Professor Jeremy Siegel recently appeared on CNBC and suggested that the U.S. equity markets were approaching fair value and that markets might “pause” some of their strong gains in 2018. Siegel still believes corporate tax cuts are one factor that supports the market strength and that earnings should receive a boost from pending changes. He saw about 5% more gains in 2017 and predicts stocks having more difficulty next year.
Absent the corporate tax plan, we’d have a cloudier picture for U.S. stocks. But one question continues to come up in conversations: what about extended market valuations and the cyclically adjusted price-to-earnings (CAPE) ratio?
A piece on U.S. market valuations I posted earlier in the year has generated a lot of interest, and I updated it with more recent data below.
Robert Shiller and Jack Bogle are market prognosticators who tend to be more subdued in their outlook for U.S. equities. Earlier this year, Bogle presented his outlook for 10-year returns at the annual Chartered Financial Analyst conference in Philadelphia and suggested we’ve seen strong gains in the markets over the last 35 years that resulted from valuation expansion, and hence had a subdued outlook. Bogle’s model was fairly simple: take the 2% dividend yield on the market today, add in his personal estimates of 4% earnings growth and subtract 2% from speculative market activity or his anticipation of a decline in valuation ratios over the coming decade, and you come up with an outlook for 4% returns over the coming decade. If we assume there is 2% inflation, this would lead to just a 2% real return after inflation. Note that this is largely similar to Shiller’s outlook for returns from high CAPE ratios.
One chart that I think is not talked about enough in the context of valuation changes on the market is the dividend payout ratio of the market. I show a smoothed 10-year average dividend payout ratio in the spirit of Shiller’s 10-year smoothed earnings for the CAPE ratio. Prior to 2000, the dividend payout ratio averaged 60%. Since 2000, the dividend payout ratio has averaged 40%. This change in the nature of how firms reinvest their earnings, conduct stock buybacks and pay dividends is absolutely critical to the future earnings growth we are likely to get.
