Report Updates
We have posted report updates on Real Matters (REAL) and FirstService Corp (FSV). One name has been downgraded while the other name has been maintained since our previous reports. One company is a technology-based network services provider for the mortgage lending industry and the other is an industry-leader in the property services sector. With these names seeing geographic expansions, organic and acquisitive growth, increasing client relationships, industry-leading position, and tailwinds from the robust housing market, we feel that these are names worth keeping an eye on.
Read the latest updates by logging in here!
Webinar With Peter Hodson
Members are invited to register for a free webinar with Peter Hodson, hosted by TD Direct Investing, on the five factors to consider in small-cap stocks on Thursday, March 31, at 1:00 PM EST. In this webinar, Peter Hodson will be discussing some common mistakes that investors tend to make when investing in small-cap stocks and he shares five criteria that he uses to filter his search for small-cap stocks that he believes have significant upside potential.
The link to register for this webinar is here!
Market Update
Markets continued to slide lower over the past couple of weeks as Russia-Ukraine tensions have elevated, and inflation continues to run hot. The Federal Reserve concluded their meeting on Wednesday and announced a 25 basis point interest rate hike and has expectations for six more rate hikes this year. Commodities continue to run high, although we have begun to see some volatility in their price action. With so much uncertainty in the markets and stocks remaining in a downtrend, we discuss the current market valuations, interest rates, and historical returns in this market update.
Rocky Start to the Year and an Assessment on Valuations
As most of us are aware by now, the markets have had a rocky start to the year. Markets have declined much more than we believe most have anticipated, and it is in these times it can be helpful to zoom out and look at the larger picture.
Market Indices and Valuation Levels
Looking at the valuation of the broader financial markets, we can see the rising and falling tide that the market has endured over the past few decades. Below is a chart of the S&P 500, TSX, and Nasdaq forward P/E valuations over the past 30+ years. The Nasdaq data begins in 2010, but we can see for the broader markets that valuations have mostly gyrated up and down over the years.
Market Valuations vs. Market Price
While the up and down volatility of the market valuations may seem daunting and instill uncertainty in most investors’ minds, it is important to keep in mind that market prices can still increase while P/E levels remain flat or even decline. Looking at the chart below, we have plotted the S&P 500 market value against its forward P/E ratio since 1990. The trends between the two mostly follow each other, although we can see in certain periods such as 2005 and 2015, that the P/E ratio declined or stayed flat while the price of the S&P 500 went higher. This is primarily explained by a strong improving economic fundamental outlook that more than offsets the price increase (earnings rising faster than price). So, while the recent declining P/E ratio of the financial markets may seem perilous, any improvements in the economic outlook can have positive impacts to the market price of the S&P 500.
Market Valuations Requiring a Reference Point
Touching on another point that we mentioned of reduced alternative investment opportunities, we have charted the Canadian and US long-term bond yields against the P/E ratio of the S&P 500. Almost everything in life needs to be understood in relation to some other thing. It is difficult to understand the value of something without being able to relate that value to something of similar quality – the same way that we know a pizza tastes good because we’ve eaten other foods, we also know a stock market P/E level is good or bad by reviewing our alternative options. Long-term bond yields have been steadily declining over the past 30+ years, and so too has the relative attractiveness of investing in bonds vs. equities. For an investor to begin justifying an S&P 500 P/E level of 10X to 15X as fair, it would also make sense that bond yields double their current levels of 2% to 4%, which is where they were last when the S&P 500 P/E was at 10X. Current S&P 500 P/E levels were nearing the dot com bubble levels, although bond yields were also three times higher than where they are today.
Historical Market Returns
Looking at the S&P 500, Nasdaq, and TSX annualized returns on various timeframes (YTD is not annualized, it is just the year-to-date return), we can get a sense of how the market has performed over the past 10 years. The past three years have been some of the best performances for the S&P 500 and the Nasdaq, and so enduring a negative year-to-date return begins to make more sense given the historical context.
Source: Eikon
Final Thoughts
Over the long-run, equities have increased in value, and although the valuation levels (P/E) can ebb and flow within a horizontal range, we have shown above that prices can continue to increase even while valuations decrease or remain flat. It is difficult to predict where future prices may go from here, although history has told us that on average market indices tend to increase in price, valuations need to be reviewed in relation to alternative investments, and volatility and negative returns are the price of admission to long-term value creation. In times like these, we find it is best to stay invested, maintain a long-term view of the market, and to not let fear shake an investor from the long-term effects of compounding returns.
Best wishes for your investing!
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