We'll have more on this thesis over the next few years, assuming the lights stay on.
First though, it is almost a tautology to say that investment gains are easier if you are starting from lower rather than higher valuations. In social science terms it's all path-dependent. In math and computer modeling it's initial conditions. Hulbert skips past that point to the fuel that drives prices, money, money, money.
Mark Hulbert at MarketWatch, July 23:
Our monthly review of stock-market valuation indicators
The stock market will barely keep pace with inflation over the next decade.
That’s the implication of a valuation model based on the ratio of the S&P 500 SPX to the M2 money supply. M2, which is calculated by the Federal Reserve, is an estimate of the total money supply in the U.S. It includes cash in circulation, checking and savings accounts, and money-market funds. Higher values of the ratio are correlated with lower subsequent equity returns — and vice versa.
The accompanying chart plots the ratio since 1970, along with the S&P 500’s subsequent 10-year annualized real total return. Over the last 54 years, the ratio hit its lowest (and most bullish) level at the bear-market bottom in 1982, when it stood at 0.06. Its highest level since 1970 was registered at the top of the dot-com bubble in 2000, at 0.32.
The S&P 500/M2 ratio currently stands at 0.25, close to the bearish extreme of the historical range. Based on the historical correlations between the ratio and the stock market’s subsequent return, a ratio of 0.25 translates to an expected real total return between now and 2034 of just 0.1% annualized.
The ratio’s theoretical basis is, to put it loosely, the notion that “money makes the world go round.” More money in circulation will eventually find its way into equities, just as less will lead to a withdrawal of liquidity from the stock market. While one can object to the ratio on a number of theoretical grounds, its strong statistical foundation means it deserves to be included in the list of valuation models that are normally featured in this monthly column. The R-squared of the correlation between the ratio and the stock market’s subsequent 10-year return is a statistically significant 49% since 1970....
....MUCH MORE
Although this measure is rather mechanistic, as Hulbert notes there are other correlations that point in the same direction. Again, more to come.
