Snakes and Ladders

Well it looks like asset prices don’t always go up.  Of course I’m not surprised by this revelation but the mainstream media did seem surprised with headlines such as “Dow loses 7 million points in the session” and “Worst market performance since dinosaurs roamed the earth” but then of course they need sensationalism as they’re attention seeking.  The market action even meant that it made the first news item on the radio for a couple of days.  It could almost be 2008 again.  It would be enough to scare people off investing if they did nothing more than listen to news sound bites.

What has really happened thus far?  I say thus far because the market can of course continue to fall...  Or it might flat line...  Or it might go up again...  By my calculations this week the S&P500 has fallen 5.2%, last week it fell 3.9% and the week before that it actually gained 2.2%.  In contrast the FTSE100 this week fell 4.7%, last week fell 3.9% and the week before that fell 0.8%.

This is what has happened to a couple of single indices and makes for great news items but how has this impacted a long term investor who buys, holds and rebalances a variety of global asset classes.  I like to think I’m one of those so let’s use my real world portfolio as a comparator.  This week my wealth has decreased by 2.3%, last week it decreased by 1.5% and the week before that it decreased by 0.4%.

An Interesting Week

Source: wikipedia

Rather than a particular focus this week my brain has been a little all over the place.  Maybe it’s the after effects of too much Christmas and New Year cheer...  What it means though is that instead of a detailed focused post today what you get is a smattering of random thoughts.  If that’s not your thing then you might want to move onto your next piece of Saturday reading.

Stock Market Fun

The big boys and girls seem to have come back from their Christmas vacations and (started to?) put the markets back in their place.  On the week:

• China’s Shanghai Composite Index is down 10.0%;
• The US’s S&P500 is down 6.0%;
• Japan’s Nikkei 225 is down 7.0%;
• Our FTSE100 is down 5.3%; and
• Our FTSE250 is down 4.0%

It’s only a week of market action but I thought it might be interesting to compare that action to a diversified portfolio that has different asset classes across multiple countries.  I hope I have one of those so comparing to my portfolio I’m down 2.3% on the week.  I’m not yet at FIRE but even now in pounds, shillings and pence that is a fall of £19,320 which is more than a year’s worth of post FIRE post home purchase living expenses.

London Housing

It’s all too rare that The Investor over at the excellent Monevator has a good rant but there was some good value this week with the post they don’t tax free time.  Like The Investor I've watched the London property market go insane so this comment

“But with London prices having moved from extreme to insane to “oh, so this is what my grandmother meant when she said flinched at 50p for a bag of chips that used to cost a ha’penny”...”

was particularly amusing.  Now every year I try and assess the house value of all the counties ofEngland and Wales so I already knew it was insane and really no longer a place for anyone who isn't an oligarch or money launderer.  Hell even the bankers can’t afford it any more.  In light of this throwing this chart together this week did make me smile:

Click to enlarge, London first time buyer gross house price to earnings ratios

Does this make my first picture today relevant?

Further UK Equity Diversification

I am a disciple of Tim Hale who in my humble opinion is the investing granddaddy for UK investors.  From the emails I receive it’s rare that I can’t refer a reader to his book Smarter Investing: Simpler Decisions for Better Results for the answer to their question.  It’s a must read for anyone serious about investing from the UK.

It’s therefore probably no surprise to find out that my investing strategy is largely based around the teachings of his book (I started in 2007 and so I used the first edition as a basis).  At its most basic he starts with what he calls a Level 1 portfolio mix consisting of Level 1 UK equities and Level 1 UK bonds.  He then goes on to show how you might diversify a portion of your wealth away from these to create a portfolio for all seasons.  Importantly though no matter what your investment horizon large allocations always stay with the Level 1 building blocks.  So the question then becomes what Index should be used to represent Level 1 Equities?  As always Hale has the answer with “For your Level 1 equity allocation, the return benchmark should be the return of the whole domestic market, which provides a diversified and representative benchmark as it includes most public companies, be they large or small and weighted according to their market size... The FTSE All Share is the index of choice for the rational investor.”

