(1) NEW: Reconciliation Principle: Returns and Forecasts Must Add Up: Hope springs eternal… until it confronts reality. The past 17 years have led investors to challenge conventional wisdom and to seek a deeper understanding of the stock market. Crestmont’s Reconciliation Principle enables advisors and investors to peel back the cloak and see the fundamental principles that drive the market. It’s empowering! The Principle enables investors to see that the current high P/E destines the stock market to an extended period of below-average returns, but it also helps them to take the actions necessary to achieve long-run investment success.
This article explores the value of understanding and assessing the environment over your investment horizon. Market weather may be hard to predict, but market climate can be credibly determined.
(2) Earnings per share in 2016 for the S&P 500 Index was finalized at $94.55. That does reflect an increase over 2015, but it’s still below the results for 2014 and 2013. Standard and Poor's currently projects an increase for 2017 of 25.9% to $119.08. However, there's six month to go. All of the years (2011-2016) presented in the Earnings Trends chart had declines in EPS from the June forecast to year-end. The average decline was 9.5%, which would result in 2017 EPS of ~$108.
(3) The stock market increased 2.9% in the second quarter for a cumulative 8.2% gain in the first half, far exceeding normalized long-term earnings growth. Normalized P/E remains "significantly overvalued" at 29.8 (certainly above the typical range for low inflation environments).
(4) The update to the current secular bear chart (with its cumulative 226% cyclical bull surge) shows continued momentum. The chart This Secular Bear...So Far appears to show the market launching into a new bull run. From the current high level of P/E, it's unlikely that the market will sustain its gains.
(5) Volatility remains in the lowest 4% of all periods since 1950. Another way to put into perspective the ultra-low level of market volatility is to consider the VIX, the recognized index of stock market volatility. The VIX has had seven days below 10 so far this year. That’s the same number of days below 10 as all prior years combined since inception in 1990. It’s an eerie calm in the markets.
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Earnings Trends: History & Future
This graph presents both (1) the historical trend for actual reported earnings per share (EPS), including a forecast by Standard & Poor's, and (2) an inset graph presenting the historical record for S&P's forecast over the past five years. To put the historical trend and future forecast into perspective, the graph includes Crestmont's assessment of the long-term baseline trend for EPS. Crestmont's baseline also puts into perspective whether current and forecast EPS are above or below the long-term trend for EPS. Note: the inset graph reflects S&P's EPS forecasts for recent years; forecasts begin about two years in advance and proceed until the year is finalized.
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The P/E Report
There are numerous versions of the price/earnings ratio (“P/E”), yet there are very few of them that can be appropriately compared to the recognized long-term average of 15. The objectives of this report are to detail the current level of the P/E ratio, to answer frequent questions about it, and to address the status of the current stock market cycle.
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This Secular Bear...So Far
This secular bear began in 2000 and has lasted well more than a decade. The surges and falls are relatively consistent in both magnitude and duration to past secular bear market cycles. With valuation levels still relatively high, as measured by normalized P/E, this secular bear has quite a way to go.
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Stock Market Volatility: An Erratic Cycle
This graph reflects a measure of stock market volatility--the statistical standard deviation of monthly changes for the S&P 500 Index. The line on the graph reflects volatility for each trailing twelve-month period starting in January 1951 and continuing with each month to present. There are several insights from the graph. First, volatility is volatile; it cycles erratically over time. Second, periods of extremely high or low volatility often follow the other. Third, volatility tends to spend most of its time around the average (i.e., within 25% above or below the average).
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Reconciliation Principle: Returns and Forecasts Must Add Up
Hope springs eternal… until it confronts reality. The past 17 years have led investors to challenge conventional wisdom and to seek a deeper understanding of the stock market. Crestmont’s Reconciliation Principle enables advisors and investors to peel back the cloak and see the fundamental principles that drive the market. It’s empowering! The Principle enables investors to see that the current high P/E destines the stock market to an extended period of below-average returns, but it also helps them to take the actions necessary to achieve long-run investment success.
This article explores the value of understanding and assessing the environment over your investment horizon. Market weather may be hard to predict, but market climate can be credibly determined.
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