Andrew Kerai, CFA serves as the Chairman of Capital Ideas Inc., a Dallas-based Registered Investment Advisor.
The past couple of years have been one of the strongest periods for the stock market in history. The S&P 500, the most widely followed index of U.S. stocks, was up 25% last year after gaining 26% in 2023. With such strong gains in consecutive years, some financial pundits have recently been warning that stock valuations are now excessively high and that a sell-off must be imminent. I don’t share their pessimism.
The Case For Optimism
As of this writing, the S&P 500 is valued at roughly 22 times this year’s forecasted earnings. While this is on the high side historically (historical average of roughly 18x), it’s not approaching levels that I would consider to be excessive. For context, valuation levels reached nearly 40x in early 2000 following the tech bubble of the late 1990s and just before the brutal bear market that kicked off the 21st century. So, while stocks are somewhat richly valued relative to history, I would argue not excessively so.
In addition, corporate earnings growth has been showing signs of accelerating in recent quarters, which I expect to continue. Since 2022, profit expansion has been fueled by the largest technology companies, which have delivered high growth rates in their core businesses while quickly monetizing new initiatives across artificial intelligence. Their stock prices have reacted accordingly. Now, we are finally beginning to see meaningful earnings growth across other sectors that had been lagging, such as financial services and consumer discretionary. The broadening and acceleration of corporate profit growth is more reflective of the early middle innings in an economic expansion versus late-cycle behavior, which would precede a recession.
A Word Of Caution
Despite this optimism, investors should always be mindful that market pullbacks are a fairly common occurrence. Since 1980, stock market corrections (10% or more declines from the previous high) have taken place, on average, once every 1.2 years. Generally, in my view, trying to time these occurrences with precision is somewhat of a fool’s errand. Building a financial plan and investment strategy that makes sense for your personal circumstances and goals is a much more productive use of time and energy. Implementing the proper strategy is far more important for your long-term financial health than trying to guess the stock market’s next tick higher or lower.
History suggests the stock market will move higher over the long run but can, of course, be volatile in the short to medium term. Beginning in the 1960s, the trailing 30-year annualized return for the S&P 500 has ranged from 9.4% to 13.7%, while returns during individual years have been as low as -37.0% and as high as 37.6% (average annual return of 11.8%).
In fact, between the end of 1999 and 2010, the stock market produced a negative return. This means that if you would have invested in the S&P 500 at the end of the 1990s and held, you would have been in the red for more than 10 years. While this is a rare occurrence (prior to the early 2000s, the last time the market produced a negative return over a full decade was the Great Depression), it highlights both the importance of implementing a proper investment strategy for your personal goals and risk tolerance as well as the need to take a long-term view. Since the end of 2010, the stock market has increased by almost 5x and produced annualized gains of 13.8%.
An Alternative To Timing The Market
A properly constructed investment strategy includes a complete and transparent review of your financial goals, needs and risk tolerance. For example, how much cash flow, if any, are you seeking from your portfolio to fund living expenses, and are you anticipating any meaningful withdrawals for the foreseeable future (i.e., a wedding, education expenses, etc.). By first identifying your financial goals, you can then build a portfolio to meet these objectives. Utilizing investment research can be a great tool when selecting the assets to populate the portfolio. This can include analyzing company financial statements before buying a stock, for example.
Combining thorough financial planning with investment research is a solid plan to place yourself on strong footing in the years to come. Not trying to “time the market” should not be confused with investing recklessly, such as buying stocks issued by unprofitable companies at exorbitant valuation levels. Remaining disciplined and rational are the hallmarks of successful investing in any market and the key to building a bright financial future. The talking heads are often promoting their own agendas, and listening to them too much is often counterproductive to these goals, not to mention your mental health.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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