I noted in a prior blog that the Fed is likely the major factor behind the current rally. Does the Fed trump analytics over the longer term? That is a question that many of my fellow analysts and Portfolio Manager colleagues have been discussing lately.
The above charts illustrate the forward returns of the S&P 500 based on current PE ratios. The top chart illustrates 10 year average returns on that index if you start off investing (buy and hold strategy) when the PE is at certain levels. The bottom illustrates 1 year historic average returns. For example: The current forward PE ratio (consensus) is around 21. Historic performance suggests a return of a small loss to a small gain for the coming 10 year period based on the current PE. One year historic return might fall between about – 20% to + 20% in the next 12 months – which makes sense given the more random statistics that occur within a shorter history. Its only over a longer period that we can spot “tenancies”
I’m not a CFA (Craig Aucoin in our office is a CFA) and this is a Technical blog. But….From what I see, this chart might imply that the Fed can push the markets up over the next year. This, so long as it keeps the flow going. Past performance has been up to 20% gains in a year when the P/E > 21. But, that Fed-flow isn’t going to last forever. The 10-year performance chart shows poor longer termed stock market performance given current P/E valuations.
The effective outlook (if you want to use this historic study as your guide) is near “0” average returns for the SPX for the coming decade. The message that I take out of this chart is that the Fed can most certainly trump neartermed stock market returns. But it won’t be a “forever” thing. Perhaps when the Fed backs off, the coming decade will be ideal for those who trade rather than passively invest.
There are many tools beyond trend analysis that Technical Analysts use to spot forward – viewing stock market returns. One of them is sentiment, which can be a leading indicator. One such indicator I like is the Smart/ Dumb money indicator. This indicator tends to be pretty good at predicting bigger moves on the market.
In a nutshell, here is how the indicator is constructed: