Everyone’s talking about the risk of an
impending stock market crash.
Even the bulls are warning that stocks might fall before rising again.
While it’s reasonable to argue that stocks are getting expensive, it may be extreme and perhaps out of line to argue that stocks are doomed to crash.
The argument that stocks and profits surged too quickly only reflects the bear’s short-term memory.
In the following 19 slides, you will see that the pace of the stock market rally has been very typical, the profit recovery has been average, valuations aren’t signaling trouble, record high profit margins are sustainable, and companies are stronger than ever. You will also see that companies will benefit from numerous tailwinds that will boost demand for a wide array of goods and services.
'The past three years' annualized return for the S&P 500 falls within the most common 10 -- 15% range. Whether measured over the past five years, from 10/25/08 to 10/25/13, or like the other periods, from the end of 2008 until now, the total return falls into the slightly above average, but still very common, 15 -- 20% range.'
Source: LPL Financial
'The annual total return of 20 -- 25% this year is the second most common outcome for the stock market since records for the S&P 500 began in 1927. In fact, were it not for the recent gains in 2010 and 2012 boosting the number of occurrences that returns fell in the 15 -- 20% range, the 20 -- 25% range would be tied for the most common annual outcome for the stock market.'
Source: LPL Financial
Stocks may look expensive relative to 10-year average earnings. But this is NOT signaling an imminent crash...
Robert Shiller, who popularised the CAPE method of measuring stocks again 10-year earnings, says CAPE should not be used to time crashes...
'I think the bottom line that we were giving -- and maybe we didn't stress or emphasise it enough -- was that it's continual. It's not a timing mechanism, it doesn't tell you -- and I had the same mistake in my mind, to some extent -- wait until it goes all the way down to a P/E of 7, or something.
'But actually, the lesson there is that if you combine that with a good market diversification algorithm, the important thing is that you never get completely in or completely out of stocks. The lower CAPE is, as it gradually gets lower, you gradually move more and more in. So taking that lesson now, CAPE is high, but it's not super high. I think it looks like stocks should be a substantial part of a portfolio.'
Source: Robert Shiller, Business Insider
Stocks may fluctuate in the near-term, but CAPE only signals low single-digit average annual returns.
'We recognise that some investors are concerned that absolute valuations for US equities are at elevated levels. This is the certainly the case on the Shiller P/E. However, we find current multiples have not necessarily been a pre-cursor of falling markets. We note that markets are typically most vulnerable when the Shiller P/E is above 26x (compared to 24x currently).'
Source: Credit Suisse
Corporate cash levels are high, which means balance sheets are more liquid than ever. They also justify higher CAPE levels.
And relative to those earnings expectations, the PE multiple says valuations are below the 15-year average.
'...the current forward 12-month P/E ratio is still well below the 15-year average (16.2). During the first two to three years of this time frame (1998 -- 2001), the P/E ratio was consistently above 20.0, peaking at around 25.0 at various points in time. With the forward P/E ratio still below the 15-year average and not close to the higher P/E ratios recorded in the early years of this period, one could argue that the index may still be undervalued.'
Profit margins are high and susceptible to cyclical swings. But they are on a sustainable long-term upward trend...
'Even more compelling - and we believe supportive of equities in an eventually rising interest rate environment (UBS' Year End 2014 10 year interest rate forecast is 3.2% vs. the current 2.75%) once the Fed is satisfied that 3% growth is achievable -- is the elevated level of Total Yield less the interest rate on the US 10 year Treasury.'
And due to aggressive refinancing at current low rates, it'll be years before we should be concerned about rates raising interest expenses.
'The estimates of fiscal drag that underlie our economic forecast assume full sequestration in 2014. Removing sequestration for one year would increase federal outlays by around $US80bn (0.5% of GDP) in CY 2014.'
Source: Goldman Sachs
'Corporate IT spending has been sluggish since 2010. Most of IT spending is productivity enhancing and stepped up tech spending in the late 1990s was a key driver of strong productivity growth. We think ageing IT equipment and companies outsourcing their IT infrastructure to produce savings will boost IT enterprise spending. Global semiconductor sales increasing to its highest level in 3 years in September is encouraging.'
Source: Deutsche Bank
'A one cent change in gasoline prices reduces annual household consumption by roughly $US1 billion. At present, gasoline prices are down -$0.26 compared to a year earlier, although the rolling 26-week average is down by a lesser -$0.12. Thus, based on the aforementioned rule of thumb, the resulting economic stimulus from lower gasoline prices is relatively mild (in the range of $US12 to $US26 billion).' -- Carl Riccadonna
Source: Deutsche Bank
'Despite the hurdles from valuation, sentiment and even technicals, one of the problems for the bears is that everyone seems to acknowledge that we are due for a correction. Even the bulls are anticipating one -- hoping for one, in fact, in the name of a pause that refreshes (keep that powder dry).'
John Hussman: '...we should neither expect, rely or be shocked by a further blowoff...'
Jeremy Grantham, GMO: 'My personal guess is that the U.S. market, especially the non-blue chips, will work its way higher, perhaps by 20% to 30% in the next year or, more likely, two years...'
Richard Russell: 'I continue to think that this bull market will end in an upside explosion.'
Bob Janjuah, Nomura: 'I still see end Q4 2013, through to end Q1 2014, as the window in which we see a significant risk-on top before giving way, over the last three quarters of 2014 and through 2015, to what could be a 25% to 50% sell-off in global stock markets.'