President Trump comes back to office amid one of the most over-valued stock markets of all time, even more inflated than at President Hoover’s inauguration months before the Black Tuesday crash of 1929. See WSJ: Make America Cheap Again. The CAPE is just one of a long list of historically prescient indicators ringing alarm bells.
Of all the measures of irrational equity market pricing, the cyclically adjusted price to earnings ratio (CAPE) developed by Yale economist Robert Shiller, since it looks back a decade and adjusts for inflation. On that basis, American stocks are 83% more expensive than when Bill Clinton first took the oath of office, 145% more than when Barack Obama first did and a whopping four times Ronald Reagan’s starting point. They even are a third pricier than at the start of Trump’s own first term.
Nothing matters more to long-term equity returns over the next decade than the level of fundamental valuation at the starting point. Today, bullish high hopes meet elevated multiples that suggest negative annual returns over the next 7 years or more.
Asset manager GMO recently forecast that the return of U.S. large capitalization stocks will be negative 5.2% annually over the next seven years after inflation. It would be like putting money into a CD today and having the bank pocket almost a third of it when it matures in 2032.
With U.S. stock markets the most widely held globally, their prospects magnify downside risk for consumer and investor sentiment worldwide. For those who manage not to go down with this ship, however, the opportunity embedded on the other side of present euphoria has also rarely been greater.
…when indexes like the S&P 500 become cheaper, which they surely will, investors should look past gloomy headlines and see the glass as half full since it will mean a better rate of return.
If a rough patch for U.S. markets is what it takes for that imbalance to right itself then it would be small solace to retirees, much less to President Trump. Those still in their saving years, though, might find that it is the pause that refreshes their nest eggs.
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