Friday's unemployment numbers weren't great, but U.S. GDP
grew at an annualized rate of 3.5% in the third quarter --
the first positive growth in 12 months and an indication that
the recession ended sometime during the third quarter. There
are even some smart people who believe we will witness a
strong recovery. It's time to reexamine my (bearish)
assumptions and ask: "What would it mean for investors if we
have a blistering recovery?"
Mining history for clues
With the publication of his Q3 Commentary in
mid-October, value manager Bill Miller staked out his
position firmly in the
optimists' camp:
There have been 14 10-year periods where stock returns
have been negative, including this one. In every one of the
previous 13, the subsequent 10-year returns have exceeded
10% real, about 50% more than average, and more than double
the return of government bonds. So every time stocks have
performed poorly for 10 years, they have performed better
than average for the next 10 years, and they have beaten
bonds every time by an average of 2 to 1, yet investors
can't put money fast enough into bond funds, and continue
to redeem equity funds.
Miller is absolutely right that periods of poor stock
market returns are generally followed by ones characterized
by strong returns. If we didn't have the wealth of historical
valuation data that we do, Miller's approach of looking at
stock market returns in isolation would be entirely
defensible. Plumbing that data, however, leads to a different
conclusion.
Robust economic growth: possible. Robust stock gains:
unlikely.
Another economic bull, Jim Grant, recently wrote in
The Wall Street Journal: "Our recession ... does
bear comparison with the slump of 1981-82." Not in every
respect: The cyclically adjusted P/E (CAPE) multiple of the
S&P 500 spent that entire recession in single digits (the
CAPE is calculated based on a moving average of prior 10-year
inflation-adjusted earnings) -- leaving quite a bit of room
for the multiple to expand. By contrast, the S&P 500 is
currently valued at 19 times its cyclically adjusted earnings
-- 16% above the multiple's long-term average.
I think the argument for a robust recovery is plausible
(although I don't personally subscribe to the notion). The
trouble for equity bulls is that such strength will be sorely
needed just to support current valuations, let alone spur
further stock market gains. That holds for the broad market
and for many individual names, too. Approximately four in 10
stocks in the S&P 500 index, representing nearly a third
of its float-adjusted market value, are currently trading at
a price-to-earnings multiple above 16, including:
Float-Adjusted Market
Capitalization*
Price-to-Earnings (NTM Earnings)*
General Electric (NYSE: GE)
$153.5 billion
16.4
Cisco Systems (Nasdaq: CSCO)
$138.5 billion
18.6
Bank of America (NYSE: BAC)
$130.4 billion
32.1
Home Depot (NYSE: HD)
$42.2 billion
16.3
Caterpillar (NYSE: CAT)
$36.0 billion Continued... |