I followed this guidance with no other exposure to UK Equities other than the All Share until late 2011 when I realised, that for me at least, I wanted more dividends than my strategy was forecast to give me at the end of my accumulation stage.  I therefore started to diversify a percentage away from Level UK Equities towards a UK based High Yield Portfolio (HYP).  Today that HYP contains 17 companies with 83% of them by valuation coming from the FTSE100 and 16% coming from the FTSE250.  I then continued with this strategy until I reached the point where it looked like my total portfolio would enable me to live off the dividends.  I’m fairly comfortably there now and so don’t need to keep growing my dividends at such a great rate.

Bond to Equity Allocation Percentages

So you’ve decided that you would like to try and gain some volatility versus return free lunch via some Bonds mixed in with your Equities or Equities mixed in with your Bonds.  The next million dollar question to answer is then how much of your wealth should be allocated to each asset class.  This is a critical question as it will likely have a big affect on your long term portfolio return.

Unfortunately, as with many investing questions, I'm yet to find a silver bullet but considerations will certainly include your tolerance to volatility and risk.  Assessing this tolerance is of course easier said than done.  For example if you’re naturally risk averse you might choose to load up with more bonds as history suggests they might dampen volatility at the expense of some return however this adds absolutely no value if you then have a low probability of  ever achieving your long term goal.  Conversely there is then no point loading up with more equities to then sell at the first significant equity downturn.  On top of this there could also be age considerations.  For example every year that passes gives you less time to rebuild wealth before retirement.

So what do others have to say about bond to equity allocation percentages?

The granddaddy of value investing, Benjamin Graham, in his excellent first published in 1949 revised multiple times book, The Intelligent Investor, says “We have already outlined in briefest form the portfolio policy of the defensive investor.  He should divide his funds between high-grade bonds and high-grade common stocks.  We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequent inverse range of between 75% and 25% in bonds.  There is an implication here that the standard division should be an equal one, or 50-50, between the two major investment mediums.  According to tradition the sound reason for increasing the percentage in common stocks would be the appearance of the “bargain price” levels created in a protracted bear market.  Conversely, sound procedure would call for reducing the common-stock component below 50% when in the judgement of the investor the market has become dangerously high.”

Valuing the UK Equities Market (FTSE 100) - May 2015

My investment strategy requires me to moderate my equity holdings based upon my view of current equity market values.  I run this valuation monthly for the Australian (currently targeting 15.5% of total portfolio value at current valuation vs 17% at fair value), US (as a proxy for my international equities and currently targeting 10.4% vs 15%) and UK (currently targeting 19.0% vs 20%) Equity markets.  Let’s look at the UK Equity market in more detail.

Firstly nominal values.  Between yesterday and the 1st April 2015 (“month on month”) prices are up 3.3% and since the 1st May 2014 (“year on year”) prices are also up 3.3%.

Chart of the FTSE 100 Price, Click to enlarge

Regular readers will know I’m not a fan of this type of chart as:

• the unit of measure, £’s, is being constantly devalued through inflation (although in the current market one wonders for how much longer); plus
• Pricing should be plotted on a logarithmic scale as opposed to a linear one as by using this scale percentage changes in Price appear the same.  

So let’s correct the chart for the devaluation of the £ through inflation (I use the Consumer Price Index (CPI) here) and convert to a log chart.  This normalised chart shows that Friday’s FTSE 100 Price of 7,031 is actually still 25% below the Real high of 9,331 seen in October 2000.  We’re also still 14% below the last Real cycle high of 8,164 seen in June 2007.

Chart of the Real FTSE100 Price, Click to enlarge

Valuing the UK Equities Market (FTSE 100) - February 2015

I have an investment strategy that requires me to moderate my equity holdings based upon my view of current equity market values.  I run this valuation monthly for the Australian, US and UK Equity markets.  While I run it monthly I've just realised that I haven’t shared that analysis for the UK market for 4 months now.  So without further ado let’s run the numbers for all to see.

Firstly nominal values.  Between yesterday and the 2nd February 2015 (month on month) prices are up 5% and since the 3rd February 2014 (year on year) prices are up 6.3%.

 Click to enlarge

Regular readers will know I'm not a fan of this type of chart as:

• the unit of measure, £’s, is being constantly devalued through inflation (although in the current market one wonders for how much longer); plus
• Pricing should be plotted on a logarithmic scale as opposed to a linear one as by using this scale percentage changes in Price appear the same.  

