April 10, 2015
By Steve Blumenthal
“I can’t change the direction of the wind, but I can adjust my sails to always reach my destination.”
– Jimmy Dean
Over the course of the first quarter, Standard and Poor’s lowered their forecast for 2015 earnings from $135 per share to $112 per share to $110 per share. With prices already high relative to corporate earnings, such a trend is not an investor’s friend.
Let’s take a look today at current valuations and see what they may tell us about the market’s return over the next ten years. Hint: it’s very low. Be prepared to adjust your sails.
Included in this week’s On My Radar:
- Quarter End Valuations
- The S&P 500 Index and Federal Reserve Intervention
- Trade Signals – Trend Remains Bullish, Risk Remains Elevated
Quarter End Valuations
- Median P/E
First, P/E is short for the ratio of a company’s share price to its per share earnings. As the name implies, to calculate the P/E, you simply take the current stock price of a company or index like the S&P 500 and divide by its earnings per share (EPS). Most of the time, the P/E is calculated using EPS from the last four quarters. This is also known as the trailing P/E. Median P/E removes the few companies that are outliers in the index (those on the high earnings side and those on the low earnings side) and gives us a sense of how the majority of the 500 companies in the index are doing.
When we compare the Median P/E against the historic average of Median P/Es, we can get some footing on what returns probably could be. Simply, is the market inexpensively priced or richly priced? The next chart, courtesy of NDR, shows the market to be richly priced. Median P/E is my favorite valuation indicator.
Note that fair value on the S&P 500 at 1600.42 as indicated by the orange arrow. The S&P is overvalued at 2093.14 (the S&P 500 index is at 2100 today). Undervalued is at 1107.71. I think those levels pretty much shape out fair value and risk and reward. Though the market may move higher, ultimately valuations will win. Remember, we want to be buyers when upside return is greatest.
- Median Price to Sales Ratio
- Price to Operating Earnings Ratio
In this next valuation chart, note the return history three months to two years later when the price to operating earnings ratio is greater than 18.2 (orange highlight). It’s best to be an aggressive buyer of equities when the price to operating earnings ratio is less than 8. It currently stands at 18.39 as of March 31, 2015. Here too the market is expensively priced.
By the above measure, the market is fairly valued at 1613.51, overvalued at 2046.41 and undervalued at 899.52 (that is a scary S&P 500 level).
- Crestmont and Shiller P/E
Periods of overvaluation and undervaluation can go on for some time. Therefore, they are not useful in determining market direction. However, they can play a role in helping us understand probable future returns and thus can help us shape the equity exposure we/you place within client portfolios. It can also help to identify high risk and low periods – simply when it makes more and less sense to implement equity risk hedges.
Finally, as it relates to valuation and forward return, I next share one of my favorite forward expected return charts. It too says to expect below normal forward equity returns – really low at approximately 2.25% (annualized before inflation).
Household Equity Percentage vs. Rolling 10-Year S&P 500 Index Total Return
The large red arrow shows a forward 10-year expected return of -3% (1999 – 2009). The small red arrow shows a forward 10-year expected return of +1% (2007 – 2017). The green arrow shows a forward expected return of 13.25% (2009 to 2019) and the yellow circle shows where we are today (expecting a forward 10-year expected return of approximately 2.25%).
The bottom green line shows the forward return potential of over 19% per year at the beginning of the great bull market in the early 1980s. I was a very young institutional broker at Merrill Lynch back then. Believe me when I say, nobody wanted to own stocks. A long secular bear market had ended but nobody knew it at the time.
If equities were cheaply priced, I’d be less concerned. They are not. By all reasonable measures, equities are expensively priced yet that doesn’t mean U.S. stocks won’t move higher (I’m in the “don’t fight the trend” camp). Overall, risk is high so put a disciplined game plan in place to deal with the high risk, low forward returns and the coming change in trend. I share a few risk management ideas each week in Trade Signals.
“I can’t change the direction of the wind, but I can adjust my sails to always reach my destination.” As shared in the intro quote – let’s keep the same in mind and do our best as it relates to our portfolios.
Trade Signals – Trend Remains Bullish, Risk Remains Elevated
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: The Primary Trend Remains Bullish for Stocks
- Volume Demand Continues to Better Volume Supply: Bullish for Stocks
- Weekly Investor Sentiment Indicator:
- NDR Crowd Sentiment Poll: Neutral Signal from Optimism (short-term Neutral for stocks)
- Daily Trading Sentiment Composite: Neutral Signal from Pessimism (short-term Bullish for stocks)
- The Zweig Bond Model: The Cyclical Trend for Bonds is Bullish
Click here for the full piece.
