“I think the one bear case that I hear a lot that I want to try to debunk is just the idea that the market is too expensive.”
– Savita Subramanian, Bank of America Equity Strategist
In last month’s article, we marveled at the amazing track record of the U.S. equity market to produce growth of dividends and investor cash flow. This month, we debunk the common argument that the stock market should be measured by valuation statistics from the past.
Great Investors Understand True Value
Last Chance to Register for April 25th!
We have been publishing our “Great Investors” article series for over 10 years now, and it has consistently been our most popular content every year. We thank our loyal readers, and we truly appreciate your comments and feedback over the years.
As you know, we have changed the format for this series from a monthly written commentary to a quarterly livestream webinar format. We will deliver a brief talk, summarizing our outlook on current events and presenting in the same style you have come to appreciate in our monthly article series. We will then have ample time for Q&A and discussion, in order to address any additional questions you may have.
Our next webinar will be held on Thursday, April 25th, and will be available via online livestream, and in person for those who can attend. For those who attend in person, our talk will be followed by a cocktail reception. We will also make a recording available for those who cannot attend at the scheduled time.
To register to attend or to request your copy of the recording, please see the registration link here.
Valuing the Equity Market
Regular readers of this article series know quite well how we feel about the financial media: It is our opinion that most of what you see on the financial news can be hazardous to your wealth. However, once in a while there is a flash of brilliance that arises out of the fray of the 24/7 media chatter.
Take, for instance, a segment that aired on the CNBC network on February 28th of this year, when a strategist from Bank of America named Savita Subramanian said the following:
“I think the one bear case that I hear a lot that I want to try to debunk is just the idea that the market is too expensive. Folks will take today’s S&P and compare it to 10 years ago, 20 years ago, 30 years ago, 40 years ago. I don’t think that makes sense because the market today is such a different animal…The S&P 500 is half as levered, is higher quality and has lower earnings volatility than prior decades. The Index gradually shifted from 70% asset-intensive manufacturing, financials, and real estate companies in 1980 to 50% asset-light tech and healthcare.”
Equity market pessimists frequently like to proclaim that the equity market is too expensive, particularly at times when markets are hitting new highs, as they are now. Typically, this argument is backed up by historical valuation statistics that “prove” stocks are overvalued compared to their historical normal valuation levels.
For example, a simple internet search yields an article in Investors Business Daily that is headlined:
Investors Ignore Screaming Alarm Saying The S&P 500 Is Overvalued
The financial media always seems to suggest that there is some kind of “screaming alarm” that investors are ignoring. In this case, the danger appears to be that investors don’t realize that stock market “PE Ratios” are too high. According to this article, the S&P 500 is currently trading at a level of roughly 20 times forecasted profits for this year, which is above the 10-year historical PE Ratio of 17.7, and much higher than the 25-year average of 16.4. Based on these numbers, the argument is that the market is dramatically overvalued and poised for a big crash.
The point that Ms. Subramanian makes so elegantly is that this kind of argument has one very critical flaw: The U.S. economy of today is not like it used to be over the last 25 years. It is better, and therefore more valuable. The companies in the S&P 500 index have shifted dramatically over the last 25 years, as highly leveraged and asset-rich companies have yielded to a new generation of low-leverage, asset-light, nimble companies in the technology and healthcare industries. The S&P 500 thus deserves a higher valuation, because it is composed of more innovative, faster-growing companies.
This is what the U.S. economy has done for generations. It is constantly innovating, constantly getting better, and constantly creating value and wealth.
Helping Those You Care About
Over the last two years, the faith of all long-term investors has been severely tested. As must happen every few years, we were basically required to do just one big thing: reject the idea that “This time it’s different,” and hew to the belief that “This too shall pass.” We must not doubt that we’ll get many additional opportunities to practice patience and discipline in the years to come.
Successful investing, while always fundamentally simple, will never be easy. You may have a family member, colleague or friend who perhaps did not fare as well during the 2022-23 bear market, and who you feel might have benefited from the sort of advice you were receiving. Should that be the case, we would certainly appreciate your introducing us to them. We very much enjoy working with you and would welcome the opportunity to offer the same level of planning and service to the people you care about.
You are more than welcome to bring a friend or family member to our event on April 25th, or to share the recording of our discussion that night.