In this article I look at the S&P 500’s response to the coronavirus pandemic, the impact on CAPE valuations and what that means for the index’s expected ten-year returns.
The world is in the grip of a rapidly expanding pandemic and countries around the world have shut down large parts of their economies and told citizens not to go outside.
The International Monetary Fund (IMF) now expects a global recession far worse than the one that followed the financial crisis and worse than any since the great depression.
Companies left, right and centre are suspending dividends and reporting revenue declines of more than 80%.
And yet despite the obvious damage being done to the global economy, the S&P 500 is not even in bear market territory.
Wot no bear market?
Okay, I lied. The S&P 500 did dip into bear market territory for a few weeks between early March and the start of April.
Having reached (yet another) record high of 3,390 in February, the US large cap index collapsed with record speed, losing more than 1,150 points (34%) in just a few weeks.
The technical definition of a bear market is a decline of 20%, so clearly the S&P 500 was in a bear market, at least for a short while.
However, over the last few weeks the market has become enthusiastic once again, with the S&P 500 gaining 28% in about three weeks.
Today (15th April) the S&P 500 sits at 2,850. That’s a mere 16% below its all-time high, which means the bear market is (for now) technically over.
So what does that mean for valuations? In other words, is the S&P 500 cheap after those double digit declines?
The short answer is no, but to understand why, we need to look at what valuations were like before the pandemic struck.
The S&P 500 went into the pandemic crash with sky high valuations
For most active investors this isn’t exactly news, but the S&P 500 has been expensive for a very long time, at least according to its long-elevated CAPE ratio (cyclically adjusted PE).
Expensive means comfortably above average, which in this case means above 17.5. That’s the S&P 500’s average CAPE ratio (the ratio of price to ten-year average inflation adjusted earnings) over the last 100 years.
When the S&P 500 was at its pre-crisis peak of 3,390, its CAPE ratio stood at 30.6. That’s a massive 75% above its hundred-year average.
To put this in context, the chart below show the S&P 500 over the last 30 or so years. The colours on the rainbow tell you whether the index was expensive, cheap or somewhere between:
Hopefully the colour-coding is fairly intuitive, but if not then here’s a quick guide:
- Bright Red = very expensive (CAPE almost twice the average)
- Yellow = normal (CAPE close to average)
- Dark Green = very cheap (CAPE almost half the average)
For example:
- In 1999: Thanks to the tech bubble, CAPE was literally off the charts and well above twice its long-run average. Five to ten-year returns from this point were terrible, as expected.
- In 2009: CAPE was pretty cheap thanks to the financial crisis. Five to ten-year returns from this point were very good, also as expected.
- In 2019: CAPE was bordering on very high at around 75% above average. Five to ten-year returns from this point were expected to be poor.
So the S&P 500 went into this pandemic at sky high valuations, and yet so far has suffered relatively muted declines.
What does that mean for current valuations?
Believe it or not, the S&P 500 is still slightly expensive
I find this incredible.
We’re in the middle of a global pandemic which is potentially worse than any we’ve seen for a hundred years.
We’re staring down the barrel of what is very likely to be the worst global recession since the great depression of the 1930s.
Many companies are earning almost no revenues, with almost every trading update mentioning a suspended dividend, application for government loans or grants, layoffs, pay cuts, capex suspensions, rights issues and other drastic measures to increase their odds of survival.
This is not what I’d call a rosy picture. And yet in the middle of all this, the S&P 500 has rallied to the point where:
- the S&P 500 isn’t even in a bear market anymore
- it’s higher than it was just over a year ago, when all we had to worry about was a tit for tat trade dispute between the US and China
- it’s still slightly expensive by historic standards
Let’s put some numbers on this.
Having started 2020 with a CAPE ratio as high as 30.6, the S&P 500’s initial 34% decline took that down to 20.2.
20.2 is lower than 30.6, but even at their most bearish, investors were still willing to place an above average valuation on US large caps.
But that was before the US government announced its $2 trillion support package.
Following the announcement of that support package, investors became even more optimistic, driving the S&P 500 up by more than 25%.
