THE MARKET IS ALWAYS right. It may have a different opinion tomorrow—perhaps radically different—but that doesn’t mean current prices aren’t the right ones.
Holler all you want that the stock market ought to be far lower. I do a fair amount of that myself (though the shouting is more akin to grumpy mumbling). But whether we like today’s share prices or not, they reflect the collective wisdom of all investors—and, if we want to buy or sell, they’re the prices we have to trade at.
That brings me to the S&P 500’s 10.2% nine-day market swoon and subsequent 5.9% six-day recovery. Around the world, every investor—amateur and professional—got a wakeup call over the past three weeks. They had a chance to contemplate today’s rich stock market valuations, rising bond yields and the potential resurgence of inflation. All of those worries received a thorough airing. Investors’ collective response: We’re happy to continue holding stocks at current prices, even though the S&P 500 companies yield just 1.8% and trade at 24.9 times reported earnings.
Are investors idiots? I think not. Quite the contrary: I believe it’s foolish to assume other investors are fools. Throughout my three-decade investing career, pundits have regularly argued that stocks are overvalued, and they have been dead wrong. Prices have—with the exception of a few relatively brief periods—remained elevated the entire time.
These lofty valuations are, I contend, bad news for long-run returns. Stocks will continue to kick off dividends and share prices may rise along with growth in earnings per share. But we can’t reasonably expect price-earnings multiples to climb in future the way they have in the past. That’s why I expect stocks to return just 6% a year over the next decade, while inflation runs at 2%.
But there’s a big difference between expecting modest long-run returns and predicting an almighty short-term crash. We will, no doubt, have occasional 20% or 30% market declines. But if there’s any message from the past 30 years—and from the past three weeks—it is this: We will likely never go back to the world of the 50s, 60s and 70s, when dividend yields averaged 4% and price-earnings multiples averaged 14.
It’s hard to imagine we’ll ever have another decade with average valuations at those levels. In an increasingly wealthy world, where many have extra cash to invest and harbor fewer fears about their own financial future, stocks are likely to remain richly priced. Are you sitting in cash, waiting for shares to return to historically cheap valuations? I fear it will be an awfully long wait.