Current stock-market valuations are almost as high as they were in March 2000
The internet bubble peaked 26 years ago this month. The most important lesson from that irrationally exuberant time is that overvaluation can lead to below-average returns for years - and even decades.
Consider the chart below, which plots the stock market's inflation-adjusted total return since March 2000. As you can see, both the S&P 500 SPX and Nasdaq-100 NDX indexes are behind where they would have been had they kept up their historical average rate of return.
This is despite the stock market enjoying a powerful and nearly uninterrupted bull market for the past 17 years. (I based the historical average return - 6.06% annualized on a real, total-return basis since 1793 - on the database maintained by Edward McQuarrie, an emeritus professor at Santa Clara University.)
Line chart showing inflation-adjusted total return of Nasdaq 100, S&P 500, and the average since 1793 from 2000 to 2024.
The U.S. stock market was extremely overvalued in March 2000. The cyclically adjusted price-to-earnings ratio $(CAPE)$ stood at an all-time record, almost triple its historical average up until that point. The message of history was unmistakable: The stock market over the next decade would struggle at best and be in the red for many years.
Consider the predictions of a simple econometric model whose inputs were monthly CAPE values back to 1881 and, for each of those months, the stock market's real total return over the subsequent decade. In March 2000, at the top of the internet bubble, that model predicted that over the subsequent decade - to March 2010 - U.S. equities would produce a real total return of minus 6.8% annualized.
That turned out to be remarkably accurate for the S&P 500, which produced a real total return over that decade of minus 7.0% annualized. The Nasdaq-100 did even worse, producing a real total return over that decade of minus 10.4% annualized.
The stock market's current valuation
This discussion has bearish implications for today's stock market, since current valuations are almost as high as they were in March 2000, if not higher, as I pointed out in a recent column. To be sure, the stock market has been overvalued for several years now, and at least so far has resisted the gravitational pull of that overvaluation. But valuation indicators shed relatively little light on the market's year-to-year returns, and have their greatest predictive power over longer periods, such as a decade.
There's another comeback I often hear when pointing out the stock market's current extreme overvaluation: History is not relevant to today, given revolutionary developments such as AI. I'm skeptical of such "this time is different" arguments, which have been heard before many times - including prominently at the top of the internet bubble.
But you should be aware that even if this argument is correct, it doesn't necessarily have bullish implications. If the future has no relationship to the past, then it's just as possible that future stock-market returns will be far worse than the historical average.
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