Last year we did a blog on valuation that was derived from a conversation with one of Australia’s leading fund managers, Paul Moore from PM Capital.
Further to this, I stumbled upon the following graph posted by James Bianco on LinkedIn that graphically represents exactly what Paul Moore was discussing.
The graph shown below looks at the correlation of current valuations (PE Multiples) relative to future returns. It further breaks it down into two components, the first being the relationship over one year and the second being the annual return over a 10 year period.
The results speak for themselves.
In the short term (first graph), which is represented by one year, there is no correlation. You might often hear people say “the market is expensive, but it can always get more expensive” as a reason to not sell or buy more. Note the graph which shows the returns over one year are scattered i.e the market can correct (become cheaper) or keep going (get more expensive).
In the long term (second graph), which is represented by the subsequent annualized returns over 10 years there is a strong correlation, purchasing assets at higher valuations will see lower annualised returns over the next 10 years. Interestingly there are periods where the market has returned negative nominal returns over the 10 year period.
That is a long wait to make money on your investment.
Given the high level of current share valuations, how much of your portfolio is in the share market?
Article by: Rob Coyte, CEO, Shartru Wealth Management