Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
United States Coronavirus Infections and Deaths Trend Forecasts Into End April 2020 - 29th Mar 20
Some Positives in a Virus Wracked World - 29th Mar 20
Expert Tips to Save on Your Business’s Office Supply Purchases - 29th Mar 20
An Investment in Life - 29th Mar 20
Sheffield Coronavirus Pandemic Infections and Deaths Forecast - 29th Mar 20
UK Coronavirus Infections and Deaths Projections Trend Forecast - Video - 28th Mar 20
The Great Coronavirus Depression - Things Are Going to Change. Here’s What We Should Do - 28th Mar 20
One of the Biggest Stock Market Short Covering Rallies in History May Be Imminent - 28th Mar 20
The Fed, the Coronavirus and Investing - 28th Mar 20
Women’s Fashion Trends in the UK this 2020 - 28th Mar 20
The Last Minsky Financial Snowflake Has Fallen – What Now? - 28th Mar 20
UK Coronavirus Infections and Deaths Projections Trend Forecast Into End April 2020 - 28th Mar 20
DJIA Coronavirus Stock Market Technical Trend Analysis - 27th Mar 20
US and UK Case Fatality Rate Forecast for End April 2020 - 27th Mar 20
US Stock Market Upswing Meets Employment Data - 27th Mar 20
Will the Fed Going Nuclear Help the Economy and Gold? - 27th Mar 20
What you need to know about the impact of inflation - 27th Mar 20
CoronaVirus Herd Immunity, Flattening the Curve and Case Fatality Rate Analysis - 27th Mar 20
NHS Hospitals Before Coronavirus Tsunami Hits (Sheffield), STAY INDOORS FINAL WARNING! - 27th Mar 20
CoronaVirus Curve, Stock Market Crash, and Mortgage Massacre - 27th Mar 20
Finding an Expert Car Accident Lawyer - 27th Mar 20
We Are Facing a Depression, Not a Recession - 26th Mar 20
US Housing Real Estate Market Concern - 26th Mar 20
Covid-19 Pandemic Affecting Bitcoin - 26th Mar 20
Italy Coronavirus Case Fataility Rate and Infections Trend Analysis - 26th Mar 20
Why Is Online Gambling Becoming More Popular? - 26th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock Markets CRASH! - 26th Mar 20
CoronaVirus Herd Immunity and Flattening the Curve - 25th Mar 20
Coronavirus Lesson #1 for Investors: Beware Predictions of Stock Market Bottoms - 25th Mar 20
CoronaVirus Stock Market Trend Implications - 25th Mar 20
Pandemonium in Precious Metals Market as Fear Gives Way to Command Economy - 25th Mar 20
Pandemics and Gold - 25th Mar 20
UK Coronavirus Hotspots - Cities with Highest Risks of Getting Infected - 25th Mar 20
WARNING US Coronavirus Infections and Deaths Going Ballistic! - 24th Mar 20
Coronavirus Crisis - Weeks Where Decades Happen - 24th Mar 20
Industry Trends: Online Casinos & Online Slots Game Market Analysis - 24th Mar 20
Five Amazingly High-Tech Products Just on the Market that You Should Check Out - 24th Mar 20
UK Coronavirus WARNING - Infections Trend Trajectory Worse than Italy - 24th Mar 20
Rick Rule: 'A Different Phrase for Stocks Bear Market Is Sale' - 24th Mar 20
Stock Market Minor Cycle Bounce - 24th Mar 20
Gold’s century - While stocks dominated headlines, gold quietly performed - 24th Mar 20
Big Tech Is Now On The Offensive Against The Coronavirus - 24th Mar 20
Socialism at Its Finest after Fed’s Bazooka Fails - 24th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock and Financial Markets CRASH! - 23rd Mar 20
Will Trump’s Free Cash Help the Economy and Gold Market? - 23rd Mar 20
Coronavirus Clarifies Priorities - 23rd Mar 20
Could the Coronavirus Cause the Next ‘Arab Spring’? - 23rd Mar 20
Concerned About The US Real Estate Market? Us Too! - 23rd Mar 20
Gold Stocks Peak Bleak? - 22nd Mar 20
UK Supermarkets Coronavirus Panic Buying, Empty Tesco Shelves, Stock Piling, Hoarding Preppers - 22nd Mar 20
US Coronavirus Infections and Deaths Going Ballistic as Government Start to Ramp Up Testing - 21st Mar 20
Your Investment Portfolio for the Next Decade—Fix It with the “Anti-Stock” - 21st Mar 20
CORONA HOAX: This Is Almost Completely Contrived and Here’s Proof - 21st Mar 20
Gold-Silver Ratio Tops 100; Silver Headed For Sub-$10 - 21st Mar 20
Coronavirus - Don’t Ask, Don’t Test - 21st Mar 20
Napag and Napag Trading Best Petroleum & Crude Oil Company - 21st Mar 20
UK Coronavirus Infections Trend Trajectory Worse than Italy - Government PANICs! Sterling Crashes! - 20th Mar 20
UK Critical Care Nurse Cries at Empty SuperMarket Shelves, Coronavirus Panic Buying Stockpiling - 20th Mar 20
Coronavirus Is Not an Emergency. It’s a War - 20th Mar 20
Why You Should Invest in the $5 Gold Coin - 20th Mar 20
Four Key Stock Market Questions To This Coronavirus Crisis Everyone is Asking - 20th Mar 20
Gold to Silver Ratio’s Breakout – Like a Hot Knife Through Butter - 20th Mar 20
The Coronavirus Contraction - Only Cooperation Can Defeat Impending Global Crisis - 20th Mar 20
Is This What Peak Market Fear Looks Like? - 20th Mar 20
Alessandro De Dorides - Business Consultant - 20th Mar 20
Why a Second Depression is Possible but Not Likely - 20th Mar 20

