Archive for the ‘Analysis’ Category

Stock Market Top — Are We There Yet?

Tuesday, August 11th, 2015
  • The US stock market appears to be in transition toward a significant top
  • Several key market top indicators are flashing caution (but they are still mixed)
  • Greater selectivity toward higher quality and larger-capitalization is in order
  • Above average cash levels may be appropriate

The stock market is in a tender condition.  Caution and selectivity, and possibly reduced allocation to equities with above average cash, is a reasonable approach for investors, particularly those who have accumulated most of the assets they are going to accumulate in their lifetime.

Investors far from retirement, or with substantial excess assets beyond their retirement needs, can be more aggressive and weather more severe market downturns waiting for price recovery.

Investors who are relying, or may soon rely on their portfolio to support lifestyle, and who do not have excess assets, have reasons to err on the side of caution; because portfolio value declines during fixed Dollar withdrawals shorten the “life expectancy” of the portfolio.  It is important for those investors that their portfolio live at least as long as they do – to avoid the “risk of ruin”.

Market timing is not a good idea for almost everybody.  It more often than not results in long-term underperformance, as a result of getting out late and re-entering late – thus leaving performance on the table.  Most peaks and troughs are too close together in price for most people to extract value by timing.  However, in the case of infrequent major marker reversals, exiting and re-entering, even if a bit late, can result in outperformance (the DotCom crash and the 2008 crash being recent examples).

We certainly face a market decline of some sort sooner than later, but the question is whether it will be garden variety (stick to your allocation) or major (get out of the way).  So what are the typical signs of a developing major market top?   A major top tends to develop when SEVERAL of the 12 factors listed below manifest themselves and CONFIRM each other in trends within broad market indexes.  The Treasury yield curve indicators are perhaps the most powerful and most important of the indicators.

Treasury Yield Curve

  • 2-Yr Treasury Yield / 10-Yr Treasury Yield Ratio
  • 3-Mo Treasury Yield / 10-Yr Treasury Yield Ratio


  • Reported Earnings Direction
  • Forward Earnings Estimates Direction
Market Breadth
  • Cumulative Net New Highs (new highs less new lows)
  • Cumulative Net Advances (advanced less declines)
  • Cumulative Net Advancing Volume (advancing volume less declining volume)
  • % Issues Above 200-Day Average
  • % Issues With Bullish Chart Patterns
Simple Chart Conditions
  • Index Price Position vs 200-Day Average
  • 200-Day Average Recent Direction
Federal Reserve Multi-Factor Indexes
  • Z-Scores vs Total Stock Market

These factors do not call exact tops, but as more of them blink caution, and as their state becomes more severe or prolonged, the major top becomes closer or more likely.

Of course, big macro surprises and “fat tail” events can preempt all of that and disrupt a market in a major way.  There are no quantitative methods to anticipate those events.  Valuation in and of itself probably can’t be shown to predict tops —  valuation can go much higher and much longer than ever anticipated.

These 12 factors, however, provide a pretty good warning or confirmation of a major trend reversal. Here what those indicators are saying now – not calling a top, but more substantial reasons for caution.

(Click Images To Enlarge)











Let’s look at the sectors of the S&P 500, breadth indicators similar to those we used for the S&P 500 overall.

Materials and Energy are in the worst shape. Financials, Staples, Utilities and Healthcare are in the best shape.

Here are the 2105 calendar year earnings growth rate estimates for each sector and the S&P 500 index:



And, here are the estimates for 2016:



The expected reversal from negative to positive growth, particularly for energy and materials, is the major notation between 2015 and 2016

Just a quick note about possible rising interest rates

These charts show the reaction of the S&P 500 to the last three Fed Fund increase cycle.  The reaction is not consistent, and shows stocks marching to more than one drummer, not just the Fed rates.  Overall, the stock market went its own way, and tolerated rising Fed Funds rate fairly well over time (up to the point that if forced the yield curve to flatten as we saw at the beginning of this report.



For intermediate-term interest rates as expressed in the 10-year bond, stocks showed  positive correlation to interest rates (meaning stock prices rose as interest rates rose) up to a 10-year yield of about 5%.  Above 5%, stocks began to have a negative correlations (higher interest rates tended to force stocks down).  We are in the good part of that chart now.



