Last week was the 13th consecutive month that the employment data was better than what Wall Street economists expected. The record streak before that was only five consecutive positive surprises. In addition, the unemployment rate dropped to 3.4%, its lowest level since the early 1950s. Last week we also saw the expected earnings growth for the S&P for the first quarter improve again (though still slightly negative). Bottom line, despite the fear of a recession for some time now, the economy continues to be more resilient than most expected. Fortifying that point, the economy in the second quarter also appears to be off to a nice start, with the latest estimate for Atlanta Fed GDP now 2.7%.
Instead of looking at economic data through the rear-view mirror though, perhaps long-term investors should be looking through the windshield and considering valuations. Valuations are often the leading driver of both absolute and relative market returns. Let’s consider the current situation for the U.S. stock market with one long-term valuation measure called the CAPE Ratio. The latest reading of the CAPE Ratio is about 29x inflation-adjusted earnings. This compares to a long-term average CAPE of 17x (median 16x). Outside of the recent time period, the U.S. stock market has only been higher during the dot.com era in the last ‘90s and in 1929. This noted, valuations are much more attractive in other markets outside of the U.S. For example, according to the monthly “Starting Points Matter” chart book, international, small cap, and value stocks have significantly lower valuations, and thus should have higher expected returns. In the end, while as investors we should always expect recessions (the economy, like the markets, are cyclical), paying attention to valuations creates potential opportunities to enhance returns as Warren Buffett even noted at the annual Berkshire Hathaway meeting in Omaha this past weekend.
Stay invested. Stay diversified. Stay disciplined.