010203040%10 YEAR TREASURY YIELD 0.54%SHILLER CYCLICALLY
ADJUSTED P/E RATIO (CAPE RATIO)2000 DOTCOM BUBBLEJAN. 2018
1929 STOCK
MARKET BUBBLE26x0.54%... YET VALUATIONS REMAIN HIGH BY HISTORICAL STANDARDS.1900 1920 1940 1960 1980 2000 2020SOURCE: ROBERT SHILLER75%50607080%DOWNSIDE EARNINGS REVISIONS... AND EARNINGS ESTIMATES REVEAL A GRIM OUTLOOK FOR PROFITS ...DEC. 20, 2019 JAN. 10, 2020 JAN. 31 FEB. 14 MARCH 6SOURCE: REFINITIVcades, an era in which they
have been richly priced.
As always, equities
deliver returns in two
packages: dividends and
capital gains. Let’s start
with dividends. At the
recent peak, rising prices
had driven the yield to just
1.87%. The selloff has lifted
yields to almost 2.2%,
better but still below the
average of over 3% since- This year, companies
spent an amount equal to
42% of their earnings on
those dividends. So, on the
dividend front, investors
are being poorly rewarded
for their risk.
On the capital gains
side, there are three driv-
ing factors: share buy-
backs, growth in profits,
and “multiple expan-
sion,” or a rising price-
to-earnings ratio. Today,
S&P 500 companies are
spending the equivalent
of all earnings that don’t
go to dividends on buy-
backs. (They are able to
fund internal investment
through added borrowing.)If the S&P continues to
steer the cash equivalent of
more than half its profits to
repurchases, share counts
will fall by 3.0%. That
would lift earnings per
share by a like amount, so
if the P/E—the figure by
which you multiply those
earnings to get the share
price—stays at 19.6, the
S&P index will advance by
the same 3%. Hence, if the
current P/E of 19.6 holds,
you’ll get a combined 5.2%
return from dividends and
buybacks alone.But these improvements
when it comes to divi-
dends and capital gains
are minor when compared
with the abyss below.
Quarterly earnings
went flat starting in Q2
of 2018 and have barely
budged since then. With
the coronavirus likely to
hammer earnings a lot
harder than analysts are
positing, even no growth
now sounds rosy.
And profits are still 40%
above where they were
three years ago. So today’s
19-plus P/E is putting a
high valuation on what
looks like an earnings
bubble. For confirma-
tion that values are out of
whack, look at the CAPE,
or cyclically adjusted price/
earnings ratio, a measure
developed by Robert
Shiller, a Yale professor
and Nobel laureate. Shiller
adjusts the multiple by
using a 10-year average of
inflation-adjusted profits, a
methodology that smooths
the lurching swings that
make equities look cheap
when profits spike and
pricey when earnings drop.
Even after the big drop,
the Shiller P/E registers- It has never stayed at
a level that high for long,
and the only times it’s been
higher were the run-up to
the market crash in 1929
and the tech bubble of - If valuations, mea-
sured by the Shiller bench-
mark, return to normal by
2021, the S&P would fall
an additional 22%, to 2150.
One thing we can be
sure of? Reversion to the
mean is a powerful force
in the markets—and it
usually prevails.
THE BRIEFBND.W.0420.XMIT.indd 19 FINAL 3/10/2020 6:48:39 PM