Are US Stocks Expensive?

US stocks are expensive right now. Recently I’ve reviewed a chart that looks at secular stock markets back to the year 1900. When we say secular stock markets, here’s what that means. We think about bull markets and bear markets; and usually we think if the market drops 20%, that’s a bear market. Those are short term measurements. When we talk about a secular bear or secular bull, we’re talking about long periods of time 15-20 years where markets are either below average or above average. We hear markets make 10% per year over time. That’s over centuries, not decades. The reality is, most decades, markets are either making more than 12% per year or less than 8% per year. Very few are between 8% and 12%.

The chart details the history of our stock market since 1900 and we’ve basically got 4 secular bull markets and 5 secular bear markets. I think we’re still in the midst of a secular bear market even though some would say, “well, we started a new bull market in 2009.” But here’s the point I want to make; this chart is color coded with red and green. In 1929, we know what happened with the Great Depression, so my bars were green through the 20’s because the market was growing and then they become red. We had the boom post World War II, from 1946 to 1964; those are green bars. Then we went into a sustained period from ’65 to the early 80s of very little growth in the stock market. After that through the late 80s and the 90s, we had an unprecedented boom.

The other aspect of this chart is where stocks were priced when every bull market ended and every bear market began. When I say priced, I am referring to the price to earnings ratio (P/E). What that means is if I’m going to earn a dollar from a share of stock, what do I have to pay for that stock? Do I have to pay $10 or $15 or $25? If I’m paying $25 just to get that $1 a year of earnings that’s pretty expensive. Looking over the long periods of time, when every bear market has begun in U.S. history, the stock prices have been trading between $20 and $25 price to earnings. Right now, where are we trading? At $26. Now, there’s one exception to this. In 2000, stocks got up to $45 per $1 of earnings. We know what happened then, we had a 12 year run of no growth in the U.S. stock market because of 2 bad cyclical bear markets.

In other words, we’re priced very, very high on stocks right now. We should be a little bit higher than the average of $16. With interest rates so low, stocks should be higher than $16; they should be maybe $18, maybe $19, but $26? I’m not seeing it. I just don’t see how we could be on the front end of one of those 10 year decades where the markets are greater than 12% per year. More than likely, I think we’re going to be less than 8% per year. You have to invest differently in those types of markets than you do in the real raging bull markets. Do you have a plan to deal with that and if you’re retired, how much risk is it worth taking to try to earn 6% per year? Do you have a balanced plan to help control that risk?