Tuesday, January 21, 2014

Investor Letter: Is This An Equity Market Bubble

Last week we published our year end 2013 Investor Letter that reviewed highlights from the past year and more importantly our outlook for 2014. In the Investor Letter we comment on a recent report from Charles Schwab highlighting that the previous five year cumulative return of the S& P 500 Index at the end of 2012 was 9%. Just one year later, the previous five year cumulative return is a whopping 126%. Given the recent strong U.S. equity market returns, some investors are assessing whether the market has entered "bubble" territory.

We often caution investors that they should not look at historical returns alone to assess the market’s future direction. What seems obvious is to research the valuation of asset classes, sectors and/or specific companies with respect to expected future returns. We discussed this in our third quarter 2013 newsletter as we highlighted PE multiple expansion (i.e., increasing market valuation or PE) occurring from 2009 until today. One of the charts in our most current Investor Letter shows the S&P 500 P/E ratio is roughly equal to its long term average. However, a wider valuation measure takes the economic profit figure used in the calculation of GDP. This profit figure is an actual data point taken from company reported profits to the IRS. By using this valuation measure, the P/E is below its long term average.

Our specific thoughts on the year ahead can be read in our most recent commentary at the following link:
From The Blog of HORAN Capital Advisors

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