Hi Reader,
We have now experienced 41 consecutive weeks of bearish investor sentiment. Interest rates have risen significantly and P/E ratios are sitting at their 25-year average.
In today's email:
🎙️ Did you catch this weeks podcast episode? Listen to Financial Advisors (Part 4): Should You Work With a Fiduciary + How to Find an Advisor. |
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Let's dive into this weeks commentary. 👇
We're often encouraged to think about our expected investment returns through the lens of a full market cycle.
I agree with this -- and depending on who you ask, a "full market cycle" is generally considered to be about 10 years.
With that in mind, it's worth mentioning that the average annual return over the last 10 years for the S&P 500 is +12.73% (ending 12/31/22).
This is well above average for those still dwelling on the last 12 months.
But the past is the past and most people are much more curious about what the future.
While I have a general disdain for forecasting...
...I believe understanding where we stand in the market cycle can help us think through the probabilities of what the next few years may look like.
And that's what I'd like to do today.
One tool we can use to evaluate the current market environment is a set of six questions Howard Marks shares in his book, The Most Important Thing.
I'll briefly address each one to see what it might mean for the future:
1. Are investors optimistic or pessimistic?
According to the AAII Bull-Bear spread, we've now experienced 41 consecutive weeks of bears outnumbering bulls.
This is the longest streak since the start of their survey. Pessimism and fear have clearly been the dominant emotions for a while now.
2. Do the media talking heads say the markets should be piled into or avoided?
Talking heads continue to call this a "stock pickers market" and are encouraging investors to "exercise caution" with their portfolios.
That doesn't sound too optimistic to me.
3. Are novel investment schemes readily accepted or dismissed out of hand?
Investors in the world of crypto and cash-flow-negative tech startups have gotten destroyed over the last year.
Given that, it's safe to say that skepticism is high toward novel investing ideas at the moment.
4. Are investment offerings being treated as opportunities to get rich or possible pitfalls?
IPO proceeds were down 94% in 2022. Coupled with the note above, the allure of easy money appears to be behind us.
5. Has the credit cycle rendered capital readily available or impossible to obtain?
Interest rates have risen significantly, and loan underwriting is increasingly stringent.
6. Are Price/Earnings (P/E) ratios high or low in the context of history, and are yield spreads tight or generous?
P/E ratios are right at their 25-year average, so there's nothing bubbly about valuations. However, yield spreads are currently negative, which I would argue is a point of caution here.
💡 What is the Price-to-Earnings (P/E) Ratio? The P/E ratio is a formula to measure the relative value of a company's stock. To calculate, divide the current stock price by the company's earnings per share (EPS). Or, type the ticker into a website like Yahoo! Finance and they will provide it. |
To be clear, nothing can tell us what will happen next.
However, we can at least make some inferences about the near future based on where we are today.
First, I agree with the consensus that we remain at the mercy of inflation and the Fed in the near-term.
But as we look at the years ahead, much of the excesses that typically drag markets down appear to be behind us.
That it is certainly a positive.
In addition, we have historic pessimism...
...and we know that the more pessimistic people are, the more pessimism must already be priced in.
Another positive for future returns!
It's counterintuitive, but John Templeton was clear that pessimism is the starting point for good returns when he said:
Given the notes above, I think it's clear that things are starting to look up.
Having said that, nobody knows when the tide will shift which is why maintaining the faith that the good days will return again is so important to successful investing.
📖 Read last weeks newsletter: Markets That Go Nowhere
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Stay wealthy,
Taylor Schulte, CFP®
I'm the host of the Stay Wealthy Retirement Show and founder of Define Financial, an award-winning retirement and tax planning firm. When I’m not helping people lower their tax bill, you can find me traveling with my wife and kids, searching for the next best carne asada burrito, or trying to master Adam Scott’s golf swing.
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