Following the post-COVID stimulus hangover in 2022, the bull market has continued to run. One of the key factors was the Federal Reserve’s decision to
A Return to the Old Normal
Published Date : May 12, 2014
The U.S. stock market performance during 2013 can be described as nothing other than extraordinary. Not only were new highs achieved, but overall return levels were the highest in 15 years for the S&P 500 and the highest in 18 years for the Dow. While the markets rose significantly, the underlying economic condition was less robust: higher taxes, sequester-imposed budget cuts, and a shrinking public sector served as a drag to overall growth. So what drove such outstanding market performance in a slow-growth environment?
While corporate earnings rose commensurate with the economic growth, the short answer is multiple expansion. Market performance is primarily driven by expectations regarding future growth of corporate earnings and the multiple the market assigns these earnings. Earnings multiples are influenced by growth rates, interest rates, and an overall view of risk. Typically they also incorporate a heavy dose of emotion, which can be euphoric or fearful. The price to earnings (P/E) ratio is a common measure of the market multiple.
From 2008 through 2012, multiples were below-average as uncertainty over the global economic outlook persisted with Europe remaining in recessionary territory and the U.S. experiencing a very slow recovery. By 2013, the U.S. recovery was in its fifth year, albeit with growth rates checking in below those of previous economic recoveries. As the year progressed, Europe emerged from recession and growth in the U.S. began to accelerate. Final U.S. GDP growth for the second half of the year came in at 3.25% compared to just 1.8% (as reported by the Bureau of Economic Analysis) during the first half of the year; Congress passed a bipartisan budget deal; and the Federal Reserve announced official plans to begin tapering asset purchases. All of these positive factors contributed to the large valuation change in the market as the S&P 500 P/E multiple expanded from 12 times to 15 times forward earnings. As the chart shows, this expansion of multiples served as the primary driver of performance in 2013 by contributing over two-thirds of the annual return to the S&P 500. Valuation adjustments such as these, with steep increases in P/E ratios, do not occur frequently and may only happen once during a complete economic cycle.
Year-to-date market returns have been impacted by economic uncertainty as a brutally cold winter clouded investors’ views of the true underlying growth rate of the economy. Despite this set-back, we continue to expect GDP growth to accelerate, leading to economic growth in the 2-3% range for the full year. While we expect the global economic growth picture to continue to brighten, in 2014 we aren’t anticipating a large contribution from multiple expansion (the gray area of the chart) to fuel domestic stock market performance. The forward P/E of the S&P 500 is now squarely in-line with long-term historical averages of 15x. Essentially, we are back to the “old normal.” Earnings and dividend growth will likely be the primary driver of market returns, suggesting a mid-single-digit return in 2014 is a reasonable assumption.
The Sand Hill Global Advisors philosophy is to position portfolios to withstand an environment that may be impacted by typical market fits and starts. While 2013 was characterized by very low volatility, we anticipate 2014 trends will be more normalized. Our clients will be well served by a balanced portfolio and our contrarian approach that is designed to take advantage of volatility over time.
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