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Growing Cheap

Jonathan Clements, 2:32 am ET

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.

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Roboticus Aquarius
Roboticus Aquarius
2 months ago

I can be a little slow on the uptake, but I have finally made market crashes my friend. It only took 25 years to get to that point ;>)

I really hate flat markets. They feel like quicksand. However, for many it’s the most comfortable time to accumulate shares, and you have to understand your own psychology to optimize your investment behavior.

Last edited 2 months ago by Roboticus Aquarius
Langston Holland
Langston Holland
2 months ago

Simple and straight to the heart of long-term stock investing. “How much does it cost?” The market battle between calculated vs. perceived value certainly made an asset allocation believer out of me.

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.

Funny. I’m the polar opposite on this. : )

Ormode
Ormode
2 months ago

Nobody knows what will happen in the future. Maybe earnings will go up, maybe they will go down. Interest rates may stay the same, or they may go up dramatically. Same thing for the price of energy.
Index investing is an obvious option for the “I don’t know” investor. However, I would suggest an equal-weighted fund instead of a cap-weighted fund like SPY.

Roboticus Aquarius
Roboticus Aquarius
2 months ago
Reply to  Ormode

I interpret market trends such that an equal weight approach seems likely be a short term winner simply due to value/growth considerations, but market trends are not reliable predictors of the future.

In a more general sense, one should be aware of the long-term risks one takes when deviating from a market weighting. I wouldn’t recommend it to anyone unless they have bought into a strategy they feel they can stick with.

I didn’t downvote this comment btw; just posted this over concern that younger investors adopting such a strategy should understand the full implications.

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