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STOCK MARKET INVESTORS are enjoying yet another strong year. The S&P 500 has gained about 14% so far, shrugging off, for the most part, uncertainty over tariffs, interest rates and the latest government shutdown.
Should this worry us?
Since ancient times, soothsayers have been attempting—without luck—to forecast the future. As it relates to investment markets, the frustrating reality is that no one knows what the future will bring. But that doesn’t mean there’s nothing we can do.
As investor and author Howard Marks emphasizes in Mastering the Market Cycle, we can still do our best to make judgments with the information we have. We aren’t completely in the dark.
What does the data say? In short, the market has had a remarkable run. Since the market bottom in 2009, the S&P 500 is up about 1,200%, including dividends. Over the past 10 years, it’s gained more than 14% a year—far above the long-term average of 10%.
Other metrics tell a similar story. The market’s price-to-earnings ratio is north of 23. That compares to a 40-year average of just 16. Investors today, in other words, are paying nearly 50% more for each dollar of corporate earnings.
The cyclically-adjusted P/E (CAPE) ratio, developed by Yale professor Robert Shiller, employs an even longer-term dataset, going back to the 1800s. It indicates that today’s market is even more expensive than it was at the peak in 1929, and that the only time it’s been more richly valued was in 2000, just before it dropped 60%.
There are other risks. Washington seems as divided and dysfunctional as ever. That’s another reason observers feel the stock market is out of touch with reality.
In late-September, Federal Reserve chair Jerome Powell commented that stocks were “fairly highly valued.” Others share this opinion.
Aswath Damodaran is a professor at NYU and well known for his expertise on valuation. In response to Powell’s recent comments, he put together a detailed analysis and reached this conclusion: “It is undeniable that this market is richly priced on every metric…”
Morningstar analyst Dan Kemp makes this observation: “The fact that equity prices have rallied as economic risks have grown suggests that we may be entering the ‘all news is good news’ part of the market cycle…”
Longtime investment manager Jeremy Grantham is even more pointed in his commentary: “This is the highest-priced market in the history of the stock market in the U.S.” In the past, Grantham has also pointed to another indicator as a market barometer: He looks for signs of what he calls “truly crazy behavior.” He saw this in 2020 and 2021, when meme stocks, SPACs and other speculative crazes drove the market higher and higher. We’re seeing shades of the same behavior today.
Consider the Meme Stock ETF (ticker: MEME). It launched in 2021 but liquidated two years later, after the market sank and the fund lost most of its value. But now it’s back. The fund’s manager just relaunched a new MEME fund, similarly designed to take advantage of the market’s current highfliers.
Or consider the flurry of new leveraged funds, with some promising to magnify daily returns by three, four and even five times. The Wall Street Journal discussed this trend in a recent article titled “These Funds Can Go to Zero.” That wasn’t hyperbole. Some leveraged funds have literally lost all of their value, and yet, fund companies are bringing more of them to the table.
Along these same lines, while I recognize the danger of anecdotal evidence, I thought it was notable last week when a high school student shared with me that he had been trading options—and making money at it.
Where do all these data points leave us?
Howard Marks offers what, in my view, is the best prescription. “We can’t predict,” he says, “but we can prepare.” Here are ways you might put that into practice:
Step one would be to bear in mind the lesson of 1996. That was when Alan Greenspan, then the chair of the Federal Reserve, declared that the market was exhibiting “irrational exuberance.”
It wasn’t an unreasonable observation: At that point, in December 1996, the market had gained nearly 70% in the space of just 24 months. And Greenspan’s concern was ultimately validated: In the end, the market did drop, by more than 50%. The problem, though, is that that decline only came later. After Greenspan’s warning, the market continued to rise for three more years, nearly doubling again before it dropped.
The result? When stocks did eventually fall, they never fell as low as they were on that day in 1996 when Greenspan issued his warning.
The lesson for investors:
Sometimes when the market looks too high, it is indeed too high. But there’s no guarantee that it can’t go higher still before it goes lower. Timing, in other words, is always an open question. Even when all of the data and all of the commentators seem to agree, we can never be sure.
That’s why it’s so important to consider your timeframe. If you have no foreseeable withdrawal requirement, then a reasonable response to a pricey market might be to do nothing at all.
On the other hand, if you do have an upcoming need for a withdrawal, then this would be a good time to audit your risk level and to take it down, if need be.
Either way, consider both your quantifiable needs as well as what you might call the Alka Seltzer question:
Ask yourself how you might react if you saw your portfolio drop 30% or 50% even if you have no immediate need for a withdrawal. Then work backward and ask whether an adjustment to your asset allocation might be in order.
