March 4, 2019: Global Stock Valuation Update

Mar 5, 2019 | All, Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

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Please note that we now list the next re-balance date on every portfolio page.

Global Stock Valuation Update

Global stock markets had a big scare in December and now they have mostly recovered, as shown in the following table: 

Major asset returns (as of 3/4/2019):
Ticker/Portfolio Name YTD
Return**		 1Yr AR 3Yr AR 5Yr AR 10Yr AR
VTI (Vanguard Total Stock Market ETF) 12.6% 6.0% 14.4% 10.0% 17.4%
VNQ (Vanguard REIT ETF) 12.3% 19.3% 7.4% 8.4% 18.3%
VEA (Vanguard FTSE Developed Markets ETF) 10.6% -3.9% 9.2% 2.7% 10.0%
VWO (Vanguard FTSE Emerging Markets ETF) 9.4% -9.3% 12.2% 4.1% 9.7%
VNQI (Vanguard Global ex-US Real Estate ETF) 8.8% 0.8% 9.0% 5.4%  
BND (Vanguard Total Bond Market ETF) 1.2% 3.5% 2.0% 2.2% 3.4%

Among them, US assets (stocks and US REITs) have shown the strongest year to date returns. 

We have regularly pointed out that US stocks are extremely overvalued. Let’s take a look at their recent valuation and compare with those in other parts of the world. 

US stocks: most overvalued

The following table shows Shiller’s CAPE (Cyclically Adjusted Price Earnings, i.e. price over its trailing 10 year average earnings) of various countries, courtesy of StarCapital: 

Country/Region CAPE-10
United States 29
Developed Markets 23.9
Developed Europe 17.6
Emerging Markets 15.5

In particular, the US CAPE-10 based valuation is the most expensive. In fact, the current ratio of US CAPE-10 over its long term average stood at 1.79, meaning 79% higher than its long term average, one of the highest in its history. See Market Indicators for more details. 

However, stock valuations in other parts of the world are fairly reasonable. This is not surprising as stocks in both developed countries (in particular, Europe) and emerging markets have languished for the past 8 years. In fact, these stocks haven’t done much since 2007:

Developed countries stocks (VEA) are just barely above their high in 2007 while emerging market stocks (VWO) is just about at its level in September 2007. 

The long term US stock return trendline

The following chart, courtesy of dshort.com, shows the long term return trendline of US stocks (S&P 500 index) total returns in one and half centuries since 1870:

Here are some interesting observations: 

  • The stock total returns (real returns) highest overshoot from its trendline is in 2000: 137%. 
  • Currently, the overshoot from its trendline is 107%. S&P 500 price would be at 1331 level if it sits on its trendline right now. That would mean about 53% reduction from its Friday’s close price 2803. 
  • The overshoot from its trendline can last as long as 35 years (since 1880 to 1915). It lasted about 13 years (1995 to 2008) in its latest reversion to mean. However, it only took about 5 years or so for stocks to have a big drop (2000-2003 bear market) even though that correction was not steep enough to reach its trendline. 
  • The current overshoot cycle has been about 10 years since 2009. 
  • If the current price level is kept without going up and down, it will take about 40 years for the trendline to catch up to the current price level. Put it another way, absent of any meaningful correction, it would take 40 years for stocks to be at their normal (average) valuation level. 

To summarize, the current US stock overvaluation cycle is one of its extremes. Though in the short term, markets have been very resilient, the danger of big correction is nevertheless is very real.    

Market overview

As most companies have reported their Q4 earnings, the earnings expectation continued to come down: Factset reported that Q1 2019 earnings growth will be -3.1% (vs. last week’s expected -2.1%) and 2019 full years earnings growth 4.1% vs. 4.5% last week. Nevertheless, the short term strong momentum in stocks continued and now they are at a critical level. Again, we have no particular insights into the short term direction and thus will stay the course and manage risk accordingly. 

For more detailed asset trend scores, please refer to 360° Market Overview. 

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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