A Valuation Warning
Jan 28th 2013 10:39AM
Updated Jan 28th 2013 11:45AM
Stocks opened slightly lower this morning, with the S&P 500 and the narrower, price-weighted Dow down 0.24% and 0.11%, respectively, as of 10:34 a.m. EST.
The week ahead
This is a heavy week with regard to earnings and economic data. More than one-fifth of the companies in the S&P 500 will release quarterly results, including six Dow components:
Friday: ExxonMobil, Chevron, Merck
The big number of the week is, of course, U.S. nonfarm payrolls, which is released on Friday morning.
On Friday, the S&P 500 closed above 1,500 for the first time since 2007. On this day in 1965, the Dow index closed above 900 for the first time, less than a year after it had broken 800. Over the next 12 months, the index managed to rise another 6%, but longer-term returns were not good: Over five years, the index declined 16%, and over 10, it lost 23%.
Is there a lesson here? Over that 10-year period, the market experienced the oil crisis and "stagflation" -- the unusual combination of slow economic growth and inflation. We were in a very different environment from today's. Still, one of the most important factors in determining stock returns was not dissimilar: valuation. On Jan. 28, 1965, the cyclically adjusted price-to-earnings ratio of the S&P 500 was 23.6; as of Friday, it stood at 22.7. That doesn't imply that investors should expect to suffer losses over the next 10 years, but current valuations are more likely to act as a drag than a tailwind on future returns.
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The article A Valuation Warning originally appeared on Fool.com.Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him @longrunreturns. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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