Styles RouteMap: Fair Value Line

Profit from divergences between actual prices and fair value


Sample of our chart technical algorithm. The red up + down arrows show our track record. The orange line is our econometric forecast.

This strategy is intended to show the index level that can be explained by economic factors based on past relationships over very many years. Divergence between actual levels and predicted levels show the extent of over- or under-valuation based on investor euphoria or fear prevalent at any point in time. Fundamental value is derived from the extent of over - or under-valuation of share prices compared to fair value depending on the rate of inflation, after cyclically-adjusting profits. (See Cyclically-Adjusted Real PE Ratio)

For the medium term charts a different strategy is presented as a Composite Economic Indicator to show the influence of a composite indicator of economic variables in recent years. Back-tested past performance of revisions to such econometric models shows that even the data already reported can be an effective trend indicator, much like EPS revisions. 

For comparability, indices have been rebased to set year-end 1994 at 100. This is designed not only to show the historic relationship but also to provide a Best Guess as to the future trend, based on our econometric models.
 
The index is shown as the thick white line on the right hand axis. The explanatory variable, the economic factor, shown as the thin yellow line, uses the left hand axis as does the Best Guess for its future development, shown as the thin orange line. Buy & sell signals, that rely solely on data already published, are represented by red arrows embedded in the price index.
 
Best Guesses suggest what would happen to future performance for each sector or style based on the econometric models we use to create the composite indicator.  They rely on Consensus Forecasts for these variables.
 
Both historic data and Best Guesses should be treated as general indications of trend only. Even though these are the best relationships that can be consistently applied across all markets, correlations may be poor for some asset classes in some regions. In other cases correlations of past performance may be good, but the modelling is subject to a high degree of uncertainty in its ability to predict future developments.