Stop shorting the market already
It seems people are getting increasingly concerned about the value of the market. We’ve had a great bull run since 2009, and I think the general consensus is that this run surely cannot continue. There’s plenty of macro fears out there, especially in regard to how governments are tinkering with the system and racking up unsustainable debt.
According to Stockopedia, the PE ratio of the market is 14.2 – a very middle-of-the-road figure. Dividend yield is 2.8%, and earnings growth is expected to be 13.8%. Now, admittedly, the growth will be analyst estimates, which tend to be systemmatically overstated. But let’s say that growth will come in at half that: 7%. So total return might be expected to be a little less than 10%. Let’s call it 5-10%. This is, as they say, better than a poke in the eye with a plastic flamingo.
OK, it’s not 20%, but then what do you seriously expect?
To put things in a little context, pub chain J D Wetherspoon (LON:JDW) released an IMS this week showing like-for-like sales up 3.7%, and total sales up 7.6%. They anticipate opening 40-50 pubs this year. And all this despite the fact that there’s apparently no future in pubs.
Analysts are expecting double-digit growth for the next 2 FYs, and it’s on a PE of 15.4.
I own some JDW – and upon reflection, I would be better off owning some racier shares. Maybe JDW will outperform the market, maybe it will underperform. But for all that, the numbers on JDW do not look frothy.
Then we have companies like supermarkets, which are on low double-digit earnings multiples, and dividend yields over 4%. No-one’s going to shoot the lights out by buying shares in them, but they still ought to provide a decent return. They look like good buys for the dividend investor.
Everyone is drawing parallels with 1999 and 2007/8; but there’s still value out there, I would suggest.
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2 comments
May I also refer you to this chart of stock market returns against interest rates: http://pragcap.com/wp-content/uploads/2013/08/Interest-Rate-SP500-081913.png
There is a clear trend of interest rates, when rising from their trough, being followed by negative stock market returns.
Hi Mark,
Don't forget that the P/E of 14.2 is forecast so would have to be revised upwards when you change your earnings growth estimate.
I think the key issue in your argument (please correct me if I'm wrong) is the use of current P/E in comparison to historical P/E's. The major unknown here is what will happen to earnings when interest rates go from current lows of 0.5% back up to 5% in a fairly rapid fashion (lower earnings => higher P/E).
Corporate profits will be affected because:
a) debt will start becoming more expensive
b) consumers will have less disposable income as interest payments start to take up a larger chunk of their earnings
c) new investment, borrowing, risk taking will slow as the risk free rate of return increases
The problem is that when interest rates rise, it won't be due to economic growth but rather it will be to moderate inflation which is starting to get higher. So in terms of interest payments rising, it's not certain that wage growth will be high enough to actually cover any significant part of this increase in interest. Government has used low interest rates to encourage people to take on debt, mostly in the form of mortgages. So maybe the interest rate rise will even trigger defaults and a crash in the UK housing market?
Please let me know your comments on the above. I'm not shorting the market but I'm contemplating which moves to play over the next year or so and this discussion is highly relevant.