It has been several months since I announced I was getting back into racing shape. As anyone who’s ever worked toward long-run fitness goals knows, training improvements often plateau. We find ourselves doing more work with less incremental gains. Our bodies get accustomed to the workload and we need to change the routines to break through the plateaus.
Similarly, the stock market has had plateaus in its history (see “Secular Bull Markets”). Like our running or fitness bodies, the markets and the economy need to adjust to a new routine. Many market pundits called the last decade the “lost decade” because of the market index’s recent plateau.
Do you remember Y2K?
There was fear that the all of the computers in the world would simultaneously crash. This crisis led to the “tech bubble” of the late 1990’s as computers and software were upgraded or replaced. Market valuations as measured by the forward looking price / earnings ratio (P/E) reached 25.6 times earnings at the market peak on March 24, 2000i. Then the tech bubble burst, sending the economy into a three year recession.
As this millennium began, less than half of American adults had access to the internet and in the home dial-up was the standard. If you don’t remember dial-up, rent the 1998 film “You’ve Got Mail” – yes, that film was released 15 years ago! (And at the expense of my machismo, I admit to having watched it!) Today, more than half of us own smartphones, taking internet access with us wherever we go. You can even watch that movie on your smartphone.
Mobile computing is the game-changer that was predicted during the tech bubble, but is just now being realized, and in my humble opinion has yet to be priced into the markets. The current P/E (of the S&P 500) is only 13.9 times earnings as of June 30. Generally speaking, a P/E ratio between 10 and 17 is considered “fairly valued”. Most of the other market valuation measures are likewise below historical averages.
While stocks are slightly below average historic values, corporate profits are soaring as a percentage of our Gross Domestic Product (GDP). The 50 year average percent of GDP represented by after-tax profits is 6.3%, but during the second quarter of this year they were 10.0%, more than 50% above the norm, according to JP Morgan’s “Guide to the Markets” 4Q, 2013.
Of course there are risks, in my opinion the most obvious being the “bond bubble” being created by the FED and our bifurcated political situation. As such, we continue to believe in a balanced investment approach.
As always, talk with me directly about your specific investment needs.
SOURCES: JPMorgan; Pew Internet; Wall Street JournalForward Price to Earnings Ratios based on the S&P 500 Index based on consensus estimates for earnings in the next 12 months.
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