The Dow Jones passed 20,000 for the first time at 1.30am on Australia Day (our time) and stayed there the following day. The rally continues.
However GaveKal Research reminds us that since 1980 corporate profits have grown by an average of 7.1% per year; over the same period the stockmarket has gone up by 9% per year. But in the last 10 years the rate of profit growth has fallen to 1.5% per year, while the stockmarket has gone up by 5.7% per year.
And for the past four years, on average profits have been slightly down, while the stockmarket was up by 13.4% per year! Over the past four years, therefore, while profit have gone nowhere, the S&P 500 has risen 60%.
The reason commonly advanced for this is that long term interest rates have declined, which justifies a higher price earnings ratio. Charles Gave calls this “bizarre”: “the decline in long rates should have absolutely zero effect on the value of the stock market”, he says.
That’s because the fall in the discount rate applied to future earnings is erased—dollar for dollar—by a corresponding fall in the growth rate of corporate earnings.”
Clearly, that is not what’s been going on. The market is pricing in either substantial increases in profits, or further declines in yield, or both – a deflationary boom.
It’s a matter of valuation, and it doesn’t have much to with Donald Trump. The US market is about 20% overvalued against historical norms, and the Fed is tightening, which usually means lower valuations.
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But as Gerard Minack points out, we have been through a period of strong outperformance by the US market, mainly pre-Trump, so a reversion to mean on Wall Street doesn’t necessarily result in poor investment performances elsewhere.
In fact a period of underperformance by US equities might be due, with emerging markets – including Australia – doing better.
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