Still No Alternative

Jonathan Clements

FOR AS LONG AS I’VE been writing about investing—37 years now—grumpy old men have been declaring that the stock market’s party will soon end with a world-class hangover.

Is it time to stock up on Tylenol?

I, of course, don’t have the slightest clue. But when the S&P 500 rises 3% on Wednesday and then plunges 3.6% on Thursday, you sure get the sense that investors are a tad uncertain about the future. That brings me to two questions I’ve been pondering.

Question No. 1: Will we get a wave of panic selling that causes stocks to become unhinged from their intrinsic value? We saw that in early 2020, and also in late 2008 and early 2009. That’s when great buying opportunities occur.

This year’s stock market slump has been dragging on for more than four months, but the decline from the S&P 500’s Jan. 3 all-time high has been relatively modest, just 13.5%. Despite yesterday’s whiff of panic, it would be hard to argue there’s widespread fear, with investors losing all sense of what stocks are worth.

I’ve been adding a little to my stock-index funds at current prices, and I suspect that five years from now I’ll be glad that I did. But I don’t think stocks are a great bargain. Still, with any luck, we’ll get there, at which point you’ll find me buying with far greater enthusiasm.

Question No. 2: Are we headed back to normal historical valuations? Because the U.S. stock market has become so dominated by growth companies, especially tech stocks, valuations will tend to be higher than the historical averages, a topic I’ve written about before.

But the rise in valuations over the past four decades has also been driven by another factor: falling interest rates. If we are indeed seeing at least a partial reversal of the four-decade trend toward lower interest rates, it’s reasonable to think stock valuations will be lower, as bonds offer more competition for investors’ dollars.

The good news: Stock valuations are already looking much improved, with the S&P 500 stocks closing yesterday at just under 21 times trailing 12-month reported earnings. If S&P Global’s analysts are correct in their earnings forecasts, stocks are now at 19.1 times 2022’s reported earnings and 17.1 times 2023 corporate profits. No, U.S. stocks aren’t dirt cheap, but valuations don’t seem absurdly high.

Back in May 2020, when yields on bonds and cash investments were so small they couldn’t be seen with a microscope, I argued that—for long-term investors—there was no alternative to owning stocks. Now that yields have perked up, bonds are looking more appealing.

But I’d argue there’s still no alternative to stocks for long-term investors. The reason: inflation. For most bonds, inflation represents a permanent loss of value. By contrast, over long periods, corporations have been able to increase their profits along with inflation, and share prices have followed suit. The weeks and months ahead may be rough for stock market investors. But the long term should be just fine.

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