I’ve often compared the market to a Rorschach test, and that’s very much the case today. That’s why the most important thing, in my view, is to maintain a balanced outlook. The reality is that even the smartest and most knowledgeable market observers still can’t see the future.
And market-timing strategies, appealing as they might seem, tend to be unreliable in practice. In his recent analysis, Aswath Damodaran tested a number of approaches to see if they would have helped investors through past downturns. His conclusion? Because every downturn is different, “there is not a single market timing combination” that would have been consistently profitable.
That’s why this is a good time—while the market is strong—to prepare, even if we can’t predict.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
A PE ratio of 23 equates to an earnings yield of 4.3% (1/23). The current yield on “risk-free” 10-year treasuries is 4.0% To me this implies a very low risk premium is being given for holding the S&P 500.
Thanks Adam for your interesting and detailed piece.
To me, this nails it:
“That’s why it’s so important to consider your timeframe. If you have no foreseeable withdrawal requirement, then a reasonable response to a pricey market might be to do nothing at all.
On the other hand, if you do have an upcoming need for a withdrawal, then this would be a good time to audit your risk level and to take it down, if need be.”
I agree. And I would argue that this would apply at all times, in all markets.
At thist stage we are in the former scenario and will gladly do nothing!
I have no idea about whether the market is overvalued, but I am paying attention to four things: (1) huge investments in AI infrastructure and applications that may or may not pay off, (2) the expansion of cryptocurrencies, (3) the creation of lots of new financial products with their own “hook” but that don’t seem to me to have a particularly solid foundation, and (4) institutional endorsements of private equity over public market investments. All of these seem to have the potential to operate like a Jenga tower – they might look great from afar, but they can topple easily.
I have heard about HIGH valuation since 2012 when Prof. Shiller said that US stocks are overvalued according to CAPE and EM stocks should be better. The opposite happened
Many meltdowns didn’t occur because of overvaluations:
2008=MBS fiasco
2018=3-4 rate increase
2020=Covid
2022: The Fed started to raise rate rapidly
2025: Tariffs will create inflation = didn’t happen
Does market timing work?
It took me 10 years to get it “right” and it works great since retirement in 2018.
If risk is “normal” my portfolio is invested at 99+%. In high risk = 99+% in MM. See the proof https://ibb.co/zT6QGzSs
a gambler only brags about their winnings. Looking at the rear-view mirror for 5 years is not “proof”. No sir. What everyone is interested in, is how to mitigate all the common risks, knowing that they are there.
Perhaps worthy of discussion is that “the market” for many off the past few years has consisted of the Magic Seven companies. When and if those magic stock prices dive investors should hold onto their hats. Returns are also skewing perceptions of how well the economy is actually doing. The economy ain’t a small number of high flying tech companies.
If there is any truth to the presidential cycle theory then next year will be the 2nd year for this president and could inflict a major market downturn.
Adam, please keep writing these most thought provoking articles. It is such a pleasure to see many sides of the coin. Thanks and please keep up the excellent job you are doing. We all much appreciate your expertise.
As a (now retired) investment professional, I always asked my clients “how long can you weather a market downturn?” The S&P 500 had a negative (inflation adjusted) return for 30 years (1929-59), 25 years (1968-93) and 16 years (2000-16). The Japanese Nikkei 225 has never even come close to its 1990 peak in inflation adjusted terms in the past 35 years. Such a prolonged downturn would have a major impact on any investor needing to make substantial portfolio withdrawals over the next few decades.
For retirees and those approaching retirement, it is advisable to keep the next decade’s worth (longer if one can afford it) of anticipated withdrawals in bonds..
I also spent 40+ years in the investment business and am still amazed at the difference between giving others advice and the advice I follow in managing my own money. My wife and I have sufficient financial resources, but like you, I sometime ago started raising my cash and fixed levels in anticipation of an expected market correction. There is so much more than mere economic tomfoolery going on at the moment that could make the next downturn worse than past cycles we have lived through, and I am very conscious that the number of years in which to earn back any losses is growing ever shorter. I appreciate what rising cash and fixed income levels will do to overall performance, but at this point in my life, security has taken precedence over performance.
I go one further. I have the next decade in Cash, in a high bearing interest account like Marcus and Ally, web based banks. And Actually the Vanguard and Fidelity money market type accounts are about one or two tenths better than the banks. I remember Bonds took a beating not too long ago, so my wife and I decided on Cash. Cash is King!
Thanks for the reminder that while we cannot predict, we can prepare.
