Stock Valuation over time

It has been shown that stock price declines are not that transitory, that they can persist for decades, and thus that even long-run investors should see risk in stock market investments.

There is also reason to believe that much of the enthusiasm for mutual funds is a sort of investor fad that has not been caused by any real learning.

Stocks can go down, and stay down for many years. They can become overpriced and underperform for a decade or several decades. The public is said to have learned that stocks must always outperform other investments, such as bonds, over the long run, and therefore, long-run investors will always do better in stocks.

Evidence also exists that investors do largely think this. But again, they have gotten their facts wrong. Stocks have not always outperformed other investments over decades-long intervals, and there is no reason to think they must in the future.

The high recent valuations in the stock market have come about for no good reasons. The market level does not, as so many imagine, represent the consensus judgment of experts who have carefully weighed the long-term evidence. The market is high because of the combined effect of indifferent thinking by millions of people, very few of whom feel the need to perform careful research on the long-term investment value of the aggregate stock market, and who are motivated substantially by their own emotions, random attentions, and perceptions of conventional wisdom.

The sense of “victory” of capitalist economies that developed after some of America’s close competitors abroad began to falter after 1990 is not likely to persist indefinitely. What then is the rough scorecard for the  likely future of the twelve precipitating factors in the opening years of the twenty-first century? Two (the Internet boom and the expansion of stock trading opportunities) will probably increase in strength, two (the Baby Boom and perceived victory over foreign economic rivals) will decrease, and the others will likely stay about the same. The conclusion is that no overall change in these twelve factors can be confidently predicted, and that, if constancy of the precipitating factors implies constancy of the market level, then returns will remain confined to the low dividend yield recently exhibited by stocks.