Ten years from now, I am fairly certain we will look back at this bull market and wonder how it kept going up for so long. By then, we should have a better understanding of where the problems were hiding. But, for now, we don't have the benefit of hindsight.
Some experts believe the future will be disappointing.
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Jeremy Grantham, a noted value investor with about $74 billion under management, has studied bubbles and believes we are about to see one in stocks.
He recently published a paper called "Bracing Yourself for a Possible Near-Term Melt-Up." He said a bubble is likely within the next six months to two years. After that, he says, the odds of a subsequent big decline are "very, very high."
GMO, Grantham's management firm, also publishes a seven-year forecast of returns for various asset classes. The latest estimate for the stock market is for an average real return of -4.6% a year over the next seven years.
That means looking back from 2025 could be a lot like looking back from 2002 and seeing a large bubble and a crash unfold over the previous seven years.
Grantham is not alone in his concerns. Another well-respected analyst, Rob Arnott of Research Affiliates, recently released a paper with the same general conclusion. Arnott is more bullish than Grantham, but he sees a 10-year average real return on stocks of about zero.
Arnott attributes the low returns to the high valuations we see today. He notes that price-to-earnings (P/E) ratios and other fundamental metrics are not useful for market timing, but that they provide a good forecast of long-term returns.
So, the long-term outlook is grim.
But, the truth is that this has always been the case. As economist John Maynard Keynes said, "In the long run, we are all dead."
The Short Term Remains Profitable
I strongly believe that it's the short term -- a timeframe measured in weeks or months -- we should focus on, as investors. And for that time period, I remain bullish. There may be a pullback, but fundamentals, including higher earnings due to tax reform, should continue to push stock prices up.
Fundamentals are improving at a number of individual companies, and among the winners are big banks. But analysts have to dig beneath the headlines to discover that fact.
When JPMorgan Chase (NYSE: JPM) reported recently, its quarterly results were well below expectations. The biggest U.S. bank (ranked by assets) reported earnings per share (EPS) of $1.07, or total earnings of $4.2 billion. This was after an accounting charge of $2.4 billion related to changes in the tax law. Excluding that charge, the bank said EPS was $1.76.
Analysts had been expecting EPS of $1.69 excluding charges and $1.16 after factoring in the tax impact. But traders looked beyond the current quarter and pushed the price of the stock up. This could be, at least in part, because of comments from JPMorgan's CEO, Jamie Dimon, who said the impact from the tax overhaul is "a big significant positive and much of it will fall to our bottom line in 2018 and beyond."
One source of increased earnings going forward will be lower tax rates. The bank's effective tax rate is expected to be about 19% this year and 20% over the near term, down from 35% previously. In all, Dimon said the bank could have roughly $3.6 billion in additional net income in 2018 as a result of the tax overhaul.
In a call with analysts, Dimon noted that the bank expects to have roughly $3.6 billion in additional earnings next year thanks to the new tax reform. Of course, new regulations are still being written and the final tax rules won't be known for some time... so that number could change.
Despite the uncertainty of the new tax rules, the bank is beginning a $20 billion, five-year investment plan that will see the firm open up to 400 branches in new markets across the country, grow its home lending to lower-income consumers, and boost wages for some retail-banking employees, among other changes.
Analysts have been raising earnings estimates to reflect the revised outlook. A total of 27 analysts following the company have published EPS forecasts for this year. In the past month, there have been 23 increases in EPS estimates, with analysts now expecting $8.84, up from $7.77 a month ago and $7.62 three months ago.
For next year, analysts are expecting EPS of $9.74, up 12% from a month ago. Increased estimates are bullish, and the strong fundamentals in this company set up a low-risk income trade opportunity.
How I'm Trading This Growth -- Without Buying Any Stock
If you're interested in catching some of the potential upside, you can always buy shares of JPM.
But I found a better trade... One that will guarantee I collect a 1.9% return in just over a month. That may not sound like much, but it beats JPM's annual dividend yield of 1.8%... and annualizes to a gain of 13.9%... all without buying a single share of the stock.
This trade uses a high-income, short-term put option on JPM. While I understand not everyone is comfortable selling options, you shouldn't let that fear or nervousness keep you from taking advantage of this tool.
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