Mauldin: "4 Charts Why You Should Run Away From The S&P 500"

Authored by John Mauldin via,

My friend James Montier, now at GMO, and his associate Matt Kadnar have written a compelling piece on why passive investors should avoid the S&P 500.

Their essay argues that the forward growth potential of the S&P 500 is significantly lower than that of other opportunities, especially emerging markets.

Let’s look at a few of their charts.

For the Next 7 Years, S&P 500 Returns Will be a Negative 3.9%

The chart above breaks the total return from the beginning of the current bull market in the S&P 500 into its four main components: increasing multiples, margin expansion, growth, and dividends.

He notes that this total return is more than double the level of long-term real return growth since 1970.

If earnings and dividends are remarkably stable (and they are), to believe that the S&P will continue delivering the wonderful returns we have experienced over the last seven years is to believe that P/Es and margins will continue to expand just as they have over the last seven years. The historical record for this assumption is quite thin, to put it kindly. It is remarkably easy to assume that the recent past should continue indefinitely, but it is an extremely dangerous assumption when it comes to asset markets. Particularly expensive ones, as the S&P 500 appears to be.

More bluntly put, the historical record supporting this assumption is non-existent. It never happened. Just saying…

The authors then describe how they build their seven-year forecasts of S&P 500 returns.

They argue that for the next seven years, returns will be a negative 3.9%. Note that GMO is not a perma-bear money-management business. Their forecasts were extremely bullish in February 2009.

They are a valuation shop, pure and simple. Investors—typically large institutions and pension funds—that are leaving Grantham’s management firm now are going to regret it. The consultants or managers who suggested that move are going to need to polish their résumés.

No Good Options Are Left

The bottom line? “The cruel reality of today’s investment opportunity set is that we believe there are no good choices from an absolute viewpoint - that is, everything is expensive (see the chart below).”

For a relative investor (following the edicts of value investing), we believe the choice is clear: Own as much international and emerging market equity as you can and as little US equity as you can. If you must own US equities, we believe Quality is very attractive relative to the market. While Quality has done well versus the US market, long international and emerging versus the US has been a painful position for the last few years, but it couldn’t be any other way. Valuation attractiveness is generally created by underperformance (in absolute and/or relative terms). As Keynes long ago noted, a valuation-driven investor is likely seen as “eccentric, unconventional, and rash in the eyes of average opinion.” [Emphasis mine.]

In absolute terms, the opportunity set is extremely challenging. However, when assets are priced for perfection as they currently are, it takes very little disappointment to lead to significant shifts in the pricing of assets. Hence, our advice (and positioning) is to hold significant amounts of dry powder, recalling the immortal advice of Winnie-the-Pooh, “Never underestimate the value of doing nothing” or, if you prefer, remember—when there is nothing to do, do nothing.

Markets appear to be governed by complacency at the current juncture. Indeed, looking at the options market, it is possible to imply the expected probability of a significant decline in asset prices. According to the Minneapolis Federal Reserve, the probability of a 25% or greater decline in US equity prices occurring over the next 12 months implied in the options market is only around 10% (see Exhibit 12). Now, we have no idea what the true likelihood of such an event is, but when faced with the third most expensive US market in history, we would suggest that 10% seems very low.

Those are wise words indeed.


The Cooler King (not verified) Huckleberry Pie Sat, 08/26/2017 - 16:16 Permalink

So basically MAULDIN is telling you (& more importantly ~ HIS CLIENTS), that the gig is up on 'stawks', & he's not gonna make you any money anymore for awhile... So the only thing left to do, I suppose is to follow MOSLEY! & whereby, if mosley was really smart ~ He'd open a fucking PIZZERIA and learn how to start fucking tossing dough in the air (& accept bitcoins for the 'pies' he sells for BITCOINS that Raffie wants to exchange)...

In reply to by Huckleberry Pie

ET (not verified) Sat, 08/26/2017 - 16:14 Permalink… and the S&P 500 are also positively correlated.Momentum chasers.When stocks crash, the cryptos will crash, too. I know way too many people who bought FANG stocks and cryptos at the same time. This is why I loaded up on gold and silver mining stocks. Unloved and undervalued.If you had a choice between four ounces of physical gold in your hand or an electronic claim to such wealth that could suddenly take a dive of more than 50% in less than a day, what would you take?A bird in the hand is worth two in the bush.

ET (not verified) Huckleberry Pie Sat, 08/26/2017 - 16:26 Permalink

In a recession there will be job lay-offs. People will need to sell their inflated assets to pay their rent and buy food. The US dollar could rise when people start hoarding cash. The US dollar could also fall when investors pivot into commodities which have been beaten down.

In reply to by Huckleberry Pie

ET (not verified) c2nnib2l Sat, 08/26/2017 - 19:25 Permalink

The ones I know are in their late 20's making close to six figures and putting money in an index fund in a 401k and also buying individual stocks like Apple.They are hardly the libertarian precious metals buyers. I have yet to hear them talk about fiat currency and fractional-reserve banking. They are momentum chasers.

In reply to by c2nnib2l

BeanusCountus Fishthatlived Sat, 08/26/2017 - 19:18 Permalink

Well said. Add in central bank buying of equities and historical charts are not exactly a comparison of the madness that is today. And the idea that "earnings" can't continue to go up is just a guess (especially with the gimmicks to manage the earnings metric that stocks trade on these days).

Anyway, actually respect these guys. Pretty good analytics. That said, a 20% pullback in today's markets would change all their future return calcs quite a bit. So my take is to sell some up here and wait for a downdraft. Note: keeping in mind the tax ramifications, which will take away anywhere from 15 to 25% of your gains if not in a retirement account.

In reply to by Fishthatlived

MoonWatcher sodbuster Sat, 08/26/2017 - 17:07 Permalink

Anyway, like I was sayin’, the S&P500 is the fruit of the sea. You can barbecue it, boil it, broil it, bake it, saute it.  There’s S&P-kabobs, S&P creole, S&P gumbo. Pan fried, deep fried, stir-fried...The central banks will never stop the printing presses, it is just to easy to make more.

In reply to by sodbuster

any_mouse Sat, 08/26/2017 - 16:40 Permalink

Think about that when you BTFD, someone is STFD.

What are the odds that you are smarter than the other side of the trade.

The markets are broken. Play in traffic to your heart's content.