To date, this relief rally has brought the S&P 500’s CAPE ratio back up to 25.7, some 47% above its long-term average of 17.5.
It also puts the index squarely back into my “slightly expensive” CAPE range, which is the slightly orange band in the chart below:
To be honest, I’m amazed at how resilient the US market has been to this crisis.
There are lots of possible reasons why the S&P 500 has been so resilient. Many would say it’s down to the S&P 500’s heavy weighting to the infamous FAANG / FAMAG stocks (Facebook, Amazon, Microsoft, Apple, Netflix, Google / Alphabet).
The S&P 500’s exposure to these companies is currently around 20%. That’s a lot, and while I suspect these companies will be more defensive than most through this crisis, I’m not sure it’s enough to explain why the S&P 500 has been so robust.
I think there are three more important reasons:
1) US investors are being optimistic: The IMF and many investors expect a significant rebound in 2021. I hope they’re right. If the global recession is V-shaped then long-term earnings and therefore stock prices should only be impacted to a small degree.
2) US investors have become used to high valuations and low yields: The pre-crisis US bull market was the longest in history, and when people live in a certain environment for long enough they think it will never end.
Even when a global pandemic comes along, they cannot imagine the market falling by 50% or more, or CAPE declining into single digits. And since market prices are driven largely by investor sentiment, neither of those things have happened (yet).
3) US investors remember what happened after the last crisis: In 2008-2009 the global financial system teetered on the edge of collapse. It didn’t collapse because governments and central banks put in place huge support packages to protect the financial system and the therefore (hopefully) rest of the economy.
This worked so well (at least so far) that the US market recovered from the lows of 2009 and went on to produce the longest bull market ever, with returns of almost 400% over ten years.
That memory is still fresh in the minds of many investors, so perhaps they expect a similarly spectacular bull market once this crisis is over.
I’m not saying the market is right or wrong to have only reduced the S&P 500 by less than 20% from its all-time high. What I am saying is that as a result of this tiny decline, the S&P 500 is still somewhat expensive by historic standards.
This is in stark contrast to the relative cheapness of FTSE 100, where the FTSE 100’s CAPE ratio was about average at the start of the year (when it stood at 7,542), but is now 25% or so below its long-term average (with the index now at 5,790).
A quick S&P 500 long-term forecast
To finish up, here’s a quick projection of where the S&P 500 could be ten years from now, if it’s CAPE ratio is close to its long-term average of 17.5.
Here are the assumptions I’m going to use:
- US CPI inflation stays close to 2%, which is the average for the last 20 years
- S&P 500 real earnings growth stays close to 4%, which is the average for the last 20 years
- Nominal S&P 500 earnings growth therefore runs at 6%
- S&P 500 CAPE returns to its 100-year average of 18 (rounded up from 17.5 to keep the optimists happy)
These three assumptions give us the following projection:
- S&P 500 cyclically adjusted earnings would increase by 79% over the next ten years
- This would take them from 105.9 index points today to 189.6 index points in 2030
- The S&P 500 would be at 3,413 in 2030
- That’s less than 1% higher than the record set earlier this year.
High valuations lead to low expected long-term returns
Obviously I’m not saying the S&P 500 will be at exactly 3,413 in 2030.
What I’m saying is that 3,400 or so is a reasonable estimate of where the index might be if inflation, earnings growth and valuations were at historically normal levels.
In reality the S&P 500 could be a lot higher than 3,400 in 2030, and it could just as easily be a lot lower.
Without the benefit of a crystal ball, the sensible thing to do is to expect things to be ‘normal’ in the future.
If we do that then we should expect the S&P 500 to have produced very little in the way of capital gains by 2030.
The size and nature of the US Covid support package is pumping a lot of cash into the US economy, cash which will find it’s way into corporate coffers, particularly FAMAG, which will support their future earnings.
Also, all that cash sloshing around combined with supply chain issues will probably spike inflation.
Hi Ruth, I’m no economist but higher inflation has been predicted for a long time, i.e. ever since the financial crisis. Mostly it seems to have (unfortunately) shown up in higher asset prices, e.g. (US) stocks, bonds and (UK) property. I have no idea where inflation will go from here, hence my default assumption that future inflation will look like the past.
