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Investment Strategy

Do Valuations Matter?

By Elliott H. Gue, on Oct. 2, 2015

What does that mean for investors? The stock market looks expensive right now; historically, buying the S&P 500 at these levels would result in positive, but subpar, returns over the next 10 years

History also tells us that investors with a longer time horizon usually have a good buying opportunity when the S&P 500 trades at less than 15 times earnings. And when the index’s price-to-earning ratio drops to less than 14, investors who back up the proverbial truck usually do well over the next 10 years.

Valuation and LT Returns

If the S&P 500 were to retrench to 15 times trailing earnings, the index would slip to about 1,700. A pullback to 14 times earnings would take the S&P 500 back to 1,585. Bear markets in US equities have averaged a 25 percent decline since 1960, a move that would take the S&P 500 from its 2015 high to about 14 times earnings.

Our outlook calls for the S&P 500 to enjoy a year-end relief rally that will approach its 2015 high. This last-gasp upsurge will resemble the rallies in US equities that took place in fall 2007 and March through September 2000; we expect a bear market to start by early 2016.

Our Wealth Builders Portfolio holdings have followed the broader market lower in recent weeks and should be dragged higher by the recovery rally later this fall. We have a three-part plan for dealing with the coming bear market.

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