So let’s correct the chart for the devaluation of the £ through inflation (I use the Consumer Price Index (CPI) here) and convert to a log chart.  This normalised chart shows that Friday’s FTSE 100 Price of 6,874 is actually still 26% below the Real high of 9,317 seen in October 2000.  We’re also still 23% below the last Real cycle high of 8,152 seen in June 2007.  We are therefore a long way from previous highs.

Click to enlarge

Valuing the UK Stock Market (FTSE 100) - October 2014

Over the past couple of weeks the mainstream media have been getting all excited about recent share price falls.  As a group of people who are paid to write stuff I guess you could easily get excited by a graph like this:

Click to enlarge, Source: Yahoo Finance

Eyeball this short term chart and of course they’re right.  Over the past 6 or so weeks there is no denying the FTSE100 has fallen 8% or so.  Personally, as a long term investor with a mechanical investment strategy I ignore it all and simply think that markets go up and they go down.  This is more the view I’m interested in looking at:

Click to enlarge, Source: Yahoo Finance

On this scale the recent pull back is a bit of noise that means nothing more than my next share purchase is likely to be made at a better valuation than it was going to be.  Providing of course that earnings hold up.  Given I’ve now mentioned the valuation word as investors let’s today spend some time valuing the FTSE 100 over the longer term rather than wasting our time on short term price movement discussions.

Firstly let’s normalise the data by:

• Correcting the chart for the devaluation of the £ through inflation.  For this dataset I use the Consumer Price Index (CPI) to devalue the £.
• Plotting the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  

The normalised dataset shows that Friday’s FTSE 100 Price is actually still 32% below the Real high of 9,339 seen in October 2000.  We’re also now 23% below the last Real cycle high of 8,171 seen in June 2007.  We are therefore a long way from previous highs.

Click to enlarge

Valuing the UK Stock Market (FTSE 100) - June 2014

When nominal charts of the FTSE100 start looking like this:

Click to enlarge, Source: Yahoo Finance

Which are showing us being within 1% of the nominal 30 December 1999 record high of 6930, the chatter in the mainstream media about the potential to reach new highs kicks off.

So what do I think about the potential to reach new highs?  Well I don’t actually even waste brain power considering it for a few reasons:

• The most important is that my investment strategy is no longer based on any form of emotion but is instead now purely mechanical.  This was done because early on in my DIY investing career I realised that no matter how much energy I expended I actually had no idea whether the market was going to go up, down or sideways.  A lot of people out there do claim to know but from what I can see most of these seem to make their money by commenting on it in the media, writing books on the topic or by selling investing newsletters.  If they really do know why are they expending energy doing this rather than making a fortune trading with this great knowledge?  I really do now believe that unless you have inside knowledge, which you can’t profit on legally, then they are all actually just like me.  They have no idea. 
• As I’ll show in this post the market is actually nowhere near a new high.
• Again, as I’ll show in this post, while I believe the market is slightly overvalued it’s still only in the bottom 17% of monthly valuations since 1993.   

Let’s run the numbers.  Firstly we’ll remove the excitement and normalise the data by:

• Correcting the chart for the devaluation of the £ through inflation.  For this dataset I use the Consumer Price Index (CPI) to devalue the £.
• Plotting the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  

Valuing the FTSE 100 - November 2013

A quick glance at one of the many FTSE100 charts published by the mainstream media might start to get the average punter a little excited.

Click to enlarge, Source: Yahoo Finance

Why?  Well, with the market closing at 6,735 on Friday we have now passed the previous nominal 15 June 2007 high of 6,732 following which the market proceeded to fall 48%.  We are also now only 2.8% from the nominal 30 December 1999 record high of 6,930 after which we saw falls of 52.6%.

A FTSE 100 Price of 6,732 also has us up 4.3% when compared with the 01 October 2013 Price of 6,460.  We are also up 14.9% year on year.

Am I getting excited?  In short, no.  This is for a few reasons:

• The most important is that my investment strategy is no longer based on any form of emotion but is instead purely mechanical.  Once I made this move I found very quickly that all emotion, whether that be pessimism or optimism, when it came to economic or market news drained from me.
• As I’ll show in this post I don’t believe that the market is actually anywhere near a new high.
• Again, as I’ll show in this post, while I believe the market is partially overvalued it’s still only in the bottom 16% of monthly valuations since 1993.   

Let’s now run the numbers.  The last time we looked at this dataset was on the 26 June 2013.

