Tuesday 14th March 2017
A little bit of history repeating….
The US S&P 500 index is pretty much as high as it has ever been….
Since March 2009, when the global financial crisis was casting its long shadow, the S&P 500 stocks have grown almost 250%. It’s been a genuine boom-time for stock market investors.
400 of the individual stocks that make up the S&P 500 index have doubled in value – at least – since 2009….
40 of those stocks have gained 1000%….
The 10-best-performing S&P 500 stocks of all have surged at least 2000%….
We are caught-up in one of the longest-running bull-markets in history. Investors who have been in the market for a few years are sitting on a big pile of gains.
It’s been the stock-market ride of a lifetime. Few can stomach the notion that the ride must come to an end. Investors have been on a rollercoaster with track that only heads one way – up.
Many of those sat in the cars appear to have forgotten that what goes up must eventually come back down to earth. And that the higher you go, the harder and faster you fall….
- Optimism rules and fuels….
Some are more caught up in summit fever than others. Some cannot and will not see an end to the climbing. New peaks must be confronted and conquered – whatever the weather forecast….
Take Andrew Adams, a market strategist at Raymond James. Only a few short weeks ago, just after the Dow had punched through 20,000, he was saying this….
‘Based on history, we could still have 7 to 8 more years left, and there’s a chance it could go longer….’
7 or 8 more years of the same? Maybe longer? I think that’s what they call unbridled optimism.
And it is optimism – much of it blind, much of it unbridled and almost all of it unfounded – that keeps the market’s engine racing.
Optimism that Trump can do what he says and make America great again with his ‘massive’ tax cuts, his infrastructural spending and his alternative version of Obamacare….
Optimism that the market can continue to grow to the same degree without the assistance of quantitative easing as it did when the Fed’s spigots were pumping fresh credit into the system at full volume….
Optimism that interest rates will never get back to normal levels. That credit will remain cheap. That debt will remain manageable. That refinancing will remain available and affordable.
Optimism that yesterday’s pigeons will not come home to roost – not tomorrow nor any time afterward….
But let us not be churlish. If optimistic Adams is right – and I doubt it with every fiber of my being – I wonder when the first ‘Dow 50,000?’ headline will appear….
- Signs that something must give….
But back to the S&P 500….
The index has risen more than 6% since New Year’s Day – and almost 20% in the last year. The upward trajectory shows no signs yet of tailing off.
This despite the profits of the same companies that comprise the S&P 500 index going down for each of the last five quarters.
That’s right, the value of S&P 500 companies is increasing at the same time their collective profits are falling….
The US market continues to set new records. Individual companies continue to increase in value. The bull market has the bit between its teeth. Investors are sitting on big gains and their appetite for more is undiminished….
But the big companies are producing less and less profit. Their performance is deteriorating – more with every financial quarter that passes….
There’s a clear disconnect between the results corporations are reporting and the values the market is attributing to those same corporations….
We think that clear disconnect is a sign that something must give.
We think it’s a sign of an upcoming correction – where things that are out-of-line and out-of-whack will be put back into a more realistic or appropriate shape….
And it’s not the only sign we see….
- S&P 500 stocks are very expensive….
Some stock and market analysts focus their attention on PE ratios (Price to Earnings).
Fair enough. But here at Money Truths we have much more faith in the Cyclically Adjusted Price Earnings ratio or CAPE.
Devised by Yale University professor, Robert Shiller, CAPE is sometimes referred to as the Shiller PE ratio…
PE ratio is the price of a stock or a market divided by its most recent earnings per share.
CAPE differs from PE ratio in that it uses an average of 10-years’ earningsper share.
CAPE provides a more balanced and longer-term picture of earnings and, as such, is a better aide in helping you decide whether a specific stock or market is expensive or cheap….
On March 1st, the S&P 500 index was perched on a CAPE ratio of 29.52. The long-term average CAPE ratio of the index is 15.64.
In other words, S&P 500 stock values are getting close to being twice as expensive as usual.
Here at Money Truths we wouldn’t buy a house, a car or a pint of milk at prices twice the norm. We doubt you would either….
On CAPE figures, S&P 500 stocks are too expensive. They are over-valued. They are due a correction. We wouldn’t be buying them.
But, there’s more to come. I haven’t quite told you the full story. History shores up our arguments further….
- We’ve been here before – and what happens isn’t pretty….
As I say, on March 1st the CAPE ratio of the S&P 500 index sat at 29.52.
That’s just a number. It is easily missed. The full meaning can be overlooked if you’re not in possession of the relevant context.
So, just so we all understand exactly what we’re looking at, here is the context in full….
There have only been two previous occasions since Black Tuesday in 1929 (the beginning of the Great Depression) when the S&P 500 index had a CAPE ratio around its current level.
The first time was in 1999 – in the late stages of the bull market that led up to the bursting of the dot-com bubble in March 2000. The S&P 500 declined by almost 50%.
The next time was in 2007 – when the sub-prime mortgage crisis spread to the wider US financial sector. In November 2008, the S&P fell to its lowest point since 1997 and finished the year 45% down.
And now, in March 2017, the S&P 500 once again finds itself over-priced and hovering around a CAPE ratio of 30.
In previous instances, such a large CAPE ratio has signaled big falls in S&P 500 stock values.
In previous instances, when the S&P 500 CAPE ratio has hit 30, it’s been a good time for investors to run for the exit doors and seek cover.
We reckon this is a clear-cut case of history repeating. The CAPE ratio of the S&P 500 tells us that it’s time to cut and run.
That’s how it looks from here….
I’ll be back with more on Friday morning.
All the best,