
The S&P Sector Value Update is published each quarter after a short delay to allow any required repositioning for my clients. It is one of many factors I look at when making investment decisions, so if you are not a client, this is really intended to get you thinking about what the wealthiest, most successful investors do. It is not designed to make investment decisions in a bubble.
It is about getting away from media opinions and evaluating the market’s condition based on current and historical facts.
I survey 1 or 2 sectors or indices in any given update. I track almost 20 sectors, but only publish a couple here.

Market Valuation: The S&P 500 is Cheaper Than in 2015/2016 — July 9, 2017
Headlines and the financial media are again selling the risks posed by high valuations.
The simplest perspective on the expense of the market, and probably the broadest, is the price-to-earnings ratio.
It’s important to note that high valuations do not imply or cause bear markets – rather they imply lower expected returns. It’s like buying…CLICK HERE to keep reading…

Is the S&P 500 Over Valued? Yes. What Should You Do?
Market Valuation Update November 2015
I’ve broken this update into 2 parts. The first will just give the big picture summary for my executive type clients & subscribers and the second, below the illustrations, is a discussion of the factors involved for those interested. CLICK HERE to Keep Reading 328 words; estimated reading time is 4 minutes…

Ouch! Stock Market Earnings Just Fell 15%!! Should You Sell? Market Valuation Update: June 2015
The stock market is driven by valuation, and valuation is driven by earnings. This is how the wealthiest investors think, and they use that thinking to help them manage their investment risk. The term is “margin of safety” and it’s an important concept. Successful investors are searching for that margin of safety, whether they are small investors with a million or two, or a vast mutual fund with hundreds of billions under management. Big or small, investment success demands the same discipline.
So what return might you get if you buy the S&P 500 or Energy Sector right now? Click HERE to Keep Reading 1005 words; estimated reading time is 5 minutes…

Is the Market Too Hot, Too Cold, or Just Right? Market Valuation Update: April 2015
Do these headlines look familiar?
Is the Stock Market Rocket Out of Fuel?
Buy Stocks, More Room to Run.
Market Way Overvalued.
8-9 Years Left in Bull Market.
You are probably getting tired of seeing articles like these. I know I am. I took these from various financial media sites over the last 120 days.
Makes zero sense, right?
The reason? When the market is selling off the media usually wants opinions about how the market is under-valued. When it’s heading up, they want to hear that it’s over-valued. This sells ads and drives investor activity, which is good for the financial media and for Wall Street.
Not usually so good for the individual investor.
This series is about getting away from opinions and evaluating the market’s condition based on current and historical facts.
Let’s use the S&P 500 via it’s proxy ETF, “SPY”, offered by State Street Global Advisors.
Both the S&P 500 and SPY are market capitalization weighted, meaning the more the company is worth, the more it counts in the index. The same goes for its earnings.
For the most recent quarter (ended December 2014) earnings were about 3.1% lower than the previous quarter with trailing twelve month earnings of $19.29. This puts today’s price (April 14, 2015) of $209.50 at 10.86x PE. Trailing twelve month earnings were still rising as of quarter end, which is good. With earnings season upon us, we’ll see if that trend continues.

Historically, the average 10 year PE for SPY has been 9.7x. At $209.50 SPY is about 12% over the average valuation of the last 10 years, but still well below the valuation peaks of 2008, when interest rates were considerably higher.
Why is this important?
Valuation and average expected return are inversely related, assuming stable earnings growth, etc.. In English, this means that if you buy when the valuation is below the historical average, all things being equal, your expected return is higher, and when you buy high in the valuation range, your expected return is lower.
To determine an expected return range for the S&P 500, my firm looks at over 50 analysis models based on hard earnings and valuation data.
Here is a condensed summary of SPY’s expected return ranges on a weighted earnings basis:

I condensed this down into 5 central tendencies so it wouldn’t be an unreadable rainbow blob. Regardless, it gives a good idea of the range of possible price outcomes.
I have a preference for investing client dollars when the central tendencies suggest double digit average expected returns. Doesn’t guarantee we’ll get ’em, but why pay $1 today to get $1.03 next year when a little bit of patience and research might turn that $1 into $1.11 or maybe $1.15 instead?
Here is a table of the expected returns given average historical valuation and average historical earnings growth derived from 40 quarters of earnings and valuation data.

So, we now know that the S&P 500 is a bit over priced and that buying here may result in returns that barely keep up with inflation in the near to intermediate term.
What happens to returns if we buy at the average historical valuation?

How about if we buy just 10% below the historical average valuation?

It’s clear why valuation is an important issue when determining when to buy the market (or a sector, or a company) and when it may be wiser to seek better opportunities.
This type of valuation thinking is a major component behind the success of investors like Warren Buffett.
It’s important to understand that interest rates play a role in valuation: lower interest rates support higher valuation, and higher interest rates drive lower valuation. Given current interest rates, and the likelihood they will remain low by historical standards for some time, a 12% premium to average value does not constitute a bubble, nor does it mean the market is greatly over-valued.
But neither does it offer a strong opportunity to make money. When expected returns are in the low to mid single digits, my firm and I look for other sectors or indices that have probabilities of higher returns. All told, we cover nearly 20 sectors and indices. There are opportunities out there; you just have to know where and how to look.
I’ll have a look at the energy sector in the next Market Valuation Update as everyone seems interested in where that’s going.
Feel free to reach out via the contact form or my email if you have questions or post a comment. I block out time each week to answer emails from this site.
To smart investing,
Dak