This year has been an incredible year for investors. The S&P 500 has a total shareholder return of 26.67% year-to-date, with the PE ratio currently at 39.64, the highest PE number in recorded history. Moreover, according to a report by Market Watch, experts are forecasting a similarly bullish 2022.
The Consensus View is Bullish
Goldman Sachs recently released a report that says that households and corporations will drive the S&P 500 to 5,100 by the end of 2022. Goldman Sachs believes that investors who believe that this 26% year-to-date return implies poor returns for 2022 are wrong. According to Goldman Sachs, since 1900, the S&P 500 has earned investors an average 12-month return of 10%, with returns averaging over 11% after 12-month gains of more than 20% and 9% after 24-month gains of more than 50%. Goldman Sachs’ position is the consensus view reflected in the emergence of retail investors, meme stocks, and #financetwitter.
The Minority View
Morgan Stanley has a different view of the markets and has told its clients not to buy U.S. stocks. The contrarian view holds that investors have underestimated the risk in the market, especially considering that the degree of overvaluation among the mega-cap companies is even greater. Although similar views were expressed in 2021, this year has been unusual given the enormous stock inflows that are unparalleled in the last 20 to 50 years. These inflows boosted markets, elevating the valuations of the best companies while keeping other names sideways. There is a chance that these overvalued companies will crash, which would panic the many inexperienced retail investors. Investors under 30 years of age have never experienced a bear market, and being in one will test their emotions in ways that they simply cannot fathom. This would lead to an even steeper selloff. One metric that supports this view is insider transactions. The most staggering conclusion from looking at the data is that we have all-time highs in insider selling, suggesting that the insider see this not as an opportunity to buy shares but to sell at a premium to less experienced investors. Even Elon Musk has recently sold off shares in Tesla. In some cases, investors have unloaded shares that they have held for decades. Other prominent insiders who have emptied shares are Charles R. Schwab, who has sold shares all year in his eponymously named brokerage; Tim Cooke of Apple; Mark Zuckerberg of Facebook parent company Meta; and Jeff Bezos of Amazon.
Suppose you ask yourself why the people who know the company most intimately are selling their shares in that company. In that case, the answer can only be that they believe that the market has reached a state of irrational exuberance and they would instead cash some chips in. In contrast, they have some control, even at the risk that the market goes even higher, because they do not believe their companies are worth what markets say they are, and they believe the valuations will collapse. As a result, the people with the least knowledge are the most bullish and aggressive in buying stocks. Over history, when insiders and experienced traders have had markedly different worldviews to less-experienced traders, the insiders and professional traders tend to be proven right. The more conservative posture of insiders is likely one reason why the US Dollar Index has been so strong this year.
In terms of PE ratios, many stocks are overvalued by about two-thirds, and that tells you the kind of decline you should expect and what it will take to get to average PE ratios. What you should know is that stocks rarely ever remain at fair value because investors tend to overreact to events. Prices do not simply revert to the mean. Instead, when prices rise or fall, investors overreact and become excessively optimistic or pessimistic, pushing valuations past fair value. So investors should think about keeping their powder dry for now and investing in assets like Series I savings bonds, or I-Bonds, which offer a 7% return and can be bought directly from the government.
According to this view, investors are allowed to invest as much as $65,000 into those instruments and hold them for 30 years, allowing you to earn a healthy interest that changes on a semiannual basis.
Predicting Stock Market Returns
The anonymous author of the Philosophical Economics blog wrote an intentionally hyperbolically titled piece, “The Single Greatest Predictor of Future Stock Market Returns,” which is one of the most insightful pieces you will read on future stock market returns. Using data from FRED, he argues that average investor allocation to equities determines future stock market returns. His argument suggests that stock markets may have lower returns going forward, so maybe rather than buying new shares, you can buy Nuna Baby essentials and keep your powder dry.