In terms of 5-year US stock market return expectations, this chart from JP Morgan Asset Management (vertical red line and current forward P/E added by us) indicates that we should expect a lower pattern of return over the next five years than we have experienced over the last 5 or so years.  We had lower P/E ratios in years past, and this shows that the higher the current forward P/E, the lower the 5 year returns that are realized.



JP Morgan points out that the data is from 1990 to the present, and that the R-squared number indicates the portion of 5-year future returns that were explained by the forward P/E (43%) – so there are other factors that explain 57% of the future returns.


Overall, it is hard to make a strong Bullish or strong Bearish case at the moment.  However, in the net I believe a cautious approach is appropriate and prudent at this time;  with above average cash allocation, and an emphasis on large-cap, established, high quality stocks with strong business models and enduring prospects; and/or domestic large-cap fund core positions with selected domestic sector or industrial satellite positions.

There is no question that such caution could have opportunity costs, but for those at or near retirement the relative risk and return balance suggests less than a full equity allocation.

As is always the case, individual suitability varies.  It is important to manage to your objectives, limits and circumstances, not to a hypothetical investor. Think about how these market status data relate to you and your specific portfolio.


Figures 1 and 6 are from the Federal Reserve Bank of St Louis
Figures 3, 4, 8 and 9 are from FactSet Earnings Insight
Figures 10,11 and 12 are from JP Morgan Asset Management
Figures 2 and 5 are generated with

While many US large-cap stocks are effectively relevant to this letter, three specifically relevant as S&P 500 funds are: SPY, IVV and VFINX.
Similarly, various US large-cap sector funds are effectively relevant to this letter, but these are specifically relevant as S&P 500 sector ETFs: XLB, XLE, XLF, XLI, XLK, XLP, XLU, XLV, XLY, XTL

Breadth Indicators Suggest Weakening Bull

Thursday, July 30th, 2015
  • The broad market is demonstrably technically weaker than the S&P 500
  • Breadth indicators suggest the Bull market is weakening
  • 7 breadth indicators provide the clues
These charts compare breadth indicators for the NYSE composite (over 4800 securities, stocks, ETFs, CEFs and some bonds, but overwhelmingly individual stocks) with the S&P 500 large-cap stocks  These are all technical factors.  Two other big ones I will write about later are the yield curve and reported and forecasted earnings (and revenue) growth. Those are fundamental factors. 

The purpose of breadth indicators is to reveal whether more or fewer of the constituents of an index are participating in a move (whether an up or down move).   

Often the case on the upside is that few and fewer stocks (the largest ones generally) are “pulling the wagon” while  more and more of the other constituents move into their own correction or bear market – that bear markets are actually a rolling event that culminates in the largest stocks eventually capitulating and joining in.

Direction divergences between the price of an index and the breadth measures is either a prediction of, or confirmation of, a change in trend direction; and divergences between the breadth of the broadest market (NYSE) and smaller indexes (SP500) can indicate potential problems for the smaller index.


The first side-by-side is a 10-year daily comparison (NYSE on the left and SP500 on the right). 

(click image to enlarge)


The top panel in gold measures the percentage of constituents with Bullish Point & Figure charts (a classic chart type with clear objective standards for Bullish and Bearish).  This measure shows little difference in pattern and levels between NYSE an SP500 (NYSE currently at 49% and SP500 and 51%), with both weakening from a strong 70+% at the beginning of 2014.  The 50% line is the “warning” line.  70+% is overbought and less than 30% is oversold.

The next panel in red (not a breadth measure, but one indicating the degree of deviation from the 200-day trend  the “strength” of the mean reversion force) plots a horizontal line at “1” for 2 Standard deviations above the 200-day; and another at “0” for 2 standard deviations below the 200-day trend.  A horizontal line value of “0.5” is at the 200-day trend line. 

Under a normal probability curve (ignores “fat tail” risks) 95% of prices are expected to be within +/- 2 Standard deviations (only 2.5% chance of price being above or below the +1 and 0 lines).  The fact is that stocks can and do sometimes move outside those boundaries for extended periods, but the odds favor reversion toward the 200-day mean trend line outside of those bounds.  Both NYSE and SP500 are in OK territory, but note that the NYSE has been breaking below the 0.5 (trend line) multiple times and much more than the SP500 during 2015.  That is a sign of comparative weakness in the broader market.

