Stocks

As of September 2013, the MSCI Frontier Markets Index (141 companies) was valued at $123 billion, a valuation < 1/3 of Apple. Being small can have negative consequences. For example, it has been estimated that it would take > 10 days to liquidate a $100 million position in a frontier market (but just an hour to dispose of a similar position in an emerging market).

Research by finance professor Xavier Gabaix theorizes a 1-day stock market drop of 20% or more is expected to occur once every 100 years; a 15% plunge once every 50 years, and a 10-15% daily drop once every 13 years. His research uses stock market data dating back to the early 1900s.

Gabaix feels stock crashes are inevitable because very large institutional investors dominate the market. Occasionally, these investors want to get out of stocks at the same time.

Since 1896, the Dow’s average monthly return has been 0.66%; the number increases to 0.75% if you exclude September. The table below shows average monthly returns for the DJIA since 1896 and through 2012 (source: Hulbert Financial Digest).

DJIA Average Monthly Return  [1896-2012]

A factor affecting stocks’ sensitivity to movements in the overall market can be measured by VIX, the Chicago Board Options Exchange’s Volatility Index. Any time volatility decreases, correlations automatically decrease.

The September/October 2013 issue of Journal of Indexes includes interviews with a number of well-respected investment experts. Shown below are edited versions of two of those interviews.

John Bogle, founder of The Vanguard Group

Even if current P/E ratios see a small decline, 7% is a very rational expectation for annual stock returns (2% dividend + 5% earnings growth).

According to the U.S. Department of Commerce, the typical U.S. corporation reports a 9.3 cent profit for every dollar of sales. Over the past 60 years, there have been only a few times when it has gotten higher (i.e., 10% in Q4 2011). Since 1953, the profit margin has averaged just 5.9% (< 6 cents per dollar of sales).

For 2013, taxpayers with > $400,000 ($450k joint return) will pay a 20% tax on qualified dividends and long-term capital gains (15% in 2012). Those whose tax bracket is 10-15% will still pay 0% for qualified dividends and capital gains.

As of May 2013, the S&P 500 was trading at 14 times its projected earnings over the next 12 months (source: FactSet). During the market peaks in October 2007 and March 2000, the P/E ratio was 15.2 and 25.6. Its 10-year P/E average (May 2003 to May 2013) was 14.1.