Crestmont Research has created a couple charts that are instructive as to the current market environment. The price/earnings ratio has been a good indicator of future long-term performance (but a terrible short-term one). You’ll see the first chart shows that all of our “bull markets” have ended with a maximum P/E ratio of about 25, with the exception of the long running bull market that ended in 2000 with a stratospheric P/E in the 40’s (and has contributed to languishing returns since).
The next chart shows where “bear markets” typically start in terms of the P/E ratio, you’ll notice there is not a single instance of a bear market starting below a P/E of 20 and all with exception of 2000 started in the 20 – 25 range.
More importantly, only one long running secular bear market started with a P/E above 10 (barely above 10). This is important for two reasons: first, the stock market got down to a P/E of 13 before rebounding fast in 2009 – this is low and a reasonable entry point for good long term returns, but it has never indicated a bottom. Second, the stock market is currently sporting a P/E above 20. Other than the massive bubble that ended in 2000 (which we are still paying the price for), a secular bull market has never started from such a high valuation level.
To expect US Stocks to return anywhere near what they have historically is to expect (and rely upon) another massive bubble. Now, this is a possibility, but a dangerous possibility to bet your lifes savings on.
Scott Dauenhauer, CFP, MSFP, AIF