The main panel (price in black and 200-day trend line in gold) shows the general shape of the price and the position of the price above or below the 200-day trend line.  You can see (as discussed with the standard deviations) that the NYSE has dropped below its trend line a lot more than the SP500 and is below now, whereas the SP500 is not.  That shows broader market weakness.  You can also see that the NYSE has been rather flat since mid-2014, whereas the SP500 has only been flat in 2015.  That show broader market leading weakness with the SP500 following on a delayed basis.

The bottom panel shows the record high percent shows new highs divided by the total of new highs and new lows normalized to a 100 point scale [ {New Highs / (New Highs + New Lows)} x 100 ].  The pink histogram is the daily value and the blue line is its 10-day average.  The horizontal lines are the 70%, 50% and 30% levels.  NYSE had significantly more below 50% levels in 2013 and 2014.  In 2015, NYSE dropped to about 50% a few times and the average is down to 25%, whereas the SP500 did not drop to 50% until recently and is now at 54%.  The broader market is weaker.

All this data is merely to validate the simple statement that you may have heard on Bloomberg or CNBC that a smaller and smaller number of large companies are holding up the SP500.  Not yet a big problem, but clearly a maturing Bull market.


Here are the same indicators on a 1-year daily basis.  It gives a better view of the current situation (but in light of the long-term picture in FIGURE 1).

(click image to enlarge)


The two main observations are that the NYSE 50-day average is declining steeply and is near the 200-day average; and the price is below the 50-day; whereas the SP500 50-day average is declining mildly and the price is above the average.  The broader market is weaker. The other observation is the 97% record high percent on the most recent day for the SP500 (a very powerful upsurge); and a “pretty good” upsurge at the NYSE (58%) suggesting that new buying interest came back to both indexes.


These 10-year charts show different indicators of breadth.  The top panel shows the percentage of constituents above their 200-day trend line.  The main panel shows the index price and its 200-day average.  The lower panel in red shows the cumulative Net New Highs (highs less lows).  The panel in blue shows cumulative Net Advances (advances less declines). The bottom panel shows cumulative Net Advancing Volume (advancing volume less declining volume).

(click image to enlarge)


The NYSE percent above the 200-day average is weaker than the SP500 (40% to 56%).  Levels below 30% seem to correspond to trend reversals (and an extreme low level defined the 2009 bottom).

The index moving below the 200-day average was not a good indicator with too many false signals (“whipsaws”); but when the 200-day itself turned down, it was a pretty good signal of a problem market.,

When the Net New Highs, and Net Advances, and Net Advancing Volume  (collectively the “Nets”) all exhibited a trend reversal, so did the NYSE and SP500 indexes.

FIGURE 4:       

These next charts are the same as immediately above, but are daily for 1 year.

(click image to enlarge)


The data to note is that since June, all three of the “Nets” turned down for the NYSE; but for the SP500 only Net Advancing Volume declined.  Net Advances for SP500 have been flat all year and Net New Highs are rising at a decreasing rate toward flat.  The broad market is weaker than the S&P 500.

The summation of these observations is that the broad market is tired; the S&P large-cap market is still rising, but with less participation among its constituents.  Overall, this is the sign of an aging bull market, and suggests that extra alertness, or extra cash, or both are appropriate.  It may also suggest that a bit more in select fundamentally and technically solid individual stocks at the expense of index allocations could be appropriate.

If we are lucky, this analysis is wrong and the party continues unabated.

Retirement Balanced Portfolio: Asset Super Class Performance From 1928

Monday, June 29th, 2015

Allocation all boils down to Owning, Loaning and Reserving.  Everything else is a variation on implementation of these three super classes.

Retirement portfolios need some Owning (for capital and income growth), some Loaning (for steady income and portfolio volatility dampening), and some Reserving (for dependable cash availability for withdrawals, and less reason to panic when the market is panicking).

The term “asset class” gets tossed around a lot and sometimes asset types that are merely subcategories of true asset classes are mislabeled as “asset classes”.  While the use of the term is certainly arguable, the three most basic asset classes are: (1) cash reserves, (2) loans made to others, and (3) ownership of something like stocks, real estate or commodities.  We think of them as “super classes”, because just about everything else falls under one of these as a subcategory (even derivatives).


Three specific examples of Loan, Own and Reserve are the 10-Year Treasury Bonds (Loan), the S&P 500 (Own) and 90-day Treasury Bills (Reserve).

