Popular Stories

By This Key Measure, the Stock Market Is Trading at Dot-Com-Era Levels

A supermarket in Chicago: Inflation adds to stock valuation woes.

Scott Olson/Getty Images

Even without a shift into reverse, the economy is decelerating.

“As we enter the second half of the year, the largest gains are receding in the rearview mirror,” writes Stephanie Pomboy in her latest MacroMavens missive. Now, the “famously ‘forward looking’ ” stock market will have to confront what she calls the “F” word—fundamentals—of slowing earnings growth in coming quarters.

Until now, stocks have followed current-year earnings prospects higher. But as the focus shifts to 2022, they’ll have to deal with high equity prices and slowing profit gains. That could be “especially problematic with valuations dangling at nosebleed levels,” Pomboy writes.

Inflation adds to the valuation woes. The “Rule of 20” posits that the sum of inflation and the stock market’s price/earnings ratio should add up to 20, writes Doug Ramsey, chief investment officer at the sLeuthold Group. Why? Empirically, that has been the median P/E for the S&P 500 index, based on trailing peak earnings according to generally accepted accounting principles, or GAAP, going back to 1957. Since 1995, the median P/E on that basis has been 10% higher.

Based on the recent consusmer-price index reading, the Rule of 20 calls for a P/E of 14.6 times—a “figure that probably sounds preposterously low to nearly all equity investors.” In actuality, the S&P trades at more than double that multiple, based on trailing GAAP earnings, a level last seen at the peak of the dot-com “new era” of the late 1990s.

Read more Up and Down Wall Street:Disco Inferno: The U.S. Could Be Headed Back to ’70s-Style Stagflation

The latter episode was followed by a “catastrophe for large-cap equity investors,” according to Ramsey. If there’s even a minor convergence between the current market P/E and what the Rule of 20 indicates, owners of S&P 500 funds and those that mimic the index “will again have a rough time of it,” he adds.

And he concludes, “For investors to make just a meager total return of 4% to 6% over the next several years, corporate fundamentals and average valuations will need to exceed their performance of the favorable new-era period. Believing the ‘glass is half full’ is no longer enough.”

Write to Randall W. Forsyth at [email protected]

View Article Origin Here

Related Articles

Back to top button