Authored by Lance Roberts via RealInvestmentAdvice.com,
There has been a litany of articles written recently discussing how the stock market is set for a continued bull rally and that last year’s 20% decline was just an anomaly. The are some primary points that are common threads among each of these articles which are: 1) interest rates are low, 2) corporate profitability is high, and; 3) the Fed continues to put a floor under stocks, and 4) there is no recession in sight. Each of these arguments, while currently accurate, are based primarily on artificial influences and conjecture.
Interest rates are low because real economic growth remains weak.
Profitability is high due to accounting gimmicks and share repurchases.
The Fed is verbally putting a floor under stocks but continues to extract liquidity from the market, and;
“There is no recession in sight” argument have been famous last words historically.
While the promise of a continued bull market is very enticing it is important to remember that all markets ultimately complete a “full cycle.” Therefore, if your portfolio, and ultimately your retirement, is dependent upon the thesis of an indefinite bull market, you should at least consider the following charts.
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It is often stated that valuations are still cheap based on forward estimates. However, as I noted on Tuesday, forward estimates are always flawed, overly estimated, and repeatedly lead to poor outcomes over time (buy high/sell low) Therefore, trailing reported earnings is truly the only measure one should use.
The chart below shows Dr. Robert Shiller’s cyclically adjusted P/E ratio combined with Tobin’s Q-Ratio. Both measures of valuations simply show that markets are not cheap which historically lead to lower future returns.
Shiller’s PE Ratio – is calculated by taking the current price of the market and dividend it by the average of 10-years of reported earnings.
Tobin’s Q Ratio – is calculated as the market value of a company divided by the replacement value of the firm’s assets.)
Most people dismiss valuations because of their inefficiency in dictating market turns. I understand.
However, valuations are NOT, and have never been, a market timing indicator. They are simply a “road map” to future returns.
On a much shorter time-frame, a look at the price of the market as compared to corporate profits give us a better clue. Currently, with the market is trading substantially above the level of corporate profits, any weakness in profit growth (which is heavily tied to economic growth) will foster a reversion in price.
Another way to look at the excess over time is by examining the inflation-adjusted S&P 500 index as compared to real profits. Note that previous extensions of price...