The Market Has Already Protected You From Inflation With 48% Gains Over 2 Years, Take Profits Now
0I was hoping to take a few weeks off just to enjoy a little break from writing, but every time I check into Seeking Alpha, I see more and more articles telling investors who need income to snap up what are supposed to be high yield bargains because otherwise inflation is going to eat all their money. This strikes me as very questionable advice in a market where earnings are predicted to flatten out now that enthusiasm for reopening after COVID-19 shutdowns has had a year to work its way through earnings. We keep hearing "cash is trash" because inflation will destroy its value. But what people are missing is that over the past two years their stocks have already risen by an amount that far more than compensates for current and coming inflation. Not only that, but the market, which was already quite highly valued for its earnings growth rate in January of 2020, has risen so high so quickly, that a reversion to even the P/E ratio present in January of 2020 would leave investors with painful losses that could take a long time to recover. The loss in buying power you would experience from taking profits from the past two years' out-sized gains and putting it into cash is far less than you may experience if even a mild correction occurs. Don't let greed convince you that market will never again have a P/E like the one it had before COVID-19 struck. The SP 500 Has Risen 48.09% since January of 2020, Its Earnings Have Grown by Far Less One look at the chart below tells you just how much the market, as defined by the SP 500, has grown since January 2020. Back then COVID-19 was still something we read about in the news that seemed to only be a concern for people living in some obscure city in China. I have charted both the SP 500 index and the Vanguard SP 500 ETF ( VOO ) since it isn't possible to invest in the SP 500 directly. VOO is one of the cheapest ways to duplicate its results. SP 500 and VOO Total Return Since January 1, 2020 Source: Seeking Alpha As you can see, investors in VOO have captured a total return of 46.89% between January of 2020 and now. This is a period of only a few weeks less than 2 years, making that return unusually high even for a market that has had quite a few impressive years over the past decade. That near 47% return includes dividends. But even when we only look at price, we can see that shareholders in VOO who spent their dividends rather than reinvesting them are still sitting on price gains of 42.78% over that brief two year period. And of course, anyone who was brave enough to buy VOO around March 20, 2020 after the COVID lockdowns started is sitting on far higher gains. VOO has gained 102.19% in price return alone and 107.04% if you include dividends since March 20, 2020. The Earnings Per Share of the SP 500 Don't Begin to Justify This Extreme Price Growth FAST Graphs shows us how the composite earnings and the P/E ratios of the SP 500 Index have varied over time. Below, on the lines of data that appear below the graph, you can see what those annual earnings per share have been over the past decade since the beginning of 2011. You can also see what the annual rate of growth of those EPS have been. SP 500 Price, Earnings and P/E Ratio since January 2011 Source: FAST Graphs As you can see from this graph the average annual earnings growth rate of the stocks making up the SP 500 throughout this past decade have fluctuated widely from a low of -15% in 2020 to a high of 35% this year, but both that low and that high are outliers due to the immense disruption caused by COVID-19 lock downs. More relevant is that over this entire period, including the two years of COVID-19 disruption, earnings have grown at a modest average annual rate of only 7.27%. Nevertheless, prices have risen consistently and dramatically with no correlation to earnings, until the Price/Earnings Ratio of the SP 500 now is elevated way beyond what it has seen in the past. FAST Graphs calculates a "blended P/E ratio" which takes into account analysts' forecasts of earning growth over the next two years. That produces a P/E ratio of 25.23. Y-Charts just look at the current data. It gives us a considerably higher P/E ratio right now, 27.07, and its historical graph shows you just how out of line that current P/E ratio is compared to those that prevailed over the last five years. YCharts: SP 500 Five Year P/E Ratio Source: YCharts Analysts' Estimates Call for Average Annual EPS Growth of No More than 10.5% Over the Next Two Years The FAST graph below shows you the SP 500's price and earnings performance over the past 20 years, along with what analysts are predicting for future EPS growth of the SP 500 over the coming two years. SP 500 Price and P/E History over 20 Years with Future EPS Estimates Note that when we look at a broader time scale, one that includes the Great Financial Crisis and the recession it caused