Break out the champagne…or don’t.
There’s a longstanding hypothesis (I wouldn’t quite call it an “axiom”) suggesting the NFL Super Bowl can predict future stock market performance. It posits that an NFC victory is a bull market harbinger, while a win by the AFC signals a bear market.
The theory was initially put forth in 1978, having played out in 11 of the prior 12 years at that point. The indicator had a remarkable 90% success rate through the 1990s – a lot of NFC wins followed by a lot of S&P 500 rallies. But it has been far less reliable since then, holding true just 8 times over the past 20 years – almost a coin flip.
Overall, the pattern has an accuracy rate of about 70%. So Sunday’s 20-13 triumph by the NFC’s Seattle Seahawks _could_ once again bring good tidings to investors.
Of course, this is more of a quirky observation than anything else. Few people truly believe that action on the gridiron can predict market performance any more than Punxsutawney Phil can forecast the weather. But the Superbowl is just one of many financial prognosticating tools — some more outlandish than others.
Have you heard of the baked bean indicator?
Adherents of this odd investment barometer believe that rising demand for the ordinary household staple can be an ominous economic sign. The thinking goes like this: when money is tight, shoppers will cut back on expensive luxuries (like steak) and stock the pantry with cheap canned goods.
Former Fed chief Alan Greenspan once theorized that a noticeable sales uptick in men’s underwear could mark a positive shift in consumer sentiment and disposable spending patterns. There are all kinds of these indicators: lipstick, champagne, movie theatre popcorn, cardboard boxes.
While I wouldn’t feel overly confident in any of these unorthodox forecasting tools, they can sometimes help paint an economic picture, particularly when combined with more useful data points like jobless claims, manufacturing activity and construction permits.
There is an index composed of ten of these subcomponents, the Conference Board Leading Economic Index (LEI), designed to identify “peaks and troughs” and detect turning points in the business cycle up to seven months before they occur.
Fortunately, investors have other real analytical instruments grounded in fact rather than superstition. For instance, the Put/Call ratio can be a reliable way to gauge market sentiment. Traders sometimes use extreme ratios as a contrarian signal to bet against the crowd.
But at the end of the day, there are few yardsticks more trusted and time-tested than the good old Price/Earnings ratio. As we speak, the S&P 500 is currently trading at 22 times trailing earnings. That’s well above the five-year average of 20.
In other words, today’s investors are paying about 10% more for every dollar of corporate profit.
Now, that doesn’t necessarily mean a turnaround is imminent. For one reason, this backward-looking metric doesn’t incorporate future growth expectations.
There’s another shortcoming. Earnings can fluctuate wildly from quarter to quarter, making stocks suddenly appear overvalued or undervalued even though share prices (and future normalized cash flows) may have deviated far less.
A year ago, you might have seen a hypothetical manufacturer with robust demand earn $3 per share and command a stock price of $30, thereby trading at 10 times earnings. Today, volume has softened, annualized profits have tumbled to $1 per share and the stock has retreated to $20, for a richer price multiple of 20.
By the P/E yardstick, the manufacturing business would now seem to be twice as expensive – even though the share price has just been discounted by one-third. Was the stock really a better buy at $30 than it is now at $20?
Well, that depends largely on the duration of this slump and the trajectory of tomorrow’s earnings. One solution to this quandary is to evaluate the business using mid-cycle assumptions (perhaps averaging the low of $1.00 and the peak of $3.00 to get a normalized annual profit of $2.00).
In much the same way, the **Shiller P/E** smooths out the cyclical ups and downs by analyzing stock prices in relation to average earnings over the past decade (rather than just the past 12 months) adjusted for inflation. It’s also known as the cyclically-adjusted-price-earnings (or CAPE).
Variations of this method have been used by some of the market’s most legendary figures, from Ben Graham (Warren Buffett’s mentor) to Sir John Templeton.
Shiller’s prize-winning research found that over the past century, the S&P has traded at an average CAPE of around 15. Richer multiples (like 25) have translated into subpar returns in the following years. And readings above 35 have been downright dangerous – red flags warnings of a steep correction.
I bring this up because in recent weeks, the CAPE has hit extreme levels near 40. The market has reached this threshold just a handful of times in recent decades, including 1999… just before the painful dotcom crash. This is officially the 3rd most expensive stock market in the past 150 years.
A caveat: readings that were considered elevated in the 20th century have since become normal, particularly since the introduction of tighter accounting standards in the 1990s. Still, crossing this level has been a bad omen every single time.
With gold and silver spiking to unprecedented peaks, certainly precious metals may be more in tune with macro uncertainties than equities. That’s another reason why I have been nudging readers towards the **Franklin International Low Volatility High Dividend** **ETF** (NYSE: LVHI). Not only does the portfolio favor foreign markets like Japan and Germany where valuations are less stretched, but also low-beta dividend payers that can provide some stabilizing ballast in choppy seas.
This defensive fund was built to weather down markets. But that doesn’t mean it can’t play offense. LVHI has chalked up average annualized gains of 15.9% over the past five years, scoring in the top-decile among 300+ category rivals – and earning a coveted 5-star rating from Morningstar.