Where does the 4% “real earnings growth” come from, historically?
Is this productivity gains due to technology? (mobile phones, internet, email, cheap energy, etc.)
If “yes” then can we observe the same growth in other countries (e.g. UK, Japan, South Africa) and in the USA outside the S&P500 (e.g. Russell 2000, Wiltshire 5000)? If not then maybe the discretionary selection of index members by S&P is responsible for this growth.
Hi Ken
My understanding is that technology is the primary driver of real earnings growth, although capital reinvestment and population growth help too.
As for other countries, you can see real global GDP growth rates on the IMF website.
Since 1982 real GDP growth across a range of countries has run somewhere in the low single digit percentages, so I assume that reflects general trends in population growth, capital reinvestment and of course technological improvements.
The FTSE 100’s cyclically adjusted earnings have grown by an average of about 2.5% since 1990, so the same sort of ballpark as the S&P 500.
I think this 1%-5% range is just the typically average growth rate of economies during this period of history (no idea about previous centuries as I’m not an economic historian) so I don’t think there’s anything special about the S&P 500’s constituent companies.
It’s been a wait for this post John, but well worth it! You’re not alone in predicting lamentable S&P returns for the next decade. From Hussman to Bogle himself, the prognosis isn’t good, and frankly, a continuation of the crash is required if forward returns are to have any chance of poking their heads above zero…
Thanks. It didn’t take a huge amount of time to write, but March was insanely busy for me because it’s reporting season and on top of that companies were producing COVID-19 updates left, right and centre, so I had an absolute mountain of reading and analysing to do. Things were a bit quieter this week and I knew you were waiting for this review so I pushed this one to the top of the list.
The conclusion that the US is expensive is no surprise to us, but for the sake of newer investors it’s useful to point out the counter-intuitive and inverse relationship between price movements and future expected returns.
BTW, it also means ‘Investing Internationally’ using ETFs such as VWRL isn’t such a great idea right now – the US takes up over 50% of it, and will do nothing but act as a drag on the rest of the world for a decade…
Thanks for your insights john. I dont really understand Cape like you do .
I’ve been waiting for Sp500 to drop so I can get in at lower prices. But I thought the other day it needs to come down a hell of alot more .I was just going off how far it has dropped and thought not enough. . I’m only 15%exposed to US and looks like it will stay that way . I ended up investing in the ftse all share instead . Prob a good move. After reading your article today.
Hi Dawn, just think of CAPE as PE with a more stable E. That’s all it is. Another way to think about it is to flip it from a P/E ratio to an earnings yield ratio, i.e. E/P.
This earnings yield is basically the same idea as the yield on a savings account or a bond.
For example, in 1999 the S&P 500 CAPE was 43, so that’s an earnings yield of 1/43 or 2.3%.
In 2009 the S&P 500 CAPE was 17, so that’s an earnings yield of 1/17, or 5.9%.
A 5.9% yield is usually better than a 2.3% yield, so by this measure the S&P 500 was more attractive in 2009 than in 1999, and history bears that out because returns from 1999 were terrible and returns from 2009 were fantastic. Those are isolated cases, but the premise holds up even when you look at more than 100 years of S&P 500 data.
More generally I would say that most index investors would probably do well to hold a diverse array of geographic indices, either through a global equity market tracker or through holding a diverse array of indices, including the S&P 500, FTSE All-Share and various European, Asian and other indices.
That’s pretty much what I did before I got into stock picking (where as you know, I still bang on about the importance of geographic diversity).
ok, i get that, but how do you get 2.3% yield on a 1/43 earnings yield?
thanks
Hi Dawn
Sorry, I wasn’t clear about that. 1/43 = 0.023, and as a percentage that’s 2.3%. Does that make sense?
yes thanks
Hi John, Love you work and look forward to your email.
Maybe the reason why valuations are high is the markets believe that Fed has put a floor under the market.
What I am trying to say is that maybe central bankers have gotten better at proping up the market and smoothing out the humps and bumps that arose in the past.
