There is no shortage of opinions on valuing the stock market. While fun to make predictions, I don't believe that there is a historical track record that confirms anyone's ability to call either Bull or Bear markets. Rather than predicting, why not acknowledge that major stock market indexes go up over long periods due to ever-increasing earnings.
The S&P 500 Index is undoubtedly the most closely watched global stock Index and demonstrates the power of long-term earnings growth. If we look back to the year 2000, the S&P 500 achieved earnings of $49.10. Step forward to 2022 and the S&P 500 earnings have grown to $197.91 (representing a compound earnings growth of 6.54% per year)
If investing was easy, the S&P 500 would have appreciated on a fairly straight line by 6.5% per year. Unfortunately, earnings changed dramatically year-to-year. In addition, investors were not consistent with what multiple they would pay for earnings (this being the frequently reported Price/ Earnings multiple).
Additionally, there are numerous other variables to consider (such as inflation, interest rates, politics, environment etc.) that affect valuations. In reality, investors cannot be certain of adding value through the timing of their purchase and sale of securities.
But don't despair. Over the longer term earnings are very likely to increase. Case in point: over the past 22 years, the S&P 500 earnings have grown by a compound annual rate of 6.5%, while the index compound annual return was 5.24% (the time period of 22 years is arbitrary, with different start and end dates, compound returns will differ wildly). We know that over very long periods, such as 1961 through 2017, S&P's annual earnings growth was most commonly in the +6% to +7% range.
As the following chart indicates investors may decide to pay 30X earnings when they are bullish and 15X earnings when they are despondent. In spite of the variable range of multiples that investors typically apply to earnings, owning equities makes financial sense over longer time frames.
Source: Robert Shiller. http://www.econ.yale.edu/~shiller/data.htm
What does this tell us about today's S&P 500 valuation? If this index earns $210 in 2022 and is currently priced at 3,954, it has a price/earnings multiple of 18.8X. Not extremely cheap relative to past multiples, but certainly in the lower end of its P/E multiple ranges.
Since we're at the lower end of the P/E range, there is always the possibility we get the bonus tailwind of multiple expansion.
Investors should be rewarded over the long term by continuing to hold (or add to) their equity allocation without predicting the optimum time to invest.
Thoughts, agreement/disagreement? email me at tim@mortonir.com
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Tim Morton, CFA is a retired portfolio manager with 45 years of experience working with private clients and is the editor of mortonir.com
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