Valuations are The Key to Long-Term Returns

Here is a copy of apart of a John Mauldin's Weekly Letter, entitled "A New Asset Class, Part Two", August 8 2008:

Let me offer one chart (courtesy of Vitaliy Katsenelson) from last week on this last topic, which illustrates the problem, and then we will jump into the final part of the speech. The current situation is worse than the chart depicts, because on Wednesday of this week the as-reported 12-month P/E ratio for the S&P 500 was 22.87 through the end of the second quarter. We have a LONG ways to go to revert to the mean. The only way for that to happen is for earnings to rise or for stock prices to fall, or some combination of both. Otherwise, you have to suggest we are in an era of permanently and significantly higher stock valuations. (Remember, these cycles last an average of 17 years. We are only 8 years into this one.)




Unrealistic Expectations

Valuations are important. They are the key to long-term returns. Your expected returns in any one 10-year period highly correlate with where you start investing. If you start when stocks are cheapest, you're going to compound at about 11 percent. But if you start when they're the most expensive, at an average PE of 22, you're going to compound at about 3.2 percent over the next 10 years. For the people and the pension funds that are expecting to get the 8 or 9 percent that they've got written into their returns in their equity portfolios, that's not good news. The following chart from my friends at Plexus illustrates the point. I should note that this calculation works not just on US stocks but in every market that I have seen studied. This is a fundamental principle of investing.

So, what we have is a situation where many aging Baby Boomers and the pension funds and insurance companies which are investing on their behalf are not likely to be able to get the returns they need in order to meet their obligations from traditional US equity holdings.

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Please Note!
This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer on the bottom for more information.

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