-The Canadian Press
John Reese is CEO of Validea.com and Validea Capital, and portfolio manager for the National Bank Consensus funds. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service. Try it.
As 2015 receded into the sunset, the Wall Street Prediction Posse made its annual foray into town and its guns were blazing. This one said U.S. stocks will surge 15 per cent in 2016; that one said a 20-per-cent decline is in the offing; still another forecast the market will be flat. It was entertaining and it made for good headlines but, at the end of the day, it was all pretty worthless.
That's because so many factors go into short-term market movements that no one has found a way to reliably predict them. Not that they haven't tried. In his 1984 classic Super Stocks, Kenneth Fisher wrote that people have attempted to divine market movements using astrology, demographic studies, sunspots, economics, technical analysis, tea leaves, and even "the skin of a dried lizard at sunset cast to the wind." But, Mr. Fisher said, while a forecaster might have a good of couple years, no one has found a way to consistently predict short-term market movements – and that still holds true.
Long-term stock market forecasting is a different story. And, to get an idea of what to expect over the long haul, you don't need wild statistical algorithms (or dried lizard skins).
Legendary Vanguard founder Jack Bogle, for example, has found that just three factors go a long way toward predicting where the market will be 10 years out. "At first, that sounds so childishly simple it has to be wrong," Wall Street Journal columnist Jason Zweig wrote in discussing Mr. Bogle's research, which was recently updated in The Journal of Portfolio Management. "But researchers in many fields have found that extremely basic formulas are often superior at making predictions about complicated systems."
The first two of Mr. Bogle's factors are dividend yield and corporate earnings growth, which comprise what he calls the "investment return," because they are determined by fundamentals. The third is "speculative return" – that is, the change in what investors are willing to pay for each dollar of earnings (in other words, whether the market's price-to-earnings ratio is rising or falling).
Currently, the S&P 500 has a dividend yield of about 2.1 per cent. Historically, corporate earnings have grown at an average of about 4.7 per cent per year, according to Mr. Zweig. Add those two together, and you get an "investment return" projection of close to 7 per cent annually for the next 10 years. The speculative return is a bit tougher to gauge. Overall, while not exorbitant, valuations are on the high side right now; if they were to come back down to historical norms, a percentage point or two could be cut off of that investment return.
Mr. Bogle's approach isn't foolproof, but what's most important is that it shows that very real, generally stable factors drive long-term stock market returns. Yes, from day to day, week to week, and even year to year, reactions to short-term data points can create big swings in the market. But in the long term, it's all about earnings and dividends.
Perhaps you think that after a couple centuries of growth, U.S. businesses are suddenly going to stop growing. (I highly doubt it.) Or maybe you think that the market is wildly overvalued. (I think that is unlikely, given the S&P 500's far-from-astronomical trailing 12-month P/E and price-to-sales ratios of about 22 and 1.7, respectively.) But if neither of those applies, you probably should continue to buy U.S. stocks if you are a long-term investor.
More importantly, history has shown that buying undervalued shares of solid businesses leads to better-than-market-average returns. Focus on these types of stocks, and your portfolio should fare well over the long term, regardless of the many short-term stops and starts that occur in the broader market. With that in mind, here are three U.S. stocks that my fundamental-focused guru-inspired strategies are high on as we head into 2016.
Thor Industries Inc. (THO): Owner of the Airstream line of campers and trailers, Thor ($3-billion U.S. market cap) manufactures and sells a wide variety of recreational vehicles throughout the United States and Canada. The stock gets strong interest from the model I base on the writings of mutual fund legend Peter Lynch, which likes its 19-per-cent long-term earnings per share growth rate, 0.74 P/E-to-growth ratio (P/E ratio divided by growth rate), and lack of any long-term debt.
National Oilwell Varco (NOV): Benjamin Graham was known as the "father of value investing," and the model I base on his writings thinks this oil services firm has been hit too hard amid the oil price plunge. The $13-billion-market-cap firm has about twice as much in net current assets as it does in long-term debt and trades for only about 10 times earnings and 0.7 times book value.
ePlus Inc. (PLUS): This Virginia-based information technology firm ($700-million market cap) is a favourite of the growth strategy I base on the writings of quantitative investing guru James O'Shaughnessy. The approach likes that ePlus has increased earnings per share in each year of the past half-decade, and that it has strong momentum (a 12-month relative strength of 87, which indicates the stock has performed better than the majority of other stocks over the past year) and good value (0.6 price-to-sales ratio).
Disclosure: I'm long THO, NOV, PLUS.
John Reese