How a $17 Trillion Bull Market Falls Short Relative to Past

Since the depths of the financial crisis, American investors have seen the value of their stocks balloon by $17 trillion as earnings rose 15-fold.

Doug Ramsey has a word for that: abysmal.

The chief investment officer of Leuthold Group LLC says profits in the Standard & Poor’s 500 Index should be 32 percent higher based on growth rates since the Great Depression. The same could also be said for stocks, where gains of 21 percent a year since 2009 still leave an index of total return 8 percent below a historical trend line calculated by Ned Davis Research since 1925.

The underperformance shows either a fundamental flaw in the economy or how much is left to go in the bull market, depending on whom you ask. To skeptics like Ramsey, $2 trillion of share buybacks and record-low interest rates should have done more to elevate corporate profits.

“You have done all this stuff to get to an earnings number that is still short of where you should be,” said Ramsey, who oversees $1.6 billion in Minneapolis. Profit “margins are spectacular, but the actual nominal rate of per-share growth is not that impressive,” he said.

In the bull camp is Jeremy Siegel, the Wharton School finance professor who published “Stocks for the Long Run” in 1994. He says investors should be glad that a 213 percent rally can still be described as underwhelming and warns that anyone who bails out now is taking a risk.

“In March 2009, we were at the worst bear market in 75 years -- you can’t say that because the market has gone up from that low, it’s necessarily overvalued,” Siegel said. “The market has the ability, if it has a few bad years, to catch up with a few good years.”

Nothing Abnormal

One thing Ramsey and Siegel agree on: the steepness of the rally since 2009 is nothing out of the ordinary.

For all the frenetic gains since 2009, returns in the S&P 500 are just now getting back to the historical averages when looked at over the long haul. They’re a little under 10 percent a year when measured from starting points 10, 20 or 25 years ago, data compiled by Bloomberg show.

The S&P 500 slipped 0.4 percent at 4 p.m. in New York, with equities falling from all-time highs.

To Ramsey, an early bull who has cut stock holdings from Leuthold’s tactical fund in the past year, the issue is the opposite of overheating. It’s that earnings that fueled the bull market are stalling too soon.

Since the financial crisis, earnings in the S&P 500 have gone from $6.86 a share in the 12 months ending March 2009 to $102.31, a gain of about 57 percent a year. Using the average growth rate from 1937 to 2007, Ramsey estimates they should be closer to $134.56 a share, and there’s no reason to think they’ll get there with profit margins already at record highs.

Corporate Maneuvers

“You’ve had all these machinations between minimizing tax liability, keeping interest expenses down and dramatically shrinking the share base to get to this trailing 12-month reported earnings number of $102,” he said. “Yet despite all those maneuvers, you’re still short of where we should be.”

Even if profit growth is falling short of its potential, there’s nothing in conventional valuation measures such as price-earnings ratios to suggest stocks are about to plunge, according to Siegel.

At 20.7 times annual profits, the S&P 500 trades above its historical average of 17.1 since 1936. But it’s lower than its average level of 24.9 since 1990 and 21.3 since 1980, data compiled by Bloomberg and S&P Dow Jones Indices show.

“People just look at the last five, six years and think it’s been a big rally, and that has to make it overvalued, but that’s the wrong way to look at it,” Siegel said. “This is a correction from the most severe bear market in 75 years and a tremendous undervaluation. The price-to-earnings ratio is not appreciably above its long term average.”

Consistent Gains

Stocks advance at a consistent rate because so does the economy, said Dan Miller, director of equities at GW&K Investment Management in Boston. U.S. gross domestic product has expanded 6.6 percent a year since 1946, while S&P 500 earnings have climbed at an annualized 7 percent, according to data compiled by Bloomberg and S&P.

While profit growth for S&P 500 companies will slow to 1.2 percent in 2015, tempered by sinking oil and a stronger dollar, the pace will rise to more than 10 percent in the next two years, according to analyst estimates compiled by Bloomberg.

GDP will expand at least 2.7 percent a year through 2017, economists’ projections show. That’s up from the average rate of 2.2 percent since 2009, the weakest recovery from any recessions since World War II.

“I look at U.S. stocks as very fully priced,” said Robert Arnott, the chairman of Research Affiliates in Newport Beach, California, and a pioneer in the field of fundamental indexing. About $170 billion is managed using his firm’s investment strategies. “Do I view them immediately vulnerable and dangerous? No. I view them dangerous for long-term investors.”

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