Weekend Economists American Bad Boys Part 1 July 12-13, 2014

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44. U.S. stocks will be ‘very disappointing’ for 10 years

https://secure.marketwatch.com/story/us-stocks-will-be-very-disappointing-for-10-years-2014-07-11

Opinion: Equities have been overvalued for some time, six gauges show



U.S. stocks are overvalued — and have been for months. That is what six well-known measures of valuation show. While that doesn’t mean a bear market is imminent, there is a high probability that investment returns over the next decade will be below average, according to Yale University economics professor and Nobel laureate Robert Shiller. Investors shouldn’t expect that what has worked for them over the past five years will continue to work in the future.

One way to gauge the market’s valuation is to compare it to past bull-market peaks. There have been 35 since 1900, according to Ned Davis Research, a quantitative-research firm. Five of these six valuation ratios show the market is more overvalued today than it was at between 82% and 89% of those peaks. They are:

* The cyclically adjusted price/earnings ratio championed by Shiller, calculated by dividing the S&P 500 by its average inflation-adjusted earnings per share over the past decade.

* The dividend yield, which is the percentage of a company’s stock price represented by its total annual dividends.

* The price/sales ratio, calculated by dividing a company’s stock price by its per-share sales.

* The price/book ratio, calculated by dividing a company’s stock price by its per-share book value, an accounting measure of net worth.

* The Q ratio, calculated by dividing a company’s market capitalization by the replacement cost of its assets.

It is noteworthy that there is such agreement among these ratios even though each calculates the market’s valuation in a profoundly different way. The sixth data point — the traditional price/earnings ratio, which focuses on trailing or projected 12-month earnings — is the one that paints the least-bearish picture. Still, it shows the market to be more overvalued than it was at 69% of those past market peaks. Shiller argues that the P/E doesn’t have as good a forecasting record as his cyclically adjusted variant.

Some investors are ignoring the warning signs from these valuation ratios, since the bull market has continued higher even though the measures have told much the same story for some time.

Yet Shiller says that it is “hardly surprising” that the market has gone up over the past year despite an above-average cyclically adjusted price/earnings ratio, since his research always has shown that it and other valuation ratios have poor forecasting power over periods as short as a year. It is his ratio’s ability to forecast 10-year returns that he finds noteworthy. He points out that it was in December 1996 that he gave his now-famous talk to the Federal Reserve that led Alan Greenspan, then the Fed’s chairman, to warn of “irrational exuberance.” The market continued to do well for three more years before succumbing in early 2000.


...The chief point of all this for investors? Simply this: The stock market isn’t poised to produce returns that are in line with even its long-term annualized average of around 10%, much less the 20%-plus returns we have seen over the past five years....MORE


Mark Hulbert is editor of the Hulbert Financial Digest, which is owned by MarketWatch/Dow Jones. Email: [e-mail]