Why the Market Drop Has Yet to Improve Valuations

Summary

Podcast Summary: WSJ Your Money Briefing

Episode: Why the Market Drop Has Yet to Improve Valuations
Date: April 6, 2018
Host: J.R. Whalen (The Wall Street Journal)
Guest: Spencer Jacob (Deputy Editor, Heard on the Street)

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Overview

This episode tackles a perplexing question for many investors: Why haven’t recent stock market drops made equities a bargain? Host J.R. Whalen speaks with Spencer Jacob, Deputy Editor of Heard on the Street, to explore why valuations remain high, what truly drives expected returns, and what savers and investors should realistically expect for the years ahead. The discussion draws on historical precedent and market valuation metrics to provide a grounded outlook for personal investors.

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Key Discussion Points & Insights

1. Why Market Drops Haven’t Improved Valuations

• Current State:

  • The stock market is 8-9% off its highs from late January, creating an illusion of better buying opportunities.
  • Despite this dip, stocks are “still very much at the expensive end of things” when compared historically.
  • Spencer Jacob [02:34]: "Unfortunately, valuation is really what does determine your expected returns. Not earnings growth, not economic growth."

• Investor Outlook:

  • Market dips can be good for long-term savers, especially younger ones.
  • However, “it’s not that cheap and that will affect future returns” for those investing now.
  • Spencer Jacob [02:34]: “If you’re saving for retirement, especially if you’re a younger person, you do like...to buy stocks more cheaply...But it’s not that cheap...”

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2. What Actually Predicts Future Returns?

• Misconceptions:

  • Many believe economic or earnings growth predict future market performance.
  • Data shows these factors have no effect on long-term returns.
  • J.R. Whalen [03:18]: “How data shows us that factors such as earnings expectations, economic growth don’t do much to project the future complexion of the market.”
  • Spencer Jacob [03:30]: “Not only don’t they do much, they do nothing. They have absolutely no bearing on what is going to happen...it tends to get baked in.”

• What Matters:

  • The decisive factor is valuation, notably metrics like the Shiller P/E (price-to-earnings) ratio.
  • Periods of low market valuation historically lead to better long-term returns.
  • Memorable Moment [04:25]:
    • “You can find some random factors that have more to do with stock returns than earnings growth, which everyone assumes is a very important factor given how often it’s mentioned by pundits on tv, for example.”
      — Spencer Jacob

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3. Historical Perspective: When Cheap Markets Delivered Gains

• Case Study – The Dow 1,000 Mark:
  • Comparing early 1980s (post-stagflation, low valuations) to the late 1960s (expensive market): after finally breaking and sustaining the 1,000-level in 1982, a massive bull market followed.
  • The difference wasn’t superior earnings growth, but just how undervalued stocks were when the rally began.
  • Spencer Jacob [06:08]:
    • "The Shiller PE ratio...was the lowest that it had been since the Great Depression. The earnings growth from 1966 onwards for the next decade actually was better than...the Reagan boom. It’s just that stocks were so cheap that you were really primed for gains almost no matter what happened."

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4. What Should Investors Do Now?

• No Crystal Ball — but Plan for Lower Returns:
  • Even with few other options, investors shouldn’t expect the robust growth of previous decades.
  • “You probably do need to save more to get to the same goal because you can’t plug in the same rate of growth that you saw over the past 20 or 30 years to the next 10 or 20 years.” — Spencer Jacob [05:03]
  • The advice is not to stop investing, but to use realistic expectations and possibly adjust savings rates upward.

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Notable Quotes & Memorable Moments

• Spencer Jacob [03:30]: “Not only don’t they do much, they do nothing [to predict returns]. They have absolutely no bearing on what is going to happen.”
• Spencer Jacob [04:25]: “You can find some random factors that have more to do with stock returns than earnings growth...”
• J.R. Whalen [04:46]: “It’s like filling out your NCAA brackets based on the color of the uniforms.”
• Spencer Jacob [05:03]: “...based on where valuations are today, your returns are going to be at the very low end of the historical range and you should plan accordingly. Probably not. Investing is not what I’m advising people to do, but you probably do need to save more to get to the same goal...”
• Spencer Jacob [06:08]: “[In 1982] stocks were so cheap that you were really primed for gains almost no matter what happened.”

