This article was originally posted in the Wall Street Journal here

By JONATHAN CLEMENTS

It is perhaps the most pressing question facing U.S. stock investors: Are we in a short-term bubble—or headed for long-term trouble?

There are plenty of reasons to be nervous about the U.S. market’s short-term outlook. Profit margins are at historically high levels. Share prices have tripled since the March 2009 market low. Valuations appear expensive based on market yardsticks like dividend yield and price/earnings ratios.

Still, it doesn’t look like we are in a bubble, and today’s lofty valuations probably will be considered fairly normal down the road. That might sound like good news, but there is a downside: It likely means we’ll see lackluster long-run returns.

Popping bubbles. The technology-stock bubble of the late 1990s and the housing bubble of the early 2000s saw prices rise to absurd levels over the course of three or four years. But that doesn’t describe what has happened to the overall U.S. stock market.

Instead, U.S. shares arguably have been overpriced for much of the past 25 years. Take the so-called Shiller P/E, named after Yale University economist Robert Shiller. It compares the S&P 500’s current level to average inflation-adjusted earnings for the past 10 years.

From 1946 to 1990, the measure—also known as the cyclically adjusted price/earnings ratio—averaged less than 15. Since then, it has averaged almost 26.

To be sure, there has been good news for stocks over the past 25 years, including rapid technological innovation, decelerating inflation and falling long-term interest rates.

But there also has been plenty of bad news. Indeed, the market has remained expensive despite much hand-wringing over valuations, worries about an aging population, two brutal bear markets, tepid economic growth for the past 15 years and all kinds of global conflict. That suggests that valuations may have shifted into a permanently higher range.

Dwindling opportunities. Why have valuations shifted higher? We appear to have too much money chasing too few investment opportunities.

This is partly driven by the loose monetary policy adopted by the world’s central banks, says William Bernstein, an investment adviser and author of “The Birth of Plenty.” But, he adds, it also is a reflection of a maturing economy.

In a subsistence society, there is little excess capital, so anybody with extra wealth can charge exorbitant interest rates to borrowers. But as societies grow richer, there is more capital available to be lent, so rates of return decline. “The richer the world gets, the lower investment returns become,” Mr. Bernstein argues.

Perhaps today’s best indicator that capital is plentiful, and investment opportunities are scarce, is the sharp increase in stock buybacks. Toronto-based pension consultant Keith Ambachtsheer calculates that over the past four years, the S&P 500 companies have had a payout yield of 4.8%, with 2.1% coming from dividends and 2.7% from net share repurchases.

“Corporations are now returning most of their earnings to shareholders in the form of dividends and share buybacks, and retaining little for capital reinvestment,” Mr. Ambachtsheer writes in his March newsletter. This, he says, is a sign of “mature capitalism.”

Shrinking returns. All this is a mixed blessing. The good news: While severe bear markets may occasionally drive down stocks to modest valuation levels, we probably won’t regularly see the S&P 500 trade at a Shiller P/E of 15.

The bad news: Stock returns in the years ahead are likely to be modest. “Because corporations are using their money to buy back stock, future earnings growth and future dividend growth are going to be slower,” Mr. Bernstein says.

On top of that, returns likely will be lower because we are starting from higher valuation levels. The Shiller P/E has climbed from 15 at year-end 1945 to 27 today. That is a onetime gain that we can’t enjoy again—unless we suffer a massive bear market first.

What are the implications for investors? I would focus on three strategies. First, look to keep more of whatever U.S. stocks deliver by holding down investment costs and minimizing your portfolio’s tax bill.

Second, compensate for low returns by upping your saving rate. According to investment researcher Morningstar, large-company U.S. stocks outpaced inflation by seven percentage points a year over the past nine decades.

In the years ahead, if the annual inflation-beating margin for U.S. stocks is just four percentage points, rather than seven, those in their 20s will likely need to save more than twice as much every year to have the same sum at retirement.

Third, consider allocating 30% or 40% of your stock portfolio to foreign stocks. Valuations in both developed foreign markets and emerging markets appear more reasonable than in the U.S., which suggests you may enjoy better returns.

Check out broadly diversified exchange-traded index funds such as iShares Core MSCI Total International Stock and Vanguard FTSE All-World ex-US.
—Jonathan Clements is the author of the “Jonathan Clements Money Guide 2015.” ClementsMoney@gmail.com

By JOSH ZUMBRUN and CAROLYN CUI

The global economy is awash as never before in commodities like oil, cotton and iron ore, but also with capital and labor—a glut that presents several challenges as policy makers struggle to stoke demand.

“What we’re looking at is a low-growth, low-inflation, low-rate environment,” said Megan Greene, chief economist of John Hancock Asset Management, who added that the global economy could spend the next decade “working this off.”

The current state of plenty is confounding on many fronts. The surfeit of commodities depresses prices and stokes concerns of deflation. Global wealth—estimated by Credit Suisse at around $263 trillion, more than double the $117 trillion in 2000—represents a vast supply of savings and capital, helping to hold down interest rates, undermining the power of monetary policy. And the surplus of workers depresses wages.

Meanwhile, public indebtedness in the U.S., Japan and Europe limits governments’ capacity to fuel growth through public expenditure. That leaves central banks to supply economies with as much liquidity as possible, even though recent rounds of easing haven’t returned these economies anywhere close to their previous growth paths.

