Salient to Investors:
Matthew Crews at Smith Patrick Financial Advisors writes:
The combination of a high CAPE valuation and above-trend earnings is bearish. Either earnings growth will rebound, or more likely market valuations will compress. The market expects a strong rebound in earnings in half2, 2013. More likely is downward earnings revisions for 2013 as earnings revert to the mean compared to the 10-yr average.
The Cyclically Adjusted 10-yr Average Price-to-Earnings [CAPE] is at its highest level of 23.9 times since the S&P 500 bottom of 13.3 times in March, 2009.
Only 4 times going back to the 1920s was the CAPE at or above 24X. During those times, the 12-month trailing earnings were running significantly above earnings 10-yr average. 3 times, the 10-yr average was running above the 85+ year trend with the 1999 period having just reached the long-term trend.
In 1966, the CAPE peaked at 24.1 times, when the 12-month trailing earnings were 35% above the long-term trend versus the average of 8% above trend, and the 10-yr Treasury was 4.6%. The CAPE subsequently troughed in 1982 at 6.6 times and when interest rates were at 14.0% and the trend in 12-month reported earnings was 15.2% below the 10-year average and falling. Subsequently earnings would trough in 1983 at 24.6% below trend.
In 1929, CAPE peaked at 32.6 times, and when the 12-month trailing earnings were 61.5% above the 10-yr average and 10-yr interest rates were at 3.4%. CAPE subsequently troughed in 1932 at 5.6 times earnings when trailing 12-month earnings were 40.5% below the 10-year average. Earnings troughed in early 1933 at 50.4% below the 10-yr average.
In December, 1999, CAPE reached 44.2 times, when earnings were 49% above long-term trend and interest rates were at 6%. The CAPE subsequently troughed in 2003 at 21.2 times, and when trailing 12-month earnings were 25.5% below the 10-yr average.
In 2007, CAPE valuations were above 24 times from June, 2003 to January, 2008, with a high in May, 2007 of 27.6 times, when trailing earnings were 54.3% above the 10-yr trend. The CAPE subsequently troughed at 13.3 times in March 2009, when the trailing 12-month earnings dropped to 87.9% below the 10-yr average.
I remain invested in the S&P and large cap stocks in general.
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