Are Stratospheric Stock Valuations Here to Stay?
The past 30 years have either been an anomaly or a new normal. Don’t bet against the latter.
The market’s lofty valuation in recent decades has baffled forecasters.
Photographer: Michael Nagle/Bloomberg
The biggest question facing U.S. stock investors isn’t about the pandemic or economic growth or even inflation. It’s about whether the stock market can maintain its historically high valuation, a perch it has commanded for most of the past three decades. Investors who want to know what to expect from the market in the coming years must address that question, and there is a lot riding on the answer.
For about 120 years from the 1870s to the 1980s, the U.S. stock market reliably reverted to its long-term average valuation, and just as important, it spent roughly equal time above and below that average. Investors could therefore expect an expensive market to become cheaper and a cheap market to become more expensive, a useful assumption when estimating future stock returns. Change in valuation is one of three key components of returns, along with dividends and earnings growth. The ability to anticipate where valuations are headed makes forecasting easier and more reliable.