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Section Timestamps

• [02:34] — Why market drops haven’t improved valuations
• [03:18 - 03:30] — Earnings and economic growth are not predictors of returns
• [04:25] — Memorable analogy: rainfall is a better predictor than earnings growth
• [05:03] — Realistic expectations for future returns
• [06:08] — Historical example: The Dow’s long journey from 1,000
• [07:02] — The long wait for value and opportunity in the stock market

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Tone & Takeaways

Conversational, clear-eyed, and grounded in both data and market history, this episode exposes some pervasive Wall Street myths. The core message: High valuations today mean muted future returns, no matter how bullish the headlines may be. Investors are encouraged to stay invested, but reset their expectations and savings goals accordingly.

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Summary for Listeners

Whether new to investing or a seasoned veteran, this brief yet incisive conversation will help recalibrate your market expectations. Don’t mistake today’s modest dips for a return to “bargain territory”—and remember, what matters long term is not the speed of the economy or company earnings, but the price you pay to own those earnings.

Transcript

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[J.R. Whalen]

from the Wall street journal. I'm J.R. whalen in New York. The drops in gyrations in the stock market might lead investors to believe that valuations are becoming more attractive and it could be time to invest. That's actually not the case. We'll explain why in a moment. First, these money items you should know the Wall Street Journal Streetwise team says it's time to add cash back into portfolios. The value of cash was demonstrated in the first quarter. Both stocks and bonds lost money the first quarter. That's happened since the aftermath of the Lehman brothers failure in 2008. Cash turned out to be the safe asset, and the past three months highlighted the lack of risk, at least in nominal terms of holding cash. Furthermore, the combination of the Federal Reserve's rate rises and the Trump administration's fiscal policy has pushed up the yield on cash and cash like products to the highest level since October 2008. And the Journal's Real Time Economics desk reports that families of more modest means are leaving expensive American urban areas and being replaced by more affluent newcomers. And the income gap between those arriving and leaving hotspots is widening. New research finds that metropolitan areas such as San Francisco, New York, Los Angeles, and Miami are seeing an influx of new residents from other parts of the US who earn significantly more than those who are leaving. And while the data can be volatile from year to year, in a number of cases the gap between the incomes of those coming and those leaving is is also widening as the affordability crunch has worsened in most places. This is your Money briefing from the Wall Street Journal. Welcome back, everybody. You'd think that after the rough and tumble the market's been through so far this year, valuations might be becoming more attractive to investors. Well, not so fast. Wall Street Journal Heard on the Street Deputy Editor Spencer Jacob is here to explain. So, Spencer, as you point out in your column in the Wall Street Journal, we have a positive earnings outlook with tax cuts and government stimulus injecting fuel. Yet valuations will remain high, and that could weigh on the market.

[Spencer Jacob]

That's right. We're about 8 to 9% off of the highs that we saw in late January. It is nice to get a discount on stocks. People look at it two ways, half empty, half full. I think if you're saving for retirement, especially if you're a younger person, you do like to see these dips in the market because it gives you a chance to buy stocks more cheaply with the money you're hopefully putting away every month. But it's not that cheap and that will affect future returns. In terms of where we are historically speaking, we're still very much at the expensive end of things. Unfortunately, valuation is really what does determine your expected returns. Not earnings growth, not economic growth. All those things actually tend to have very little bearing on how you're going to do over the next decade or so.

[J.R. Whalen]

That was a really interesting part of your column in the sense that how data shows us that factors such as earnings expectations, economic growth don't do much to project the future complexion of the market market. It really comes down to valuation.

