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115 Stock Market Update, 05/28/2018

As of today, the total USA market Index is $28.4 Trillion, which is 142.5% of the last reported GDP. The USA stock market can be therefore expected to produce an annualized return of negative 2%. This includes the returns from the dividends, currently yielding at 1.73% while inflation is rising to an annual rate of 3.2%. For a retired investor such results are not acceptable.

It is the purpose of this blog to review current investment conditions and to consider what alternatives may be available.


As of 2018-05-28 the US Stock Market is Significantly Overvalued.


The negative expected return of -2% for 2018 are based on calculations by Dr. Charles Tian as shown in https://www.gurufocus.com/stock-market-valuationsThe expected returns are calculated as follows: Investment Return (%) = D now equal to 32.1%.  That is 90% higher than the historical mean of 16.9%. That also confirms a substantial overvaluation of US stocks.  

Another approach to expected valuations comes from Prof. Robert Shiller of Yale University who invented the Schiller P/E to measure the market's expected valuation. The Schiller P/E is a more reasonable market valuation indicator than the P/E ratio because it eliminates fluctuation of the ratio caused by the variation of profit margins during business cycles as shown in https://www.gurufocus.com/shiller-PE.php.

If we assume that over the long term, the Shiller P/E of the market will reverse to its historical mean, the future market return will come from three parts: Contraction or expansion of the Schiller P/E to the historical mean; Dividends and Business growth.

The investment return is equal to: Investment Return (%) = Dividend Yield (%) + Business Growth (%) + (Mean_Shiller_PE/Current_Shiller_PE)(1/T)-1. From this one can set the Shiller P/E's current level (2018) rate as -1.5% and the future market return as -2.8%:


The Shiller Price/Earnings ratio now equal to 32.1%.  That is 90% higher than the historical mean of 16.9%. That also confirms that there is a substantial overvaluation of US stocks.  

With negative returns investors have asked about the international markets if they would be better served. Therefore, the purpose of this blog is offer an overview of the valuations of 18 largest economies in the world. Starting with GDP ranking, in $ Trillions in current US$, the dominance of the USA shows ups as follows:


The GDP earning capacity is overwhelmed by $33 Trillions of the GDPs of the USA and China. That exceeds the sum total of the GDPs of all other countries.

From an investor standpoint what matters is not the GDP but market capitalization. USA with a market cap of $28 Trillions has the capacity to absorb all savings and can exceed the market capitalization of all other countries:


Only Japan, China, UK, France, Canada and Switzerland have the market capitalization where investors could be placing their investments.

However, what matters is the ratio of total market cap to the GDP. These are the GDPs in U.S. dollars for these countries. Original GDP data was in each country’s national currency. They are converted into the U.S. dollar using the exchange rate of May 2014:


The large pools of market capitalization can be found in China and Germany, where shares appear to be underpriced.  Switzerland, Japan, USA, UK, Canada, Australia, Sweden and Singapore show that stocks are overpriced. What then matters is the risk/reward ratio for various countries. Political stability will warrant making investments in above average market cap to GDP ratios. Investors must make choices where to park their investments and whether the markets are politically attractive. 


Based on market to GDP ratios as compared with the USA, the top candidates dfor international diversification could be China and Germany. However, additional considerations of risk may influence the decision how much to invest outside of the USA.

Conclusion:

There is no question that the rising risks are making USA investments questionable. The 2017 decision to lower corporate taxes, repatriate earnings while rising debt must be considered when the inflated prices of the USA stock market are used. The decisions by the current administration to inject into to last year’s corporate profits over a Trillion $s of profits must be discounted. 

Depending on consideration of safety and stability international markets may offer a place where to invest if increased diversification is desirable.      










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