This may or may not be a good thing but it would account for why the market has not fallen harder and further (yet?)
Cheers
Hi John, thanks.
I think you’re probably right. The US market didn’t fall much to begin with (about 30%+ which isn’t much in the face of a near-total economic shutdown) but then rebounded very strongly following the Fed’s announcement.
Whether the market is right or wrong I don’t know, but what it does mean is that the US market is not broadly cheap. I’m sure there are cheap stocks if you dig under the covers, but at the market level it still looks highly priced to me.
John, It’s all very odd isn’t it. There is so much logic in the CAPE arguments and the variants in its value over time.
And yet, I’ve held Microsoft for donkey’s years and it has gone up over 500% and the dividend has grown inexorably along the way.
In 1999 the P/E was around 80 at the peak. Today it is 30, but the earnings of Microsoft are absolutly massive compared to back in 1999.
In 1999 the share price hit $58 on a P/E of 80, yet today it is $175 on a P/E of 30 — maybe it’s far too cheap?
OK comparing a whole market index with an individual stock is clearly unfair, but if you select some companies that have market growth which is potentially parabolic this is what can happen. Nick Train is often of the opinion, that if you invest in good companies, good things tend to happen.
So the point is, if you look at say the Cloud it still has exponential growth over the next 10 to 20 years and Microsoft is right in the thick of it as number two with a faster growth than Amazon.
If you look at payments this too will have exponential growth, as a large % of transactions are still in cash (on a worldwide basis I mean).
Companies like PayPal are front and centre in this sphere and it has huge potential.
The P/E of PayPal could be considered high at 26.
Having bought PayPal since launch it is up 174%, even after the market correction. I won’t be selling it and fully expect it to overtake the % growth Microsoft has achieved.
Fasten up the CAPE John, there is a storm on the horizon !!
Hi LR, yes, but as you say comparing individual stocks to an index is not super useful as they’re two entirely different beats. CAPE is useful for investors who are either looking to buy the whole index or buy individual stocks within that index.
Obviously within any index there will be 100 baggers and stocks that went to zero, but CAPE tells us about the average valuation and expected returns and therefore, perhaps, the number of attractive opportunities we might find within a given index.
As for there being a storm on the horizon, there’s always a storm on the horizon. It’s just that most of the time we can’t tell for sure which direction it’s coming from!
Last week’s action is driving the S&P back up towards ‘bear market over for sure’ territory. As you say, incredible given the macro-economic state of the entire world… but a point worth noting is this:- you’re not alone in spotting that returns over the next decade from the S&P may be miserable, because the CAPE is so high, and those future returns have effectively already been eaten. So there’s literally no point buying it now! Even if it regains its old highs, over the next decade, it’s just likely to wobble up and down. Seek elsewhere, my friends. Internationally! 🙂
I have always struggle to come to terms with CAPE. I do not think there is any valuable information in how much the earnings were in the last 10 years with the next 10 years earnings, not to say that many companies would not be part of the S&P 500 for the next 10 years.
The fact that FTSE 100 has a lower CAPE does not mean it would offer a higher investment return in the next 10 years.
I think that we need to remind that we price the future discounting Free cashflow when we purchase stock in a company. It is the future prospects of that company that we are interested, and some FTSE 100 companies have pretty bleak prospects!
Eugen, the relationship between the earnings of the last 10 years and the next 10 years has been explored and documented. You state “I do not think there is any valuable information …”. Other people have reported the value of this information.
In particular, I refer you to the work of John Hussman. He regresses the total return of each actual 10 year period against the previous N years of (inverted) CAPE. For N = 10 the correlation co-efficient is about 70%, from memory (if anyone looks it up please post the accurate figure).
70% means that an investor’s returns in the future 10 years are 70% explained (thus 30% unexplained) by the current valuation (i.e. current price per 10 years of earnings).
Hussman also tests Warren Buffet’s measure of S&P500 versus GDP and finds that it also explains future returns to a useful extent.
With a bit of curve fitting, Hussman finds that a 12 year lookback provides slightly better ‘explanation’. He also modifies the Buffet GDP a little bit. The ‘explanation’ rises to 90%!
