Tag: S&P 500

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S&P 500 tunnel vision

Stocks are growing increasingly bullish, after strong earnings results for the last quarter, with the S&P 500 closing above 5000 for the first time.

S&P 500

Even small caps are growing increasingly bullish, with the Russell 2000 ETF (IWM) testing resistance at 200. Breakout would signal that the current narrow advance is broadening.

iShares Russell 2000 Small Caps ETF (IWM)

The Price-to-Sales ratio remains elevated, at 2.56, warning of long-term reversion towards the mean at 1.70.

S&P 500 Price-to-Sales

Sales growth improved slightly to 5.2% for the December quarter, compared to December 2022. But this is before inflation; so real growth remains low.

S&P 500 Sales Growth

Operating margins shrunk to 10.7%, with 75.6% of corporations having reported, from earlier estimates of 11.0%.

S&P 500 Operating Margin

Treasury Market

Ten-year Treasury yields are testing resistance at 4.20%. Breakout would offer a target of 4.60% — a bear signal for stocks.

10-Year Treasury Yield

The 2-year Treasury yield — normally a reliable leading indicator of the Fed funds rate — is currently rising, warning that Fed rate cuts are likely to remain on pause for longer.

Fed Funds Rate & 2-Year Treasury Yield

The long-term challenge facing Treasury is the rising projected budget deficits, with debt likely to grow at a faster pace than GDP. CBO projections vastly understate the likely deficit as Brian Riedl explains below:

CBO Projected Deficits

Revised CBO Projected Deficits

Gold & the Dollar

The Dollar Index retraced to test support at 104 but is greatly influenced by the direction of the Fed funds rate and Treasury yields.

Dollar Index

Gold is ranging between $2000 and $2055 per ounce. The lower close at $2024 suggests another test of support at $2000.

Spot Gold

2023 is the first time that the gold price has kept rising while ETF gold holdings are falling. Cause of the divergence is believed to be strong central bank purchases over the past 12 months.

Gold ETF Tonnage

Conclusion

The S&P 500 is vastly overpriced when we compare the current price-to-sales ratio of 2.56 to its long-term average of 1.70. Sales growth is also falling, while operating margins are shrinking. Investors seem to have tunnel vision, focused on rising prices rather than underlying fundamentals.

Long-term yields are rising, with the Fed expected to postpone rate cuts until mid-year, which is bearish for stocks.

Federal deficits are expected to grow to $3.6 trillion by 2034, warning of rising inflationary pressure and higher Treasury yields. The Fed may suppress long-term yields but that is likely to increase inflationary pressure even more.

The short-term outlook for Gold is bearish — if long-term yields rise — but the long-term outlook is strongly bullish because of expected rising inflation and central bank purchases.

Acknowledgements

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S&P 500 losing touch with reality

The S&P 500 climbed to a new high after breaking resistance at its January ’22 high of 4800. Rising Trend Index troughs warn of strong buying pressure. Pricing seems to be losing touch with reality.

S&P 500

The S&P 500 Price-Earnings ratio climbed to 24.2 on December 31st and is forecast to reach 24.9 at the end of the quarter (based on the current index price and forecast Q1 earnings). The chart below shows the pricing history of the index (and its predecessors) over the past 120 years. We use highest trailing earnings to eliminate distortion caused by sharp falls in earnings during past recessions. Prior to the Dotcom bubble, PE had never exceeded 20 times earnings — even during the heady booms preceding the Black Friday crash in 1929 and Black Monday in 1987. The long-term average PE of 16.5 (since 1973) suggests that the index is currently over-priced by close to 50%.

S&P 500 PE of Highest Trailing Earnings

The price-to-sales ratio of 2.57 shows a similar excess compared to the average of 1.70.

S&P 500 Price-sales Ratio

The operating margin of 11.0% in the December quarter has declined from its 2021 peak at 13.5% but is still above its 10-year average of 10.2%. We expect margins to revert to the mean over the next year or two.

S&P 500 Operating Margins

While margins are still reasonably healthy, annual sales growth plunged to 4.0% in the December quarter. Core PCE inflation of 2.9% in 2023 means that real growth in sales was a paltry 1.1% last year.