Personal note
The travel schedule is ramping back up. I’m in NYC April 20-22 for an iShare’s Conference and several media interviews, then I’m off to San Diego for my friend John Mauldin’s Annual Strategic Investment Conference April 29 through May 2. The speaker lineup is outstanding and the timing is right (stay tuned – I’ll share the best of my notes with you). Envestnet’s Annual Conference is up next May 6-8 in Chicago and then I’m speaking at an advisor sponsored client event on May 12.
Two important graduations are near. It was just four years ago when Brianna ran to me after her high school lacrosse game, jumped in my arms and told me she was going to the University of Michigan. After a brief pause, she said, “psych – I’m going to Penn State”. I did my best to brainwash her in that direction (I’m way too Penn State biased to be balanced – I know, not good!). Of course, I was thrilled though I did get comfortable with the Michigan idea. Her graduation is on May 10 and has time flown by. One more graduation follows in early June. Susan’s oldest son, Tyler, is graduating from high school. He has some great options and I’m excited to see which path he chooses. What a great kid. Time is passing much too quickly as I’m sure it is for you.
So, here is a toast to slowing down. I’ll be slowing down in front of the TV – it’s Master’s weekend.
Wishing you an outstanding weekend. Have fun!
With kind regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended and/or undertaken by CMG Capital Management Group, Inc. (or any of its related entities-together “CMG”) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
Certain portions of the content may contain a discussion of, and/or provide access to, opinions and/or recommendations of CMG (and those of other investment and non-investment professionals) as of a specific prior date. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current recommendations or opinions. Derivatives and options strategies are not suitable for every investor, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Moreover, you should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from CMG or the professional advisors of your choosing. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisors of his/her choosing. CMG is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.
This presentation does not discuss, directly or indirectly, the amount of the profits or losses, realized or unrealized, by any CMG client from any specific funds or securities. Please note: In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, have not been independently verified, and do not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods.
CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM: Mutual Funds involve risk including possible loss of principal. An investor should consider the Fund’s investment objective, risks, charges, and expenses carefully before investing. This and other information about the CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM is contained in each Fund’s prospectus, which can be obtained by calling 1-866-CMG-9456. Please read the prospectus carefully before investing. The CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM are distributed by Northern Lights Distributors, LLC, Member FINRA. NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Hypothetical Presentations: To the extent that any portion of the content reflects hypothetical results that were achieved by means of the retroactive application of a back-tested model, such results have inherent limitations, including: (1) the model results do not reflect the results of actual trading using client assets, but were achieved by means of the retroactive application of the referenced models, certain aspects of which may have been designed with the benefit of hindsight; (2) back-tested performance may not reflect the impact that any material market or economic factors might have had on the adviser’s use of the model if the model had been used during the period to actually mange client assets; and, (3) CMG’s clients may have experienced investment results during the corresponding time periods that were materially different from those portrayed in the model. Please Also Note: Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance will be profitable, or equal to any corresponding historical index. (i.e. S&P 500 Total Return or Dow Jones Wilshire U.S. 5000 Total Market Index) is also disclosed. For example, the S&P 500 Composite Total Return Index (the “S&P”) is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. Standard & Poor’s chooses the member companies for the S&P based on market size, liquidity, and industry group representation. Included are the common stocks of industrial, financial, utility, and transportation companies. The historical performance results of the S&P (and those of or all indices) and the model results do not reflect the deduction of transaction and custodial charges, or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. For example, the deduction combined annual advisory and transaction fees of 1.00% over a 10 year period would decrease a 10% gross return to an 8.9% net return. The S&P is not an index into which an investor can directly invest. The historical S&P performance results (and those of all other indices) are provided exclusively for comparison purposes only, so as to provide general comparative information to assist an individual in determining whether the performance of a specific portfolio or model meets, or continues to meet, his/her investment objective(s). A corresponding description of the other comparative indices, are available from CMG upon request. It should not be assumed that any CMG holdings will correspond directly to any such comparative index. The model and indices performance results do not reflect the impact of taxes. CMG portfolios may be more or less volatile than the reflective indices and/or models.
In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professionals.
Written Disclosure Statement. CMG is an SEC registered investment adviser principally located in King of Prussia, PA. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at (http://www.cmgwealth.com/disclosures/advs).