Note that my new novel “The Child Remover” is now available on Amazon as both a paperback and in a Kindle version.
IS THE STOCK MARKET TOO HIGH PRICED?
Since I started doing this blog, I have used the price/dividend (P/D) ratio as a criterion to determine if the stock market was overpriced. I did this because the P/D had been a traditionally stable and reliable measure for extended periods. However, when the economy crashed in 2009, something changed to make this ratio less useful. As expected, many companies had to cut dividends. But when earnings returned, companies began holding back huge sums of cash rather than increasing dividends. This is sometimes referred to as the $1.7 trillion “Dividend Vault.” This has resulted in lower dividends than would normally have been expected, making the P/D ratio unusually high and no longer a viable bench mark. Because of pressure from stockholders, the return to higher dividends has now started. But it may take several years before dividend levels return to prior levels.
Per: http://www.loomissayles.com/Internet/InternetData.nsf/0/4ED2439036D9911585257B42005959C8/$FILE/AContinuingCaseforDividends.pdf, in 2012, companies paid out 32% of operating earnings in dividends. If companies were paying 38% of operating earnings, which they did on the average for 20 years, the current P/D ratio would be 20% lower. This would still indicate that the market was overpriced, but perhaps only by 30% versus the 50% I have been showing.
A lot of news reports have been saying that the S&P 500 has recently reached record highs. Not so. Per Shiller’s data, when adjusted for inflation the current S&P 500 price is 79.6% of its all-time high hit in August, 2000. http://www.multpl.com/s-p-500-price/. But looking at the chart, the price is still historically high. The current price is about 35% to 40% higher than its mean trend line since the Great Depression.
Because the P/D ratio has lost meaning for the last few years, I will no longer include the P/D ratio calculation. So, how do we determine if the market is overpriced? Beats me! Maybe the same way we determine if gold is overpriced (we guess). Or, based on the above numbers, consider going back into the market if it drops 30%.
MAYBE WE CAN ESTIMATE FUTURE STOCK MARKET PRICE CHANGES BASED ON THE EXPECTED FUTURE ECONOMY!
Well, most economists say that future economy expectations are already priced in. So, unless we are smarter than everyone else on predicting the economy, we have no ready advantage. But at least we can look at some of the big forces affecting the economy and see if we can perhaps see something others have not.
The results of the Sequester have yet to be felt. But if the Sequester cuts are not reversed, we are likely going to see a recession by perhaps the end of the year. Retail sales look like they are already weakening due to the recent 2% raise in Social Security tax back to its previous level. That is equivalent to a 1.5 hit on GDP! As Sequester unemployment and reduced hours come into effect later in the year, the slowing in retail sales is likely to get another big hit. But here’s the kicker! Does anyone know what Congress will do? Will the Sequester get cancelled once the legislators start feeling the heat from voters when the economy slows? Certainly those up for reelection next year are going to have second thoughts.
Housing prices have recently been going up, mainly because of a mini-bubble the Fed has started with its 3.5% mortgage rates. Even at the current low 2.1% inflation rate, a qualified buyer may very well be making money on a home purchase when the gains from mortgage interest deductions on taxes are included. The only thing that is keeping this bubble mini is that banks are not allowing those without good credit to buy, nor are they allowing the fictitious home appraisals that were so common in the most recent housing fiasco. Also, with $1 trillion dollar of education debts in the age group most likely to start buying houses, this bubble is limited in size because housing demand will be limited by those huge debts.
The labor force participation rate has dropped to 63.3% from its high of 67.3% in 2000. So 4% fewer potential workers are contributing to the growth of our economy. This is bad, right? But in those same years, GDP has grown 64%. That means that we have become much more efficient! Now, what if we grow from here! We have 4% of workers, who, with the right kind of jobs and the right pay, will likely be willing to come back to work. And with the improved efficiencies, our economy will steam! Yes, part of the efficiency gains came by basically freezing the wages for most workers (when inflation is included). But, with needed tax changes in closing loopholes where the wealthy and corporations got all the recent gains, can’t future gains be shared much as they were in the 1980’s? This isn’t all that much of a stretch!
Where would the additional jobs come from? Well, with the added efficiencies, already there are some trends showing jobs moving back to the US. And if the US becomes energy independent, which I and others believe is going to happen, this will give us another cost advantage, along with the direct and indirect jobs added by the expanding energy industries. And this will be long term, because the first stage will be oil and gas recovery, with the second stage being solar and wind with natural gas backup. This could be an exciting future for the US. And, this is one area that I do not see yet incorporated in future economic forecasts or the likely related gains in the stock market.
Okay, time to dampen the optimism. Although North Korea may be all bluff with no related resultant war, Iran and its nuclear development is more likely to result in conflict. Israel will go after Iran’s nuclear facilities, and the US is likely to be drawn into the conflict, at least on a military material and support basis. And this is likely to happen within a year or two. Then, all bets are off because the US will not yet be energy independent.
As always, people should use their own judgment/data to affect their own investment strategies; and they should not blindly use the above information. Intelligent people can, and do, disagree.