S&P 500 Annual Sales Growth

Conclusion

The S&P 500 is over-priced relative to earnings and sales growth, with long-term intrinsic value estimated at  3200 — roughly two-thirds of the current price. If the Fed continues to inject liquidity to support financial markets ahead of the November elections, we do not expect a major correction in 2024 — bar a major geopolitical event that impacts on energy prices.

The following year is likely to prove more difficult, however, with the Fed draining liquidity to ease underlying inflationary pressure and Treasury increasing issuance of notes and bonds, driving up long-term yields.

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Santa rally: Monetary easing offsets China woes

China’s economy is struggling despite injection of moderate stimulus and efforts to support a collapsing real estate sector. Shrinking demand from China threatens a global economic contraction. G7 central banks have responded with monetary easing, causing a broad rally in stocks. This is most likely a bear market rally, with far shorter duration than a bull market.

China’s Shanghai Composite Index is testing primary support at 2900, warning of an economic contraction. The Trend Index peak near zero confirms selling pressure.

Shanghai Composite

Copper, however, has penetrated its descending trendline. Follow-through above 8500 would test resistance at $8750 per metric ton, threatening a wide double-bottom reversal with a target of $9500. Breakout above $8750 would signal global economic recovery, while reversal below $7800 would warn of a global recession.

Copper

US Stocks

The S&P 500 is testing it 2022 high at 4800, buoyed by injections of liquidity into financial markets.

S&P 500

The equal-weighted S&P 500 broke resistance at 6300, suggesting a broader rally than just the top 7 stocks. Retracement that respects the new support level would confirm the target at 6665.

S&P 500 Equal-Weighted Index ($IQX)

The Russell 2000 small caps ETF (IWM) threatens a similar breakout above 200, offering a target of 240. Breakout would confirm that investors are growing more aggressive (risk-on) and downplaying risks.

Russell 2000 Small Caps ETF (IWM)

Interest Rates

Ten-year Treasury yields are retracing to test resistance at 3.9% or 4.0%; respect is likely and would confirm the target of 3.5%.

10-Year Treasury Yield
An increase in supply of Treasury Notes will test bulls’ conviction next week:

A raft of fresh, post-Christmas government bond supply will put that comprehensive bullishness to the test. Next week, Treasury will auction $57 billion, $58 billion and $40 billion in two-, five- and seven-year notes, respectively. That’s up 20%, 15% and 7% from their average sizes over the past four monthly auctions. (Grant’s Current Yield)

The 2-year Treasury yield (purple below) is falling in anticipation of Fed rate cuts next year. A peak in the 2-year tends to lead the first rate cuts by 6 to 9 months. The signal misfired with the SVB banks crisis in March but the October peak warns of Fed rate cuts in Q2 or Q3 of 2024.
Fed Funds Rate Minimum Target & 2-Year Treasury Yield

International Stocks

The FTSE 100 is testing resistance at 7700, with a Trend Index trough at zero signaling buying pressure.

FTSE 100

The DJ Stoxx Euro 600 — reflecting the top 600 stocks in Europe — broke resistance at 470. Follow-through above 480 would test the 2022 high of 494.

DJ Euro Stoxx 600

Japan’s Nikkei 225 is testing long-term resistance at 33750. Breakout would signal a fresh primary advance but declining Trend Index peaks show a lack of commitment from buyers.

Nikkei 225 Index

The ASX 200 is testing resistance at 7600, buoyed by strong iron ore prices and falling long-term bond yields. A sharp rise in the Trend Index indicates buying pressure but reversal below 7400 would warn of a correction to test support at 7000.

ASX 200

Gold & the Dollar

The US Dollar Index respected resistance at 102.50, confirming the target at 100. Trend Index peaks below zero signal strong selling pressure.

Dollar Index

Gold broke through resistance at $2050, closing at $2053 per ounce. Expect retracement to test the new support level; respect would confirm another attempt at $2100. A falling Dollar and increased bullion demand from central banks is expected to maintain upward pressure on Gold prices.

Spot Gold

Conclusion

Stocks are rallying in response to falling long-term Treasury yields and in anticipation of Fed rate cuts next year. But falling LT Treasury yields is a medium-term rally in a long-term bear market, with LT yields expected to rise in 2025. Fed rate cuts are also a bearish sign, normally preceding a recession by several quarters — falling earnings are definitely not bullish for stocks.