Market Oracle FREE Newsletter

Coronavirus-bear-market-2020-analysis

How Market Valuation Affects Future Stock Returns

Stock-Markets / Stock Market Valuations Mar 27, 2019 - 07:44 PM GMT

By: John_Mauldin

Stock-Markets The price/earnings ratio (P/E) has a multiplier effect on stock returns. Over 10–20 years, it can dramatically increase or decrease your total return.

In the secular bear market of the 1960s and ‘70s, shrinking P/E ate away almost all the return from earnings growth and dividend yield.

In the 1980s and ‘90s, rising P/E more than doubled the return for investors.

But P/E’s effect goes beyond earnings and capital gains. It has a big effect on dividend yield, too.


The chart below shows a high correlation between P/E ratio and dividend yield. Historically, High P/E leads to low dividend yields and low P/E leads to high dividend yields.



For example, the same dividend yield is twice as big under P/E at 10 than it is under a 20 P/E.

Bottom line: a low P/E raises the odds of both higher returns and higher dividend yields.

So, where is today’s market on the valuation spectrum?

Fairly Valued or Overvalued?

Actual reported earnings show that today’s P/E stands near 20 and up to 30 in a few instances.

The long-term historical average is around 15. P/E has declined below 10 only during periods of high inflation or significant deflation. And when inflation is low and stable, it rises toward the mid-20s.

That means P/E is now above average. The question is: is it fairly valued?

The next chart shows a long history of economic growth (measured with nominal gross domestic product) and earnings growth (measured with earnings per share for S&P 500 companies).

We see the effects of business cycle fluctuations in EPS around a steadier economic growth in GDP:



Some investors believe the elevated corporate earnings are unlikely to revert. They cite tax changes, trends in service industries, technology, and other causes. 

Yet all those factors have affected the economy for more than a century. None have prevented business cycle-driven reversion. 

Plus, if we were earlier in the cycle, P/E would be near 20 and the market would be fairly valued. That’s not the case today.

Using various methods to normalize the business cycle shows us that P/E now is near 30. As such, the market is at high risk of correction.

What to Do About It

Warren Buffett’s first rule of investing is: “Never lose money.” His second rule is to never forget the first rule!

It’s true because losses have a disproportionate effect on future returns compared to gains.

The next chart shows how a small loss needs a larger gain to break even. Getting back where you started requires progressively higher gains as losses grow:



The relationship works in both directions. A 40% loss can wipe out a 67% gain. Likewise, a 40% loss requires a 67% gain to recover.

This disproportionate effect occurs because the loss occurs on the higher value.

There are many ways to manage portfolio risk and control losses, including:

  • direct hedges (e.g., options),
  • active management (e.g., dollar cost averaging, rebalancing, value investing),
  • portfolio structure (e.g., diversification).

You can achieve diversification portfolio-wise in a number of ways.

First, hold securities not correlated with each other so the portfolio’s engines work independently.

Second, include holdings that are historically counter-correlated. These holdings are expected to zag when other holdings zig.

The goal is not to find direct offsets, but rather to expect that each component will deliver more upside than downside.

And don’t let this discourage you altogether.

The outlook of low returns is not destiny. It is only a statement of current market conditions. Recognizing it helps you better manage investment portfolios.

There are many options for your portfolio other than investing in highly valued stocks. Ask your investment advisor about such options.

Join hundreds of thousands of other readers of Thoughts from the Frontline

Sharp macroeconomic analysis, big market calls, and shrewd predictions are all in a week’s work for visionary thinker and acclaimed financial expert John Mauldin. Since 2001, investors have turned to his Thoughts from the Frontline to be informed about what’s really going on in the economy. Join hundreds of thousands of readers, and get it free in your inbox every week.

John Mauldin Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules