(The following is summary of an article from advisor.ca)
The general consensus amongst economists is that the worst of the recession is over and that an economic recovery is fully underway. Many argue that we are looking at an unprecedented investment opportunity. “My personal view is that you are looking at an epic long-term buy-in point in the stock market”, says Fritz Meyer, senior market strategist with Invesco.
Despite the optimistic outlook for the economy, many people may be unwilling to believe it due to the role of the media. The most widely reported piece of economic data is the unemployment rate, which routinely shares the front page news with corporate layoffs. But the unemployment rate is a lagging indicator of economic growth, often trailing the economy by as much as 15 months. Thus, if an investor sits on the sidelines waiting for better employment data, they will likely have missed the stock market rally by as much as two full years.
In fact, August 1939, September 1974, and February 2009 are the only three periods over the last 100 years in which the S&P 500 had a 10-year return at or below 0%. Since the average returns since 1935 have been hovering around 11%, a reversion to the mean would require substantial gains over the next decade.
Investors are also concerned with the intrinsic value of their assets, measured by the price-to-earnings (P/E) ratio. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. Meyer estimates that the combined earnings of the S&P 500 should be about $100 per share in a normal economic environment. With the index currently hovering around 975, that indicates a P/E multiple of about 9.75 times normal earnings potential. Based on current earnings however, that multiple is at about 16 times, but were at the trough of a recession. Therefore, if the 16 times multiple were applied to earnings expected in the recovery, the S&P 500 should be around the 1600 mark. To reach that mark the index would need to climb 64% from its current value.