Investors will need to be agile, to take advantage of the current bullishness in stocks while guarding against:

  • a trend reversal in long-term yields; and
  • signs that the broad economy is falling into recession.

Vacation

This is our last newsletter of the year as we close our office for two weeks over Christmas and the New Year.

We wish all our readers peace and goodwill over the festive season and hope for a less tumultuous year ahead.

The Magpie by Claude Monet

The Magpie by Claude Monet

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Dovish Fed, Dollar falls, Gold climbs

Long-term Treasury yields plunged in response to a dovish Fed meeting which kept rates on hold, with a target range of 5.25% – 5.00%. Ten-year Treasury yields are now testing our target at 4.0%.

10-Year Treasury Yield

Declining inflation and signs of labor market easing moved the FOMC to discard the additional rate hike and increase projected rate cuts to 75 basis points next year. Their dot plot now shows 2024 ending with a target range of 4.5% – 4.75%.

10-Year Treasury Yield

Unemployment is forecast to rise to 4.1%, from 3.8% at the end of 2023, but still close to full employment. PCE inflation is projected to slow from 2.8% at the end of ’23 to 2.4% by the end of ’24, with real GDP growth slowing from 2.6% in 2023 to 1.4% next year.

QT continues unchanged at the rate of $95 billion per month: $60 billion Treasuries and $35 billion MBS.

The S&P 500 closed at 4707, headed for a test of its previous high at 4800. Breakout would signal a primary advance, with a target of 5500.

S&P 500

The equal-weighted S&P 500 ($IQX) also rallied strongly, testing medium-term resistance at 6300, compared to the early 2022 high of 6665.

S&P 500 Equal-Weighted Index

Large caps show plenty of buyer interest but the Russell 2000 small caps ETF lags far behind. Normally small caps lead in the first stage of a bull market, so this warns that investors are more risk-averse than in a typical bull market.

Russell 2000 Small Caps ETF (IWM)

Gold & the Dollar

The Dollar weakened, as no doubt intended. Breach of support at 102.50 would offer a target of 100.

Dollar Index

Gold jumped to $2031 per troy ounce. Recovery above $2000 signals another test of resistance at the earlier close of $2070. Dollar Index breach of support at 102.50 would be likely to push Gold above $2070, confirming the medium-term target of $2250 per ounce.

Spot Gold

Conclusion

The bull-trend in stocks, bonds and Gold continues. Breakout to new highs on the S&P 500 and Gold are likely. But beware that the bullish outlook is built on an unstable foundation, with commodities warning of a global recession and record-high federal debt-to-GDP limiting Fed options if the Treasury market is threatened by large outflows.

Acknowledgements

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S&P 500 rallies while consumer sentiment falls

The University of Michigan Index of Consumer Sentiment declined to 61.3 for November. Levels below 70 in the past have signaled a recession.

University of Michigan Consumer Sentiment

Consumer sentiment is in sharp contrast to robust personal consumption expenditures which at 93% of disposable personal income are well above pre-pandemic levels.

Personal Consumption Expenditure/Disposable Personal Income

Mortgage rates above 7.0% failed to dampen discretionary spending, with most households having locked in low fixed mortgage rates over the pandemic.

30-Year Mortgage Rate

Home Sales

Existing home sales declined to an annual rate of 3.8 million, with households are reluctant to give up their cheap fixed-rate mortgages.

Existing Home Sales

New home sales surged as a result, boosting residential construction.

New One-Unit Home Sales

Inflation Expectations

The University of Michigan November survey shows 1-year inflation expectations increased to 4.50%.

University of Michigan Inflation Expectations 1-Year

Five-year expectations increased to 3.2%, with the 3-month moving average of 3.0% well above the Fed’s 2.0% target.

University of Michigan Inflation Expectations 5-Year

Rising inflation expectations mean that the Fed is unlikely to cut interest rates in the foreseeable future.

Interest Rates

10-Year Treasury yields continue to test support at 4.40% after Treasury weighted new issuance towards the front-end of the yield curve — largely funded by money market funds currently invested in repo. Breach of support would offer a target of 4.0% — bearish for the Dollar.

