Luxury Goods

Is the market expensive now?

Superyacht “Eclipse.” Photo: Moshi Anahory. Source: Wikipedia

The stock market has been on a run. Since October of this year the stock market has hit a succession of new highs. A lot of folks look at this market and say that that the market is pricey. When you divide the market’s valuation by the last 12 months’ worth of earnings, the aggregate price-earnings ratio – currently 23 times earnings – is higher right now than it has been 87% of the time since 1936.

Source: Morningstar, 361 Capital

But the valuation is a terrible timing tool. If you avoided investing in the stock market when valuations had spiked, you would have missed out on some of the greatest bull runs ever. What’s more, comparing the current level of earnings to something recorded 80 years ago is foolish. Accounting rules have changed dramatically. Foreign currency transactions, construction work-in-progress, stock options, and countless other items are now included in a company’s earnings. It’s anachronistic to put our current measure of earnings into the same denominator as those from 20, 40, or 80 years ago.

You might as well say that bread is cheap now because in 1930 a loaf cost 4.5 times what a chocolate bar cost, and now a loaf costs twice as much as the candy. But a lot of things have changed – the size of the loaf, the size of the chocolate bar, and the ingredients of both the loaf and the chocolate.

Photo Evan-Amos. Source: Wikipedia

Right now, valuation measures are high because we are coming out of a 6-quarter long earnings recession. In fact, this may be the longest earnings recession ever that hasn’t led to a general downturn. But remember: the definition of earnings has changed. So, unless you can go back and re-state 80-years of history, maybe this has happened before.

I’m not saying looking at ratios is meaningless. You just have to be aware of what’s different. Accounting standards have changed. Human nature – and the desire by managers to look good – hasn’t.

Douglas R. Tengdin, CFA

By | 2017-07-17T12:21:29+00:00 February 14th, 2017|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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