“The classic notion is that you cannot have a condition of oversupply,” said Daniel Alpert, an investment banker and author of a book, “The Age of Oversupply,” on what all this abundance means. “The science of economics is all based on shortages.”

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By KATE DAVIDSON and ERIC MORATH

U.S. consumers boosted their spending in March but showed signs of continued caution despite months of cheaper gasoline and rising confidence.

Sales at retailers and restaurants increased 0.9% last month to a seasonally adjusted $441.4 billion, the Commerce Department said Tuesday. That was the biggest monthly gain in a year, but it was still down from November, when retail sales reached their highest level since the end of the recession.

Economists surveyed by The Wall Street Journal had expected total sales would jump 1.1% in March to offset three months of declines. The disappointing performance underscored the economy’s difficulty in accelerating almost six years into the expansion.

“This outcome confounds all the standard consumer-spending models,” said J.P. Morgan Chase chief U.S. economist Michael Feroli. “Job gains, wealth gains, low gas prices and very high consumer sentiment would all point to solid consumer spending increases.”

Retail-sales data can be volatile from month to month. Spending surged last fall before slowing during harsh winter weather in much of the country. The dip was reminiscent of a slowdown during the first quarter of 2014, when below-normal temperatures and severe weather kept shoppers away from stores.

A March thaw was expected to drive a bigger rebound in consumer spending last month. “Instead, consumers’ high level of confidence seems only to be matched by their conservatism,” Mr. Feroli said.
Compared with a year earlier, overall retail sales were up 1.3% in March. In March 2014, the year-over-year increase was 4.5%.

The latest report follows a string of weak economic data that has led many economists to dial back estimates for first-quarter economic growth.

J.P. Morgan economists put their estimate at 0.6% while Morgan Stanley sees first-quarter growth at 0.9%. The Federal Reserve Bank of Atlanta on Tuesday put its first-quarter growth estimate at an annualized 0.2%.

 

“There’s a lot of signs that would point to a healthier economy,” Nordstrom Inc. Chief Financial Officer Michael Koppel told investors last month. Those include steady hiring, lower gasoline prices and a strong stock market. But “it’s not like we’ve seen that breakout performance” for discretionary spending.

Despite the overall sales increase in March, economists said the details within Tuesday’s report were disappointing.

The higher sales were largely driven by car purchases, which rose 2.7% last month. But weak sales at gas stations continued to hold back overall growth, despite an uptick in oil prices in March. When excluding both gasoline and autos, sales rose 0.5% last month.

A surge in spending at home-improvement stores, including building supplies and garden-equipment retailers, also helped boost sales in March.

“The East Coast really had a hard winter, and we supply a lot of the goods that help people with that, and that helped us,” Ace Hardware Chief Executive John Venhuizen said in an interview. “We’re fortunate that a lot of our business at Ace…is not as much driven by desires and discretionary spending as it is by needs.”

Americans also spent more on furniture, clothing and accessories in March. They trimmed spending on electronics and appliances, online shopping, and groceries and beer.

The retail-sales data are adjusted for seasonal variations but not for price changes. The report doesn’t include estimates for most services, which make up the bulk of consumer spending.

Paying less at the pump should free up money for U.S. consumers to spend elsewhere. But many are socking that money away, or using it to pay down debt.

The personal saving rate climbed to 5.8% in February, its highest level since the end of 2012, the Commerce Department said last month.

Americans also pared down their credit-card balances in February, posting the largest percentage decline in nearly four years, according to the Federal Reserve.

Still, some economists and merchants expect sales will continue to rebound in coming months.

Lisa Kornstein, founder of the Scout & Molly’s boutique clothing stores, said sales slowed in February when winter weather hit. But warmer temperatures and lower gas prices recently have led to a steady stream of shoppers at the Raleigh, N.C., location she operates.

“The door is propped open and we’ve had a consistent stream of traffic all day,” she said last week. “The economy is doing better…and I think people had a little bit of cabin fever.”

Sales at her stores are up between 7% and 10% from a year earlier, she said.

In a speech last month, Fed Chairwoman Janet Yellen said she expected a rebound despite disappointing retail sales data in the early months of 2015.

“I think consumer spending is likely to expand at a good clip this year given such robust fundamentals as strong employment gains, boosts to real incomes from lower energy prices, continued increases in household wealth and a relatively high level of consumer confidence.”The Fed is watching the data as it weighs whether the economy is strong enough to withstand an increase in interest rates.

“For a Fed that is supposedly focused on the data, we suspect the retail sales report is another factor tilting the deck toward a September liftoff rather than June,” said John Ryding and Conrad DeQuadros, economists at RDQ Economics.
Write to Kate Davidson at kate.davidson@wsj.com and Eric Morath at eric.morath@wsj.com

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By NICOLE FRIEDMAN

The expansion in U.S. oil production, a major driver behind crude’s nine-month slide, is close to slowing, some investors and analysts say. For April the EIA forecasts the smallest month-over-month gain in output from U.S. shale production since January 2011. However, few are likely to call a bottom – refineries in the Middle East and Asia will idle to perform seasonal repairs, potentially forcing more oil into storage.

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By NICOLE FRIEDMAN And ERIN AILWORTH

Some oil companies are beginning to reap gains by closing out their hedges early at the behest of their lenders. The one-time cash windfall should help them stay afloat for the time being, but could be detrimental if oil prices remain in this slump for a prolonged period.

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