Buffet says “Price is what you pay. Value is what you get.”
A lot of people (particularly less experienced investors) discover CAPE and then get p**sed off with it, because it doesn’t give them what they were hoping for, i.e. an infallible market timing tool. It never claimed to do that. All it provides is a way of smoothing out P/E, which is a hard number telling you what you’re paying for each dollar of earnings. Moving averages are useful, basically, and the correlation between index CAPEs and the returns to be expected over the next 10 or 12 years is so strong you’d be foolish to ignore it. Basically, it tells you if you’re overpaying, today, right here, right now. Overpaying for anything is a bad idea. Unless you’re Brewster, trying to shed the cash for ulterior motives. And BTW, yes, some FTSE 100 companies have bleak prospects. As do all the stocks in the S&P 500 excluding the FANNNNNNNGs.
I supposed CAPE can be used for market timing if the unit of time is ‘one decade’.
e.g. buy when CAPE indicates that returns over the next decade are attractive and come back and check once every decade (not before!)
Thank you for another good article. I don’t like to rely on the wisdom of others too much but I do think it’s telling that Charlie Munger says nobody’s calling Berkshire Hathaway for funding. That Berkshire aren’t quietly making secretive positions suggests US markets aren’t priced rationally for the fundamentals. To keep with this Berkshire train of thought the Buffett indicator would suggest the outlook isn’t great. https://www.gurufocus.com/stock-market-valuations.php
I think the sentiment is interesting for these 80+ P/E companies. My opinion is that they have great competitive positions but no margin of safety. In in a finite world growth has to falter and at some point valuations have to reflect earnings potential or lack thereof. It seems likely that exuberant sentiment will drive valuations beyond fair value before they settle and I’d rather stay sober and avoid playing pass the bomb even if I miss out.
By contrast the FTSE has some less exciting offerings: utilities, commodities, oil, tobacco, housebuilders, financials, retail etc. We can be sceptical about tobacco and oil’s long term prospects. However, most of these industries are crucial to our modern economy and I feel slightly more comfortable holding them. Companies that have proven they can generate cash rather than ones which are near impossible to value except with forward guesstimates.
US Corporate and Sovereign debt are a complex elephant in the room. I’m not brave enough to call out the world’s biggest economy’s productivity but the trend and need for ever more bailouts and stimulus with each upset is problematic if/when QE reaches its limits during a protracted downturn. I wonder if credit downgrades (like the UK just had from Fitch’s) coupled with lower productivity, low tax revenues and a rising cost of servicing sovereign debt would move the US closer to a Eurozone style crisis of austerity and higher taxation which would negatively affect equity prices. I’d happily be corrected if anyone disagrees with the probability of this or this general line of thought though! And I don’t want to catastrophise too much as I hope this pandemic doesn’t last long enough for this to be credible.
Hi Keith
Last I heard, Berkshire had about $130bn in cash waiting to be invested in the right business at the right price.
A quick google search doesn’t show anything happening in Berkshire-land, so if the amount of cash put into the market by Buffett is a proxy for value, then it doesn’t look good for the US.
As for the FTSE 100, it’s hard to find anyone who’s a fan. Most people seem to say it’s full of bad, rubbish companies. I’ve even heard the phrase ‘old economy’ businesses, which sounds a lot like the argument that Unilever et al were rubbish and outdated in the 1990s.
The more things change….
I’m a fan of the FTSE 100. It yields like a good un, it’s comprised of big wealthy companies who obviously aren’t just going to ‘accept their fate’ and roll over, and it’s mostly international, so it’s not totally reliant upon the internal ups and downs of the UK economy. As an index, the cr*p drops out and is replaced with up and coming stars from the 250, and it’s seriously undervalued right now as far as I can see. So what’s not to like? Guessing what will or won’t be ‘hot’ sectors in the future is a mug’s game.
Thanks John.
Read an article by Hendrick Bessabinder( hope iv’e spelt it right).
