The chart below shows corporate profits as a share of GDP, with a reminder of how elevated levels relate to subsequent profit growth. I can’t emphasize enough that the issue is not what happens to profits over just the next 4 years, however. The issue is whether current profit margins are representative of what investors should expect for the next 50 years. More on that below.
Past weekly comments have presented numerous valuation models that all have a roughly 90% correlation with actual subsequent 10-year market returns, based on properly normalized earnings, forward earnings, dividends, revenues, and so forth. All provide a uniform message:
We currently estimate a negative prospective total return for the S&P 500 on all horizons of less than 7 years, with prospective nominal total returns most probably within the range of 0-3% over the coming decade. Notably, these estimates draw from the same valuation methods that – in real time – correctly warned of negative 10-year returns in 2000, defended us against the bulk of the 2007-2009 collapse, and estimated positive 10-year prospective returns in the 10-14% range in early 2009 (our stress-testing response at the time was emphatically not driven by valuation concerns). At an index level, the S&P 500 is richer than it was in 1937, 1972 and 1987. Valuations are similar to those at the 2007 peak and all but the final weeks of the 1929 peak. Index valuations are clearly less extreme than in 2000, but even so, the overvaluation of the median stock has never been greater than at present.