10-Year Treasury Yield

Stocks

The S&P 500 is testing its July high of 4600. Breakout is uncertain but would not signal a bull market unless confirmed by other indices.

S&P 500

The S&P 500 Equal-Weighted Index ($IQX) has recovered less than 60% of its last decline.

S&P 500 Equal-Weighted Index

The Russell 2000 Small Caps ETF (IWM) is even weaker, retracing less than 50% of its last decline, suggesting that investors have little appetite for risk.

Russell 2000 Small Caps Index iShares ETF (IWM)

Dow Jones Transportation Average has also retraced less than 50%. The Trend Index below zero continues to warn of selling pressure.

Dow Jones Transportation Average ($DJT)

Gold and the Dollar

The Dollar Index retraced to test resistance at 104. Respect is likely and breakout below 103 would offer a target of 100.

Dollar Index

The weakening Dollar is bullish for Gold which is testing resistance at $2000 per ounce. Breakout would offer a short-term target of the previous high at $2050.

Spot Gold

Commodities

Dow Jones Industrial Metals Index ($BIM) fell sharply, warning of another test of primary support at 153. Breach would warn of a global recession, especially if mirrored by a similar breach in Copper.

Dow Jones Industrial Metals Index ($BIM)

Copper is testing its descending trendline at 8300. Reversal below primary support at 7800 would warn of a global recession. China consumes about 50% of the world’s copper production, most of it used in construction. So a lot depends on China’s efforts to rescue their ailing property sector.

Copper

The downward spiral of China’s ailing property sector shows no sign of abating despite the government’s rollout of a seemingly endless series of supportive but as yet ineffective measures, with the crisis stretching for over three years…..

The market for Chinese developers’ dollar-denominated bonds has seen a meltdown over the past two years, losing 87% of its value. The rout has wiped out $135.5 billion of value from $154.9 billion of outstanding notes, according to analysis by Debtwire. (Caixin)

Brent crude is testing resistance at $83 per barrel. Respect would warn of another downward leg to $72 and strengthen a bear market warning from Copper and base metals.

Brent Crude

Conclusion

Personal consumption expenditures remain strong despite falling consumer sentiment. The S&P 500 is testing resistance at 4600 but the advance is narrow, with investors avoiding risk in the broader market.

The Dollar weakened on the back of falling long-term Treasury yields, boosting demand for Gold which is testing resistance at $2000 per ounce. Breakout would offer a short-term target of $2050.

Copper and base metals are expected to again test primary support as doubts remain over China’s ailing property sector. Breach of support would warn of a global recession.

Inflation expectations remain persistent, with five-year expectations at 3.0% in the November University of Michigan consumer survey, well above the Fed’s target of 2.0%. The likelihood of rate cuts in early 2024 is remote unless a major collapse in financial markets forces the Fed’s hand.

Acknowledgements

Macrobusiness: China’s property black hole sucks in the CCP.

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Moody’s negative outlook and falling consumer sentiment

Ten-year Treasury yields continue to respect support at 4.50%. We expect another test of resistance at 5.0%.

10-Year Treasury Yield

Moody’s kept their AAA rating for the US government but changed their outlook from stable to negative. The reasons cited  — large deficits and a polarized ineffective Congress — are strong arguments for higher Treasury yields:

Moody's Rating

Japan has also broken above 150 yen to the Dollar, increasing pressure on the BoJ to relax their cap on long-term JGB yields. Any move to relax yield curve control would be likely to cause an outflow from US Treasuries and the Dollar, driving down prices.

USDJPY

Inflation

Inflation expectations are rising, with University of Michigan 1-year expectations jumping to 4.4% — and the 3-month moving average to 3.9%.

University of Michigan Inflation expectations 1-Year

Five-year expectations are also rising, reaching 3.2% in October, with the 3-month moving average at 3.0%.

University of Michigan Inflation expectations 5-Year

Higher inflation expectations add to upward pressure on long-term yields.