They, like the super classes to which they belong, are substantially minimally or even negatively correlated over reasonable periods of time.

While stocks and bonds have periods of high correlation, such as in panics, where there may be a rush to cash for safety and liquidity; for the most part they react differently to different circumstances, making them good pairs, along with cash reserves in a portfolio where risk (volatility) control is an important goal.

For most asset categories really long-term data is hard to find, but for 10-year US bonds, US large-caps stocks (S&P 500 and precursors), and 90-day T-Bills; we have data back to 1928 as proxies for the Loan, Own and Reserve super classes.

Let’s see how those super classes behaved in total return, price return and income return in an annually rebalanced tax-deferred or non-taxable account from 1928 through 2014.

The portfolio we use here is 60% US large-cap stocks, 31% 10-year Treasury Bonds, and 9% of 90-day T-Bills. US large-cap stocks are the S&P500 and its precursors.

That is a specific modification of a generalized 60/40 portfolio to make room for a three bucket (9%) operating reserve for retirement accounts.  The reserve is important to create fairly high certainty of capital available for withdrawal for up to 3 years, which is helpful to avoid panic in a steep down stock or bond market.

There are very few periods where a balanced portfolio is down for more than 3 years, so the 9% 3-bucket reserve can help a retiree glide over a bear market without selling assets at fire sale prices to fund living expenses.  Selling assets at depressed prices in retirement is a good way to outlive your assets — and that is not a good thing.

In practice, the 60% in stocks would likely include different market-cap sizes, and some international in most cases; and the 31% in bonds would likely include different durations and perhaps qualities, and maybe some international; and the 9% in reserves (90-day T-Bills as proxy here) would probably consist of 3% in a money market fund (duration about 90 days),  3% in an ultra-short bond fund (duration about 1 year) and a short-term bond fund (duration about 2.5 to 3 years).

Figure 1 is a chart showing the annual total return of the 60/31/9 portfolio from 1928 (87 years), along with the three-year moving average of total return:

Figure 1: Total Return – 60 stock / 31 bonds / 9 reserve

60-31-9 total return

There were some substantial dips on an annual basis, but the 3-year average was almost always positive, and where negative was mostly only mildly so.  Except for the Great Depression where the 60/31/9 declined over 14%, the worst decline was less than 4.5%

There were only 7 years of the 3-year average that were negative, and only two periods had back-to-back negative years: 1931-1932 and 1941-1942.  Two of the 7 down years had declines of less than 0.5%.

Specifically for individual years, there were 19 out of 87 years with a negative return (21.84%) of the time.

The periods of back-to-back negative periods were:

  • 4 years from 1929-1932
  • 2 years from 1940-1941
  • 2 years from 1973-194
  • 2 years from 2001-2002

The traditional 60/40 fund uses the S&P 500 index and the Aggregate Bond index.  That fund had total return less than negative 22% in 2008 (ref: Vanguard Balanced Fund VBIAX), whereas this 60/31/9 portfolio illustration uses Treasury debt for both the 31 and the 9.  Since 2008 was a year of panic, Treasury debt outperformed Aggregate Bonds.  This example portfolio declined 15.56% in 2008.

Both VBIAX and this example portfolio declined more than 22% and 15% from their intra-year 2007 peak to their 2008 intra-year bottom, but this memo is only about calendar year performance.

Figure 2 is a chart showing the price return separate from the income return for the 61/31/9 allocation.

Figure 2: Price Return and Income Return – 60 stock / 31 bonds / 9 reserve

61-31-9 price and income return separately

As you might expect the income return is far less volatile and more reliable than the price return.  That is important to retirees who are drawing on their portfolios.

The brown line is the price return and the green line is the income return.  The dashed black line is the 4% return level that relates to the 4% rule of thumb for retirement withdrawals.

While total return had 19 negative years of 87, price return had 29  (33.33% of the time).  It was the income return that saved the portfolio from the 10 extra negative years.

The specific back-to-back negative price return periods were:

  • 4 years from 1929-1932
  • 3 years from 1939-1941
  • 3 years from 1946-1948
  • 2 years from 1973-1974
  • 2 years from 1977-1978
  • 3 years from 2000-2002

With regard to the 9% 3-bucket reserve, individual bonds are probably not a practical alternative for most retirees for a variety of reasons. Here are three low-cost Vanguard funds that could probably fulfill the objectives and uses of the 9% reserve.

