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MONEY MANAGER GMO recently noted that, “There are no bad assets just bad prices.” The occasion was the S&P 500’s price outrunning earnings by 70% over the seven years through March. GMO’s punchline: The same thing happened in the seven years that ended with the dot-com peak in March 2000. This, of course, did not end well.
Two decades ago, I remember a friend telling me of steep losses in his retirement savings, the result of moving his entire 401(k) into aggressive, tech-heavy mutual funds during the runup. For some, it’s hard to be fearful when others are greedy. We hold out for the “last dance” in a market that hasn’t yet peaked.
As I write this, the S&P 500 continues its seemingly relentless march higher, even as we wait for corporate earnings to claw their way back to the levels we enjoyed in March 2020, when the bottom dropped out of the economy.
We read all the time that “past performance is no guarantee of future results.” For investing decisions grounded in principles that change slowly, if ever, there are some things we can count on. One principle that comes to mind: After a period of extremes, each investment’s rate of return eventually reverts to its long-term average.
Being old enough to have lived (thankfully) through both the dot-com bust ~ 2000 and the decade later recession in ’08-09, I’ve found myself fully migrated, inadvertently, to a long term buy and hold strategy. Pre-2000 I had few dollars, hence only a few chips, that I threw the way of Microsoft, Cisco, and the like, that hemmed and hawed with the various bubbles. But, now 20+ years into it, riding the tech wave (as well as healthcare) in aggregate has been, to be modest, a successful strategy. Yes, it’s crossed my mind that, yet again, we may be on a bubble about to pop. But will it pop so much that I’ll fall all the way back to 2020/2010/2000 levels? Seems unlikely to me, so for assets I’m not really intending to touch in the near term, it’s been my approach to stay put and buy on dips.
David – Just to clarify, there is no “waiting for corporate earnings to claw their way back to March 2020 levels.” In 2019, the total S&P 500 pre-pandemic earnings were $163, in 2020 they declined to $140, and in 2021 they are on track to be $200-205 +/-. Earnings already well exceed pre-pandemic levels. Despite the recent increases in the S&P 500 value, the price to earnings ratio has actually declined since the January 2021 peak due to these earnings increases.
Thanks for the comment. You’re probably right, though we don’t yet know for sure. According to S&P Global, the reported earnings of the S&P 500 companies were $139.47 in 2019. For the 12 months through March 2021 — the period for which we now have 100% of companies reporting — we were at $128.20, according to S&P. S&P is estimating $159.48 for the 12 months through June, which would indeed mark a full recovery for corporate profits, but we don’t yet have all companies reporting.
Exactly. Looking at Shiller’s CAPE spreadsheet, Dec 2019 was the recent peak for SP500 earnings. Those had already begun a decline which accelerated in March 2020 and continued dropping monthly until January of this year.
GMO’s broader point about price outrunning earnings over the last seven years should say in focus here. Even with a diversified portfolio which matches our risk tolerance I’m mindful of value when allocating new money or rebalancing.
A seasoned investor suggested to me that the recent gains could be due to inflation rather than irrational exuberance. Stock prices getting higher along with everything else. It doesn’t make them a better, or worse value. Not sure I agree but it is a comforting thought in the short term.
An asset allocation that matches your risk profile is the best response to fears of a market crash.
I’d amend to say that there are also bad instruments/products. (Leveraged as an example)