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Feb. 28, 2012, 12:01 a.m. EST
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By Mark Hulbert, MarketWatch
CHAPEL HILL, N.C. (MarketWatch) "” Does the stock market's behavior over the last 10 months add up to a lot of sound and fury signifying nothing?
/quotes/zigman/3870025 SPX 1,367.59, +1.85, +0.14%
It certainly looks that way on the surface. The S&P 500 index /quotes/zigman/3870025 SPX +0.14% , for example, is just 0.3% higher now than where it closed at the end of last April. For all intents and purposes, that's a wash "” especially considering the extraordinary volatility the market has had to endure along the way.
There have been some at least moderately encouraging sub-surface developments, however, especially on the valuation front. Relative to earnings, the market is in slightly better shape now than 10 months ago.
Consider first the price-to-earnings ratio when calculated on the basis of trailing as-reported earnings. The reason to calculate the ratio this way: It's comparable to the historical values back to 1871 that are included in the database maintained by Yale University finance professor Robert Shiller. ( Click here to access that database. )
That ratio for the S&P currently stands at 15.2. The comparable ratio at the end of last April stood at 16.6. So at least according to this measure, stocks are about 8% cheaper today than last April.
What about the so-called Cyclically Adjusted Price Earnings ratio, or CAPE, which Shiller has proposed as a superior measure of stock market valuation? It currently stands at 22.7, versus 23.7 at the end of this past April "” a 4% improvement.
Though the magnitude of these improvements are perhaps not overwhelming, at least their trends are in the right direction.
There are several flies in the ointment, however. And at least one of them is a serious cause for concern.
One that many of the advisers I monitor have been noting: Earnings-growth rates are markedly lower now than they were last year. As recently as the quarter that ended last Sept. 30, for example, the year-over-year EPS growth rate for the S&P was 21%. For the quarter we're in right now, in contrast, that growth rate is estimated to be just 12.5% "” and even that may turn out to be optimistic.
This turns out not to be as big a worry as it might otherwise seem, however.
Earnings growth rates that are too high are simply not sustainable for very long, as illustrated in the accompanying chart. That chart, based on data from Ned Davis Research, shows that the market over the last nine decades has actually tended to do better when earnings are growing more slowly than when growing at the blistering pace seen over the last couple of years.
A potentially more serious fly in the ointment: Though Shiller's Cyclically Adjusted Price Earnings Ratio is slightly lower than it was at the market high last April, it remains significantly above its long-term norms. In fact, it is 38% higher than the ratio's average back to the late 1800s, and 43% higher than its median.
This cannot easily be dismissed because Shiller's CAPE has an impressive record forecasting the market's long-term return. Consider a simple econometric model that uses the CAPE to predict the S&P 500's inflation-adjusted dividend-adjusted return "” a model that is quite significant at the 95% confidence level that statisticians often use to determine if a pattern is genuine.
That model's current forecast: Less than a 1% annualized real total return over the next decade. That's far lower than the long-term average of close to 7% per year.
To be sure, this is a very long-term forecast. The CAPE can remain at well-above-average levels for several years, and even creep higher. Long-term valuations exert only a weak gravitational pull on the market's shorter-term returns.
The bottom line? From a long-term point of view, stocks are overvalued relative to historical norms. But, from a shorter-term perspective, the good news is that they are not quite as overvalued as they were last April.
Click here to learn more about the Hulbert Financial Digest.
/quotes/zigman/3870025 Add SPX to portfolio SPX S&P 500 Index 1,367.59 +1.85 +0.14% Volume: 572.53M Feb. 27, 2012 4:32p var embeddedchart124732823Chart = new EmbeddedChart('#embeddedchart124732823', NormalChartStyleNoDecimals, 240, 80, '1dy', '5mi', null, null, null, 'US:SPX'); jQuery.data($('#embeddedchart124732823').get(0), 'embeddedchart', embeddedchart124732823Chart); //$(document).ready(function() { var storywidth = $('#mainstory').width(); var maxwidth = storywidth; $('#maincontent pre').each(function (index, value) { var thiswidth = $(value).width(); if (thiswidth > maxwidth) maxwidth = thiswidth; }); var offset = maxwidth - storywidth; if (offset > 0) { var margin = 13; var blanketwidth = $('#blanket').width(); var contentwidth = $('#maincontent').width(); $('#blanket').width(blanketwidth + offset + margin); $('#maincontent').width(contentwidth + offset + margin); $('#mainstory').width(storywidth + offset + margin); } //});Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.