9 pct reserve bucket



US Stocks Bullish Breadth By Market-Cap

Thursday, June 25th, 2015

There are different ways to measure breadth in markets.

One common approach is to measure the percent of stocks in an index above the 50-day average and above the 200-day average.  However, that does not tell you what the averages themselves are doing.

While we recognize the importance of the 50-day and 200-day averages, we also like to look at the 3-month (63-day) and 1-year (252-day) averages; and also to note the direction of those averages at their tip (are they up or turning up).


This table compares the breadth of the S&P 500 large-caps, S&P 400 mid-caps, and S&P 600 small-caps using the 3-month and 1-year averages, and a determination of the direction of the last 10-days of those averages.

By these breadth indicators, it looks like small-caps are stronger than the mid-caps, and that the mid-caps are stronger than the large-caps.

Convention says that as an overall market deteriorates, the small-caps lose breadth before the mid-caps, and that the large-caps are the last to fade.

That has not always been the case (such as in the 2000 dot-com crash), but is often the case.  If that conventional wisdom holds in this case, the market it not ready to roll over, because the small-caps and mid-caps have better breadth than the large-caps.

On the other hand, for all three market-caps, the breadth indicators are not particularly strong in the high 40’s to mid 60’s.

Using the more conventional 50-day and 200-day approach, the deterioration in the breath for all three market-caps plus the mega-cap S&P 100, gives a reasonably assuring picture.  The breadth has been stronger, but the markets are not yet in trouble with breadth indicators.

% Above 200-day (S&P 100, 500, 400 and 600) 10 years monthly

200 breath

% Above 50-day (S&P 100, 500, 400 and 600) 10 years monthly

50 breadth


US Sector Asset Flows vs Total Returns – Following The Money

Thursday, April 23rd, 2015
  • Energy and Healthcare have strongest relative asset flows among stock sectors
  • Energy sector appears to be in accumulation stage
  • Healthcare marches on
  • Info Technology shows above average asset flow strength, but less than Energy and Healthcare
  • Utilities sector may be in distribution stage

Asset flows can be indicators of developing strength or weakness of a fund, which sometimes confirms price movements and sometimes diverges from prices. If asset flows diverge from price patterns, there is a suggestion of a trend reversal in the prices.  While not diagnostic alone, divergence between price patterns and asset flow, should trigger further investigation of fundamental and technical factors. Let’s look at relative asset flows for MSCI US sectors as they have been realized through Vanguard sector ETFs.  Those ETFs obviously do not show all sector asset flows, they do show relative flows within the Vanguard sector family.  By focusing on relative asset flows, we think the Vanguard ETFs provide a reasonable window. Asset flows are net of asset performance. These are the symbols for the Vanguard ETFs based on the 10 MSCI Global Industry Classification Standard “GICS” system.

Vanguard Materials ETF (VAW)
Vanguard Consumer Discretionary ETF (VCR)
Vanguard Consumer Staples ETF (VDC)
Vanguard Energy ETF (VDE)
Vanguard Financials ETF (VFH)
Vanguard Information Technology ETF (VGT)
Vanguard Health Care ETF (VHT)
Vanguard Industrials ETF (VIS)
Vanguard Telecommunication Services ETF (VOX)
Vanguard Utilities ETF (VPU)

Figure 1 illustrates the relative flows using a red, yellow, green shading method for the preriods:

  • 2012 – March 2015
  • 12 months
  • 6 months
  • 3 months
  • 1 month

Healthcare showing strong flows is not at all surprising, given the strong price performance for a considerable time.  The surprise, if any, is the strong flows into the energy sector.  It looks like investors have seen long-term value in energy and have been putting money there.  Utilities have shown the weakest flows.

Figure 1:


Figure 2 shows the relative asset flows on a monthly basis from 2012.  Energy flows were relatively average until mid-2014, when they picked up the pace to strong relative flows. The energy asset flows began improving their relative strength in April 2014, and has a strong relative flow in May 2014.  By February 2015, energy accounted for 80% of asset flows within the 10 sectors, and was 43% in March (numeric data not show in Figure 2).

