On My Radar: High Market Valuations vs Low Forward Returns by John Mauldin, Mauldin Economics

A recurring theme in my letters is the various ways in which we can go about determining valuations for stocks and other investments. My good friend Steve Blumenthal has gathered a number of charts from various authorities showing different ways to look at valuations for today’s US stock market. He topped it off with some very good estimates of forward-looking returns on total US equity portfolios. He is not arguing to get out but rather to be aware of where we are and to temper your expectations for the future. Steve writes in an easy, fluid style that I think you will enjoy as this week’s Outside the Box.

I’m in New York and on Monday was part of the closing-bell ceremony at the NYSE, where Monty Bennett, the chairman of a new public company (whose board I am on), Ashford Inc., rang the bell before we headed over to Bobby Van’s to hang with the Friends of Fermentation. I got to spend some quality time wioth my friend Art Cashin (more below).

Steve Blumethal was in NYC, and we were able to sit down and catch up, and I also got to see George Gilder and Jim Grant do a presentation. Lots of other meetings as well before I headed out to speak at a small, intimate conference in New Hampshire, where I get to hang out with David Rosenberg, Gary Shilling, Marc Faber, and probably a few friends who will show up and surprise me. I will be looking at apartments on Manhattan, where I will be for a whole month starting mid-June. I have always wanted to stay for an extended time in NYC, and a special opportunity opened up for me that requires me to be there for a whole month (and maybe more later!)

I went to the NYSE floor early to spend some time with Art Cashin and walk around.. It had probably been 10 years since I actually walked around the floor. I generally just head over to Bobby Van’s after the exchange closes, or Art comes to dinner somewhere in Midtown with “the guys.” I was really amazed at how different the floor felt this time. I’d been told and had read that the physical exchange is shrinking, but it’s hard to really understand that until you’re actually there. As I sat with Art later, marinating some ice cubes with the Friends of Fermentation, I commented on the changes. Art pointed out that physically there are 80% fewer people, both as “seats” and as support staff, than there was 10 years ago. That is an astounding number. He walked me up to one “post” where stocks were trading. In the past, the traders would be looking at screens and madly punching buttons to make trades and would be handling at most 4-5 stocks. Today, a post will handle 30 stocks and all the trading is automated, with the trader there for special situations, which didn’t seem to develop as I was walking around.

The options floor of the American Stock Exchange has been squeezed into an alcove about the size of a floor of my apartment building. That is the entire options trading exchange. Most of the options are traded by computer, but when traders or investors are looking for something unusual or “in size” they can go to a specialist. During my 10 minutes of walking around, I actually heard one large, complex block trade, an option on the QQQs, being put together in the old-fashioned, open-outcry manner. Ten years ago there would have been a full-on constant buzz.

I seem to remember three massive caverns filled with trading posts, which have been more or less pushed into one of the original rooms with lots of room to spare. You could set up a bowling alley in several of the lanes, as there was nobody walking in them. A lot of people recognized and stopped me, and we talked about the markets. Many of them had changed jobs several times in order to be able to stay on the floor. There is a certain romantic camaraderie that I would find enjoyable, I think.

One of the big (and to me very sad) changes has been the ability of the exchange to deal with problems. In the “old days” Art could just walk around, and if he saw something that didn’t look or feel right he could literally halt trading until things got settled. While he could technically do that today, it wouldn’t do any good. Perhaps as much is 80% of the trading is actually done outside of the exchange floor, so halting trading on the floor would do nothing except disadvantage members. I think the day is going to come when we are going to miss having a sheriff walking the “city streets” looking out for the little guys.

It’s time to hit the send button. Have a great week. We are supposed to get a lot more rain in our part of Texas, which I wish we could send west and south. Our lakes around here are finally full once again; and Texhoma (the largest in Texas), after being as down as far as I have ever seen it, is now full and threatens to overflow the dam. Have a great week!

Your always watching valuations analyst,

John Mauldin, Editor
Outside the Box

[email protected]

On My Radar

By Steve Blumenthal
May 15, 2015

“Anyone in investments should know that when you add together a number of uncorrelating returns, something magical happens.”

– David Harding of Winton Capital Management

This week let’s take a look at current market valuations (high) and what they are telling us about probable 10-year forward returns (low). The stock market has had an outstanding five year run. With that, I believe, many individual investors have misguided expectations. The market is overvalued, over-believed and over-margined yet trend evidence remains positive and Don’t Fight the Fed an important theme. For now.

I share some concluding thoughts below (please note: the piece prints longer than normal due to the number of charts).

Included in this week’s On My Radar:

  • Valuations
  • Forward Returns
  • Don’t Fight the Tape or the Fed
  • Trade Signals – Zweig Bond Sell Signal Timely, Stock Trend Remains Positive


One of my favorite valuation measures is median PE. It is based on actual reported earnings (not Wall Street’s oft over-inflated forward estimates). This first chart shows median PE to be 21.5 (price times earnings) on April 30, 2015. The 51 year average median PE is 16.8.

Note that in the upper left of the chart that the Median Fair Value (taking current earnings times 16.8) is a S&P 500 level of 1627.24. The market is at 2121 today and was at 2085.51 at April month end.

Overvalued is measured at a 1 standard deviation move above Fair Value or S&P 500 level 2128. We are a long way away from undervalued or S&P 500 level 1126.29.

The next chart looks at S&P 500 PE based on (normalized earnings). The current reading is 20.3.

The data in the box in the upper left of the charts shows the S&P 500 Gain/Annum when this PE measure is above 16.5 (shaded grey). It shows that PE has been above 16.5

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