2024 Q2 Market and Economic Update

The S&P 500 (as measured by SPY) returned 15.21% in the first half of the year. This would be an excellent full-year return.  It’s always good to look at what drives a return.  Strong earnings growth that is sustainable demonstrates that actual value has been created by the companies in the index, while an increase in the valuation investors are willing to pay today for future earnings merely pulls forward future returns into the current period.  It may seem quaint that I am discussing valuation today, as the people who have made the most money recently seem to be those unburdened by such concerns.  Or as John Hussman said, “There is no question that investors increasingly disregard valuations during speculative episodes, to the point where valuations are typically dismissed altogether by the peak of a bubble, in preference for passive, price-insensitive speculation (one dare not call it “investing.”) The unfortunate consequence is that market participants come to completely forget the arithmetic that links valuations, cash flows, and actual subsequent returns.”[1]  It is simple math that the return on investment is linked to the price paid.

My favorite valuation metric is the Shiller PE, which measures the price of the index divided by long-term trends. It increased from 31.7x at the end of last year to 36.3x at the end of last quarter – a 15.1% increase. Based on this, 99% of the return in the first half was driven by valuation increasing, and 1% by the underlying companies producing value. The 36.3x multiple is 68% above its fifty-year average, and 38% above its twenty-year average. For historical reference, prior peaks were 29.1x in September 1929, 45.5x in April 2000, and 39.6x in 12/21. To get back to average, the S&P would have to immediately lose 41%, or grow sustainable ongoing earnings by 68%. To get back to the 1982 low, it would have to lose 81%. This is not a prediction, but it does explain why investors have enjoyed such incredible returns for the last fifteen years

Keep reading the Outlook here: 2024 Q2 Market and Economic Update.pdf

[1] (Hussman, 2024 )