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Investors were cautious for much of the month, likely waiting to see what President Trump would do during his first few weeks in office. After a slow close to December, equities picked up the pace during the early part of January as each of the indexes listed here closed the first full week of the month posting gains of nearly 1.0% or more. The market moved very little for much of the month until January 25, when stocks surged. The Dow reached the magic 20000 for the first time while both the S&P 500 and Nasdaq reached all-time highs. The stock market rally proved to be short-lived, however, as investors pulled back from stocks and moved to gold and long-term bonds. Nevertheless, each of the indexes listed here posted month-over-month gains, led by the Nasdaq, which closed the first month of 2017 over 4.0% ahead of its 2016 year-end value.

Despite OPEC’s agreement to cut production, oil prices have remained in the low $50s per barrel for the month, reaching a high of $54.87 early in January and a low of $51.70 a few days later. But by the close of trading on January 31, the price of crude oil (WTI) was $52.80 per barrel. The national average retail regular gasoline price was $2.296 per gallon on January 30, up from the December 26 selling price of $2.254. The price of gold climbed at the end of January, closing at $1,212.50 on the last day of the month, up from its December 30 price of $1,154.30.

 
 
 
did you know?

Robert J. Shiller of “irrational exuberance” fame developed his own PE Ratio, the PE10 that bases its calculation of PE ratios on the ratio of the current level of the S&P 500 to the trailing 10-year average inflation-adjusted earnings of the companies comprising the index. Some significant numbers and dates to consider:

  • The Shiller PE since 1871 is 16.7.
  • The post-World War II Shiller PE is 18.7.
  • On February 17, 2017, the Shiller PE stood at 29.14.

Source: Shiller PE Ratio

 
 
bright ideas
 
PE Ratios Are Imperfect Market Predictors
Why financial advisors should follow PE Ratios, but be wary letting them drive investment decisions

On January 25, 2017, the Dow Jones industrial average cleared the 20,000 barrier. But what does that really mean for the markets? A number like 20k catches headlines, and the media and investors have fun with it, but in true economic terms, 20k does not actually mean anything. What does mean something is the current run up of the market and whether the market has become overpriced. One way of examining the market prices is by looking at the Price to Earnings (PE) ratio.

The Historical PE
At Beacon, our portfolios invest in sectors, so we don’t use PE ratios in our calculations, but we definitely do consider them in their historical context. For example, if we look at the equity market today, it is pricey. The S&P 500 PE ratio “since 1900 is approximately 15.8, and the ratio since 1946 (the post-World War II period) is 17.3.” So historically, the normal PE ratio is about 16.5 based on trailing twelve month’s (TTM) earnings.1

How pricey does that make the current PE ratio currently? As of February 17, 2017, The S&P 500 PE Ratio stood at 26.39.2 That number puts the PE ratio nearly 60 percent higher than the historical average or “about double the range of ‘pricey’.”3

Source: Beacon Capital Managment

Let’s look at two very significant times in recent history to get a better perspective of what these values mean today.

The Recent Bubbles
The PE ratio on March 31, 2000, was 28.2. This was at the peak of the dot-com bubble and after the bubble burst you wound up with a minus 22 percent return over the next 12 months. The next bear market took an even bigger hit. On November 30, 2007, the PE Ratio peaked at 23. The market gave us a minus 38 percent return over the next 12 months. But, in both of those cases, we can identify specific bubbles. How do those relate to our current economic climate?

Our Unique Times
If you look at just the PE Ratios, you could say, “wow, those are out of line right now. Maybe I should do something.” However, the reason this time appears to be a little different is the big surprise we had with the election. Basically, the entire market had priced in a Clinton victory. There was panic, then the market decided to ramp up to a Trump presidency, initially. (For more on the emotional impact of the election on the markets, click here to read my recent Investopedia article!)

Now, the markets have gotten a second wind. The policies the Trump administration have in play are attractive to the business community. The tax reforms and financial regulations that are on the table would, in theory, allow companies to move faster, bring out new products more quickly, and generate more revenue.

So, the markets today are looking ahead. They realize the earnings are low, but they’re hedging that the Trump philosophies will bring earnings up, bringing the PE Ratio more in line with its historical average.

1. https://www.marketwatch.com/story/is-the-stock-market-overpriced-2017-01-03

2. https://www.multpl.com/

3. https://www.marketwatch.com/story/is-the-stock-market-overpriced-2017-01-03
Stop-Loss
Today’s marketplace is more unpredictable than ever. Things could keep going up with the changes the Trump administration has in place. But what if they don’t? What if even one of the regulatory plans falls through? What would that do to the markets? Losses are more powerful than gains, and at today’s prices, that leaves a long way to fall. At Beacon, we believe our mechanical stop-loss approach is more important than ever to help eliminate these questions and uncertainties while still participating in upside potential.

For more tips and insights on how Beacon portfolios work to deliver consistent returns in today’s market, contact your wholesaler today!

 
 
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Beacon Capital Management, Inc. is an investment advisory firm registered with the Securities and Exchange Commission. Additional information about Beacon Capital Management is also available on the SEC’s website at www.adviserinfo.sec.gov under CRD number 120641. Beacon Capital Management only transacts business in states where it is properly registered, or excluded or exempted from registration requirements.

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