Financial Conditions

Financial conditions remain loose — despite the strong rise in long-term yields — with the spread between Baa corporate bonds and the equivalent Treasury yield at a low 1.84%.
Moody's Baa Corporate Bond Spreads

Economic Outlook

Low consumer sentiment, with the University of Michigan Index at 64, continues to warn of a recession.
University of Michigan Consumer Sentiment

Heavy truck sales — a reliable leading indicator — are falling steeply. A fall below 35,000 units would be cause for concern.

Heavy Truck Sales

Stocks

The S&P 500 ended the week stronger, with a bullish candle testing resistance at 4400.

S&P 500

Small caps continue to warn of weakness, however, with the Russell 2000 iShares ETF (IWM) likely to test primary support at 162. Trend Index peaks below zero warn of strong selling pressure. Small caps tend to outperform large caps by a wide margin in the first phase of a bull market — clearly not the case here.

Russell 2000 Small Caps iShares ETF (IWM)

Global Economy

Copper is retracing for another test of primary support at $7800 per metric ton. Breach would warn of a global recession.

Copper

Gold

Gold broke support at $1900 per ounce, indicating a test of $1900. Rising long-term interest rates are undermining investor demand for Gold.

Spot Gold

But Gold is supported by strong central bank purchases, led by China.

Central Bank Gold Purchases & Sales

Australia

The ASX 200 retreated below 7000 on Friday but a bullish close on the S&P 500 should see retracement to test resistance. Declining Trend index peaks, however, warn of rising selling pressure.

ASX 200

Conclusion

We expect upward pressure on long-term Treasury yields to continue, boosted by Moody’s negative outlook for the US, a weakening Japanese Yen and rising inflation expectations.

Declining heavy truck sales and weak consumer sentiment are bearish for the economy. The S&P 500 remains bullish but small caps are more bearish, warning that this is not a broad-based recovery.

Copper breach of $7800 per metric ton would warn of a global recession.

We remain overweight cash, money market funds, short-duration term deposits and financial securities (up to 12 months), defensive stocks, critical materials and gold.

Acknowledgements

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Debt reduction, buybacks and S&P 500 P/E multiples

There is a rising trend — especially in the telecommunications, utilities, and REITs sectors — of selling off non-core assets and using the proceeds to reduce debt. Rising long-term interest rates are likely to accelerate this trend.

Debt reduction reduces funds available for stock buybacks. This chart from S&P Dow Jones Indices shows buybacks on the S&P 500 have been declining since Q2 of last year.

S&P 500 Buybacks

Without buybacks, S&P 500 earnings growth is expected to follow declining year-on-year sales growth, removing the justification for high earnings multiples.

S&P 500 Sales Growth

Price-earnings multiple for the S&P 500 is expected to decline towards its 50-year average of 16.4.

S&P 500 Price/Highest Trailing Earnings

Conclusion

Debt reduction is likely to accelerate the decline of stock buybacks, eroding support for elevated price-earnings multiples.

Declining sales growth is likely to reduce earnings growth and further erode the justification for high earnings multiples.

The price-earnings multiple for the S&P 500 is expected to decline towards its 50-year average of 16.4 (based on highest trailing earnings).

Acknowledgements

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Copper breaks support while crude gets hammered

Copper broke support at $7900/tonne, signaling a primary decline with a target of its 2022 low at $7000. The primary down-trend warns of a global economic contraction.

Copper

The bear signal has yet to be confirmed by the broader-based Dow Jones Industrial Metals Index ($BIM) which is testing primary support at 155.

DJ Industrial Metals Index ($BIM)

Crude oil

Crude fell sharply this week, after a 3-month rally.

Nymex Light Crude

The fall was spurred by an early build of gasoline stocks ahead of winter, raising concerns of declining demand.

Gasoline inventories added a substantial 6.5 million barrels for the week to September 29, compared with a build of 1 million barrels for the previous week. Gasoline inventories are now 1% above the five-year average for this time of year….. production averaged 8.8 million barrels daily last week, which compared with 9.1 million barrels daily for the prior week. (oilprice.com)

Gasoline Stocks

Crude inventories have stabilized after a sharp decline during the release of strategic petroleum reserves (SPR).

EIA Crude Inventory

Releases from the SPR stopped in July — which coincides with the start of the recent crude rally. It will be interesting to see next week if a dip in this week’s SPR contributed to weak crude prices.