Figure 2:


Figure 3 plots the rolling 3-month asset flows to the energy sector in dollar terms versus the rolling 3-month total return.  This year, the asset flows into energy are stronger than the total return would led one to expect.  This is not a divergence, but it does suggest we may be in an accumulation stage, where quieter money is moving to the sectors.

Figure 3:


Figure 4 shows the energy the trend  (200-day average) is still down, but the price is rising short-term toward a cross of the trend; but still 23% below the total US stock market (VTI), as shown in the lower panel (energy ETF divided by total US stocks ETF). Given the way crude oil seems to have formed a base in the 40s (Figure 5), the strong relative asset flows in to energy seem to be reasonable.

Figure 4:


Figure 5 shows what seems to be a forming possibly a double bottom base for oil before moving up into the 50’s.  Much to go wrong, but the turn up in energy stock prices, oil prices and strong asset flows, suggests energy is currently an attractive opportunity.

Figure 5:


Figure 6 shows the 3-month asset flows and 3-month rolling returns for the healthcare sector.  It has been the best performing sector for some time, and the asset flows show a complementary, supportive pattern.  Unless the biotech sector is bubbly and pops or deflates, healthcare is probably still a good place to have assets.

Figure 6:


Figure 7 shows the lovely price chart for healthcare. What else can be said about that — it’s lovely.

Figure 7:


Figure 8 show flows and returns for information technology. The relative flows are above average, but not as strong as for energy and healthcare (see Figure 1).  The flows appear more up-down-up-down variable than for energy and healthcare.

Figure 8:


Figure 9 shows price variation that generally corresponds with the rise and fall of the asset flows, but much more dampened that for the flows.

Figure 9:


Figure 10 shows flows and returns for utilities.   It reveals more negative flows than the other sectors we have looked at so far, which themselves are in synch with the rolling returns.

Figure 10:


Figure 11 shows a price chart for utilities that is not consistent with the recent negative asset flows.  The prices are rather flat, while the flows are negative.  Is this a distribution phase?

Figure 11:


Figures 12 and beyond show asset flows, rolling returns and price patterns for the remaining sectors, which have asset flows which are neither relatively strong or weak, included here for completeness, but not the focus of this article.

Figure 12:


Figure 13:


Figure 14:


Figure 15:


Figure 16:


Figure 17:


Figure 18:


 Figure 19:


Figure: 20


 Figure 21:


Figure 22:


Figure 23:


5-Yr Projection of Mean Reversion for S&P 500 Price, GAAP Earnings and Dividends

Monday, July 28th, 2014

One approach to seeking fair value, or simply what is most likely, over the intermediate-term to long-term is the assumption of mean reversion.  That approach basically assumes that long-term means act a bit like gravity or a magnetic attraction that pulls on prices, earnings or dividends to return to the mean growth level.

It may take a lot of patience for that approach, and if there is a permanent structural change in markets, the former mean may not continue to serve as gravitational or magnetic attraction.   On the other hand structural changes are few and far between, making mean reversion a pretty good bet more often that not.

So, lets discover the long-term means for S&P 500 prices, GAAP earnings and dividends; and then apply those means to make reasonable 5-year projections of those dimensions into the future.

Let’s use the S&P monthly data available from Professor Shiller at Yale (you can download the data for yourself to do various studies on your own).  That data begins in the 1800’s using precursors to the S&P 500, such as the Dow Industrials and other data, but we will confine our study to actual S&P 500 data from its inception in 1957 (more than 57 years of data).


The long-term compound growth rate of the price of the S&P 500 is 6.88%.  Continuing that growth curve out 5 years comes up with a future  price projection in the vicinity of 2700.  That is around 36% to 37% above the current level.



The long-term compound growth rate of the GAAP earnings for the S&P 500 is 5.90%.  Continuing that growth out 5 years comes up with a future earnings level projection in the vicinity of $115 per index share. That is around 14% above the most recent 2-month trailing earnings levels.



The long-term compound growth rate of dividends for the S&P 500 is 5.37%.  Continuing that growth out 5 years comes up with a future earnings level projection in the vicinity of $45 per index share.  That is around 20% above the most recent 12-month  trailing dividend level.



Now let’s look at the growth trends since the effective beginning of the internet era in 1995, and also use the long-term growth factors from that beginning to see where that ends up.

