SUPPOSE THE S&P 500 ended the year at Friday’s close of 4455.48. Let’s also assume that the analysts at S&P Dow Jones are correct, and the S&P 500 companies have 2021 reported earnings equal to an index-adjusted $185.32. That would put the S&P 500 at 24 times earnings, versus today’s 34.8.
That would be considered high by historical standards, though it isn’t outrageous given today’s low interest rates. But what would it take for stocks to look like a compelling investment? A market crash would do the trick.
But consider an alternative scenario: Suppose stocks treaded water at current levels, while corporate earnings climbed 5% a year. Five years later, at year-end 2026, the S&P 500 would be at 18.8 times earnings, below the 19.9 average for the past 50 years. If earnings grew at 7% a year, the S&P 500 would end 2026 at 17.1 times earnings, which is the average for the past 100 years. In other words, it wouldn’t take many years for today’s richly valued stock market to start appearing cheap.
One other observation: The prospect of a big market crash likely terrifies many investors. But the idea of stocks treading water for five years probably wouldn’t unnerve many folks at all. Yet, over the next five years, a big market crash followed by a recovery to today’s level would likely leave investors wealthier—assuming that, during the intervening five years, they took advantage of lower share prices by reinvesting their dividends, rebalancing their investment mix and adding new savings to their portfolio.