As a (now retired) investment professional, I always ask “how long can you weather a downturn”. Yes, the markets will usually bounce back, but maybe not for a very long time. For instance the S&P 500 stayed in negative, inflation adjusted, return territory for 30 years (1929-59), 25 years (1968-93), and 16 years (2000-16). The Japanese Nikkei 225 Index has never come remotely close to its 1990 peak in inflation adjusted terms. Retirees and those nearing retirement have to consider the safety of the next decade (possibly more if they can afford it) of withdrawals when setting their portfolio’s asset allocation.
There is good evidence that a diversified portfolio with stocks and bonds (or other uncorrelated investments) with regular rebalancing can compensate for the swings of the stock market. If at some point the market corrects from the AI bubble, you can rebalance when stocks are low. I realize there is a several year period needed for this, i.e. set aside immediate funding needs.
When retired, the Will Rogers quote will creep into your psyche..”I’m not so much interested in the return ON my money as I am in the return OF my money” !!! 6.2% on a 7 yr MYGA from Canvas Annuity, PBNV.. a buffer ETF that protects you at 20% downside, up over 10% in last year, resets your lock in for a year Nov 1st. If you already won the game, why are you still playing?
Thanks for the timely reminder!
One useful rule of thumb I learned from an advisor many years ago is to imagine that your equity allocation suddenly loses 50% of its value and doesn’t recover for a decade. If you could still live well under that quite realistic worst-case scenario then your stock percentage is reasonable.
Also of note is that both Vanguard and Morningstar are currently recommending 30-40% in equities and the rest in bonds along with a slice of cash for short-term needs as the risk:reward “sweet spot” starting point – essentially turning the classic 60:40 on its head. This is because bonds are (finally) offering a decent real (above inflation) return, while, as you point out, stocks are very richly valued. In that regard though, it’s only the U.S. market, in which the Magnificent 7 have a total market share of 40%, that’s overvalued. Jonathan Clements’ advice to own the TOTAL market – including international equities at global market cap (currently around 35%) has never seemed wiser.
Thanks as always Mr. Grossman for your excellent writing.
But isn’t owning the top 500 companies in the S&P 500, including the global market, I think so. And so does Buffett, therefore my take is, owning about 80% in the S&P 500 and 20% in cash, works for me.
Great article Adam. We are taught to “buy low sell high”, to mitigate the more common, emotional practice of “buy high and sell low in a panic”. Every time I see articles like this one, I reallocate some stock funds to bonds, in order to practice “sell high” and take some profit off the table. If I do so within sheltered accounts (TSP, 529, 401k, etc), I also avoided the cost of actually selling the funds. If 1929 or 2007 happened again, I plan to reallocate in the reverse and “buy low and buy low”.
Such good advice. And positive action we can take Monday morning–making sure money we need near-term is out of reach of the eventual market plunge, whether that’s in a few days or a few years.
It clearly does not apply to everyone, but for those of us gradually moving money from our traditional IRAs to our Roth IRAs and paying the corresponding taxes, we might consider moving a significant amount to the Roth while the valuations are way down. You can move a lot more shares for the same amount of money and thus taxable impact.
Selling low, after a drop in valuation, is a price penalty. That’s like harvesting the turkey long after Thanksgiving, when they dropped weight after a harsh winter. Is this penalty smaller or larger than the current tax penalty (assuming Roth conversion is done during a lower tax bracket in your financial journey)? In Roth conversion, we are not moving “shares” from IRA into Roth IRA; we are selling the shares, pay an income tax, then buy some other shares in Roth IRA. I’m think that we should convert incrementally, at the highest prices and at the lowest income tax bracket to mitigate RMD.
It’s true we aren’t trading shares when we convert, but we are trading dollars with tax due for dollars that will never be taxed again. Here’s Jonathan’s article from the Guide:
https://humbledollar.com/money-guide/roth-conversions/
Some really great advice Adam. With a son entering college in 2008, and the market at an all time high in the fall of 2007, I fortunately moved his money out of equities at just the right time. My next son, who began college in 2011, had his college fund decimated. Fortunately, he received scholarships that covered almost all his expenses for four years so we still had some money left over. Adam is right, if you are going to need the money, get it out–especially now. With the market as it stands today, if you have kids heading to college in a few years and have been saving in equities, time to trim those sails.
I really like the logic of your article. The market makes me nervous and at 68 I fear getting caught in a huge downturn that lasts for years while I’ve currently got more money than I ever had before. I’m at a sort of “why risk what I do have for something that I don’t need” moment of lowering my risks. But in doing so I have to prepare myself for losing out if I’m wrong and not getting future gains if they come.
I think it was Bill Bernstein who said you can stop playing when you’ve won the game.
Love Howard Marks’ commentaries. And Grantham’s. Playing a little defense is appropriate here, but it’s hard to watch the Mag 7 run without wanting to jump on the bandwagon with both feet.