Market momentum now seems to outweigh simple math in the minds of most investors, and we are not entirely immune. Today our tactical funds are positioned with net equity exposure of 50%, the midpoint of the normal 30-70% range. That’s a higher allocation than if we considered only business cycle dynamics and equity valuations.
It’s no surprise that U.S. Large Caps were the #1 asset class performer in 2019. We were surprised that last year was the only one of the decade in which the S&P 500 won the annual performance derby. Here we review the annual performance of “Bridesmaid” asset class and sector, “Perfect Foresight,” and Lowest P/E sector.
With 2020 representing The Leuthold Group’s 40th year of publishing Perception For The Professional, we perused the first few Green Books for relevant nuggets from 1981, but the backdrop could not have been more different. Therefore, we instead turned the clock back 20 years, thinking it might yield insights more resonant with today’s environment.
An occasional critique of our valuation work is that we consider “too much” market history to form a judgment as to what constitutes “high” or “low.” This type of feedback declined during and after the financial crisis (when historic valuation thresholds were temporarily revisited), but it has become more pointed as the U.S. market has soared to new highs.
The relative domination of Mega Caps might leave the impression that valuation of the “typical” (or median) Large Cap stock is reasonable. It’s not. The fall rally leaves all major valuation ratios for the median S&P 500 stock in the top decile of the 30-year history, and above the levels prevailing at the September 2018 market high.
The bull market took out another old record last month when the S&P 500 topped the cumulative total return of the 1949-56 upswing. The total return since March 9, 2009, is now 468%. Since the highs of March 2000, the S&P 500 cumulative total return is actually a few basis points behind U.S. 10-year Treasury bonds.
With promised breakthroughs on Brexit and the trade war miraculously occurring on the same day, few pundits now believe the market is anywhere close to an important peak. (A peak in the S&P 500, that is, since peaks occurred long ago in the ACWI, MSCI Emerging Markets, NYSE Composite, Value Line Arithmetic, S&P MidCap 400, and the Russell 2000.)
On October 3rd, the S&P 500 briefly traded below the high it made in January 2018 before reversing to close the day higher.
A recent theme in our valuation work is that we no longer need to assume a full-blown “reversion to the mean” to illustrate current U.S. stock market risks: Even a reversion to “old” bull market highs in ratios like S&P 500 Price/Sales, Price/Cash Flow, and Normalized P/E would result in bear-sized losses.
We thought Jerome Powell’s “Christmas Capitulation” would be tough to beat, but he accomplished that two days ago with what could be called his “Spring Surrender.” That, in turn, has rekindled hopes of a stock market melt-up along the lines of 1998-99, which, as old-timers will remember, followed a late-cycle correction that was nearly identical to the one seen last year.
With all the excitement over the Fed’s shift in rhetoric and the excellent subsequent market action, there’s a danger of losing sight of the broader cyclical backdrop for U.S. stocks. Remember, the economy is still operating beyond government estimates of its full-employment potential, and it’s not as if the Fed has actually eased policy—as it did successfully at a similar late-cycle juncture in the fall of 1998 and (ultimately unsuccessfully) in the summer of 2007.
In late January we speculated how long it would take for the S&P 500’s bloated valuations to reach more reasonable levels. The S&P 500 now trades back where it was in January and the seven-month break included some of the best growth rates most have ever seen. We found ourselves asking: Did chubby Mr. Market shed any pounds as he pedaled away on his stationary bike?