According to an article in Quartz today, March 9, 2017, marks the 8th birthday of the US bull market which started on March 9, 2009. According to the article, this is the 2nd longest and 4th strongest bull market in history for the S&P 500. However, before we celebrate too excessively, we should pause and take a look at the S&P 500’s current valuation as a result.
However, before I discuss the S&P 500’s current valuation I think it only proper that I share my views about the stock market in general. I believe it’s very important for investors to focus specifically on what they own rather than the broad markets. Most renowned investors seem to agree that investing is most intelligent when it is most businesslike. Furthermore, they understand that the health and vitality of a specific company is reasonably ascertainable and generally accurate enough to be relied upon.
In contrast the often erratic and mostly irrational daily short-term volatility of stock prices in general is not. Therefore, once I have a solid handle on the intrinsic value of the companies I own, I never sweat the market. I know from a preponderance of evidence that the future rate of change of earnings and dividend growth when purchased at a sound valuation determines my longer-term future returns. That is all I concern myself with and trust it explicitly.
This attitude and opinion is based on my belief that it is a market of stocks rather than a stock market. However, with that said, common sense would indicate it’s harder to find attractive value when the general market is excessively high, as I believe it is today. So even though I do not sweat the market, I am smart enough and prudent enough to be cognizant of its relative valuation.
Moreover, as milestones go this article marks the 10th article that I have written on the S&P 500 since I started writing on Seeking Alpha in 2009. NOTE: You can find my previous articles by going to my profile and clicking on the ticker SPY. Considering that I started writing in the throes of the Great Recession, my previous offerings have been generally bullish. This can be attributed to the fact that I considered the market as represented by the S&P 500 fairly valued up to 2013, which was when I penned my last S&P 500 offering. As I will illustrate later, I considered the S&P 500 continuing to be reasonably valued until the fall of 2013.
However, that changed in August 2013, which partially explains why I haven’t written about the S&P 500 specifically since the beginning of 2013. The rest of my explanation can be attributed to my dear departed mother who taught me that if I didn’t have anything good to say, I shouldn’t say anything at all. But with reverence to my mother’s wishes, I feel I owe it to my readers to point out the excessive valuation I currently see with the S&P 500.
Setting The Stage: Principles Of Investing
As anyone who has been following my work knows by now, I don’t believe it’s possible to forecast stock markets or the economy, at least not with the precise timing that most people expect. As Warren Buffett once said: “The fact that people will be full of greed, fear or folly is predictable. The sequence is not predictable.”
On the other hand, there are rational longer-term expectations that can be relied upon. For example, I believe it is an absolute truth that every recession eventually ends. Whether it lasts 18 months, 11 months or 24 months, etc., doesn’t really matter to investors with a long-term perspective. What does matter is the absolute fact that it will end. Regarding the stock market, every bear market ends with a bull market and vice-versa. As the old adage states, “Wall Street Climbs a Wall of Worry” and that is all you really need to know about timing markets or the economy.
On the other hand, there are other important truths that I will only mention today, each deserving of their own independent post. For example, overvaluation or undervaluation is calculable with reasonable precision using simple and straightforward mathematics. Therefore, overvaluation should always be either avoided or recognized and then treated with extreme caution.
In contrast, I contend that undervaluation should be embraced by investors as risk is reduced and potential returns enlarged. It’s not possible and certainly not necessary to find perfect tops or bottoms. It’s more than enough to be essentially correct; investing is rarely a game of perfect. It’s also enough to know that recessions only happen every so often and always ends within a timeframe that precludes being referred to as the long term. There are other factors and characteristics to think about, but these are the major ones.
Given what has been written in this post thus far brings me to the focal point of the entry. The five or so years following every recession that I have observed in modern times have experienced strong above-average growth of earnings. Since earnings determine market price in the long run, this is vital knowledge. Of course, the reason is simple. Coming off of depressed earnings and business results, comparisons are easier as things return to normalcy. Therefore, above-average growth manifests, as trend line norms return. This is exactly what has happened since the last recession ended in the spring of 2009.
Leaner and meaner, well-run companies exit recessions poised for accelerated earnings growth. With inventories under control and competition lessened, higher margins and increased market share drives earnings upward. For the discerning long-term investor with money to invest low valuations followed by resurging growth offers a great buying opportunity. Consequently, 2009 represented exactly that opportunity which is why I have been writing bullish articles on the S&P 500. As previously mentioned, all things good or bad must someday come to an end. Although I believe it’s impossible to time it perfectly, after such a long bull run caution is certainly now in order.
The S&P 500 Earnings And Price Relationship
The following earnings and price correlated F.A.S.T. Graphs™ on the S&P 500 clearly illustrates the overvaluation I am writing about. There are two important valuation references that the reader should focus on. The orange line on the graph represents a P/E ratio (earnings multiple) of 15, which I consider a fair and reasonable valuation. The dark blue line represents a normal P/E ratio of 18.6 since 1998.
From these valuation references we can see that stocks as represented by the S&P 500 were at or below the orange line as we came out of the Great Recession and have risen above it since the fall of 2013. But most importantly, as it relates to this article, prices have risen above the higher normal P/E ratio of 18.6 since the beginning of this year.
Bonus Video: A Deeper Analysis of the S&P 500 valuation.
Be Smart: Invest For the Long Term
This article is dedicated to the prudent long-term investor. Long-term oriented investors never assume that their investments will produce instant success. Long-term investors understand that the most reliable way to generate above-average returns is to be