The market looks strong and Wall Street is wrong about that 'lost decade' for stocks

MW The market looks strong and Wall Street is wrong about that 'lost decade' for stocks

By Peter Morici

The business cycle and company earnings are in better shape than the CAPE ratio indicates

With this year's stock market gains so concentrated among the Big Tech companies with huge bets on artificial intelligence, markets were extraordinarily volatile both before and after the presidential election.

You can take a breath; U.S. equities remain reasonably priced and still a good long-term bet for your savings. The S&P 500 price-earnings ratio is now about 30. Over the past 25 years, the U.S. benchmark index has averaged about 26, and at the last business cycle peak in February 2020, it was 27.

Yet while the market's current P/E may look elevated, U.S. companies are becoming more efficient and profitable. Estimates for fourth-quarter and 2024 sales and profits growth are 4.8% and 12.2%, respectively, and for 2025, 5.7% and 14.8%, according to FactSet.

Analysts at Goldman Sachs created a stir last month with forecasts, based on economist Robert J. Shiller's Cyclical-Adjusted Price-Earnings $(CAPE)$ ratio, indicating the outlook for U.S. stocks is poor and bonds may be a better bet than stocks over the coming decade.

CAPE is the ratio of average stock prices to inflation-adjusted average earnings for the past 10 years. Currently, that figure is approaching 38.0 - well-above its 25-year average of 28.0.

Yet 10 years is arbitrary and doesn't correspond to the average length of U.S. business cycles- the most recent expansion lasted 146 months until the COVID-19 shutdowns killed it. Profits in the numerator for the current CAPE calculations are depressed by the extraordinary pandemic shutdown and recession. Plus, over the decades markets have gradually supported much higher P/E ratios - for the 25 years ending in 1999, the S&P 500 P/E averaged about 15.

Moreover, in September 2021, CAPE computations were throwing off similarly bearish signals for stocks. Since that time, the S&P 500 SPX has gained more than 25%.

The Goldman Sachs argument leans heavily on the fact that large firms have trouble sustaining outsized revenue and earnings growth over the long term. Landing new customers becomes more challenging for these companies once they dominate their market, in addition to becoming a target for competitors and attention from government antitrust regulators.

In the late 1960s and early 1970s, the so-called Nifty Fifty stocks led big gains for the U.S. market, but ultimately the 1970s was a lost decade for stocks. The late1990s tech boom, led by Microsoft $(MSFT)$, Cisco Systems $(CSCO)$and Intel $(INTC)$, also was followed by weak stock returns in the 2000s.

Nowadays the so-called Magnificent Seven stocks - Alphabet $(GOOGL)$, Amazon.com $(AMZN)$, Apple$(AAPL)$, Meta Platforms $(META)$, Microsoft, Nvidia $(NVDA)$ and Tesla $(TSLA)$ - collectively represent about one-third of the S&P 500 and account for about half of the index's gain so far this year.

Among the Big Tech stocks, other companies to watch are those experienced with business software applications, such as Salesforce $(CRM)$ and Adobe $(ADBE)$, and are marketing AI agents - specialized programs that can be immediately applied to boost productivity and save labor.

My advice remains the same as ever: Spend only as much on a house as you can afford. Keep an emergency fund and cash for large expenses in a money market account as well as fixed-income assets with varying maturities, such as U.S. Treasurys and CDs.

Invest the remainder of your portfolio in diversified individual stocks or a broad-based, inexpensive U.S. index fund - for example, Vanguard Total Stock Market Index Fund VTSMX or Vanguard Total Stock Market ETF, its exchange-traded counterpart VTI.

Diversified portfolios have the potential to capture the broader economic growth and new profitable firms that will emerge. AI will lead the way. Spending on AI equipment and services is estimated to rise from $185 billion last year to about $900 billion in 2027, according to a Bain & Co. report, and, Goldman Sachs research predicts, could increase U.S. labor productivity by perhaps one percentage point a year.

Many jobs will be created and destroyed in this AI revolution, but the U.S. economy will be poised for a growth trajectory closer to 3% than 2%. And it won't just be companies we now recognize that prosper.

Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.

More: Here's one reason investors should stick with stocks - despite warnings of a 'lost decade' ahead

Also read: Yes, stocks are crazy expensive right now. These 5 charts show just how extreme valuations have become.

-Peter Morici

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November 19, 2024 07:05 ET (12:05 GMT)

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