Maybe you have a pile of cash to invest, but you’re terrified of putting it into a US stock market near record highs. Or you’re worried about a market reversal and wondering if it’s time to cash out. If either scenario sounds familiar, do what banks and brokerages do when issuing their stock market forecasts: Bet on the market moving higher.
They’re likely to be right, even though the market is unmistakably frothy. The S&P 500 Index is coming off its best two years since the 1990s. At 25 times forward earnings, it was only more expensive just before the dot-com crash in 2000 and the tech wreck in 2022. The biggest seven companies in the S&P 500 by market value, which collectively account for more than a third of the index, are even more expensive, with a median P/E ratio of 31.
Add in the return of meme stocks, and the bewildering $75 billion leveraged bet on Bitcoin better known as MicroStrategy Inc., and it all looks like a classic prelude to a stock market smackdown.
Still, Wall Street strategists haven’t been deterred from forecasting fresh gains this year. That’s because, while valuations are a useful gauge of medium-term stock returns, they’re a terrible barometer of short-term market moves. A better guide for how the market is likely to perform in any given year is its past behavior. That history shows that the market grinds higher more often than it backtracks.
Much more often, in fact. From 1928 to October 2022, which marked the end of the last bear market, the S&P 500 was in a bull market 78% of the time, based on a day count compiled by market strategist Ed Yardeni. Corrections are more common, but they’re typically mild and short-lived setbacks in broader bull markets.
The market usually rises because earnings typically grow, and higher profits result in higher stock prices. Since 1990, 12-month trailing earnings per share for the S&P 500 were higher 72% of the time over the previous year, counted monthly. That roughly aligns with the frequency of bull markets.
It also explains why Wall Street strategists are typically bullish, and why, directionally, they’re usually right. Their average forecast called for higher year-over-year S&P 500 earnings 73% of the time since 1990, and they were right on 79% of those occasions.
So, it’s not surprising that strategists on average raised their price target for the S&P 500 yet again despite a plainly overheated market. All 25 strategists that Bloomberg tracks expect S&P 500 earnings to grow this year — the average forecast is $268 a share, up from actual earnings of $239 a share last year. They also assume a price-earnings ratio of 24.2 for the S&P 500, slightly below its current multiple. That yields an S&P 500 price target of about 6,500, roughly 10% higher than its current level.
It’s so easy, anyone can do it. Just slap a reasonably higher earnings number on the S&P 500 — since 1990, strategists have raised their forward one-year earnings target by 7% on average, which, probably not coincidentally, matches the S&P 500’s annualized earnings growth since the 1950s. Then multiply your earnings target by roughly the index’s current P/E ratio, et voila, you’re a Wall Street strategist.
Occasionally, you and the suits will be wrong when bear markets turn up. But no one can predict those reliably, and they shouldn’t matter to long-term investors because the market always recovers, or at least always has.
The market’s enduring resilience makes longer-term forecasts even easier and more reliable, and they point to higher levels than you might imagine. If S&P 500 earnings continue to grow by 7% a year, the S&P 500’s price should approach 33,000 in 30 years and more than 126,000 in 50 years, based on the index’s historical average multiple of 18 times earnings. With a longer view, hanging around in cash doesn’t seem quite as appealing.
I’m mindful of the danger of throwing around heady numbers when the market seems toppy. I’m reminded of economist Irving Fisher’s infamous claim on the eve of the 1929 market crash that stock prices had reached “a permanently high plateau.” Or of Dow 36,000, a book published just before the dot-com crash in 2000 that predicted the Dow Jones Industrial Average, a competing market tracker to the S&P 500, would more than triple in a few years.
Timing, not directionality, felled those predictions. Dow 36,000 took longer than the authors estimated, but it was ultimately worth the wait. The Dow Jones and S&P 500 have returned 8.2% a year during the 25 years since the book’s publication in 1999, including dividends. Meanwhile, one-month Treasury bills, a common proxy for cash, paid just 1.8% a year over the same time.
The results were similar following Fisher’s ill-timed endorsement. If you had bought the S&P 500 at the peak of the market in 1929, you would have earned 6.4% a year for the trouble over the subsequent 25 years, while T-bills paid just 0.7% a year.
One thing investors should do is revisit their allocation to stocks. After two years of strong gains relative to other assets, most people’s stock allocations have probably crept higher, resulting in portfolios with higher long-term expected returns but also more volatility. It’s also not unreasonable to allocate more to cash than one normally would to take advantage of the next buying opportunity, as Warren Buffett appears to be doing.
But bailing altogether on an expensive market or putting off investing new savings is a losing strategy — there’s no way to know when the market will decline, and stocks are likely to provide the best return over time despite their occasional stumbles. A better plan is to invest regularly, preferably using low-cost, broad market index funds, and stay invested. No matter how frothy the market, it will be higher in the future, and a lot higher than you might anticipate. Wall Street is betting on it.
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