Night Moves: Media Sounds The Siren On Market Valuations

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Night Moves by Christopher Pavese, The View from the Blue Ridhge

With the S&P’s first close above 2000 after nearly tripling from its 2009 low, the talking heads are out in full force.

  • In a recent interview with the FT, Brian Belski at BMO, put a 4200 target on the S&P 500 by just compounding the current level of the S&P forward for a decade.  ”Based on historical evidence, stocks typically enter a very long period of expansion after emerging from a period of negative 10-year returns. We found that, on average, these periods last for roughly 15 years and deliver average annual returns of about 16%. Given that 10-year holding period returns emerged from negative territory a little over a year ago and currently stand at 5.5%, it is not unreasonable to assume that there is about 10 years and 10% of average annual returns left to the current bull market. To get to an S&P 500 level of more than 4200, we have assumed that 2 percentage points of the return is dividend, and just compounded the current 1962 level of the S&P forward for a decade.”
  • Morgan Stanley reached a similar conclusion in a recently published report, titled 2020 Vision.  Rather than simply extrapolate annual stock returns forward, at least the US Equity Strategy Team at MS considered fundamentals.  There 3000 target on the S&P was based on extrapolating 6% annual earnings growth through 2020.  ”The current expansion is more than five years old and there are no signs as yet that the global economy is overheating. The current US expansion has already lasted longer than the average expansion in the post-WWII period, but it isn’t unreasonable to expect that this expansion could be the longest on record. The US Equity Strategy team notes that EPS growth of 6% per year from 2015-2020 would drive S&P500 earnings to near $170. A 17x multiple would translate into a peak level for the S&P500 near 3000 under this scenario.”
  • To top it off, the WSJ ran a story this weekend titled, The Case for Sticking with Stocks – No Matter the Price.  ”To be sure, many money managers insist that there is no way of knowing in advance whether the stock market is overvalued or undervalued. Investors, they say, should instead focus on issues like diversification, costs, their own risk tolerance, and their investment horizon—owning more stocks when they are young and fewer when they are older, for example.”


Our friends at Emerald Asset Management, recently ran an analysis (chart below) comparing a hypothetical investment in a static balanced portfolio to a strategy rebalanced according to the Shiller P/E.  When valuation was in the highest 25% of historical observations they shifted a portion of the portfolio from stocks to bonds.  Conversely, when valuation was in the lowest 25%  of historical observations, they shifted a portion of funds from bonds to stocks.



Night Moves


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