By Nicholas Colas of Convergex Last Time US Stocks Were So Expensive, This Happened Summary: The best argument for avoiding US stocks is simple: valuation. Using the Shiller PE Ratio (price divided by a 10 year lookback at earnings), domestic equities trade for 29.9x earnings versus a long run average of 16.7x. The last time they were this expensive was early 2002, or 15 years ago. So how have they done since? The S&P 500 has appreciated 116% (a 5.3% CAGR) since February 2002 on a price basis. With dividends reinvested, that return jumps to 175% (a 7.1% CAGR). Not bad, but not the 9.5% average return from 1928 - 2016 either. As for how we got here, look to Consumer Discretionary (up 197% on a price basis), Health Care (+172%) and Energy (+170%). The largest drag was Financials, up only 10.0% since February 2002. But if the long term is a pretty good story, consider that 1) equities were down 22.0% in 2002 and 2) part of the appreciation over the last 15 years is due to exceptionally low long term interest rates. To get a similar outcome over the next 15 years, earnings growth may be the only driver.
According to the US Government, I will live to the ripe old age of 82.4 years. If I can make to age 62, however, that buys me 3 more years and I will expire halfway through 85. And if I make it to 70, I can tack on almost another year on top of that, within sight of 90. If you would like to see your own expected life span, just click here for the Social Security Administration's "Life Expectancy Calculator": https://www.ssa.gov/cgi-bin/longevity.cgi
My goal, therefore, is to get to 62 years old in decent health. Statistically, that is the easiest way to tack on a few more years of life. And it fits with my mantra on such matters: "The purpose of life is to stay alive." Or, as my doctor tells me, "You're a guy. If you can make it to 60, you can make it to 80".
Equity market valuations play a similar role in estimating future returns - essentially they are one measure of the potential longevity of any given bull or bear market. High valuations point to lower future returns; lower valuations hold the promise of better future returns. Given that low valuations tend to occur during periods of economic and capital markets turmoil when asset prices (and investors) are depressed, this all makes good intuitive sense. Or, as the old trading saw goes: "Instead of crying, you should be buying."
One measure of current US stock market valuation is the Shiller PE, which is simply the price of the S&P 500 divided by the average earnings of the index over the prior decade. Here's how it looks right now:
There are two problems with crying "Fire" in the theater over this number. First, it is not exactly a clean data set. The accounting rules over earnings have changed a lot in the last 100 years, after all. Second, interest rates play a critical role in equity market valuations, and the Shiller PE ignores them entirely. With long rates as low as they are you would expect to see very high equity market valuation. That's just math.
Still, there is some good work out there on how Shiller PEs can inform our perspective on future returns. Cliff Asness of AQR wrote one piece back in 2012 where he looked at 10 year returns on US stocks based on the starting Shiller PE. Here is what he found:
We can take this analysis one step further, and look at what happened the last time the Shiller PE was close to 20; conveniently, it was 15 years ago - right at the start of 2002. What's happened since? A few points:
So if you had gone all-in on US stocks the last time the Shiller PE was this high and waited 15 years, you would have more than doubled your investment. Yes, you would have had to live through some pain first. The S&P 500 was down 22.0% in 2002, after all. And then there was 2008, down 36.6%. On the plus side: over the last 15 years those (2002 and 2008) are the only down years for the S&P 500.
So how did we get a 7.0% averaged compounded growth rate from a relatively high starting point for US stock valuations? Here's how:
Can history repeat itself over the next 15 years? The Shiller PE of today is exactly where it was 15 years ago, after all, and things worked out fine. A few final thoughts:
That, along with lower rates, is what allowed US stocks to break the drag of a high Shiller PE back in early 2002. For the next 15 years, however, earnings will almost certainly have to go it alone if stocks are to replicate the performance of the last decade and a half.
In early 2016, physical gold hit $1,050 an ounce, which marked a level that gold investors hadn't seen since the latter half of 2009. After hitting $1,900 an ounce in 2011, gold shed 45% of its value as the U.S. economy improved, the U.S. dollar strengthened, and the Federal Reserve teased at, and finally began, raising its benchmark federal funds rate.
By While the Labor Department's fiduciary rule is scheduled to take effect April 10, some experts predict that President Trump will somehow, someway put the kibosh on the rule that requires financial advisers to act in their client's best interest, adhering to a fiduciary standard with respect to retirement accounts such as IRAs and 401(k)s.Read More
Gold price to 2 month high as fiery Trump declares New American Order - 'Trumponomics': Politics and economic policy in 140 characters - The 'intelligence' according to Trump - Trump, Putin and Russia - the great bromance - Trump - Bull in a China shop - Trade and currency wars with China and other nations - Trump - Fan of gold and golden tweets - Conclusion - Trump may be the 'Golden Ticket' "The market is now worrying about what would come out from the new administration," Bob Takai, chief executive officer and president of Sumitomo Corp.Read More
U.S. lawmakers recently introduced legislation calling for 2020-dated coins in commemoration of Muhammad Ali, the legendary boxer, advocate and philanthropist. The Muhammad Ali Commemorative Coin Act, numbered H.R.579 in the House and S.166 in the Senate, seeks up to 100,000 $5 gold coins in 90% gold and up to 350,000 silver dollars in at least 90% silver.Read More
Half a world away at the World Economic Forum in Davos, Switzerland, Nobel Laureate economist Joseph Stiglitz made remarks earlier this week that the US should "get rid of currency." Physical cash means there is no one else standing between you and your savings. But Professor Stiglitz and his colleagues don't want that.Read More
This looks more like the beginning of a market correction than the start of a serious bull run, according to Julian Emanuel, U.S. equity and derivatives strategist at UBS. "The wall of worry which has supported stocks for 8 years has given way to a deep sense of hope and optimism," Emanuel said in a recent research note.Read More
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