Markets

This simple calculation means stocks could rise another 30% from here

Key Points
  • Investors worry that a lack of volatility may be paving the way for a correction.
  • Yet Jeffrey Saut of Raymond James says one valuation measure may mean the S&P 500 could reach 3,100.

The stock market's almost pathological lack of volatility is making some investors nervous that an earthquake could be on the horizon, but that may be misguided.

In fact, the market's somnambulant nature these days could be disguising a sharp rally ahead, according to one analysis.

Jeffrey Saut, chief investment strategist at Raymond James, comes to that conclusion using a little valuation math.

He believes the CBOE Volatility Index, the market's fear gauge, is running low not because of too much complacency but rather as part of an "upside consolidation" taking place that has pushed the market to record highs. The VIX, as it is called, uses options to measure the market's expected annualized change over the next 30 days. It's been running around 10, compared with a historical average closer to 20.

Valuation and volatility have been all the talk these days: With the trading at an above-average level of 18 times forward earnings, that makes the market look at least a little expensive and subject to a fall that could be confirmed by investor complacency.

However, Saut believes valuation is a poor teacher when it comes to determining where the market will trade.

Moreover, he said that discounting several years of "aberrational low" multiples on the index in the 1970s and 1980s tells an entirely different story. Remove those unusual periods from the calculation and the average price-earnings ratio since 1990 becomes 23.85, rather than the long-term 17 often used for comparison.

If the current market hits that multiple, that would take the S&P 500 all the way up to about 3,100 — or a gaudy 30 percent surge from current levels.

Saut isn't the only one who believes the market is flashing positive technical signals.

Bank of America Merrill Lynch strategists compare the levels of the 30-day VIX and its longer-term cousin, the CBOE S&P 500 3-Month Volatility Index. When the ratio between the two breaks above 1.2, that has coincided with strong moves higher the last three times.

While the BofAML scenario is not as optimistic as Saut's, it suggests a breakout to 2,500 on the S&P 500 — a 4.7 percent rise in the near term — is not out of the question.