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Mark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD became a service of MarketWatch in April 2002. In addition to being a Senior Columnist for MarketWatch, Hulbert writes a monthly column for Barron's.com and a column on investment strategies for the Journal of the American Association of Individual Investors. A frequent guest on television and radio shows, you may have seen Hulbert on CNBC, Wall Street Week, or ABC's World News This Morning. Most recently, Dow Jones and MarketWatch launched a new weekly newsletter based on Hulbert's research, entitled Hulbert on Markets: What's Working Now. Collapse
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There have been some at least moderately encouraging sub-surface developments, however, especially on the valuation front. Relative to earnings, the market is in slightly better shape now than 10 months ago.
Consider first the price-to-earnings ratio when calculated on the basis of trailing as-reported earnings. The reason to calculate the ratio this way: It's comparable to the historical values back to 1871 that are included in the database maintained by Yale University finance professor Robert Shiller. ( Click here to access that database. )
That ratio for the S&P currently stands at 15.2. The comparable ratio at the end of last April stood at 16.6. So at least according to this measure, stocks are about 8% cheaper today than last April.
What about the so-called Cyclically Adjusted Price Earnings ratio, or CAPE, which Shiller has proposed as a superior measure of stock market valuation? It currently stands at 22.7, versus 23.7 at the end of this past April "” a 4% improvement.
Though the magnitude of these improvements are perhaps not overwhelming, at least their trends are in the right direction.
There are several flies in the ointment, however. And at least one of them is a serious cause for concern.
One that many of the advisers I monitor have been noting: Earnings-growth rates are markedly lower now than they were last year. As recently as the quarter that ended last Sept. 30, for example, the year-over-year EPS growth rate for the S&P was 21%. For the quarter we're in right now, in contrast, that growth rate is estimated to be just 12.5% "” and even that may turn out to be optimistic.
This turns out not to be as big a worry as it might otherwise seem, however.
Earnings growth rates that are too high are simply not sustainable for very long, as illustrated in the accompanying chart. That chart, based on data from Ned Davis Research, shows that the market over the last nine decades has actually tended to do better when earnings are growing more slowly than when growing at the blistering pace seen over the last couple of years.
A potentially more serious fly in the ointment: Though Shiller's Cyclically Adjusted Price Earnings Ratio is slightly lower than it was at the market high last April, it remains significantly above its long-term norms. In fact, it is 38% higher than the ratio's average back to the late 1800s, and 43% higher than its median.
This cannot easily be dismissed because Shiller's CAPE has an impressive record forecasting the market's long-term return. Consider a simple econometric model that uses the CAPE to predict the S&P 500's inflation-adjusted dividend-adjusted return "” a model that is quite significant at the 95% confidence level that statisticians often use to determine if a pattern is genuine.
That model's current forecast: Less than a 1% annualized real total return over the next decade. That's far lower than the long-term average of close to 7% per year.
To be sure, this is a very long-term forecast. The CAPE can remain at well-above-average levels for several years, and even creep higher. Long-term valuations exert only a weak gravitational pull on the market's shorter-term returns.
The bottom line? From a long-term point of view, stocks are overvalued relative to historical norms. But, from a shorter-term perspective, the good news is that they are not quite as overvalued as they were last April.
Click here to learn more about the Hulbert Financial Digest.
Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.
World Bank warns: China is a ticking time bomb
Dollar falls against euro after German vote
Stock valuations now versus last April
Asia markets mixed, but Japan rebounds
Buffett's successor is an obvious choice: me
Buffett's successor is an obvious choice: me
Stock valuations now versus last April
World Bank warns: China is a ticking time bomb
As the song says, Greece is the word
Free Homes, Made to Order for Wounded Vets
Asia's Week Ahead: China Data, Australia PM
U.S. Investors Start Week with Heavy Data releases
Did Apple Signal a Top to the Market Rally?
Mark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD... Expand
Mark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD became a service of MarketWatch in April 2002. In addition to being a Senior Columnist for MarketWatch, Hulbert writes a monthly column for Barron's.com and a column on investment strategies for the Journal of the American Association of Individual Investors. A frequent guest on television and radio shows, you may have seen Hulbert on CNBC, Wall Street Week, or ABC's World News This Morning. Most recently, Dow Jones and MarketWatch launched a new weekly newsletter based on Hulbert's research, entitled Hulbert on Markets: What's Working Now. Collapse
On Personal Finance
Be savvy about mobile banking safety
Vital Signs
Health coaches can change your playbook
Read Full Article »