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Election Day, Where Are We with Market Valuations

November 06, 2012 | About:

Today is election day. Americans get to choose who will lead them in the next four years. There have been a lot of hype in the media about who would be better for the stock market. We are not in the position to pick who is better. But we want to point out that it is the market valuation that matters, instead of the president.

Barack Obama inherited a great recession when he was elected president. But in a sense he was lucky, because the stock market as measured by the total market cap over GDP was at around 60%. It was at its lowest valuation in more than a decade as of the fourth quarter of 2008. Shortly after Barack Obama was sworn in, the total market cap sank to about 50% of GDP. Today, this ratio stands at above 90%. As we pointed out before, historically this ratio was higher than its current value only twice: the tech bubble in the end of 1990s and the housing bubble in 2004 to 2007. Both ended badly.

This is the historical ratio of total market cap over GDP:

With its current valuation, the stock market is positioned to deliver a long-term return in the order of 3% to 4% a year, as shown in our Stock Market Valuation page. The predicted and actual returns are in the chart below:

Therefore, no matter who gets elected today, the stock market will not be very rewarding for investors due to its valuations. Of course, there will be a difference made by the policies from different administrations, which will impact the growth part of the formula in stock market returns.

This prediction from the ratio of total market cap over GDP agrees with the conclusion from the approach of Prof. Robert Shiller of Yale University. You can check out our Shiller P/E page for details. As of today, Shiller P/E predicts that the market is about 29% higher than its historical mean. This is implies a future annual return of only 3.2%.

As investors, what should you do? We believe that reasonably valued high-quality companies will outperform the market, like those in our Buffett-Munger Screener. High-quality predictable companies that are traded at historical low P/S or P/B ratios also carry smaller risk than the market. Please check out those companies, too:

· Predictable companies with historical low P/S ratios

· Predictable companies with historical low P/B ratios

Rating: 2.6/5 (5 votes)


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