Let’s firstly remove some of excitement by:

• Correcting the chart for the devaluation of the £ through inflation.  For this dataset I use the Consumer Price Index (CPI) to devalue the £.
• Plotting the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  

Looking at the chart this way reveals the FTSE 100 in a very different light.  That light shows that Friday’s FTSE 100 Price is actually still 27% below the Real high of 9,273 seen in October 2000.  We’re also still 17% below the last Real cycle high of 8,084 seen in June 2007.

Click to enlarge

Give Me the Dividends Mr CEO (Valuing the Australian Stock Market)

As a stock market investor there are only 2 ways for your wealth will grow – share price appreciation and the reinvestment of dividends which are also hopefully appreciating on a per share basis.  How do CEO’s achieve this share and dividend per share appreciation for us?  I see two distinct methods.  The first is what I like to see and includes:

• funding of focused and targeted R&D to generate new products with unique selling points when compared to the competition allowing market share gain;
• looking for new white spaces in the global market where products can be sold; and
• tirelessly working to find operational efficiencies which increase profitability for a given amount of earnings, to name but three.

The second method I'm not so keen on and includes:

• the merger and acquisition (M&A) of companies that supposedly have “synergies”.  Sure, some acquisitions work resulting in 1+1=3 but “study after study” also “puts the failure rate of mergers and acquisitions somewhere between 70% and 90%”.
• share buy backs.  Maybe I'm being cynical here but why do I believe CEO’s undertake share buy backs?  I believe it’s to boost Earnings per Share and the Share Price.  Now why would they want to boost those?  A lot of Executive bonuses are based improving metrics such as these including straight up cash incentives but more stealthily through incentives like share options.

What would I prefer to see from CEO’s?  If they are out of ideas on how to grow the top and bottom lines organically then give the profits back to me in the form of dividends.  Unlike the CEO I can then reinvest those dividends across the whole market if trackers are my thing or a completely different sector if I think that one is overvalued in any world location.  This gives me an advantage over the CEO who only has his/her own company or “synergistic” companies to choose from.

Give Me the Dividends Mr CEO

It’s not a perfect science, because issues like company and shareholder taxation get in the way which/do cause forced behaviours/distortions, but if we look at the ratio of dividend yield to earnings yield we might be able to get some idea of which countries CEO’s are trusting the shareholder and which are having delusions of grandeur and trying to line their own pockets.  Today the S&P500 has a dividend yield of 2.0% and an earnings yield of 5.7% for a ratio of 0.35 meaning US CEO’s are only giving the owners of their company’s 35% of company earnings.  In contrast the FTSE100 is offering a dividend yield of 3.6% (80% more than the US) and an earnings yield of 6.7% for a ratio of 0.54.  So FTSE100 CEO’s are giving back 54% of earnings.  Now let’s jump to another developed country with a relatively small population – Australia.  The ASX200 today has a dividend yield of 4.3% (19% more than the UK and 115% more than the US) and an earnings yield of 5.6% (pretty much identical to the US) for a ratio of 0.77 or 77% of earnings being returned to shareholders.  A visual representation of this can be seen in the chart below.

Click to enlarge

This method doesn’t claim to be perfect and I could write a page of caveats as to why but it does give some food for thought and further analysis.  One of which is that the reason the return to shareholders is so large in Australia is because Earnings are falling while CEO’s naively maintain (or increase) dividend payments.  Let’s therefore step away from the method and analyse whether the Australian Share Market is good value.

Do Retained Earnings find their way to the Shareholders via Share Price Growth

Running this site brings a number of benefits.  To continually provide original content it forces me to continuously research beyond that of the mainstream media, which I find generally contains a lot of vested interests.  It also keeps me accountable to my original Retirement Investing Today philosophy.  If I can’t walk the Save Hard and Invest Wisely for Early Retirement line then how can I expect others to consider following my footsteps, after having done their own research, when I’m not living what I preach.  Yet so often amongst the world of “experts” we see just that.

Let me give a very simple example.  I’m generally a fan of The Motley Fool, particularly the forums, however take some time to read These Savvy Investors Have Just Hit The Jackpot which I thought would be relevant given I added Vodafone to my HYP back in December 2012.  Besides the article being full of errors it was the last sentence that really did it for me – “Maynard does not own any share mentioned in this article.  The Motley Fool has recommended shares in Vodafone and GlaxoSmithKline”.  So somebody is prepared to write an article about how great something is but isn’t prepared to put any of his own skin in the game.  That’s certainly not how this site works.

