3 Reasons The Aging Bull Market Is Running Out Of Steam

Brad Tompkins

expensive stock market valuationsWhen you are managing your retirement portfolio, it makes sense to keep tabs on the economic factors that have reliable correlation to long term investment performance. Future stock market returns looking out 10 years or more are inversely related to market valuations. A low valuation implies higher long term returns and a high valuation historically leads to diminished portfolio returns. Peek into Warren Buffet’s investment playbook. He has an extremely public, well timed “Buy Low, Sell High” move published in Forbes magazine in 1979 and 1999.

What was his reasoning to support the trades? Market valuations and forward looking expected returns over the next decade. 1979 market consensus was that stocks were dead. Valuations were a full standard deviation below the mean. And true to form, the market proceeded to create returns not far under 20% for the next 20 years. Conversely, in 1999 market valuations were inconceivably 3 standard deviations above the mean. Over the next 10 years the market returned less than 3% CAGR.

With this in mind, let’s take a look at this aging bull market and provide some context for future discussion.

Market Valuations Stretched

So if we could peer into the Oracle’s crystal ball, what would we see right now? I believe the foggy message would tell us the market is expensive by most measures and today would certainly not be a buy low moment compelling us to convert bags of money into stocks. Chris Kimble contributed this article with a succinct visual summary of the recent lofty valuations: “Cheers: Market Valuations are only 91% above 100-Year Averages!“. There are 4 different valuation methods combined into a composite view.  The various calculations include Shiller’s cyclically adjusted 10 year PE ratio which spans business cycles; the Crestmont PE ratio where the “E” denominator is a normalized GDP derived profit figure; Tobin’s Q ratio which reflects stock valuation over balance sheet book value; and finally the simple S&P 500 price deviation from a very long term regression.

The math behind the valuations is fascinating but you don’t need a PhD to understand how rarefied today’s market atmosphere happens to be. This aging bull market is currently stretched beyond 1929, 1964, 2007 high side deviations and only a bit short of the 1999 irrational exuberance. Expected market returns over the next 10 years are in the low single digits. Now don’t confuse this with a crash prediction. The valuations can revert to mean by the market simply treading water at these price levels for several years while the denominators have time to catch up. While we are at it, I’ll throw in the additional disclaimer that short term returns are completely unpredictable.

GDP Slow Growth

We might dig a little deeper into one key metric — GDP growth — that has significance in 3 of the valuation calculations. Ross Heart explores this topic in more depth here: “How Much Future GDP Has Been Stolen By Fed ZIRP?“. Central Bank intervention has likely run its course in being able to spur new growth. The US, European, Chinese & Japanese bankers have flooded the world with QE funds yet the economies are having an increasingly difficult time achieving recent target growth figures. Without significant GDP growth, the diminished expected returns in stock markets will languish years longer.

Strong Dollar

A contributing factor for GDP slowing down recently is the quick rise in the value of the US Dollar. Almost all large US multinational companies rely to some extent on overseas market sales. That is especially true for big pharma, techs, and industrials. With the 20 percent increase in the US Dollar, which loosely translates into a 20 percent price increase for foreign customers, there will almost certainly be a decrease in total exports. Exports make a meaningful contribution to US economic activity and the strong dollar headwind creates significant drag for GDP growth.

Odds Against Several More Years of Strong Stock Returns

In 2009, the market valuation was just below the long term mean, QE was just beginning and GDP had nowhere but up to go. It wasn’t an easy decision at the time but made sense to anticipate equity outperformance and to get aggressive accumulating stocks. Fast forward to today’s relatively expensive valuations and we’d be well served to expect an environment where strong returns over many years to come are highly unlikely.


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Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.