The majority of stocks have lifetime returns that are less than one month treasuries. The best performing 4% of stocks were responsible for all of the wealth created in the stock market from 1926-2018.Do stocks outperform treasuries bills? a lot of people use this information as the case to hold cap weighted indexers. The losers outnumber the winners, 14 stocks created 20% of the wealth.
Hi Michelle, that’s more or less what I’d expect if you look at all listed stocks.
It’s like private companies. About half of startups fail within the first five years and probably a very small percentage make it to multiple decades.
The lesson is that most investors should stick to well established companies with long track records, and preferably large or mid cap over small cap. Also look for market leaders rather than also-rans.
Hi John
I have not looked at your blog for a while, but I thought I would look and see how your portfolio has fared over the last few weeks
As you may recall I spent some time looking at your method several years ago but decided to follow a more international approach
You talk at some length about the CAPE ratio and the S & P 500. I understand the logic, but I don’t think it is particularly useful as if you follow the logic you will never invest in the US, which has been and is likely to continue to be the best place to invest – if you invest in the right sectors
a link comparing, FTSE 100 with S & P and QQQ since 2008
https://stockcharts.com/freecharts/perf.php?SPY,PSRU.L,QQQ&n=2989&O=011000
and a more recent chart which shows the growth of the tech sector over the last 5 years in the US and the dominance of the sector; I see no reason for that to change, with the possible exception of healthcare. The virtual absence of a tech sector from the UK was one reason why I followed the route I did
https://stockcharts.com/freecharts/perf.php?$SPX,XLY,XLC,XLK,XLI,XLB,XLE,XLP,XLV,XLU,XLF,XLRE&B=$SPX&n=1372&O=011001&B=$SPX&I=$SPX
I know that your focus is on dividends and income from the UK market, but even taking the robust dividend yield, it is clear that the total return from QQQs has been significantly higher
Also, I suspect that the oil majors will struggle to maintain their dividends past this quarter, but we shall see, and I don’t think that banks will be in a position to maintain dividends in the short term either, so the FTSE 100 yield – and price is likely to fall
best wishes
Hi Nicholas
After all these year’s I’m still here!
“I don’t think [CAPE] is particularly useful as if you follow the logic you will never invest in the US”
Unfortunately this idea crops up repeatedly, so I should probably address it more often. The idea of looking at CAPE isn’t to make binary in/out decisions based on it. That’s a bad idea. There are various more sensible ways to use CAPE. Primarily a) adjusting stock/bond/etc weightings, i.e. have more in the index when CAPE is low and less when it’s high. So rather than never being invested in the US, a CAPE-based investor might have just been underweight US stocks and overweight other international indices. b) using it as a broad gauge of what the index might be expected to return over a decade, assuming historically typical inflation, growth and valuations at the end of that period.
I disagree that the US is the best place to invest. The world of investing is far too diverse to make such a blanket statement, and what is best depends heavily on how each investor defines best and their particular skill set (or lack thereof).
“growth of the tech sector over the last 5 years in the US and the dominance of the sector”
I think this is as much a risk as it is a source of potential returns. The US is somewhat weighted towards tech, and on the horizon I can see the Chinese coming. The launchpad of a relatively captive 1bn strong local market means Chinese tech companies can scale just as easily as US companies, and of course the competitive landscape there is not exactly level. So I would not be surprised one little bit to see Chinese tech companies standing as the world’s largest companies in 2030. That isn’t a prediction but it far from an unlikely outcome either.
However, more generally I agree that most people should invest more internationally than I do, and that it is usually a good idea to own the world via a global stock/bond tracker. That’s what my son’s JISA is invested in.