The negative of my approach is that you the reader generally only ever see one viewpoint, which is my life.  Of course the much valued Comments provide different viewpoints which benefit everyone but I also get an additional benefit, email from readers, which is what today’s post is all about.  A couple of weeks back I received a well thought out email which used some of the regular data that I publish on this site but which was used to answer a different question to that which we usually look at.  Some of the conclusions were also slightly contrarian.  After some email banter that reader has generously allowed me to publish that email.  I hope you enjoy the different viewpoint.   

"
Dear RIT

The big question - Do retained earnings find their way to the shareholders via share price growth?

After a lucky run in business I retired 5 years ago aged 40.  As only a third of my portfolio earnings are paid out as a dividend I have been searching for an answer to this big question.
I came across your FTSE 100 Cyclically Adjusted Price Earnings Ratio (FTSE 100 CAPE) Update post and I'm certain the answer is in there but you need to look at the data slightly differently. Please stay with me as you will love the outcome.

The S&P 500 Cyclically Adjusted Price Earnings Ratio (S&P500 CAPE) Update - August 2013

This is the monthly review of the S&P500 including a couple of S&P 500 valuation metrics.  The last review can be found here.

S&P500 Price

At market close on Friday the S&P500 was Priced at 1,691.  That is a rise of 1.4% when compared with 1,669, which is the average closing Price of each trading day last month.  It is 20.5% above last year’s August monthly Price of 1,403.  Note that for this index I only look at monthly average Prices as opposed to hourly or daily as I’m a very long term investor and just don’t need the noise associated with more granularity.  I’ll leave that for the traders out there.

We can then look at how this Price compares to history which is shown in the chart below.

Click to enlarge

This is a similar chart to that which you will see in many places within the mainstream media when displayed over a long term.  It looks sensational and in my opinion isn’t very helpful.  Let’s therefore adjust it to the chart below where I try to show what is really going on with Prices.  I make two adjustments:

• Correct the chart for the devaluation of the US Dollar through inflation.  
• Show the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  For example let’s say we have two historic prices of 10 and 100.  If they both increase in price by 10% then they increase by 1 and 10 respectively.  On a linear scale it would appear as though the second has increased by a factor of 10 more than the first where on a logarithmic scale they will appear to have changes the same.  Less sensational but more correct. 

Click to enlarge

The FTSE 100 Cyclically Adjusted Price Earnings Ratio (FTSE 100 CAPE) Update - June 2013

Ever since Bernanke opened his mouth about potentially easing back (not stopping) on the amount of Quantitative Easing he is undertaking each month we've seen the price of many asset classes fall.  This has included the FTSE100.  Am I worried about it?  Well as a person who is investing large amounts every month into the markets the answer is no.  I hear you ask why.  Well if I use the FTSE100 as an example I’ll show today that both company earnings and dividends  are rising.  Therefore a falling price combined with rising earnings and dividends simply means a higher dividend yield and earnings yield.  That means that I'm simply buying the market at better value.

Let’s now run the numbers.  The last time we looked at this dataset was on the 30 April 2013.

FTSE 100 Price

In early morning trade today the FTSE 100 was priced at 6,160.  That is a fall of 4.5% when compared with the 01 May 2013 Price of 6,451.  It’s still 17.1% above the 01 June 2012 Price of 5,260.  How this pricing compares with history can be seen in the chart below.

Click to enlarge

This is a similar chart to that which you will see in many places within the mainstream media.  Let’s now remove the sensationalism by:

• Correcting the chart for the devaluation of the £ through inflation.  For this dataset I use the Consumer Price Index (CPI) to devalue the £.
• Plotting the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  

Looking at the chart this way reveals the FTSE 100 in a very different light.  That light shows that the compound annual growth rate (CAGR) in today’s £’s has only been 1.7%.  Correct it by the Retail Prices Index (RPI) and that falls to 1.0%.