Strategic Petroleum Reserves (SPR)

Stocks & Bonds

The 10-year Treasury yield recovered to 4.78% on Friday.

10-Year Treasury Yield

Rising yields are driven by:

  • a large fiscal deficit of close to $2T;
  • commercial banks reducing Treasury holdings; and
  • the Bank of Japan allowing a limited rise in bond yields which could cause an outflow from USTs.

Bank of Japan - YCC

The S&P 500 rallied on the back of a strong labor report.

S&P 500

The S&P 500 Equal-Weighted Index test of primary support at 5600 is, however, likely to continue.

S&P 500 Equal-Weighted Index

Expect another Russell 2000 small caps ETF (IWM) test of primary support at 170 as well.

Russell 2000 Small Caps ETF (IWM)

Labor Market

The BLS report for September, with job gains of 336K, reflects a robust economy and strong labor market.

Job Gains

Average hourly earnings growth slowed to 0.207% in September, or 2.5% annualized. Manufacturing wages reflect higher growth — 4.0% annualized — but that is a small slice of the economy compared to services.

Average Hourly Earnings

Average weekly hours worked — a leading indicator — remains stable at 34.4 hours/week.

Average Weekly Hours

Unemployment remained steady at 6.36 million, while job openings jumped in August, maintaining a sizable shortage.

Job Openings & Unemployment

Real GDP (blue) is expected to slow in Q3 to 1.5%, matching declining growth in aggregate weekly hours worked (purple).

Real GDP & Hours Worked

Dollar & Gold

The Dollar Index retraced to test new support at 106 but is unlikely to reverse course while Treasury yields are rising.

Dollar Index

Gold is testing primary support at $1800 per ounce, while Trend Index troughs below zero warn of selling pressure. Rising long-term Treasury yields and a strong Dollar are likely to weaken demand for Gold.

Spot Gold

Conclusion

Long-term Treasury yields are expected to rise, fueled by strong supply (fiscal deficits) and weak demand (from foreign investors and commercial banks). The outlook for rate cuts from the Fed is also fading as labor market remains tight.

The sharp drop in crude oil seems an overreaction when the labor market is strong and demand is likely to be robust. Further releases from the strategic petroleum reserve (SPR), a sharp fall in Chinese purchases, or an increase in supply (from Iran or Venezuela) seem unlikely at present.

Falling copper prices warn of a global economic contraction led by China, with Europe likely to follow. Confirmation by Dow Jones Industrial Metals Index ($BIM) breach of primary support at 155 would strengthen the bear signal.

Strong Treasury yields and a strong Dollar are likely to weaken demand for Gold unless there is increased instability, either geopolitical or financial.

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Investing in Real Estate

In Monday’s update, we compared investing in stocks to investing in financial securities and concluded that stocks offer better long-term performance. Today, we use long-term data series for US and Australian real estate to evaluate their comparative performance.

US real estate data was sourced from Prof Robert Shiller, who created the Case-Shiller Index series. The chart below shows that US home prices from 1933 to 2023, a period of ninety years, appreciated to 69.5 times their original value.

Home Price Index

Adjusting for inflation, we get real appreciation of 2.9 times.

Again, CPI seems to understate inflation. Comparing the home price index to Gold, rather than CPI, provides a more accurate measure of appreciation in real terms. Gold appreciated 94.5 times over the same period, so the home price index actually lost value.

Calculation: 69.5/94.5 = 0.735 (i.e. a 26.5% loss of value)

Comparing data sources

A second source of home price data compares median prices, based on sales of existing homes, from 1953 to 2023. That shows growth of 22 times over the past seventy years, which is close to the Home Price Index appreciation of 21.25 over the same period.

Median Home Prices, Existing Homes

Australia

Australian housing data is harder to come by but we found an excellent source of long-term median house price data in the 2007 UNSW thesis of Dr Nigel David Stapledon. Using data from within the thesis, we were able to adjust nominal house prices to reflect constant quality (house values with no improvements) below.

Median Home Prices, Existing Homes, Constant Quality

Australian house prices appreciated 191.4 times between 1933 and 2006.

