Mind your P's and E's -- rational expectations after 2017

Apr 25, 2018 | Jeremy Goldfarb


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Unlike mathematics where absolutes can be defined (that is, if you add 1+1, you will always get 2), determining future market performance seldom, if ever, contains any absolutes. We can draw from past instances where there was a 1, and another 1, and when we put them together, we got 2. An example is US treasuries (you will have heard this in business news of late) looking at the 2 year and the 10 year as the spread between the two narrows (that is the difference in the yield on the 2 year, and the yield on the 10 year).

 

Each time in the past when the two have flattened, and then crossed over (the yield on the 10 year becomes less than that of the 2 year), a US recession has followed. It's been a fool proof measure. But will it hold this time if in fact, it does happen? To coin Mr. Twain: " history does not often repeat itself, but it does rhyme".

 

I'd like to turn your attention to the attached paper provided to me by the good folks and Capital International. It looks at past P/E ratios and there position relative to future returns. If we go by the letter of recent history, the equity market returns we can expect for the foreseeable future are far less robust that those we have just experienced. Is that the case though?  

 

So, 1+1 will always equal 2 both today, tomorrow and any day thereafter. However, in our world, the variability of both 1's can change.....it's never that matter of fact, so make sure you adhere to your investment discipline and don't get caught up too much on what happened yesterday, or the day before.