[Spencer Jacob]

Not only don't they do much, they do nothing. They have absolutely no bearing on what is going to happen. The reason for that is pretty simple, is that it tends to get baked in. You hear that refrain that earnings growth is fantastic. If it pans out the way that people have projected, especially because of tax cuts, it will be fantastic this year and pretty good next year as well. The economy is growing at what for this expansion counts as a pretty rapid clip, but it's baked in. Don't forget we were at record stock prices just a couple of months ago. We're not that far off of it historically speaking. We're not at but close to the top end of where we tend to be not just in this cycle, but where we tend to be in all cycles in terms of long term measures of value that is predictive of how stocks are going to do.

[J.R. Whalen]

What did somebody tell you in your column that rainfall was a better predictor than other things?

[Spencer Jacob]

Yeah, rainfall has nothing to do with stocks rainfall. You just pick something random like who won the World Series or whatever. Those have nothing to do with stock returns. But you can find some random factors that have more to do with stock returns than earnings growth, which everyone assumes is a very important factor given how often it's mentioned by pundits on tv. For example.

[J.R. Whalen]

It's like filling out your NCAA brackets based on the color of the uniforms. Which colors you like best.

[Spencer Jacob]

Yeah, it didn't work for me.

[J.R. Whalen]

This it sounds like for investors to capitalize on valuation, we need a significant pullback more than what we have seen to then be followed by growth.

[Spencer Jacob]

Unfortunately, that's what it has to be. It doesn't mean we have to see a significant pullback, but what it does mean is that when you're saving, and there really are not very many other avenues for putting your money away, you still should be investing in the stock market. But you also should realize that over the next 10 to probably 20 years, based on where valuations are today, your returns are going to be at the very low end of the historical range and you should plan accordingly. Probably not. Investing is not what I'm advising people to do, but you probably do need to save more to get to the same goal because you can't plug in the same rate of growth that you saw over the past 20 or 30 years to the next 10 or 20 years.

[J.R. Whalen]

The Dow is sitting in the neighborhood of 23, 24,000. And you raise a good example in your column. And just going back in history, when the Dow broke through the 1000 mark permanently in late 1982 was followed by what many characterize as the Reagan bull market. That seemed like that was a good opportunity at that time to capitalize on rising valuation.

[Spencer Jacob]

Yeah. So just for some context, the Shiller PE ratio, which is a P E ratio that measures not just this year or last year, it measures the trailing 10 years of actual earnings growth adjusted for inflation, was the lowest that it had been since the Great Depression. Now, the market first touched 1000 in 1966, early 1966 touched it very briefly back then. And it's a long, long period between touching 1000 and breaking through 1000. The market was near its most expensive since the 1920s boom. That really is what made all the difference, is that at one time you were at a very high valuation. At one time you were at a very low valuation. The earnings growth from 1966 onwards for the next decade actually was better than it was during the quote, unquote, Reagan boom. It's just that stocks were so cheap that you were really primed for gains almost no matter what happened.

[J.R. Whalen]

Well, a good reason to follow Spencer Jacob in the hurt on the street pages in the Wall street journal and on WSJ.com to see how history can guide us toward understanding today's market. Spencer, thanks for being with us.

[Spencer Jacob]

Thank.

[J.R. Whalen]

And that's your Money Briefing. I'm JR Whalen in New York for the Wall Street Journal.

[Small Business Owner]

Access to affordable credit helps me pay my employees, but I don't really need it.

[Retail Industry Representative]

Inflation is killing me, but who cares? Big retailers are making record profits. That's why we support the Durbin Marshall credit card bill.

[Small Business Owner]

See, banks and credit unions help small businesses make payroll. This bill would cut the vital resources

[Retail Industry Representative]

they need while increasing megastore profits. They deserve it, don't they?

[Electronic Payments Coalition Spokesperson]

Tell Congress, stop the Durbin Marshall money grab for corporate megastores paid for by the Electronic Payments Coalition.