At the beginning of 2014, when we wrote our periodical market valuation article, we wrote “Buffett Indicator And Shiller P/E Both Imply Long Term Negative Market Returns.” But guess what, 2014 was another strong year for the market. The S&P 500 index was up more than 13%. This is after a 30+% gain in 2013. Since the market recovery in 2009, the stock market has been up for 6 consecutive years. Where do you stand with the market valuation and implied return at the beginning of 2015?
Buffett Indicator and Shiller P/E
The ratio of Total Market Cap over GNP, Warren Buffett’s “the best single measure of where valuations stand at any given moment,” is standing at 120%, which is up from 115% in Jan. 2014. Historically the ratio was only higher than it is now at the tech bubble of 2000. It was at a lower 107% even at the peak of financial bubble in 2007, before the dramatic collapse of the stock market. Its historical mean is around 85%. Below is its historical chart. This chart is updated daily at the page of market valuation measured by the ratio of total market cap over GNP.
Shiller P/E currently sits at 26.4, which is 59% higher than the historical mean of 16.6. The ratio sat at 25 a year ago. Only in 1929 and 2000 tech bubble the ratio was higher, both were followed by market collapses. Below is the historical Shiller P/E chart:
Implied Future Market Returns
If we assume that the ratio of total market cap over GNP (Buffett’s indicator) and Shiller P/E will reverse to their mean over time, which they always did in the past, the future market returns do not look good. Using 8 years as time the market will reverse to its mean, both Buffett’s indicator and Shiller P/E suggest that the stock market will average 1% a year (~2% dividends contribution included) over the next 8 years. At 1% of total market return, the market indices will be lower than they are now after 8 years.
For details of the calculation and how these indicators worked in the past, go to:
· Where Are We With Market Valuations?
· Shiller P/E – A Better Measurement Of Market Valuation
This conclusion is exactly the same as it was a year ago.
Though history has proven that the long term market return projection based on Buffett indicator and Shiller P/E are quite accurate, it is never a short term indicator, just as 2014 displayed.
Investor Margin Debt
Investor margin debt is still as high as it was in Jan. 2014:
What Are Different in 2015 From 2014?
The expected market returns and the level of the investor’s margin debt are similar to where they were in 2014. What are different?
We have observed that the capital market are turning more cautious, as indicated by BofA Merrill Lynch US High Yield CCC Or Below Option-Adjusted Spread, which now sits at 9.95%, 250 base point higher than it was a year ago, and trending higher.
Another important capital market indicator, Chicago Fed National Financial Conditions Leverage Subindex, is also showing cautious signs. The indicator currently sits at -0.14, higher than it was in -0.6. A higher number here would mean a tighter capital market. See below:
Howard Marks (Trades, Portfolio)’ Remarks
Howard Marks (Trades, Portfolio), Chairman of Oaktree Capital and one of the smartest invests in the world, certainly noticed the recent credit market trend. In his latest memo, he wrote: “In particular with regard to the distress cycle, confident and optimistic credit markets permit the unwise extension of credit to borrowers who are undeserving but allowed to become overlevered nevertheless. Negative subsequent developments can render providers of capital less confident, making the capital market less accommodative.”
Howard Marks (Trades, Portfolio) described the three stages of a bull market:
· the first, when a few forward-looking people begin to believe things will get better
· the second, when most investors realize improvement is actually underway, and
· the third, when everyone’s sure things will get better forever
He also wrote the three stages of a bear market:
· the first, when just a few prudent investors recognize that, despite the prevailing bullishness, things won’t always be rosy,
· the second, when most investors recognize things are deteriorating, and
· the third, when everyone’s convinced things can only get worse
Is the recent increase of the junk bond yield an indication of “the capital market less accommodative” and “a few prudent investors” started to recognize that?
He further wrote: “… great buying opportunities wouldn’t arrive until a negative igniter caused the tide to go out, exposing the debt’s weaknesses. The current oil crisis is an example of something with the potential to grow into that role.”
Presidential Cycle
For whatever it’s worth, we want to point out that 2015 is the third year of presidential cycle. Historically presidential third year is good for stock market. This is the statistics for the presidential cycle since 1957:
Year | # of Years | # Up Years | # Down Years | Average Gain | Max Gain | Min Gain |
Presidential Year 1 | 14 | 9 | 5 | 8.3% | 31.0% | -17.4% |
Presidential Year 2 | 15 | 9 | 6 | 3.1% | 38.1% | -29.7% |
Presidential Year 3 | 14 | 14 | 0 | 16.5% | 34.1% | 0.0% |
Presidential Year 4 | 14 | 11 | 3 | 6.5% | 25.8% | -38.5% |
Therefore, the third year is the best for stock market. It never had a down year since 1957.
We will see…