Hi John
Fair enough – I agree that my statement was rather sweeping
I’m afraid that I am in the Terry Smith school of only investing in companies with high ROE and using his ODD principles
and also persuaded by Warren Buffett and other’s views that it is better to focus on total return rather than just dividend yield – Warren has a detailed example in one of his letters of the calculations, but Terry Smith also covered it by looking at the total return of his portfolio, compared to equity income funds
all of which is to say that I believe in investing for total return rather than dividend income – but as you say, each investor needs to follow what works for them
and dividend income is certainly reassuring
best wishes
The Nasdaq hit a high around the turn of the century, then crashed and took about 13 years to get back to breakeven. So tech isn’t always king. Add the FTSE 250 to that chart and wonder at how it outperforms the S&P. And frankly, the US doesn’t historically outperform any other market, it gets its turn at the top like everyone else. The current turn has been extreme because of the status of the dollar as world reserve currency, and the (hopefully temporary) fad for ‘financial engineering’ in the States, along with the effective nationalisation of their own market by Fed actions. As for Buffet, he doesn’t pay dividends, he acquires them. His modus operandi has been to buy companies that spin off huge quantities of cash, and use that cash to buy other things. Just saying ‘-)
Hmm….
The purpose of my original comment was to counter the view that the current CAPE ratio of S & P 500 means that you should be underweight the US
Investing internationally, naturally commented about the performance of FTSE 250 and the S & P 500
I’ve added FTSE 250 to the chart – similar story
https://stockcharts.com/freecharts/perf.php?SPY,PSRU.L,QQQ,HMCX.L&n=2489&O=011000
I could spend time discussing the difference in the QQQs over the last 20 years, but there is not really space to do that here
It is hard to see how tech will be toppled any time soon with 5G, blockchain etc all being rolled out; if anything the last 3 months have accelerated the process as people have had to move “online”
As for the dollar – yes the US gets a free ride because it is the world’s reserve currency, effectively since WW2 – but is that likely to change soon?
And how has GBP done against the dollar over the same period?
https://stockcharts.com/freecharts/perf.php?$GBPUSD&n=2489&O=011000
Also look at some of the videos by Peter Ziehan
https://zeihan.com/
to give more context on the global competitiveness of the US
Yes the Fed has backstopped the bond market in the latest crisis – but most other countries have adopted similar measures to support companies
I don’t disagree that the huge debt and deficit are major issues for the US – but similar issues apply to other countries like the UK and the EU
With regard to Buffett, as you say he accumulates dividends and invests in companies that spin off cash – especially the now huge insurance operation, which generates a massive “float” for investment; per the latest letter some $129Bn. His investment performance and approach needs to be viewed in the light of that free leverage
But as he explains in one of his letters, there are good tax and investing reasons not to distribute dividends – and his shareholders agree with him
But each to their own – as you can guess my portfolio is heavily weighted to the US and tech and is presently in a better position than as at the end of February, but I am under no illusion that this could change radically if we get a sudden sell off over the next few months as economic reality catches up with the market
As I said above – each investor needs to do what works for them and enables them to sleep easy at night!
You added the FTSE 250, but you only went back to 2011. Try going back to 2000. You might be surprised.
Pretty much every sane voice in the US is pointing out that returns on the S&P over the next decade are likely to be p**s poor because of the engineered rises that have been inflicted on it recently. Projections in the sub 1% annually range aren’t uncommon. Still, feel free to keep betting on ‘the horse that won last time’.
You could also argue that the best companies have re invested their high return on capital back into the business to grow hence the market has given them high p/e ratio which have been the difference to their stellar share prices from 2008.Will the market decide those ratings are justified in this environment, if only we knew the future,that’s the reason why I agree with John regarding world trackers one large cap one small with their weightings heavily scewed to America around 65% which is expensive,that weighting will adjust accordingly to how economies grow.
I find it depressing that valuations are so high. Artificially high of course. It helps to keep wealthier people wealthy (80% of the S&P500 is held by the wealthiest) while making it more difficult for younger generations.
I am wondering if maybe this time the US will see some CPI inflation. The various stimulus packages not only target Wall Street but also Main Street. The Fed and other central banks have hoped for years to get some inflation going. Maybe we’ll finally see it creeping up and do the valuations now might appear high, but double inflation for the next 5 years and we might be regretting not having bought into the S&P500 when we had the chance in March.
I don’t know what will happen over the short term, but longer I can only see the S&P500 rising with all the quantitative easing. The caveat to this is where the Fed panics over inflation and the rug is pulled out from under the markets.
