New Round Numbers in Stocks! What Does it All Mean?

“What to do when the market goes down? Read the opinions of the investment gurus who are quoted in the WSJ. And, as you read, laugh. We all know that the pundits can’t predict short-term market movements. Yet there they are, desperately trying to sound intelligent when they really haven’t got a clue.” – Jonathan Clements


Lately, investors have become infatuated with the level of the main stock market indexes because we’ve crossed some nice round numbers.

Dow 16,000! S&P 1,800! Nasdaq 4,000!

It’s a bubble. No, we’re heading higher.

So, what’s my take on the current level of the market?

There’s no need to always try to analyze every new high or round number reached.

It’s like the odometer on your car hitting 100,000 miles. It’s interesting for about 30 seconds and then you move on. That’s how you should be viewing these new thresholds.

Just because stocks hit a certain level, performance number or valuation metric does not mean that they all of the sudden have to do something crazy, like crash or zoom higher. There are far too many moving pieces to base your investments on a few different indicators of market health.

Markets hitting new highs don’t mean they can’t stay here or move higher.

And do you know what else is currently at all-time highs? Nominal GDP. So the stock market has hit new highs at same time as total economic output.  Stocks and the economy don’t always move together but it’s nice to know both are near their peak at the same time.

Obviously, stocks and economic growth can both expand and contract. They don’t only go in one direction.

The chorus of investors proclaiming a stock bubble grows louder as the market continues to advance. The sheer number of people claiming this is a bubble makes me think it’s probably not the case (but that’s not to say it couldn’t happen eventually).

Bubbles happen when people lose their minds and make gambles based on the greater fool theory of prices rising not on fundamentals but the expectation of irrationally higher prices.

Let’s look back at prior peaks in the market to see how things have changed since the last two bubbles burst. This table contains the prior highs in the S&P 500, the aggregate company earnings numbers and the relevant interest and inflation rates:

perspective

So what does it all mean?

Obviously many investors would gladly take the interest rates from 2000 & 2007 with today’s miniscule yields.

But you don’t get to view these things in a vacuum. There are always new and changing circumstances at different points in each cycle.

So while interest rates and inflation are much lower now, earnings are much higher. Are any of these levels sustainable? I don’t know. That’s what people calling this a bubble are basing their projections on.

If I had to guess I’d say that over the very long term (decades) interest rates and stocks will both move higher (I know, not really going out on a limb here). In the short term I have no clue.

Warren Buffett had this to say on the stock market recently:

“I wrote an article for The New York Times (five years ago) that said they were very cheap. And every now and then, you can see that that they’re very overpriced or very underpriced. They’re definitely not way overpriced. They’re definitely not underpriced.

If you live long enough, you’ll see a lot higher prices. I don’t know what stocks will do next week or next month or next year, but five or 10 years from now, they are very likely to be higher.”

I wouldn’t be surprised if interest rates or stocks either rose or fell. I do know that I don’t want to rely on predicting these levels to dictate my actions.

I continue to believe we will see a garden variety correction in the market before we see another huge crash (see The difference between a correction and a crash).

Either way, I’m not going to base my investment plan on my ability to predict the direction of the stock market. I will continue to stay diversified, keep my costs low, rebalance periodically and keep my emotions out of the equation.

I would advise you to do the same, whether you think we’re in a bubble or not.

Source:
S&P Earnings: 1960–Current (Damodaran)

Further Reading:
How to think about new highs in the stock market
Stocks will go down
Now is not the time to get greedy

Here’s my reading list for this week:

  • Rebalancing still works (Big Picture)
  • Even the wealthy get killed in the markets (Reformed Broker)
  • Will you be sorry buying stocks at this level? (Jason Zweig)
  • What’s in Larry MacDonald’s portfolio (My Own Advisor)
  • How investors should handle the raging bull market (Financial Post)
  • Punish yourself now to retire early (MarketWatch)
  • Cutting through the financial noise to a well-balanced portfolio (Carl Richards)
  • A history of investment mistakes and lessons (Retire Before Dad)
  • Everything is amazing and no one is happy (Motley Fool)
  • Investors flee emerging markets at the wrong time (Larry Swedroe)
  • Restaurant owner turns down $10 million offer for building be bought for $150,000 (NY Times)
  • 50 unfortunate truths about investing (Business Insider)
  • 6 reasons for index fund investors to give thanks (Rick Ferri)
  • It’s expensive to find out if you can outperform the market (CFA Institute)

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  1. More Stock Bubble Talk - A Wealth of Common Sense commented on Dec 03

    […] mailbag: I read your article about stock levels (New Round Numbers! What Does it All Mean?) and I’m curious how you could claim stocks are not currently in a bubble created by money […]