One week after I wrote a post about the S&P 500 being up 14.5% year to date, the index is now up 16.5%! As I wrote last week, this is a spectacular increase even when judged on an annual basis, and our year to date rise already puts 2013 in the top 1/3 of all years in $SPX history.
As the previous statistic would imply, at least 1/3 of all years show greater increases than we have had so far this year, so one might think that a continued rise isn’t impossible. However, if you take the market’s initial valuation into account a continued rise would be a more rare event.
Using the Shiller Cyclically Adjusted PE ratio, the market started the year at 21.9x earnings. Since 1900 there have been 33 years that the market has begun the year with a Shiller PE ratio greater than 20x. Only 7 times has it risen more than 16% in those years (using the $DJIA). All of those occurrences happened within the last 20 years, most of them in the 90’s.
Many of the older investors that I speak to who have been investing for 20+ years are some of the most bullish people that I know. It’s likely that part of the bullishness is because these investors have seen the illogical heights of valuation that securities can be pushed to in a bull market. Still, to the extent that one believes that the 90’s were an anomaly and that we have spent the last 12 years unwinding a stock market bubble, a return to higher valuation is unlikely. Within that framework it seems similarly unlikely that we will have an annual close much higher than we are today.
Source: FRED, multipl
(Note: Yes, there are plenty of flaws with the Shiller PE, but it does help smooth the effect of abnormal spikes that occur with a traditional PE ratio like in 2009 and it has been calculated back to 1900. I also realize that it’s not a perfect comparison to use CAPE and Dow, but it’s close enough)