Unfortunately the data ends there, so we had to calculate a weighted average of median houses for 2007 to the present.

CoreLogic kindly provided us with values for their hedonic Home Value Index (for 5 Capital Cities) which also adjusts for quality:

Property Type	31/01/2007	31/07/2023
Houses		$399,182	$891,747

The gain of 2.23 is slightly higher than the 2.14 calculated from weighted average data for the 8 capital cities provided by the ABS.

Median Home Prices, Weighted Average of 8 Capital Cities

We opted for the higher figure from CoreLogic as likely to be more in line with the earlier Stapledon data. That gives a total nominal gain, adjusted for quality, of 426.8 for the ninety years from 1933 to 2023.

The price of Gold fines was fixed at £6-3/9 per troy ounce fine according to the Sydney Morning Herald on 2 January 1933, that converts to 12.375 Australian Dollars. Total gain for Gold in Australian Dollars over the past ninety years is therefore 232.9 times (A$2881.90/12.375).

We calculate the real gain for Australian house prices as 1.83 times over the past ninety years (426.8/232.9).

Conclusion

The US Home Price Index lost 26.5% in real terms, over the past ninety years (1933 – 2023), when compared to Gold.

The S&P 500 appreciated 6.8 times over the past ninety years when measured against Gold, and 9.7 times compared to US real estate (Home Price Index).

Using Gold as the benchmark, we conclude that Australian real estate prices appreciated faster than US real estate over the past ninety years, growing 1.83 times in real terms, whereas the US depreciated to 0.735 of its original real value.

We suspect the difference is largely due to the substantial fall in US real estate values after the 2008 sub-prime crisis, whereas Australian home prices continued to grow. We expect that performance of the two will converge in the long-term.

Lastly, when measured against Gold, US stocks outperformed Australian real estate. The S&P 500 grew 3.7 times against Australian home prices, in real terms, over the past ninety years.

This does not mean that we should ignore real estate as an investment medium. But a portfolio concentrated in real estate, without diversification into stocks and precious metals, could underperform in the long-term.

Acknowledgements

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Why invest in stocks?

Some clients are understandably nervous about investing in stocks because of the volatility. Invest at the wrong time and you can experience a draw-down that takes years to recover. Many shy away, preferring the security of term deposits or the bricks and mortar of real estate investments.

The best argument for investing in stocks is two of the most enduring long-term trends in finance.

First, the secular down-trend in purchasing power of the Dollar.

Dollar Purchasing Power

Inflation has been eating away at investors’ capital for more than ninety years. Purchasing power of the Dollar declined from 794 in 1933 to 33 today — a loss of almost 96%. That means $24 today can only buy what one Dollar bought in 1933.

The second trend, by no coincidence, is the appreciation of real asset prices over the same time period.

The S&P 500 grew from 7.03 at the start of 1933 to 4546 in June 2023 — 649 times the original investment.

S&P 500 Index

Gold data is only available since 1959. In April 1933, President Franklin Roosevelt signed Executive Order 6102, forbidding “the hoarding of Gold Coin, Gold Bullion, and Gold Certificates” by US citizens. Americans were required to hand in their gold by May 1st in return for compensation at $20.67 per ounce. Since then, Gold has appreciated 94.5 times its 1933 exchange value in Dollar terms.

Spot Gold Prices

Over time, investing in real assets has protected investors’ capital from the ravages of inflation, while financial assets have for long periods failed to adequately compensate investors in real terms (after inflation). The chart below compares the yield on Moody’s Aaa corporate bonds to CPI inflation.

Moody's Aaa Corporate Bond Yield & CPI

Conclusion

Purchasing power of the Dollar depreciated by 24 times over the past ninety years due to inflation. Adjusting for inflation, the S&P 500 has grown to 27 times its original Dollar value in 1933, while Gold gained 3.9 times in real terms.

We would argue that the consumer price index understates inflation. Gold does not grow in value — it is constant in real terms.

If we take Gold as our benchmark of real value, then the S&P 500 has grown 6.8 times in real terms — a far more believable performance.

Stocks are a great hedge against inflation provided the investor can tolerate volatility in their portfolio. How to manage volatility will be the subject of discussion in a further update.

Acknowledgents

 

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