Click to enlarge

FTSE 100 Earnings

As Reported Nominal Annual Earnings are currently 504, up from 481 on the 01 May 2013.  They are down 10.4% on last year and down 19.8% on October 2011’s peak of 628.  Or course this looks better than it really is as inflation flatters the result.  I therefore plot a chart below, again on a logarithmic axis, showing Real (inflation adjusted) Earnings performance over the long term.

The S&P 500 Cyclically Adjusted Price Earnings Ratio (S&P500 CAPE) Update - June 2013

This is the monthly review of the S&P500 including a couple of S&P 500 valuation metrics.  Last month’s review can be found here.

S&P500 Price

At market close on Friday the S&P500 was Priced at 1,627.  That is a fall of 0.8% when compared with 1,640, which is the average closing Price of each trading day last month.  It is 22.9% above last year’s June monthly Price of 1,323.  Note that for this index I only look at monthly average Prices as opposed to hourly or daily as I’m a very long term investor and just don’t need the noise associated with more granularity.  I’ll leave that for the traders out there.

We can then look at how this Price compares to history which is shown in the chart below.

Click to enlarge

This is a similar chart to that which you will see in many places within the mainstream media when displayed over a long term.  It looks sensational and in my opinion isn’t very helpful.  Let’s therefore adjust it to the chart below where I try to show what is really going on with Prices.  I make two adjustments:

• Correct the chart for the devaluation of the US Dollar through inflation.  
• Show the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  For example let’s say we have two historic prices of 10 and 100.  If they both increase in price by 10% then they increase by 1 and 10 respectively.  On a linear scale it would appear as though the second has increased by a factor of 10 more than the first where on a logarithmic scale they will appear to have changes the same.  Less sensational but more correct. 

Click to enlarge

S&P500 Earnings

As Reported Nominal Annual Earnings (using a combination of actual and estimated earnings) are currently $90.96.  That compares with this time last year at $87.92 implying earnings growth of 3.5% year on year.  Or course this looks better than it really is as inflation flatters the result.  I therefore plot a chart below, again on a logarithmic axis, showing Real (inflation adjusted) Earnings performance over the long term.

The New FTSE 100 Cyclically Adjusted Price Earnings Ratio (FTSE 100 CAPE) Update - April 2013

Welcome to the new look UK FTSE 100 monthly stock market review which includes a couple of valuation metrics.  The last time we looked at this dataset was on the 10 March 2013.  This monthly review will now loosely follow the same format we use for the S&P 500 which will enable us to get some consistency across regions going forward.

FTSE 100 Price

At market close on Tuesday the FTSE 100 was priced at 6,430.  That is a rise of 0.8% when compared with the 01 March 2013 Price of 6,379 and 9.5% above the 02 April 2013 Price of 5,875.  How this pricing compares with history can be seen in the chart below.

Click to enlarge

This is a similar chart to that which you will see in many places within the mainstream media.  Let’s now remove the sensationalism by:

• Correcting the chart for the devaluation of the £ through inflation.  For this dataset I use the Consumer Price Index (CPI) to devalue the £.
• Plotting the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  

Looking at the chart this way reveals the FTSE 100 in a very different light.  That light shows that the compound annual growth rate (CAGR) in today’s £’s has only been 2.0%.  Correct it by the Retail Prices Index (RPI) and that falls to 1.2%.

Click to enlarge

FTSE 100 Earnings

As Reported Nominal Annual Earnings are currently 483, up from 458 on the 01 March 2013.  They are down 18.3% on last year and 23.0% on October 2011’s 628.  Or course this looks better than it really is as inflation flatters the result.  I therefore plot a chart below, again on a logarithmic axis, showing Real (inflation adjusted) Earnings performance over the long term.

Click to enlarge

The Best Performing Stock Market in the World

In the modern day we see many of the emerging economies of the world moving forward with high growth while in contrast many of the mature western economies have anaemic growth at best.  This was reinforced last week with the UK reporting preliminary quarterly growth of 0.3% (1.3% annualised) while the US fared better with an annualised 2.5%.  In contrast on the 15 April 2013 we heard that China was growing at 7.7%.  Does this mean we should all be selling our mature market equities and loading up on emerging markets?  Or do we get enough benefit from the fact that many mature market companies are exposed to high growth markets?

