The Market Hits All-Time High. So What?

Dianne Lob

Dianne F. Lob (pictured) and Ding Liu

With the US stock market repeatedly reaching all-time highs in recent weeks, many investors are becoming leery of investing in stocks. Focusing on the market’s level is a mistake, in our view. It’s market valuation, not level, that matters. 

Since 1900, the S&P 500  Index has been close to (within 5%) of its prior peak almost half the time. There’s a simple reason for this. The stock market goes up over time, along with the economy and corporate earnings. As a result, the market typically has regained its prior peak level fairly quickly after dropping. Then, it has resumed its upward march (Display 1).

The Market Is Often Near Prior Peaks Because It Rises

Fear of investing at market peaks is understandable. In the short term, there’s always the risk that other investors will decide to take gains, or that geopolitical, economic or company-specific news will trigger a market pullback.

But for longer-term investors, market level has no predictive power. Market valuation—not market level—is what historically has mattered to future returns  (Display 2).

Market Level Doesn't Matter; Market Valuation DoesThe green bars on the left side of Display 2 show average market returns after points at which the market level was close to its prior peak. The dotted line shows average market returns after all points since 1970 (we don’t have good valuation data before then).  Over 1-, 3-, 5- or 10-year periods, annualized returns were about the same after points at which the market was close to its prior peak level as after all points since 1970.

Display 2 also shows that buying when the market was at least 5% below its prior peak level (indicated by the blue bars) didn’t help much. It added slightly to annualized returns over 1- and 10-year periods, but detracted from returns over 3- and 5-year time periods.

By contrast, buying at high valuations detracted significantly from returns—and buying at low valuations added significantly. The green bars on the right side of Display 2 show annualized average market returns for 1-, 3-, 5- or 10-year periods after market valuations were expensive, based on price-to-trailing earnings; they’re far below the dotted line that indicates showing the average for each period since 1970. The blue bars show returns after points when market valuations were low; the returns for these periods were significantly above average.

What does all this mean for investors today? The S&P 500 may be at an all-time high level, but it’s far below its all-time high valuation. At 18.7 times trailing earnings, the US market today is more expensive than average but it’s not extremely expensive (Display 3). Outside the US, however, equities haven’t rebounded as far, so the MSCI World Index  of developed-market equities remains close to its long-term average valuation.

US Stocks Are Somewhat Expensive vs. Earnings, But Very Cheap vs. BondsBut with interest rates still near historical lows, bonds are extremely expensive. Both US and global stocks are very attractively valued versus bonds, as shown by the earnings yield premium bars on the right side of Display 3.

While there’s always the risk of a market correction, we think long-term investors should invest in stocks at close to their strategic allocations. And, as always, it’s wise to diversify globally.

The views expressed herein do not constitute research, investment advice, or trade recommendations, and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein.

Dianne F. Lob is Chairman, Private Client Investment Policy Group at Bernstein Global Wealth Management, a unit of AllianceBernstein. Ding Liu is a Senior Quantitative Analyst at Alliance Bernstein.

4 comments

  1. Sanford Gallanter

    The recent book “The Crash of 2106″ makes a strong case for an upcoming failure of our economic system. What thought has Bernstein given to that possibility and the defensive moves that would be put in place if that prediction starts to prove out? Will the facts you present have an impact on the disaster scenario?

    • Dianne Lob

      We are constantly assessing a broad range of alternative economic and political outcomes. Our forecasts for potential capital markets returns are based on a Monte Carlo simulation of 10,000 potential scenarios, some very dire indeed. We don’t model economic chaos or war, although we model unspecified severe disruptions.

      In addition, we constantly reassess shorter-term risks to our portfolios and actively seek to protect our client assets, using tools like Dynamic Asset Allocation to modify our client’s exposures based on the risks, returns and correlations that we see in the short term. Over the last three years, at times when we have felt it was appropriate, we have taken action to reduce clients” equity exposure and also purchased protection against a deep market downturn.

      • bill gammill

        Are you purchasing protection from potential equity declines now? If so can you explain what you are doing? Is this done for every client or on a customized basis?

        • Dianne Lob

          We purchased protection from equity market declines in the form of put options for much of the past year; we recently removed this protection because our research suggested that the short-term risks surrounding the Fed””s policy outlook were beginning to ebb. We purchased the options for all investors who use our dynamic asset allocation service.

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