Stocks are up, bonds are up. Hey, it doesn’t take a brain surgeon to see that 2006 is shaping up to be a pretty good year for investors. But how good is good? And what does it mean for the future?
In pursuit of an answer, or at least some perspective, we crunched the numbers and found that the past three years aren’t all that extraordinary when compared with equity performance history over the past generation. Compare the results for yourself:
The S&P 500’s total return this year is 14.1% through November 24, and the index’s three-year annualized performance is 12.0%. In both cases, that’s above the long-run average of about 10%. Does the recent run therefore offer a reason to worry? Has the market overextended itself?
Not necessarily, at least not based solely on the historical context. Looking at rolling three-year total returns for the S&P 500 through the end of October 2006 (courtesy of Morningstar’s Principia software), the latest 36-month stretch looks middling. For the three years through October 31, the S&P 500 advanced by 11.4% a year. Not bad, although it pales by the best trailing 36-month run through July 1987, which posted an astounding 33.3% annualized gain.
Looking at the opposite extreme, the three years through March 2003 rank as the greatest bloodletting since 1979, with the S&P 500 shedding an annualized 16.1%.
Based on those extremes, the S&P’s performance of late looks fairly unspectacular. Of course, statistics will tell you anything you want. With that in mind, the question is whether the recent gain looks encouraging based on the future rather than the past? By that standard, the analysis becomes more complicated.
Consider earnings and valuation. First, the rate of earnings growth for the S&P 500: it’s been stellar of late, rising 10%-15% in each of the past six quarters through this past June, according to an article in yesterday’s New York Times that cites Thomson Financial data. Even better: the S&P in this year’s third quarter is expected to post a nearly 20% rise–which would be the highest in nearly two year. But the party downshifts considerably thereafter: the outlook calls for a sharp slowdown in earnings growth as 2007 unfolds.
As for valuation, the S&P 500’s p/e is around 17, which is the lowest in years, according BullandBearWise.com. A bargain? Yes, based on recent history.
But it’s the future that counts. History is a guide, and as we see it a poor one at the moment. Looking to the recent past has rarely offered less insight about what comes next, in our view. Economic, financial and political upheaval is everywhere these days, although you wouldn’t know it by looking to Mr. Market, who appears relatively calm and comforted. That will change, perhaps soon. Meanwhile, our over weighted cash allocation continues to burn a hole in our pocket. No matter: we can stand to blaze a bit longer.