Eight years ago from yesterday the S&P 500 set its closing low of the Great Recession bear market. We couldn’t know it at the time, but that day marked the end to one of the worst bear markets on record. Since that low close of $676, the S&P has risen 250% to $2,365 where it closed yesterday. Here’s the path it took.
Pretty impressive. In fact, this bull market is the second longest and second strongest going all the way back to the Great Depression.
In addition to experiencing the second greatest rise since the Great Depression, this market is now also experiencing the second most stretched valuations of all time… just a few percent behind the Dot-Com Bubble. To be clear, that’s not a good thing.
One difference between now and the Dot-Com Bubble is that extreme valuations are more widely distributed across the entire market today than they were in the Dot-Com Bubble. Back then, the extreme valuations were more heavily concentrated in a particular sector (technology). I’ve included a chart from Dr. John Hussman’s recent commentary that illustrates this point, although it’s a concept that’s been widely discussed for the last couple years. The chart, instead of showing the average, shows the median price/revenue ratio of the 500 or so stocks within the S&P 500. The median stock valuation is far higher today than it has ever been.
Although not a reliable indicator of short-term returns, a few valuation measures are reliable indicators of longer-term returns (approximately 10 years). Two of my favorites are presented below.
In the short-term, market prices are driven by investors’ appetite for risk. So long as that appetite exists, the market can hold up and even be propelled higher. The catch is that investors’ risk appetite can change very quickly, and it’s difficult to measure.
Shiller P/E
Currently, this is the third highest it’s ever been – behind the Great Depression and the Dot-Com Bubble. Can you recall what happened to market prices after this metric’s prior peaks (e.g 1929, 1937, 1966, 1999, 2007)?
Market Cap / GDP
Currently, US Total Stock Market Capitalization to GDP is about 131%, which is the second highest on record. The record for this ratio was set at the peak of the Dot-Com Bubble in March of 2000 at about 142%, but, as we already discussed, excessive valuations are far more widespread today.
What about shorter-term returns? There aren’t reliable indicators of short-term performance, which is why market timing strategies aren’t able to consistently outperform the general market. It’s difficult to measure investors’ risk preferences and, besides, they are so volatile and change so quickly. Although, it appears Consumer Sentiment has been a decent indicator of subsequent 12-month returns as illustrated by JPMorgan in the chart below.
Consumer Sentiment Index
We observe that when consumer sentiment peaks out it is usually followed by subdued / negative price returns for the subsequent 12-month period.
Again, one caveat is that you don’t know you’ve hit a peak until it’s well in the rear-view mirror. Regardless, sentiment does seem to be at a relatively high level, which implies muted returns over the next twelve months while valuations discussed above imply a significant contraction and muted returns over the next ten years.
Always consult a professional advisor who intimately understands your goals, resources, risk tolerance and unique circumstances before making significant investment decisions.
Past performance is no guarantee of future results. Data from third-party sources is believed to be reliable but accuracy cannot be guaranteed.
This material is for general information purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any security. Ken Melotte may have positions in securities or investments mentioned in this publication, which may change at any time without notice. The information herein may include preliminary information and/or “forward-looking statements.” Due to numerous factors, actual events may differ substantially from those presented. Any opinions expressed herein are current only as of the time of writing and are subject to change at any time without notice.
