Monday, July 10, 2017


Is it just me, or are the capital markets seemingly oblivious to the “warning signs” I see forming on the investment horizon? Is it the incredible heat we’re experiencing here in the desert this summer that is causing market participants to “see” refreshing oases in the near-term horizon, or are they just mirages? As the first half of calendar-year 2017 comes to an end, it’s an opportune time to review market and economic conditions as they are today, not as we wish them to be, and to try to identify “trends” that may impact our clients’ capital during the remainder of the year.

Two weeks ago, I wrote a report on the markets entitled, “Investing Through The Looking Glass” (, wherein I labored to make the point that the markets haven’t been behaving rationally in recent years, and especially this year, with its near-record low volatility.  I struggled to explain the distance traditional, reliable, “fundamental” measures of valuation had traveled from the present reality, but I’m not sure I did it as well as two pictures I’m attaching could have:
The chart above shows the past ten years of the S&P 500 Index.  “Price” on the left vertical axis is represented by the S&P 500 Index value drawn at every point in time (dark purple line), and the Index’ rolling four-quarter (annual) earnings, expressed as “EPS” (Earnings per Index Share) are measured along the right vertical axis (light blue line).
There is a thin red line that crosses horizontally from the current 12-months’ Earnings per Index Share of about $112, the same exact level those earnings were at back three and a quarter years ago in March 2014.  Since that time, while earnings have actually declined, and have still not regained their previous “high”, set back in September 2014, the Index’ value (i.e. “Price”) has continued to rise an additional +33%.
In fact, this disparity in the growth of earnings relative to the growth in actual earnings has been occurring for a while.  From July 1st, 2012, through June 30th, 2017 a period of five years, the trailing four quarter Earnings per Index Share actually reported has risen just 12%, while the Index price has risen by 80%.  That leads to this:
A little more than five years ago, the S&P 500 Index’ Price/Earnings Ratio (“P/E”) was 14.87 times annual (trailing) reported earnings, meaning investors in the S&P 500 Index were willing to pay a little less than $15 per each dollar of Index earnings delivered.  Today, the P/E is 25.65 times earnings, meaning today’s investors are paying over $25 for the same dollar of earnings.  For some longer historical perspective, from December 31st, 1988 to June 30th, 2017, a period of almost thirty-nine years, Standard & Poor’s Senior Index Analyst, Howard Silverblatt, tells us the “average” P/E Ratio over that time has been 18.78 times each dollar of Index operating earnings.  And that period included the “roaring ‘90’s” when we say P/E Ratios on the S&P 500 Index reach an astounding 32 times earnings, bringing the long term average up to that 18.78.  (Source:
As Warren Buffett once famously said, “In the short run, the stock market is a ‘voting’ machine.  But in the long run, the stock market is a ‘weighing’ machine.”  In other words, market sentiment (“Irrational Exuberance”?) may temporarily “vote” stock prices higher, but over time, the “weight” of time-tested, fundamental measures of valuation overcomes sentiment, and at the end of bull markets, overwhelms it.  I for one don’t like “over-paying” for anything, and especially not for stocks.  Buying high, and being forced to sell low, is not a great strategy.
As always, we welcome your comments.
 Jay R. Penney, CFP®, CFA®, AIF®
Chief Investment Strategist

Read the full article in the downloadable PDF »