To try and get an idea I ran the Google search “the best performing stock market in the world” and was rewarded with the result that in 2012 the Venezuela IBC returned around 300%.  I was disappointed with this result and the majority of the other Google results for three main reasons:

• As a private investor are we really going to put a significant portion of our wealth into the Venezuela stock market?  Or the Turkish XU100, Egyptian EGX, Pakistan KSE or the Kenya NSE for that matter?  Well as somebody who is searching for consistent return over many years I know I’m not.
• The majority of results simply show the performance of the major stock market within each country.  This is flawed because each of these markets is priced in the local currency of each country and we all know that currencies move for all manner of reasons including varying rates of currency devaluation caused by inflation.  You therefore cannot compare one with the other as they have different units.  It would be like saying Car A which is travelling at 110 km/hour is going faster than Car B which is travelling at 100 miles/hour.  A clearly ludicrous statement. 
• As the results only use the major stock market for each country they are only looking at the capital gain of each of these markets.  If we truly want to understand the best performing market then we should also consider the contribution from dividends because dividends matter.

Let’s therefore answer the question from a personal long term investor perspective while considering the three points above.

The New S&P 500 Cyclically Adjusted Price Earnings Ratio (S&P500 CAPE) Update - April 2013

I've been publishing a review of the S&P500 and all its nuances every month for over 3 years.  This is data that I personally use for my own investments and as my knowledge has grown so too has the content posted but the format has remained largely unchanged.  I've received no complaints but to me the format has now grown a little unwieldy, not as clear as it could be and probably most importantly I've become a little bored with it.  Last month’s review can be found here.  I've therefore spent some time reformatting the charts, adding some more relevant historical content and hopefully arranging the content into something a little more logical.  I hope it works for you.

S&P500 Price

At market close on Friday the S&P500 was Priced at 1,555.  That is a rise of 0.3% when compared with 1,551, which is the average closing Price of each trading day last month.  It is 12.2% above last year’s April monthly Price of 1,386.  Note that for this index I only look at monthly average Prices as opposed to hourly or daily as I'm a very long term investor and just don’t need the noise associated with more granularity.  I’ll leave that for the traders out there.

We can then look at how this Price compares to history which is shown in the chart below.

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This is a similar chart to that which you will see in many places within the mainstream media when displayed over a long term.  It looks sensational and in my opinion isn’t very helpful.  Let’s therefore adjust it to the chart below where I try to show what is really going on with Prices.  I make two adjustments:

• Correct the chart for the devaluation of the US Dollar through inflation.  This unfortunately means, unlike the mainstream media in recent times, I can’t report that the S&P500 has reached new all time highs as in real terms it is still 22.5% below the Real high reached in August 2000.
• Show the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  For example let’s say we have two historic prices of 10 and 100.  If they both increase in price by 10% then they increase by 1 and 10 respectively.  On a linear scale it would appear as though the second has increased by a factor of 10 more than the first where on a logarithmic scale they will appear to have changes the same.  Less sensational but more correct. 

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Building FTSE100, FTSE250, FTSE Small Cap and FTSE All Share Data Sets

There are many UK stock market Indices, each of which is trying to measure something different.  The one mostly reported by the mainstream media is the FTSE 100 which is also the Index we regularly use to value the UK stock market.

This week I was looking to dive a bit deeper into some of these other UK Indices to conduct some more detailed analysis.  I trawled the internet for datasets but surprisingly, given the sheer amount of financial data freely available online, I came up blank for sensible datasets.  I therefore had to put my more detailed analysis on hold and spend a number of hours reconstructing a number of FTSE UK indices.  While I haven’t conducted a large amount of analysis yet I thought it was worth sharing the data as it will form a basis for a number of pieces of analysis I intend to do going forward.

The FTSE indices I’ve chosen to reconstruct are:

• The FTSE100 Index which consists of the 100 largest UK public companies.  These 100 companies make up about 81% of the UK market. 
• The FTSE250 Index which is the next 250 largest companies after the FTSE100.  These 250 companies make up about 15% of the UK market.    
• The FTSE Small Cap Index contains smaller companies outside of the FTSE100 and FTSE250. These companies make up about 2% of the UK market.    
• The FTSE All Share Index which is a combination of the FTSE100, FTSE250 and FTSE Small Cap Indices.  It therefore contains about 98% of the UK market.

