Future Returns from US Equities

There will be more attractive prices in the future, and holding extra cash until then may be the most sensible strategy, as equities tend to punish investors when they can least afford it

Daniel Needham 17 March, 2015 | 10:02AM
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US equity market prices are up over 300% from the lows of March 2009. In hindsight, there is little doubt that this was a significant low for the US market. It is reasonable to assume at least part of this increase reflected a correction of extremely low pricing of US equities. An increase of this magnitude raises the valid question of whether or not US equities are over-priced.

Estimating the fair value of any asset requires the discounting of the expected future cash flows over the life of the investment.  This involves an estimate of the cash flows, the risk and uncertainty of these cash flows and the opportunity cost of the capital. Comparing price with this estimate of fair value is at the heart of value investing. This applies equally to aggregate equity markets as it does to individual companies.

To apply this to US equities, we can view the aggregate market as an individual company. The US economy looks relatively strong and US corporations are currently very profitable across a number of different measures. However, asset prices should compensate for the prospective risk of investing and the drivers of equity market fundamentals are pro-cyclical. While the situation looks rosy at present, revenue, profits, dividends, buy-backs and price earnings ratios all tend to fall during economic downturns.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Daniel Needham  is Global Chief Investment Officer for Morningstar Investment Management.