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3 Charts Sometimes just a few charts can say so much. At a time of so much conflicting information any insight that can add some clear perspective is very welcome. So here are just 3 charts that help us assess where the equity markets currently stand. First up is the long term chart of equity market value. The Price to earnings chart, where the earnings are based on rolling 10 year earnings (P/E10), is probably the most useful indicator of long term equity market value. The chart below tracks back to 1871!
The chart shows that with a current P/E10 of 21.8, that we are now in the top quintile of valuation on a historical basis. Obvious the more expensive the market is when you buy the worse your prospective return will be. This is measureable as is shown in the next chart. This shows that at current valuation levels you should expect on average a negative inflation adjusted 5 year return of - 3%. 
The next question is what is the quality of the current rebound in earnings? The chart below shows the massive swings in the profits of the financial industry. Federal government policy has done everything it can to restore financial earnings and return them to the recent extraordinary peak of a few years. Leaving aside the issue of whether this is appropriate policy, the question is how sustainable are these earnings as they approach previous peak levels, particularly as they seem to have become largely disconnected with non-financial earnings.
Summary The stock market can always trade higher from whatever level or valuation it has reached, however extended it may appear. However, valuation does tell us that even if the market does trade higher any gains are highly likely to be given back at some point in the not too distant future. This means that buying in to the overall market at higher and higher valuation levels becomes increasingly appropriate only for short term trading, rather than long term investment. Even more so when the basis for the recovery in earnings is so narrowly focused on the banking sector, and so heavily induced by extreme government measures.
Notice All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Chris Belchamber (the author) may or may not have investments or positions in any assets or derivatives cited above. Communications from the author are intended solely for informational purposes. Statements made by various authors, advertisers, sponsors, and other contributors do not necessarily reflect the opinions of the author, and should not be construed as an endorsement by the author, either expressed or implied. The author is not responsible for typographic errors or other inaccuracies in the content. We believe the information contained herein to be accurate and reliable. However, errors may occasionally occur. Therefore, all information and materials are provided "AS IS" without any warranty of any kind. Past results are not indicative of future results. |
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