Most people assume that the S&P 500 Index will go up over long holding periods. Wharton School Professor Jeremy Siegel popularized the proposition in his 1994 book Stocks for the Long Run, and index-investing pioneer John Bogle made it easy for the masses to act on Siegel’s wisdom. That idea (which is indeed true in modern US history) has generally served investors well. But even as an adherent to Siegel and Bogle’s principles, the near-universal acceptance of the “stocks always go up” mantra is starting to worry me.
In a memo published Tuesday titled On Bubble Watch, legendary investor Howard Marks reflected on perhaps the most prescient call of his career: an essay published 25 years ago that warned about irrational behavior in dot-com-related stocks. As Marks puts it, one of the key features of the internet bubble was a can’t-lose attitude about stocks. Here’s Marks:
I always say the riskiest thing in the world is the belief that there’s no risk. In a similar vein, heated buying spurred by the observation that stocks had never performed poorly for a long period caused stock prices to rise to a point from which they were destined to do just that.
What he’s referring to is the George Soros theory of “reflexivity,” the feedback mechanism between investor expectations and realized performance. If enough people believe stocks are a sure thing, their price-insensitive buying can push prices higher for a considerable time, reinforcing those initial beliefs — at least until real-world events intervene to force asset prices lower.
It’s worth considering whether something similar is afoot today. US stocks have delivered a compound annual growth rate of around 17% since the bear-market bottom of 2009, with only two calendar years of negative total returns. In a sense, the few drawdowns that have taken place have only reinforced the urge to go all-in on the S&P 500, because stocks have inevitably roared back. No one who entered the investment industry after 2010 has experienced a drawdown deeper than the short-lived 34% swoon of 2020 or longer than the nine-month, 25% peak-to-trough bear market of 2022.
All of this has burnished the reputation of the invincible US stock market and sent trillions of dollars its way, including into the surging exchange-traded fund industry. In 2024 alone, US-listed exchange-traded funds took in a record $1.1 trillion, of which $793 billion went to ETFs with a US focus. Four of the top five were US stock index trackers, led by the Vanguard S&P 500 ETF.
The latest Federal Reserve data from 2022 suggests that stock ownership is more pervasive than ever among households — which is largely a positive development — but the popularity of equities may also have come at the expense of less volatile bonds. After a decade and a half of equity outperformance, the 60/40 stock-bond portfolio has been declared dead more times than I can count.
Meanwhile, the latest global fund manager survey from Bank of America Corp. shows record high allocations to US stocks and record-low cash positions, suggesting that the pros have been drinking the same Kool-Aid as retail investors.
Wall Street strategists, who generally doubted the market’s potential in 2023 and 2024, have now caved to the view that the real risk is staying on the sidelines. And among single-stock analysts, there’s a near-unanimous standing recommendation to invest in the Magnificent 7 growth companies, the superstar stocks that now constitute a third of the S&P 500 by market capitalization. About 81% of all sell-side recommendations encourage investors to buy the Mag 7: Alphabet Inc., Amazon.com Inc., Apple Inc., Meta Platforms Inc., Microsoft Corp., Nvidia Corp. and Tesla Inc. And if you drop Tesla (the most preposterously valued) from the list, the percentage of Mag 7 buy recommendations climbs to 86%. It does, indeed, seem like an unusually large investor base is in on the US stock market trade.
Overall, the S&P 500 trades at about 22 times blended forward 12-month earnings, a multiple that the index has only exceeded in the periods 1998-2000 and 2020-2021 in data since 1990. In the past, I’ve explained away the high multiple by citing changes in index composition and the extraordinary growth record of the leading companies, and those arguments still hold some water. But in addition to the high multiple, the underlying earnings expectations are also lofty. If something goes wrong for a couple of the index’s behemoths, they could easily start to take index investors down with them. Perhaps Soros’ reflexivity would kick in and bring stocks even lower in a cascade of lost faith.
Again, I don’t have many quibbles with the facts around Stocks for the Long Run; I’m just worried that too many people have bought into the idea. For the sake of completeness, I should point out that more recent work by Edward McQuarrie has uncovered a very long stretch of time prior to the Civil War when stocks meaningfully and sustainably underperformed bonds. McQuarrie also documents a variety of multi-decade periods of negative real equity returns in international markets such as Norway (-4.4% annualized in the 30 years ending in 1978); Italy (-2.4% annualized in the 30 years ending in 1991); and Japan (-0.8% annualized in the 30 years ending in 2019). While not nearly as long as those episodes, US investors have also endured lost decades following the Nifty Fifty craze of the 1960s and the elevated valuations of the dot-com bubble. In other words, stocks aren’t always a sure thing over longer holding periods. I sincerely doubt that markets are heading back to the 1800s, but it’s certainly conceivable that today’s valuations and market concentrations could set the stage for an underwhelming 10 years.
In his latest memo, Marks concludes that he is just laying out “the facts as I see them”: that valuations are unusually high and that such valuations have historically been associated with subsequent periods of poor returns. Personally, I have no idea if the US bull market is in the 6th, 7th or 8th inning — and I’m not ready to stick my neck out and suggest we’re in the 9th. But so many people are in on the secret that the upside has diminished meaningfully and the risks have escalated.
The sensible next step would be to reacquaint ourselves with some of the investments that aren’t nearly as popular, starting with 10-year Treasury notes now yielding around 4.7%. And what about deeply unloved emerging market equities that proved in the 2000s that they can outperform when US stocks struggle? Whatever happens in 2025, it sure seems prudent to curb US stocks fanaticism and rediscover the benefits of diversification. At some point, the crowd will turn its attention elsewhere, and no one wants to be the last one off the bandwagon.
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