Investing in the stock market has proven to be a wise choice for those seeking strong returns and building a robust portfolio. When you invest in stocks, you become a shareholder in a company and can profit by selling shares as the stock value rises or by holding onto them and receiving dividends. Stocks offer liquidity and diversification, allowing investors to purchase individual stocks, mutual funds, or exchange-traded funds (ETFs). On average, stocks have historically returned between 8 and 12 percent per year over the long term. However, it’s important to remember that economic conditions and emotional decisions can impact returns.
While optimism and excitement currently dominate the market, it’s crucial to consider that fear, doom, and gloom may return at some point, significantly affecting stock values. Therefore, it’s important to understand the historical performance of stocks over different time periods.
Over a 20-year rolling period, historical data shows that the stock market has never had a negative return. This suggests that investing with a time horizon measured in decades is the safest approach. Even during severe economic recessions and market weakness, the market has performed positively over 10-year periods. Negative returns have only occurred during significant events such as the Great Depression, the Tech Bubble, and the Global Financial Crisis.
It’s worth noting that from 1966 to 1982, the overall stock market struggled, but this poor performance primarily affected large cap stocks. Large cap refers to companies with a market capitalization greater than $10 billion. However, small cap stocks performed well during this time.
Since the stock market bottom after the Global Financial Crisis in 2009, U.S. stocks have delivered an impressive annual return of 16 percent, surpassing the 30-year average of around 10 percent. The Dow Jones Industrial Average (DJIA), a prominent U.S. stock market index, has experienced significant fluctuations over the years.
In 2024, the DJIA’s average closing price is approximately 38,000, with a year-to-date return of 2.6 percent. In 2023, the index had an average closing price of 34,121, boasting an exceptional annual return of 13.7 percent. However, 2022 faced volatility, with an average closing price of 32,900 and a negative return of -8.8 percent. Since the Global Financial Crisis, only the pandemic year of 2020 and 2022 suffered market pullbacks. In 2021, despite the pandemic, the DJIA soared to an average closing price of 34,055, delivering an impressive annual return of 18.7 percent. However, during the Global Financial Crisis in 2008, the DJIA experienced a significant decline, with an average closing price of 11,200 and a staggering annual loss of -33.8 percent.
While stocks come with higher risk due to market volatility, they also offer significant growth potential. The numbers listed above demonstrate this potential. However, it’s important to consider the current state of the stock market and its valuation.
Various indicators suggest that the stock market is relatively expensive at present. One common measure of valuation is the Price-to-Earnings (PE) ratio, which compares a stock’s price to its earnings. The current PE ratio for the S&P 500 is reported to be 24x, suggesting that investors are paying 24 times the earnings for each dollar invested in the market. Historically, the average PE ratio for the S&P 500 is around 15-16. The lowest recorded PE ratio was 5 in 1917, while the highest was 123 in May 2009, just before the Great Financial Recession.
Another valuation metric is the Shiller PE (CAPE) ratio, which considers average earnings over a 10-year period. The current Shiller PE stands at 31, which is 19 percent above its 200-month moving average of 26. While it’s above the historic median, it’s still well below the peaks seen in the past century.
The Buffett Indicator, which compares total market capitalization to GDP, also suggests overvaluation. Currently, the Buffett Indicator stands at just under 200 percent, about two times the annual GDP, well above the historical trend line. This metric indicates that the stock market is strongly overvalued relative to GDP.
Estimates suggest that the American stock market is overvalued by 65 percent, meaning that it would require a 39 percent drop to bring it back to its long-run equilibrium level. While strong earnings growth may justify higher valuations, investors should remain cautious. Market conditions can change rapidly, so staying informed and adopting a diversified investment approach is essential.
In conclusion, investing in the stock market can be a lucrative endeavor over the long term. However, investors must be aware of the risks associated with market volatility and consider the current state of the stock market. Historical data provides valuable insights into stock performance over different time periods, highlighting the importance of a long-term investment horizon. Additionally, various valuation metrics indicate that the stock market is relatively expensive at present, suggesting the need for caution and diversification. Consulting with a financial advisor before making any investment decisions is always advisable.
