We still have some way to go before asset prices normalize for the S&P 500 index, which makes up about 90% of US stock market capitalization. The CAPE and all price-to-fundamental ratios like it (e.g. Tobin’s Q, Buffett’s PE, etc.) are still high and they are all higher than their long-run averages by about the same percentage. That consistency reinforces the notion that it’s the market’s price that is the issue and not that there is something fundamentally different this time with respect to earnings, free cash flow or the replacement cost of business assets.

The CAPE is 24.90 after (last week’s) drop in the S&P 500 to 1970.89. Even if we generously assumed that real S&P earnings for the most recently available month (March 2015’s $100.57) was the proper figure to use in the denominator (as opposed to the lower real $79.13 S&P earnings over the last ten years), the S&P 500 index could still fall another 15% before the CAPE reached its long-term average (16.63). Unfortunately, no one knows when it will regress back to that level. It is impossible to predict it.

In addition, few consider that maybe the current CAPE average is too high. Both the numerator and denominator in the CAPE are adjusted for CPI inflation, so it reduces the ratio to long-run fundamental market and business activity. The CAPE averaged 14.78 from January 1881 through December 1994, which is 11% less than today’s CAPE average since 1881, largely because today’s CAPE average includes the greatest bubble in the market’s history (the dot com bubble). That suggests the S&P could fall 25% from 1970.89 even with the generous earnings figure used for the denominator.

PAR does not care about the market as a whole when it invests client funds in its Separate Account Value Investing (SAVI) strategies, so PAR is not investing as if the market were going to drop another 25%. PAR is still looking from the bottom up for SAVI  clients because that is the way to uncover opportunities that have an MOS, but there should be no surprise that there are far fewer opportunities when the CAPE is 24.9, like today, than when the CAPE is 13.3 as it was in March of 2009.

March 2009  was the last time PAR became fully invested. Most of those new positions in which PAR invested in 4Q08 and 1Q09 to become fully invested were gradually liquidated over the subsequent twelve- to eighteen-months and have largely sat in cash  since. PAR’s SAVI strategies are only a small part of PAR’s clients’ portfolios.

PAR Wealth Management also offers traditional wealth management services as a fee-only fiduciary. PAR Wealth Management is a goals-based financial adviser. Once a client’s goals are quantified and prioritized, PAR Wealth Management allocates that client’s capital to investments with qualities that match those specific goals and how a client feels about risk. Capital for short- and intermediate-term goals are generally allocated to safer, more-liquid investments. For a large percentage of a client’s long-term goal allocation, PAR Wealth Management generally chooses external managers who demonstrate an ability to capture factor premia.

Update 8-24-15: I do not want to leave the impression that the only way for the CAPE to normalize is for the S&P 500 to drop precipitously. The other way is for the denominator–earnings–to rise considerably. But, the denominator will not rise without growth in value-creating economic activity in the private sector, and that takes time. Value-creation has been stagnant since 2008 and there is little on the horizon to suggest that the private sector will turn robust. In any case, the numerator (the level of the S&P 500) would have to rise much slower than the denominator. So, either way, whether it is a numerator that falls or a denominator that rises or some combination, it portends low stock market returns over the next decade. As I have written before, invest accordingly.

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http://ngam.natixis.com/docs/265/1012/2015%20Individual%20Investor%20Survey%20white%20paper_FINAL,0.pdf

Many of the findings show that individuals are unrealistic and confused. Individual investors say they need 9.7% returns above inflation to meet their goals, which is higher than last year, although 84% said they would choose safety over performance, also higher than last year.

Among respondents, 57% said they had NO financial goals, 67% have NO financial plans, and 77% rely on gut instincts to make investment decisions. Despite this admitted lack of planning, 66% of respondents claimed strong knowledge of the income they would need in retirement: namely, 63% of pre-retirement income, which is less than the 75% to 80% that many advisers recommend.

Friends, if you would have answered the same way on any of these questions, call or email me. We can help you plan for the future. If costs are an issue, these findings show that the only thing more expensive than a financial adviser is the lack of a financial adviser.

It is no wonder that Natixis draws one clear conclusion from the survey:

One thing is clear: Now is the time to help investors set clear goals and plans, while also enhancing their knowledge and understanding of markets, investments and strategies to help them meet their goals.

ray@parwealth.com

PAR Wealth Management employs goals-based planning and asset allocation to help you define and reach your goals. PAR Wealth Management offers you access to Money Guide Pro, the top goals-based planning software for advisers and their clients, and Yodlee, a leading account aggregation tool, so that you can see all of your assets and real-time progress toward your goals with one login (marketable securities are updated real time across all accounts no matter where the assets are held).

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