{"id":1219,"date":"2025-01-13T12:00:53","date_gmt":"2025-01-13T12:00:53","guid":{"rendered":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/?p=1219"},"modified":"2025-01-20T19:52:48","modified_gmt":"2025-01-20T19:52:48","slug":"https-financialpost-com-investing-investors-betting-decades-more-skyhigh-profits","status":"publish","type":"post","link":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/https-financialpost-com-investing-investors-betting-decades-more-skyhigh-profits\/","title":{"rendered":"S&P500 P\/E ratios suggest investors are betting on decades more of skyhigh profits"},"content":{"rendered":"

Martin Pelletier: Historically, higher starting valuations consistently lead to lower returns<\/p><\/blockquote>\n

Markets have taken an important turn over the past week that only a few are picking up on. Anthony Crudele, former S&P pit trader and financial pundit, summed it up perfectly when\u00a0he posted<\/a>\u00a0\u201cThe market is currently in a \u2018good news is bad, and bad news is good\u2019 scenario. To me, that\u2019s a bearish environment. If the market is focusing more on rate cuts than growth, it suggests the bulls are losing steam.\u201d<\/p>\n

This is what I worry the market has turned into: one that is overly dependent on loose monetary policy to backstop growth assumptions, with the Fed pumping money into the markets and boosting companies\u2019 ability to grow. This is then used to substantiate record setting valuations. In today\u2019s environment, you have the S&P 500 dominated by tech stocks that have never before in their entire history\u00a0traded at these levels<\/a>, even during the dot-com bubble.<\/p>\n

There are those who would say that \u201cthis time is different\u201d given the quality and magnitude of the growth potential, especially from the artificial intelligence boom. This certainly has some merit. However, I think it\u2019s worth exploring things from a historical perspective whenever I hear those four famous words.<\/p>\n

In his recent memo entitled\u00a0On Bubble Watch<\/a>\u00a0famed investor Howard Marks takes a look back at his years of direct market experience. While he doesn\u2019t say there is a bubble and leaves that for us to decide, he certainly does reinforce the importance of understanding the roots of investing.<\/p>\n

\u201cIf there\u2019s a company for sale that will make $1 million next year and then shut down, how much would you pay for it? The right answer is a little less than $1 million, so that you\u2019ll have a positive return on your money,\u201d he writes.<\/p>\n

He then goes on to explain how price-to-earnings (P\/E) ratio, or multiples, value the company\u2019s worth into the future.<\/p>\n

\u201cStocks are priced at \u2018P\/E multiples\u2019 \u2014 that is, multiples of next year\u2019s earnings. Why? Because presumably they won\u2019t earn profits for just one year; they\u2019ll go on making money for many more. When you buy a stock, you buy a share of the company\u2019s earnings every year into the future. The price of the S&P 500 has averaged roughly 16 times earnings in the post-World War II period. This is typically described as meaning \u2018you\u2019re paying for 16 years of earnings.\u2019 It\u2019s actually more than that, though, because the process of discounting makes $1 of profit in the future worth less than $1 today. The current value of a company is the discounted present value of its future earnings, so a P\/E ratio of 16 means you\u2019re paying for more than 20 years of earnings (depending on the interest rate at which future earnings are discounted).\u201d<\/p>\n

Now fast forward to today and let\u2019s apply this to the world\u2019s two largest companies: Apple Inc. and Nvidia Corp. Essentially, you are currently paying for well in excess of 30 to 40 years of earnings. When looking over the next decade, I have confidence in both of these companies\u2019 ability to deliver strong earnings to creditors and investors, but I do worry about the risk of maintaining their existing multiples at the end of the decade (which has never been done before), which would have a major impact on the value of your investment.<\/p>\n

There are even pockets of exuberance where a company like Tesla Inc., the ninth largest in the world, is trading at more than 100 times earnings and a market cap representing nearly two-thirds of the entire automotive industry. Simply, ask yourself: Will two out of every three cars on the road in the next decade be a Tesla?<\/p>\n

Marks wraps it up with a bow by highlighting\u00a0a chart by JP Morgan Asset Management<\/a>. It has 324 monthly observations (27 years x 12) from 1988 through late 2014 showing the forward P\/E ratio on the S&P 500 at the time and the annualized return over the subsequent 10 years.<\/p>\n

Regardless of what some pundits will tell you, there is a very strong relationship between valuations and subsequent annualized ten-year returns. Clearly, higher starting valuations consistently lead to lower returns, and vice versa. Today\u2019s P\/E ratio is noticeably in the top decile of observations, implying that when at these levels 10-year returns have been between plus two per cent and minus two per cent. Therefore the risk of losing money gets underpriced and overpriced. Ask yourself: With history being your guide, what environment are we in today if you had to invest for the next 10 years?<\/p>\n

This is why we prefer to take an approach that at least offers some near-term downside protection, especially when the cost of doing so is inexpensive given how overly bullish everyone is. We do this through multiple strategies, including the use of portfolio diversification, options, ETFs, and structured products. As Marks once said, \u201cInvestment success doesn\u2019t come from \u2018buying good things,\u2019 but rather from \u2018buying things well.\u2019\u201d<\/p>\n

Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc., operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit\/oversight and advanced tax, estate and wealth planning. The opinions expressed are not necessarily those of Wellington-Altus.<\/em><\/p>\n

View Financial Post article<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

Martin Pelletier: Historically, higher starting valuations consistently lead to lower returns Markets have taken an important turn over the past week that only a few are picking up on. Anthony Crudele, former S&P pit trader and financial pundit, summed it up perfectly when\u00a0he posted\u00a0\u201cThe market is currently in a \u2018good news is bad, and bad […]<\/p>\n","protected":false},"author":229,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_oasis_is_in_workflow":0,"_oasis_original":0,"_oasis_task_priority":"","_exactmetrics_skip_tracking":false,"_exactmetrics_sitenote_active":false,"_exactmetrics_sitenote_note":"","_exactmetrics_sitenote_category":0,"footnotes":""},"categories":[21],"tags":[],"class_list":["post-1219","post","type-post","status-publish","format-standard","hentry","category-financial-post"],"_links":{"self":[{"href":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/wp-json\/wp\/v2\/posts\/1219","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/wp-json\/wp\/v2\/users\/229"}],"replies":[{"embeddable":true,"href":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/wp-json\/wp\/v2\/comments?post=1219"}],"version-history":[{"count":4,"href":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/wp-json\/wp\/v2\/posts\/1219\/revisions"}],"predecessor-version":[{"id":1223,"href":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/wp-json\/wp\/v2\/posts\/1219\/revisions\/1223"}],"wp:attachment":[{"href":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/wp-json\/wp\/v2\/media?parent=1219"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/wp-json\/wp\/v2\/categories?post=1219"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/advisor.wellington-altus.ca\/trivestwealthcounsel\/wp-json\/wp\/v2\/tags?post=1219"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}