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Sound Advice: January 5, 2022

Where do we go from here? 

When you consider the wide variety of factors that impact the economy and the investment markets, it would be unrealistic to be encouraged by prospects for the next few years.  Yet, although opportunities for continued progress may be more limited, there are always some worth considering.

Let’s put this in perspective. 

Following the 23 trading days of The Pandemic Plunge, which saw prices collapse by 34%, the Standard & Poor’s 500 Index then rebounded 113% by the most recent December 31st.  On that date, the forward price-earnings ratio of stocks in the index had risen to a lofty 21.2 compared with a 25-year average of 16.8.  (That ratio is calculated by dividing the latest level of the index (4,766) by the estimated earnings of the included companies for the next 12 months.)  By all measures, that’s a hefty valuation, one that’s even more so since it depends on estimates of what’s to come, which are anything but assured.

Other measures confirm this.  The latest dividend yield on the S&P 500 Index, is 1.35%, which compares with a 25-year average of 2.0%.  A sharply lower dividend yield means a much higher valuation.

Since inception 95 years ago, the S&P Index has returned almost 10% a year, on average, but the range of returns has varied widely.  Although annual returns were positive in 32 of the latest 42 years, there have been times such as the three years following the dot.com bust and 2008, when the bottom never seemed to be in sight.  Yet as night becomes day, recoveries followed.  Patience and fortitude were the keys.

It seems reasonable to expect a more moderate pace for U.S. equities over the next few years.  Strong gains are typically followed by slower progress.  And, whether progress is fast or slow, there are always hiccups along the way.

What’s more, regardless of the overall market tone, one or more asset classes always moves higher.  In 2008 and late 2018, which were both difficult times, the strongest asset class was treasury bonds.  Now, given the prospect of rising interest rates, treasuries, particularly those with long maturities, may be among the least desirable holdings.

Better values are found among international and emerging market equities, but it may be a while before those economies regain their footing.  All this said, proper diversification remains the key to risk-managed rewards ahead.

N. Russell Wayne, CFP®

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