In 1995, HTML had been around for a few years, and eventually it included ways to add images, not just text. That image capability was added and expanded to browser capability when Mark Andreesen released the Netscape browser in November 1994.  The internet rapidly transformed from a Geeky academic and military technology, to a personal and commercial technology.  It has been disruptive and transformative in business and for stocks ever since.

Keep in mind that if January of 1995 was particularly high or low relative to fair value, the projection would be comparably high or low.  For reference and to make your own judgment about that, here are the multiples at as of December 30, 1994:

  • GAAP earnings yield 5.95% (P/E ratio 18.81)
  • Dividend yield 2.90%
  • Moody’s long-term Baa corporate bonds 9.1%
  • 30-yr Treasuries 7.89%
  • 10-yr Treasuries 7.81%
  • 5-year Treasuries 7.81%
  • 2-yr Treasures 7.69%
  • 3-mo Treasuries 5.6%

The yield curve was essentially flat, while today it is steep. and the Fed was not such an intrusive player.


These charts have two 5-year projections.  The black dotted plot is a simple exponential trendline on the data from the beginning of 1995 projected out 5 years.  The red solid line is a projection from the beginning of 1995 at the long-term growth rate of the price of the S&P 500.

The exponential trend line is heavily influenced by the extremes of the dot-com bubble, while the long-term growth rate projection is impacted by the degree of “normalcy” of the starting point multiple.

The exponential projection suggests there is little if any price growth in the 5-year future of the S&P 500.  The long-term growth rate applied to the internet era suggests a price level 5 years out in the vicinity of 2900, or about 31% to 32% cumulative price change over the next 5 years.

At a minimum, the explosive growth of the past few years driven by both earnings recovery from the deep 2008 crisis, and by P/E multiple expansion.  Those forces are behind us, not in front of us.


There are many optimists among the analyst community, and there are long-term optimists who expect a correction, but there is a much more limited number of outright long-term pessimists.

Two prominent pessimists are Bill Gross of PIMCO and Jeremy Grantham of GMO.

  • PIMCO, as you may know, is predicting stock price appreciation in the 3% to 5% range over the next several years.
  • GMO is another important voice expressing concerns. Their quarterly asset class 7-year forecast is for negative 1.7% rate of return for US large-cap stocks (essentially the S&P 500), negative 5.2% return for small-cap stocks (essentially the Russell 2000), and positive 2.8% for high quality stocks. They see positive 3.6% returns for emerging market stocks,

As to High Quality Stocks, we suspect for the most part GMO was thinking about large-cap stocks that have not participated fully in this momentum market, and which are particularly strong otherwise – such as with consistent but modest revenue and dividend growth, low leverage and strong Balance Sheets, and wide business moats.  See our post of high quality stocks.)


The exponential trendline from the beginning of 1995 suggests earnings are already too high by about $10 per index share ($100 versus a 5-year projection of about $90).  Let’s hope that is not a good forecast, because the absolute level of earning and the associated negative growth rate would probably crush the stock market.

We do have historically high profit margins, historically low corporate borrowing costs, stagnant wages, above historical earnings growth rates, above average P/E multiples, and stock market capitalization that is at an historically high ratio to US GDP.  Those are key fundamental risk factors that should be evaluated.

The long-tern earnings growth rate applied to the earnings at the beginning of 1995 projected out 5 years, suggests earnings of about $122 per index share, or about 21% above current levels.

Standard & Poor‘s forecasts 2014 GAAP earnings of $119.87 (basically the 5-yr projection level at the long-term growth rate); and $136.39 for 2015.  The 3-year period leading up to the end of 2015 would have a compound earnings growth rate of 16.39% (about 2.5 times the long-term earnings growth rate).  They may be right, but if they are way wrong, there will be major market problems.



The exponential 5-year projection for S&P 500 dividends goes to about $40 per index share (about a cumulative 7% growth).  The long-term dividend growth rate applied from the beginning of 1995 suggests a 5-year projected cumulative growth of about 22% to about $46 per index share.


On balance, we have a greater faith in the growth of dividends than in the growth of either earnings or index price.  We also share GMO’s prediction that high quality stocks will do better over the next few years than large-caps in general.  Additionally, our client basis is at or near the end of the accumulation stage of their financial lives, where assets cannot be replaced easily or at all from new wages or business profits.  That means asset preservation is key, further pushing us in the direction of dividend and high quality bias within the stocks allocation, along with some amount of allocation to partially market neutral assets, such as long/short funds or positions.