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What to Expect from the US Stock Market

  • The S&P 500 has not grown in the last 14 months.
  • A fundamental and interest rate perspective show that the S&P 500 is overvalued.
  • Strategies that include stock picking, emerging markets or beaten down cyclicals might prove best.


The S&P 500 has rallied in the last two months, from the February 11 low of 1829 points to the current 2083 points. This is an increase of 13% but to understand what is going on in the markets a longer term perspective has to be taken. The S&P 500 reached its all-time high in May 2015 with 2130 points but it had already crossed 2100 points in February 2015. This means that the S&P 500 hasn’t grown in the last 14 months. If the S&P 500 does not break the all-time high level in the next 30 days, it will be the longest no growth period since the 2009 financial crisis. The previous longest no growth period was from April 2011 to June 2012.

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Figure 1: S&P 500 from 2006 to 2016. Source: Yahoo.

A halt in growth for a longer period of time could mean several things. Before analyzing those implications let’s first take a look at the market’s fundamentals.

Fundamental Perspective

The PE ratio for the S&P 500 is 22.95. This means that the earnings related returns investors can expect from stocks in the long term is 4.35%.

“Put together a portfolio of companies whose aggregate earnings march upwards over the years, and so also will the portfolio’s market value.” Warren Buffett

This return could increase if corporate earnings grow in the future but currently this is not the case. S&P 500 corporate earnings have declined by 15% since their high reached in September 2014. The decline in the corporate earnings could be one of the explanations for the halted growth of the S&P 500.

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Figure 2: S&P 500 corporate earnings for the last 10 years. Source: Shiller Yale.

When talking about market fundamentals the best person to go to is Nobel laureate and Yale University professor Robert Shiller. Shiller developed the Cyclically Adjusted Price-Earnings ratio (CAPE) which uses 10 years of Earnings Per Share (EPS) data to calculate the price earnings ratio (PE) for stocks in order to get a more accurate measure of overvalued or undervalued markets. The below figure shows the historical CAPE and long term interest rate.
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Figure 3: CAPE Price earnings ratio and long term interest rate. Source: YALE.

The current CAPE ratio is 26.24, thus at similar levels to the 2007 CAPE. The enigma factor is the low interest rate which enables liquidity and inflates assets. From a historical and fundamental perspective, the stock market is overvalued. The fundamental overvaluation increases the general risk of investing in stocks and when combined with the low interest rates the risks are even higher.

The Interest Rate Perspective

The low interest rate makes the current historically low returns from stocks seem acceptable as investors are in search for any kind of yield. The current yield on the 10-year treasury note is 1.75% which implies that investors are expecting a premium of 2.6% for investing in stocks seeing that the indirect return from earnings is 4.25%. Any increase in the relatively risk free yield on the treasury notes would strongly influence the expected return on stocks. The overview of the FOMC (Federal Open Market Committee) participants’ assessments of appropriate monetary policy indicates that more rate hikes are plausible and consequently higher rates on treasuries and also an increase in expected returns from stocks should be expected.

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Figure 4: FOMC participants’ assessments of appropriate monetary policy. Source: Federal Reserve.

The target long term interest rate of 3.5% would probably induce a 4.5% treasury yield that, when adding a stock risk premium like the current one of 2.6% would result in an expected return from stocks of 7.1%. The 7.1% expected return would translate in a PE ratio of 14.08 for stocks. With the current earnings of the S&P 500 this would imply a level of 1277.9 points or a 39% decline from current levels.  Except for the fundamental overvaluation and low interest rate influence there is another trend that makes stocks risky, the ETF trend.

Technical and Behavioral Perspective

An interesting article was recently published by Morningstar discussing the shift from actively managed funds to passively managed exchange-traded funds. 18 Morningstar 500 funds suffered outflows of at least 40% of assets under management in the trailing 12 months ended February 2016, 61 shed 25% or more, and 168 had outflows of 10% or more. On the other hand, exchange-traded funds have increased their inflows. For an investor this means that the market is becoming more passive, thus thinks less and is more prone to high diversification by buying small amounts of each component of an asset class like ETFs do. This confirms the previous analysis and makes the detachment from fundamentals and the uncorrelation of the market to the earnings decline easier to understand. As most of the investors holding ETFs are not sophisticated and might easily panic in a stronger market decline the above mentioned potential market decline of 39% due to fundamentals might be even greater due to the investors’ weak hands and forced asset sales by ETFs.


By looking at the corporate earnings investors should expect returns of about 4.35%. The potential negative influence of increased interest rates on corporate profits has not been taken into account in the above return. Any increase in the base interest rate would increase the corporate interest expense and consequently lower corporate earnings. On the other hand, a potential market decrease of 39% makes the risk/reward very unattractive for investors looking for stable long term returns from the stock market.

Seeing that the market has not grown in the last 14 months there can’t be talk about a boom or bubble that would justify the potential downside in the risk reward analysis. The best thing to do could be “Sell in May and go away” or go for the more defensive stocks that have stable dividends and can easily weather higher interest rates, market and economic downturns. The ETF strategies and the trend of investing in them creates possibilities for stock pickers. And last but not least, several markets have been strongly beaten down in the last period and might conceal some long term value. Examples of that are commodities markets, some emerging markets, or for the more risk loving investors a good strategy in this markets could be a short one, but more about that in the next newsletters.


The Case for Gold Now

Gold has had a resurgence of late. Is it because in this volatile market investors want to put their money toward something solid, or is it something else?

