Category Archives: Asset Management

Forward P/E And 10 Year Returns

Since 1988 stocks have always produced a negative 10 year return when the Forward Price to Earnings ratio was 22 or higher. This chart says nothing about 1 year returns. Then returns are all over the place whether the Forward P/E is 12 or 22. Although you can see from the chart that positive returns are lower 1 year out compared to when the Forward P/E is lower.

This data is for the US and I have no idea what these charts would look like if you would take an index like the Nikkei 225 or a European index such as the Euro Stoxx 50 or the AEX Index.

Forward PE and 10 year returns
Forward PE and 10 year returns

If you invest on a long term basis the lower the Forward P/E for the market the better your return could be.

Forward PE and 1 year returns
Forward PE and 1 year returns

As of the end of June 2019, the Forward P/E for the S&P 500 is 16.9. This was above the average of the last 30 years. This average is skewed to the upside though because of the extreme valuations during the 2000’s Dot-com bubble in stocks.

S&P 500 Forward PE ratio
S&P 500 Forward PE ratio

Are Buybacks The Main Driver For The Rally In Stocks?

A fascinating chart I came across on Twitter. Since the financial crisis around $ 3 trillion has been flowing in to passive index funds which typically have a lower fee than active funds. But what is interesting about this is that there have been no net inflows in US stocks since the financial crisis.

All the money that has flowed into passive index funds have been offset by an outflow of actively managed funds. In fact, there is actually $350 billion less in US equity funds (both active and passive) than before the financial crisis.

Cumulative US Equity Fund Flows
Cumulative US Equity Fund Flows

At the same time the S&P 500 is up 300%. Even more when dividends are factored in.

S&P 500 from 2003 till September 2019
S&P 500 from 2003 till September 2019

So why then are stocks higher if demand from investors in funds actually down $ 350 billion over the last decade?

Buybacks

The answer could be because of demand for stocks from buybacks. Buybacks have become more popular since the financial crisis. With buybacks a company uses its own money to buy back its own shares in the market. Buybacks are popular because they are a very tax efficient way to generate shareholder value.

When a company performs a stocks buyback program the company buys back their shares on the stock market. This way the amount of outstanding shares is reduced. Remaining shareholders will share their profits with less shareholders. This should lead to an increase in the price of the remaining shares.

If a dividend is paid out a tax must be paid in this received dividend. A capital gains tax only has to be paid when the shares are sold. So during the period which an investor holds his shares no taxes have to be paid (which is different from when a dividend is paid).

S&P 500 Quarterly Buybacks
S&P 500 Quarterly Buybacks

Eurozone debt to GDP and Eurozone debt service ratios

Here is a chart depicting the the debt to GDP ratios for non-financial corporations, governments and households in the Eurozone from 2000 till 2019. The chart shows how Eurozone households have been deleveraging since 2010. European governments and corporations have started deleveraging more recent in 2015.

Eurozone debt to GDP ratios for non-financial corporations, governments and households
Eurozone debt to GDP ratios

Here is another chart showing Eurozone debt service ratios for households and non-financial corporations from 2000 till 2019. These are a GDP-weighted average of France, Germany, Italy and Spain. Helped by low rates these ratios are now as low as in 2000. No sign of excess as in 2008.

Eurozone debt service ratios for households and non-financial corporations
Eurozone GDP-weighted debt service ratios for France, Germany, Italy and Spain

Via Guide to the Markets – Europe

Yield on bonds of European companies with credit rating ‘A’ is almost at 0%

Very interesting chart via Twitter. The current yield on bonds of some European companies who have a credit rating of A is almost at zero percent (0%). Could it go negative?

 Yield on bonds of European companies with credit rating A

The S&P 500 Is Still Valued Below The Average Forward P/E Of The Last 30 Years

JP Morgan Funds Twitter account posted a nice graph on Twitter today showing that, even while the S&P is trading near an all time high, this rally could go a lot further. The S&P 500 is still trading below the average forward P/E of the last 30 years according to the graph. According to this chart the S&P 500 is fairly valued and we are not experiencing some kind of bubble. Of course earnings will need to keep growing in the future to keep justifying a higher price.

JP morgan S&P 500 forward price equity graph chart 20 years showing fair value

Capitalization Weighted vs. Equally Weighted Portfolio’s

I came across an interesting article in the Journal of Asset Management today where a comparison is made between a capitalization weighted (CW) portfolio and an equally weighted (EW) portfolio. In a CW index stocks are weighted for their market capitalization and in an EW index every stock is equally weighted. Most mutual funds use the CW approach for their investment portfolios.

“Figure 1 displays the performance of the DJEURO and the equivalent EW portfolio over the observation period. The cumulative return of the EW portfolio was 38.42 per cent compared with -4.70 per cent of the DJEURO, with a difference equal to 43.12 per cent”

Equally weighted and capitalized weighted dj euro stoxx

“Figure 2 shows the performance of the DJEURO50 index and its EW version. In this case, the cumulative returns of the EW portfolio and of the DJEURO50 index were 11.60 per cent and -16.63 per cent, respectively, showing a difference equal to 28.23 per cent.”

equally weighted and capitalization weighted dj euro stoxx 50

The reason the EW portfolio does better than the CW portfolio is because of the automatically rebalancing every quarter. The EW portfolio follows a contrarian view in that it sells overvalued stocks each quarter to rebalance the portfolio. The EW portfolio is also more diversified because it has a larger share of mid- and small cap stocks in its portfolio unlike a CW portfolio which exists for a large part out of large cap stocks.