Hi AAJ, I think there’s a significant risk that we’ll see a lot more inflation over the next 20 years, where by “more” I mean above 5%. However, the uncertainties are huge and another reasonable assumption is that we’ll have global deflation driven by demographics (more “unproductive” retired people and fewer “productive” workers, driving less consumption and less output, hence less or negative inflation).
Sadly this pandemic shows that we rarely have any idea what the future has in store, hence the need for caution.
Suggestion John.
You could knock up the value report for something like VWRL, and then you’d be giving your readers an easy way to tell whether the FTSE (for example) was a good deal compared to ‘rest of world’.
Possibly. I’m going to do a market valuation article in July hopefully. VWRL (Vanguard’s FTSE All-World ETF) is 57% US and the US is mostly the S&P 500, so the S&P 500 is actually a reasonable proxy for “rest of the world”. I’ll have a look around for some All-World data but if I can’t find it then I’ll stick to the comparison of FTSE 100 etc vs S&P 500.
OKEYdoke. My own clumsy attempts at analysis seem to be suggesting that from here, we’ll be lucky to see S&P average annual returns above 3% or so. And as you say, seeing as half the VWRL is US stocks, it tends to get dragged down too. As far as I can make out, for that single reason, it will be lucky to beat 7% or so going forward…
I tend to agree. I think the only saviour of US returns going forward is likely to be continued record growth rates of its largest (mostly tech) companies.
If you look at the long-run real US earnings growth rate (e.g. using Robert Shiller’s CAPE spreadsheet) you’ll see that growth increased to record levels following WW2, for various somewhat obvious reasons (Europe had blown itself to bits, the US had built up a huge manufacturing base, the UK had to repay debts to the US, etc). Then growth picked up again after the 1990 recession, possibly fuelled by a mixture of US tech dominance and repeated massive stimulus packages from the government.
If that real US earnings growth rate can stay where it is or go even higher then CAPE may stay elevated while the S&P 500 still manages to produce double digit returns. It’s possible, but it requires a lot of optimism about the US’s ability to maintain tech domination and for its government to keep stimulating the economy. Both are possible, but neither can go on forever.
At the very least there’s a risk of inflation, and of course there’s the rise of Chinese tech outside China (assuming these companies can avoid being extensions of the Chinese government). Perhaps a Huawei search engine is just around the corner which is much better than Google? Perhaps WeChat will really begin expanding internationally? Those are competitors the FANGs can’t simply buy up.
Who knows? All I know is that US CAPE is high and historically that has not been good for returns over the next decade or so.
Forgot to mention – looking at the multipl.com website ( https://www.multpl.com/s-p-500-earnings-growth/table/by-year ) over the last 20 years the S&P appears to have averaged about 18% growth per year. That’s quite a different figure from the 6% generally quoted. Is there a problem with the shiller data? Even if I strip out the 5 years which could be considered ‘outliers’ (such as the recovery after the dot com crash) it still comes in at almost 11%…
I doubt there’s anything wrong with Shiller’s data. The numbers on that site are annual growth rates and there can be big differences between average annual growth and annualised growth. If you annualise growth using Shiller’s data you’ll get the correct figure for whatever period you’re looking for. Also, whether growth is 6%, 11% or 18% depends very much on the start and end points. As I said in my other comment, real growth in US earnings has been going up and up and up, partly because of lower inflation and partly because of US tech domination and repeated government stimulus packages.
Mmmm…. I even went to the earnings page and constructed a spreadsheet with annual earnings, calculating the increase or decrease from the previous year, and then the average annual growth since 2000, which was WAY over 6%. Can you point me to your source for the (widely quoted!) 6% pre inflation earnings growth so I can try to get to the bottom of it? Thanks!
OK, done some more digging, which bears you out (surprise!).
The average total return since the 1920 has been 9.6%. Knock off inflation whichhas generally been higher that 2%, and you get down to the 6% kind of area. Or you could look at it as the ‘excess return’ over bonds, which has been about 5.8%, close enough for Covid.
The 2010s just happened to be a blinder, rolling in at an average of over 13%, which skews Shiller’s numbers. Here’s a pic, not sure if it will display.