On the surface, yes, investors are putting money on gold because it feels safer than the current rocky seas of our global markets. Gold has always been a safe haven, and after the stock market’s awful start to the new year that has continued into February prices for the precious metal have risen by about 6%. After a few years of falling value, it appears that the downward trend has reversed and gold is gaining but is not yet at its peak, which makes now a good time to invest. And that’s just for physical gold, gold ETFs are on an uptrend as well.

However, the Fed has recently raised interest rates and there is a promise of more rate hikes coming. Gold doesn’t pay interest, which should mean now would be an unfavorable time to buy gold, but gold is defying this convention and rising anyway. Why? Because in its last meeting, the Federal Reserve articulated a less hawkish stance on a previously projected rate rise in March due in large part to the slowing in China that is dragging down the predictions for the global economy—and the U.S. economy— along with it. This vocalized a growing fear and has gold gaining to its highest price in 3 months.

But apart from market volatility and growing fear, what reason is there to buy gold? Answer: there are other things happening in the gold market that investors should be acutely aware of as they will make a dramatic impact on the future value of gold.

As I’m writing this, gold sits at roughly $1,126, but by the end of the year I believe we could see it go to $1,300 or higher, and in the years to come it is bound to become far more valuable. The following are few of the big circumstances that make gold a good bet now while prices are still relatively low.

Central Banks Are Collecting Gold

For several years now, central banks world-wide have been beefing up their holdings of gold, especially China and Russia. Of course this may be safe-haven buying, or related to diversification, but other factors make me think that there is more going on. In fact, figures from the People’s Bank of China show that they aren’t merely setting gold aside for a rainy day, they have in fact boosted their gold holdings by more than 6% since announcing in July 2015 that they have had a 57% percent jump in their gold holdings in the last 6 years and have been urging the Chinese people to buy gold, resulting in record imports.

So why are China and other countries stock-piling gold? It likely has to do with the devaluation of currencies the world over.

When the world was plunged into recession in 2008 – 2009, the Fed and other central banks around the globe stimulated economies by printing massive amounts of money. This resulted in boosted economies, certainly, but it was an incredibly risky monetary experiment, and now currencies are being devalued as a result of the money printing and central banks are collecting gold as a hedge. Central Banks are now running out of options for boosting up their economies and are reaching for tools that seem to point to a race toward devaluing paper currencies around the world that could result in an all-out currency war, as evidenced most recently by Japan’s new negative interest rate policy.

Gold has become the safe haven of choice for anyone with exposure to a weakening currency, and Michael Armbruster of Altavest said to MarketWatch that “gold’s strength is based on flight to safety from the world’s money-printing central banks.”

As countries continue to accumulate gold in huge quantities to back their currencies, it is unlikely that the price of gold will remain low for much longer.

Another Global Recession is Coming

Volatility in global markets, economic slowing world-wide, plunging oil prices, geopolitical uncertainty, and trillions of dollars of debt piling up across the globe have recently sparked a lot of speculation about the next financial crisis. Some of the biggest names in the financial world have warned of another global recession coming as early as this year, with George Soros citing a collapse in China and Jeffrey Gundlach warning that the high-yield debt market could implode. If either of those predictions become true, or worse if they both did, the world would undoubtedly find itself plunged into another recession that could very well be more harsh than the last.

On national levels, it’s undeniable that the U.S. has enormous debts, as do France, Britain and Japan, etc. One unknown event could send a nation into what Vice called a “debt death spiral” reminiscent of Greece, but on a much larger scale. The U.S. alone has accumulated over $19 trillion in national debt, and there is a $29 trillion corporate debt hangover that could prove to be a catalyst for another recession.

Should the debt bubble burst, central banks will have to develop new tools with which to boost up their economies—like the Federal Reserve’s multiple rounds of Quantitative Easing after the last financial meltdown—though a meltdown of the world’s debt bubble may be of too great a magnitude to impact an inevitable collapse. Such a crisis would see people scrambling into the gold safe haven in droves and would inevitably drive up the price of the yellow metal far higher than the $1,900 an ounce it reached in August 2011.

The World is Running Out of Mineable Gold

In the next two decades rare gold will become seriously scarce.

Goldcorp, one of the largest gold producers in the world, released a slide in 2014 that estimated peak gold production was expected in 2015. When peak gold is reached global production declines until gold prices spur producers into identifying new sources and begin mining them. While peak gold happens regularly—four times since 1900—new deposits of the precious metal are becoming increasingly less common, and the new deposits that are being found contain smaller quality quantities that are becoming increasingly harder to mine.

MarketWatch quoted Eugene King, European metals and mining analyst at Goldman Sachs, as saying “The combination of very low concentrations of metals in the Earth’s crust, and very few high-quality deposits, means some things are truly scarce.” It is an inevitability that gold producers will run out of deposits of mineable gold, the question is when. Goldman Sachs and the Visual Capitalist have both reported that it will happen within the next 20 to 30 years.

History has taught us that when gold looks like its going to hit absolute zero, producers expand their search for gold to less accessible places and technology advances to create new methods of extracting the commodity. However, the reality is still that technological advances of a certain magnitude take time, and that gold is scarce and this planet will run out of new deposits of it.

For more than 4,000 years gold has been used as a measure of wealth, and I see that as only becoming more true in the coming years and decades. While gold can be recycled and reused, the impending shortage of new gold will send prices skyrocketing if there is even gold available to buy. For those investors who invest in gold now, this will mean that their holdings will skyrocket in value. For those who don’t, this could mean that gold will become unattainable.