Acropolis is a St. Louis-based, fee-only wealth management firm. We serve individual investors, institutional investors and 401k plan sponsors. We specialize in retirement planning together with 401k and IRA rollovers.
To learn more about our financial planning services, please contact us at 1-888-882-0072.
During the tech bubble in the late 1990’s, I had the feeling that seeing five years of 20 percent plus returns was a one in a lifetime type event and that was going to be it for me.
Looking at the data today, that was a pretty good bet since there have only been a few times when the average return for five years has been greater than 20 percent. There was a short period in 1937, during the mid-1950s and right before the crash of ’87.
Much to my surprise, the return for the S&P 500 for the five years that ended in February, 2014 is 23.0 percent, in the top half percent of five year returns. Yes, the bull market that was born on March 9, 2009 after a grueling 53.94 percent peak-to-trough decline that started on October 9, 2007.
Although the crash is referred to as the 2008 Financial Crisis, it started in late 2007 and ended in early 2009.
If you had the bad fortune to invest everything in stocks at the high in 2007, you would have endured a horrible loss of value, but five years after the crash, you would have made back all of your losses and even earned a positive return of 37 percent or so, which works out to about to a five percent per year return from the top of the market in 2007 to today.
That happens to exactly match what you would have earned in bonds, based on the return of the Barclays Aggregate Bond Market index (which, incidentally, was the Lehman Aggregate back in 2007), albeit with a lot less volatility.
When it first dawned on me that the returns that we’ve had in the past five years resembled what we earned during a bubble got me a little spooked. Looking at it visually (and throwing in what happened next) is even spookier.
Over the years, I’ve seen a lot of chart overlays like this that compare different periods and different markets that imply impending doom and I’ve found that they don’t add up to much. While the returns are similar over these two periods, very different things were happening.
In the mid-1990s, the stocks had a relatively normal valuation. I’ll use the Shiller PE ratio here which puts the price over 10-year average earnings. In 1995, when the last 20 percent per year gains started, the Shiller PE Ratio was 25, which is over the long-term average Shiller PE ratio of 17.5.
During the bubble, the Shiller PE Ratio rose to 45 – an expansion of 80 percent that took the Shiller PE Ratio to 2.5 times the long term average. Earnings rose, but not nearly as fast as prices.
At the birth of the current bull market, the Shiller PE ratio was 13.4, almost 25 percent below the long-term average.
Today, the Shiller PE is around 25, which is about 40 percent above the long-term average Shiller PE of 17.5. Does that mean we’re in for a 40 percent crash? I don’t think so.
For one thing, the average is just that, an average. A few weeks ago, I wrote that the Shiller PE showed that the market was overvalued, but I said that prices float pretty far from the average most of the time. At the time, I said I would put a range around the average to put it in a little more perspective, so I’ve done below.
In this chart, we see the Shiller PE ratio from 1926 through today in blue, the long-term average in a solid orange line and a reasonable range around the average (one standard deviation) in the dotted orange lines.
What you can see from looking at this chart is that current valuation is right around the top of the range that I created. While I don’t think we’re staring at a 40 percent drop, I do think that valuation matters.
Studies that others have done and that we’ve replicated show that the Shiller PE explains about 40 percent of the returns over the next decade. I’ve pointed out that this means that 60 percent is still unexplained, so in engineering terms, the noise is still louder than the signal.
In other words, it’s not enough signal to trade on, but I do think it means that investors should lower their expectations about returns over the next decade. After all, the valuation could move slowly back to average over ten years, happen overnight, or not at all.
There is a lot of math and science in investing, but there’s a lot that still can’t be explained. Five years ago, no one, including me, actually wanted to buy a lot of stocks, it was hard enough just hanging on. Now that prices are higher, stocks are easier to own emotionally, but I think it’s fair to say that the expected return is lower.
That said, the expected return is still higher than bonds and since those are our two basic choices, the basic equation is unchanged. Each investor has to determine how much risk they need or can afford to take to meet their long term goals, which I believe is no easy task.
Stocks were basically flat yesterday after Tuesday’s strong rally. Some smaller economic releases like the ADP private payrolls report and the ISM services data were softer than expected, but the news from the Fed’s ‘beige book’ was modestly positive. All of the reports included the negative impact of this winter’s cold weather.
Stock markets rallied hard yesterday, rising sharply on comments from Vladimir Putin who said that there is no immediate need to invade eastern Ukraine yet. Personally, I don’t think that’s such an outstanding statement, but stock markets loved it and the S&P 500 closed at a new all-time high.
As tensions eased, bond markets pulled back and the yield on the 10-year US Treasury bond fell back to 2.70 percent, which is a big move in one day from 2.60 percent.
US stocks, as measured by the S&P 500, made big gains in the month of February and pushed to new record highs. Click here for the February Market Recap.
The charts below from Bespoke Investment Group show the longest and strongest bull markets, which they define as a period without a 20% correction. The current bull market ranks seventh in duration and fifth in strength (return). This bull market is about a month away from moving into the sixth spot for duration, but it could be a while before it moves up the ranks in terms of strength.
Markets were a bit of a seesaw Friday and were up more than a percent in the mid day, but dropped back in the last hour of trading on the increasing tensions in the Ukraine. It was still a record close for the S&P 500.
The second estimate of fourth quarter GDP was released in the morning and markets shrugged off the downward revision from the first estimate of 3.2 percent to 2.4 percent.
Markets were marginally lower yesterday as a decline in consumer confidence rattled investors.
While more people surveyed by the Conference Board said that present conditions were better than they were a month ago, their expectations about the future were worse. It’s likely that the recent slowdown in jobs growth is to blame.
Vanguard released a study last week examining the investment decisions that occur after the IRA contribution deadline.
Those of you with a Traditional or Roth IRA may be familiar with the deadlines for IRA contributions: you have until April 15th of any given year to make a contribution for the previous year. For example, you have until April 15, 2014 to make your 2013 contribution.
The chart below from Vanguard shows a spike in money market funds within IRAs between January and April. Given that we regularly help clients make IRA contributions between January and April, this chart isn’t all that much of a surprise.
Markets were sharply higher yesterday, as Janet Yellen did not disappoint in her testimony to Congress. Her prepared remarks reflected the policy statement from the Fed’s January meeting and the Q&A period, though long, didn’t contain any surprises.
Treasury bond prices fell as Yellen indicated that the Fed would probably continue to slow their bond purchases even as jobs growth appears to be slowing down. The ten-year US Treasury bond added five basis points to close at 2.75 percent. That’s still down from the 3.00 percent rate on January 2nd, but higher than the 2.61 percent close on the first day of this month.
In other good news out of Washington DC, House Republicans opted not to fight for any concessions on the debt ceiling, which means that we won’t face another battle on that front until March 2015.
Markets were largely quiet in yesterday’s trading, moving slightly lower on a disappointing private sector employment report. The big jobs number comes out this morning and we’ll see whether last month was an aberration or something to really worry about.
Speaking of worry, the bond market appeared to be in a little bit of a funk today over the unresolved debt ceiling issue. While it seems likely we won’t suffer through another all out battle between the political parties, it still isn’t resolved.