SP 500: Caveat Emptor!
The S&P 500 Index is entering expensive territory with the cyclically adjusted price-earnings ratio at 22.64 approaching the average of 25.0 from the post ICT crisis to the advent of the Lehman debacle. The current level is also at the upper end of the range that existed from 1881 to the start of the ICT bubble in the latter part of the 1990s.
On the normal basis, with the PE calculated trailing 12-month earnings, the market is inexpensive at 17.86 times earnings compared to the past 20 years. However, the market is expensive compared to the long-term historical average of 15.5 times earnings.
The Q Ratio defined by Doug Short as the total price of the market divided by the replacement cost of all its companies is currently at the upper end of the range since 2003 and near the previous peaks in valuation since 1900 bar the ICT bubble in the latter part of the 1990s.
Source: dshort.com
Sitting on a price to book value of 2.3 times the S&P 500 is still significantly below the average at 2.3 times compared to 2.9 since 1981. Barring the ICT bubble the average is closer to 2.5, though.
Sources: Various internet; Plexus Asset Management.
If the S&P 500's long-term historical earnings growth of 6% in real terms is factored in and given the average dividend yield of 3.7% of the S&P 500 over the past 70 years, the capital return over the next seven years is expected to be minus 1.1% per year. If the exit dividend yield turns out to be that of the past ten years' average of 2.1%, though, the capital return will be 6.1% per year.
Sources: Hussman Funds; Plexus Asset Management.
In light of the extended valuation levels I think the market is currently discounting the latter and view it as close to the upper limit of what can be expected. I will treat any further significant strength in the market with the utmost caution.
At best, it seems to me that year-on-year growth in the coming years could range between 0% and 10%.
The declining trend of the peaks in the Coppock indicator of the S&P 500 is also worrisome, indicating that further significant upward momentum will be a hard-fought battle and not without risk.
The technical position is also telling me that a significant correction may be in the offing.
Caveat emptor!
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Author: Prieur du Plessis
Dr Prieur du Plessis
investmentpostcards.com
With 25 years' experience in investment research and portfolio management, Dr Prieur du Plessis is one of the most experienced and well-known investment professionals in South Africa. More than 1 000 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns. He also published a book, Financial Basics: Investment, in 2002.
He holds the following degrees: BSc (Quantity Surveying) (Cape Town), HonsB (B & A) (cum laude) (Stellenbosch), MBA (cum laude) (Stellenbosch); and DBA (Doctor of Financial Management) (Stellenbosch).
Prieur is chairman of the Plexus group of companies, which he founded in 1995. Previously he was general manager: portfolio management at Sanlam, responsible for the management of investment portfolios with total assets in excess of $5 billion.
Plexus is a pioneer in the mutual fund industry and has achieved a number of firsts under Prieur's leadership. These include the authoritative Plexus Survey, a quarterly analysis of the consistency of the performance of unit trust management companies, the Plexus Offshore Survey, the Plexus Unit Trust Indices, and the PlexCrown Fund Ratings.
Plexus is the South African partner of John Mauldin, American author of the most widely distributed investment newsletter in the world, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.
In 2001 Prieur received the Santam/AHI Business Leader of the Year award for corporate leadership, business acumen and entrepreneurial flair. He was also profiled in the book South Africa's Leading Managers (2006). Plexus received the AHI/Old Mutual Enterprise of the Year award in 1997 and was also included in the book South Africa's Most Promising Companies (2005).
Prieur is 52 years old and lives with his wife, TV producer and presenter Isabel Verwey, and two children in Welgemoed, Cape Town. His recreational activities include long-distance running, motor cycling and reading. He belongs to the Cape Town Club, Johannesburg Country Club, Gordon's Bay Yacht Club and Swiss Social & Sports Club.
Copyright © 2008-2012 Dr Prieur du Plessis
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