then I compare this theoretical market cap with the actual market capitalization of these corporations. To calculate the theoretical market capitalization, I discount by the Aaa-rated corporate bond yield a smoothed NIPA profit series of these corporations. For a more detailed description of the process, see my March 28, 2003 weekly commentary entitled “ Kasriel Stock Market Valuation Model Update”(available at http://www.northerntrust.com/library/econ_research/weekly/us). The profits data are reported by the Bureau of Economic Analysis and are only available through 2003:Q3. The actual market capitalization data are reported by the Federal Reserve Board and also are only available through 2003:Q3. So, I have had to estimate the over/under valuation of nonfinancial corporation stocks for 2003:Q4. I assumed that the actual market capitalization of these stocks in last s year’ fourth quarter increased by the same percentage as did the combined market capitalization of stocks traded on the New York Stock Exchange and the NASDAQ. I assumed that nonfinancial corporate profits in the fourth quarter grew at the same rate as they did in the third quarter. This last assumption probably biases upward 2003:Q4 theoretical market capitalization inasmuch as the economy grew at only half the pace in Q4 as it did in Q3. The chart below shows my estimates of the over/under valuation of nonfinancial corporations’stocks in the aggregate. From 2002:Q3 through 2003:Q3, the aggregate value of these stocks was consistently undervalued in a range of –7.4% to –15.2%. However, by fourth quarter of last year, stocks became overvalued by 1.9%, which is close enough to being deemed fairly valued for private sector work. 2 Nonfinancial Corp. Mkt. Cap: Over (+) Under (-) Valuation % 160 120 80 40 0 -40 1990 1992 1994 1996 1998 2000 2002 note: 2003:Q4 datum is estimated. Given that 2003 ended with this subset of the stock market being fairly valued by my model, given that profit growth is likely to slow somewhat in 2004, and given that the Aaa corporate bond yield is likely to drift up some in 2004, it is difficult to see stocks advancing as rapidly in 2004 as they did in 2003. Paul L. Kasriel, Director of Economic Research (firstname.lastname@example.org) Note: The “Kasriel” valuation model is not used by the investment policy committee of the Northern Trust Global Investments. ____________________________________________________________________________________________ The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.
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