We begin with the following excerpt from Sam Stovall's (Chief Equity Strategist at S&P Cap IQ) latest missive:
"Since WWII, bull markets have averaged four years in duration, mainly because of the treacherous third year. Of the prior 10 bull markets, five declined in price in year three, with three of these resulting in new bear markets."... "Surviving the critical third year has traditionally resulted in a revival of upward momentum. Indeed, of the six bull markets that celebrated their fourth birthday, five (83%) went on to celebrate their fifth birthday, recording an average price increase of 21%."
So, lets do the math.
On the bull's 4th anniversary date of March 9, 2013, the S&P 500 stood at 1551.18. If we add to that the average price increase noted in Sam's commentary, 21%, we get to 1877 next spring. Using a good operating earnings estimate for the twelve months ending March 2014 of $106, stocks will be priced at 17.7 times earnings. At virtually 18 times earnings, the most enthusiastic types will note that the rule of 20 roolz: 20 - inflation rate = appropriate P/E ratio*.
Sounds good. Then there's this from Orcam Financial Group (via Pragmatic Capitalism via Marc Chandler's marctomarket.com).
Given the fact that there is little to no advance signs of a market turn from such data plus the fact that the data seems to be coincident to each other** plus the fact that so much has changed in terms of the very structure of the market that such data is likely highly contaminated, all that one can do is note that the US equity market is at a point where problems ensued.
Investment Strategy Implications
When looking to divine the future for equities, history is a mystery. As Sam is found of noting, it's a guide not gospel. And certainly no substitute for logic and analysis. Reliance on simplistic rules of thumb (like the rule of 20) is fool's gold.
Investors operate in a changed environment yet far too many rely on tools and methodologies better suited for a more simple time. It's like the difference between analyzing an economy that is perceived to be closed when it is anything but.
Given the interconnected nature of the globalized economy and markets plus the complexity of relationships and financial instruments plus the speed with which a seemingly minor incident can transmit and transmute itself throughout the global network, the rise to valuation normalcy is problematic for anyone who believes that the extraordinary economic and financial times we live in warrant a below average P/E.
Count me in that camp. My enthusiasm is curbed.
*Actually, according to one source, the rule of 20 is more like the rule 19.3, which would be nearly spot on given that inflation tends to run closer to 1% than 2% in the current environment.
**I suppose one could argue that the fall off in NYSE margin debt precedes the drop in equity prices. But given that we are talking about only two episodes, this is hardly a large enough sample to work from.
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