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Negative Rates May Expand Market’s Multiple

The big news from economist Fritz Meyer's CE webinar on Advisors4Advisors on September 10, was his analysis of how negative rates in Germany are driving down bond yields in the U.S. 

In recent weeks, Fritz has described a realignment in asset class valuations that makes it wise to expect lower returns on bonds permanently. To be clear, it’s reasonable to expect lower returns on bonds for the long run. Why? The main cause is changing national demographics of the world's major economies, a long-term fundamental factor driving the GDP growth rates and is an unsung competitive advantage for the U.S. versus other developed economies.   


In the two-minute transcribed segment of his 75-minute presentation shown below, Fritz delves deeper into how negative rates are likely to impact U.S. financial assets and concludes it improves the stock market p/e ratio.


For financial advisors, tinkering with asset allocations of portfolios is not trivial. A revaluation of a core portfolio’s asset classes is not a trade; it’s not tactical. It’s a strategic asset allocation decision based on long-term economic fundamentals, and that's our approach in creating financial advisor content. 


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Here below is the transcript Fritz Meyers about a long-term revaluation that may be under way. The slides and transcripts for Fritz's monthly webinars can be purchased for $50 a month.

If all you want is acces to Fritz's monthly webinars and CE credit for CFPs, it's only $10 a month . 


Now let’s address the market’s multiple explicitly, which is what you see in the top data series. And here, in the red data series, is the S&P 500 P/E ratio on trailing 12-month earnings, and it’s 18.1 times at present. It’s 16.3 times on 2020 operating earnings. By the way, in that calculation I’ve shifted forward from 2019 because we’re only less than four months away from the end of this year. So I’ve moved forward. But it’s 16.3 times on the 2020 earnings estimates.


Now here’s a major point that I wanted to make this month that I haven’t said before, so I included this box. If investors, in fact, become convinced that negative yields abroad and sub-2%U.S. bond yields are here to stay.  I think it is entirely conceivable that we enter a new era of higher P/E ratios. And I don’t think that calculation is any secret to any of you because I think we all understand that the market’s P/E ratio is a direct function of inflation expectations and bond yields.


So if, in fact, investors come around to a notion … And this would be radically new, radically new, because we’ve never in the history of the world experienced negative bond yields, at least as far as I know. I’ve never read about any instance in which you have to pay the bank to hold your money or you have to pay a bondholder to hold your money. And yet, that’s the world today. Now, is this a transient phenomenon? Absolutely not. I don’t think it is. I don’t think it is. I think this is a new world. None of us have ever seen this. Nobody has ever anticipated this. It has seemed inconceivable, and yet that is, I think, what we’re looking at.


And my point with respect to market valuation is, to the extent investors start to internalize this … And they haven’t done this yet. This is brand-new thinking. This is cutting-edge. You are witnessing [laughs] a once in all-time history shift, possibly, in sentiment, suggesting that if bond yields are negative, then the only game in town increasingly becomes common stocks and yield on common stocks. Today’s dividend yield on the S&P 500 is about 1.9. And a bond is 1 and a half percent. And the bond could actually go lower. It could go lower. So my point is to suggest that, first of all, 18.1 times trailing earnings is right in line with the historic norm for a low-inflation environment. But secondly and more importantly, to the extent that new attitudes take hold with respect to the direction for bond yields longer-term, P/E ratios could conceivably find new higher plateau sustainable levels. It only makes sense. It only makes sense because of the relative attraction of common stocks versus fixed income. Hope everybody understands that because I think it’s such a significant point.

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