Can we value a security against the trend of the economy?

In short yes - for certain benchmark securities.

Think about securities that capture the trend of the whole economy, like the S&P 500 or the US 10y Treasury.

These large benchmarks are linked to the trend of the economy at large, so it’s fair to assume that when the economy moves, their underlying value changes too.

We have several measures of economic growth, the most timely being New Order PMIs which gauge the trend of new business for companies.

Taking SPX as an example, when PMI New Orders goes up one can expect better trend from earnings, and vice versa.

Using PMIs as an anchor of fundamental value, we can begin to gauge value for SPX by means of a regression.

Let’s say that for any 5-points of shift in PMIs, SPX usually goes up 10%. However recently, the PMIs stayed flat but SPX rose 6%. Then we can claim that the SPX should be 6% lower - it is 6% overvalued!

Here is how this looks like in practice:

We use these indicators to gauge moments when price action is out of line with the broad economy.