Each of these Indices has two variants.  The first is the Price version of the Index which is the weighted market capitalisation of the companies within the Index on the day of interest.  These are the Indices you usually see on television or in the papers.  The second is the Total Return Index which assumes that all dividends (or other cash distributions) are reinvested back into the Index.  By looking at the change in both of these Index values between any two dates you can calculate a lot of interesting information which includes:

• The Price Index will allow you to calculate the annualised Capital Gains that you could have achieved, after expenses, if you had bought a tracker fund or ETF and it tracked the index well.
• By then calculating the annualised gain from the Total Return Index and subtracting the Price Index annualised Capital Gain we can then calculate the additional annual return that could have been gained by that same fund or ETF through reinvested dividends.  I intend to run this analysis in an upcoming post as this is one reason why I was looking for the data in the first instance.

Charts for the FTSE100, FTSE250, FTSE Small Cap and FTSE All Share Price and Total Return Indices can be seen below.  These take the value of the respective Index on the first possible investment day of each month.

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The FTSE 100 Cyclically Adjusted PE Ratio (FTSE 100 CAPE or PE10) – March 2013 Update

 This is the Retirement Investing Today monthly update for the FTSE 100 Cyclically Adjusted PE (FTSE 100 CAPE).  Last month’s update can be found here.

As always before we look at the CAPE let us first look at other key FTSE 100 metrics:

• The FTSE 100 Price is currently 6,484 which is a gain of 2.1% on the 01 February 2013 Price of 6,347 and 9.3% above the 01 March 2012 Price of 5,931.
• The FTSE 100 Dividend Yield is currently 3.42% which is down against the 01 February 2013 yield of 3.47%.
• The FTSE 100 Price to Earnings (P/E) Ratio is currently 14.44.  
• The Price and the P/E Ratio allows us to calculate the FTSE 100 As Reported Earnings (which are the last reported year’s earnings and are made up of the sum of the latest two half years earnings) as 449.  They are down 13.0% month on month and down a large 23.9% year on year.  The Earnings Yield is therefore 6.9%.

So we find ourselves in a continuation of the interesting situation that I highlighted last month.  Nominal Earnings are falling off a cliff and have been consistently falling since October 2011’s Earnings of 628.  They are now down 28.5% since then yet in comparison Prices are increasing.  Nominal Prices are up 27.7% over the same period.

The first chart below provides a historic view of the Real (CPI adjusted) FTSE 100 Price and the Real FTSE 100 P/E.  Look at the trend line of the Real Price.  After you strip out the effects of inflation the perceived market value is doing not much more than oscillating above and below a flat line which we are now sitting on.  The second chart provides a historic view of the Real Earnings along with a rolling Real 10 Year Earnings Average for the FTSE 100.

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The S&P 500 Cyclically Adjusted PE (aka S&P 500 or Shiller PE10 or CAPE) – March 2013 Update

With the mainstream media this week reporting new nominal highs for the Dow Jones Industrial Average lets also run our own regular analysis of the US market to get some detail on what is really going on in this market.   As always instead of the Dow, which only looks at 30 large companies, we’ll turn our attention to the S&P500 which looks at 500 leading public companies.  Last month’s update can be found here.

Before we crunch the numbers it’s worth pointing out that while titles like Asian markets climb after Dow Jones hits record high make for great headlines, I can’t help but feel that this is misleading the general public as they might actually think that the market is at new highs.  Of course regular readers will know that Dow isn’t at a new Real (inflation adjusted) high, but only at Nominal highs, as the unit of measure that the Dow and S&P500 is measured in, the US Dollar, is constantly being devalued through inflation.  When it comes to the S&P500, the Real high was way back in 2000 and we are still some 22.5% below that level.  

Let’s now look at the key S&P 500 metrics:

• The S&P 500 Price is currently 1,543 which is a rise of 2.0% on last month’s Price of 1,512 and 11.1% above this time last year’s monthly Price of 1,389.
• The S&P 500 Dividend Yield is currently 2.0%.
• The S&P As Reported Earnings (using a combination of actual and estimated earnings) are currently $89.63 for an Earnings Yield of 5.8%.
• The S&P 500 P/E Ratio is currently 17.2 which is up from last month’s 17.0.

The first chart below provides a historic view of the Real (inflation adjusted) S&P 500 Price and the S&P 500 P/E.  The second chart below provides a historic view of the Real (after inflation) Earnings and Real (after inflation) Dividends for the S&P 500.

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