Stock prices are up over 150% from the lows hit in 20091. As the barometer shows below, the S&P Composite added another 32.4% in 2013 alone. Last January, our newsletter front page was titled, “Happy New Era!” We believed then that we were on the verge of entering a mega-bull market; a cycle that could last as long as 20 years. Certainly 2013 did nothing but stamp its approval on our theory, but can it continue? We believe the market is still fairly valued even at these levels, but will probably not rise at last year’s pace.
We look at stock valuations through multiple lenses and currently all views are positive. From a long-term perspective, we rely on the historical channeling of the total return real S&P Industrial Index. We have illustrated this graph for many years in newsletters and market reviews and it suggests that the Dow Index today could be anywhere between 10,000 and 41,000 while not being out of line with past history. At a current Dow of 16,400, we like the opportunity.
We also look at valuations from a bond lens. We statistically ask which investment is most attractive over the next five years, stocks or corporate bonds. We have referred to this in-house technique as our economic model. A major factor is inflation, which has been barely over 1% the last twelve months and less than 2% annually over the last five years2. This absence of inflation adds safety and valuation to the bond segment, so our model implies that if the Dow were 1,000 points higher today, we would consider it overvalued compared to bonds and we would recommend lower stock exposures.
We also use two moving averages to give us short term clues to market direction and these remain very positive. Indeed, price to earning ratios, now pushing twenty, might seem high but in the midst of low inflation/interest rates we believe the valuation is fair.
The Dow was at 15,500 when the real total return of the S&P finally reached its 2000 peak numbers. If we consider this the beginning of the megabull era, we might get a glimpse of what could lie ahead. Using the same definition in past mega-bull markets, these occurred in 1949-1968 when the Dow Industrials Index rose over 400%, and 1985- 2000 when the Dow rose over 750%. This suggests that the Dow could reach 100,000 before we incur another mega-bear market like 2000-09. That may seem absurd to some, but there are several themes going on in this country that could just get us there.
We believe that housing, manufacturing, and energy will continue to be foundational to our country’s economic recovery, as they proved to be in 2013. Then we have the maturing of the Millennials, composed of those born between 1982 and 2000, a group larger than the Baby Boomers! Their spending should be an economic boost by the end of this decade, extending the mega-bull era well into the 2020s.
We recognize we make mistakes, but we are pleased that our clients have maintained maximum stock exposures since 2009. A Warren Buffet investment philosophy is “Stay sane while others go crazy.” We think our clients stayed the course and should keep doing so.
1 As measured by the S&P 500 from March 9, 2009 to December 31, 2013.
2 Inflation is measured using CPI data provided by the Bureau of Labor Statistics. http://www.bls.gov
Index information is used to represent market performance, but you cannot invest directly in an index. Past performance is not indicative of future results.
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