Why Nervous Investors Should Sit Tight

A trip back into history might help nervous clients stay in the market.
 
Valuations, rising rates and the aging economic expansion have made both investors and fund managers nervous. But the fact is, based on historical data, valuation measures and other indicators aren’t much use in predicting the market’s next move.
 
History shows that using valuation, interest rate trends and the length of economic expansions to make predictions is tricky, according to Sam Stovall, chief investment strategist at institutional research firm CFRA.
 
“These readings have usually been mixed at market tops, offering little guidance on sidestepping the onrush of a new bear market,” Stovall wrote in a report Monday.
 
The current economic expansion is in its 98th month—nearly three years older than the average economic expansion since 1948, Stovall said. That might normally be a cause for concern.
 
“But no one would describe today’s economy as being overheated,” he said.
 
At prior market peaks since 1948, U.S. GDP rose at an average annualized rate of 3.9 percent, a bit higher than the average 3.2 percent for the entire period. But the latest second quarter reading was just 2.6%, well below the averages, Stovall notes.
 
The yield curve, or difference between the 10-year and one-year Treasury rates) averaged 0.3 percentage points at tops versus an average 1.02 points since 1953. The current yield curve “remains encouraging at 0.98,” Stovall reports.
 
Meanwhile, the P/E on the S&P 500’s trailing 12-month reported GAAP earnings is 23.5—“a bit unnerving,” Stovall admits, compared to the average 18.1 at market tops and 16.7 overall since World War II.  But low inflation typically accompanies higher P/E ratios, and the current headline CPI of 1.7 percent hovers around historical lows.
 
Of course, when the market sells off, it’s impossible to know how low it will go or how quickly it might recover.