Opinion: These 3 stock market benchmarks nailed the dot-com bubble in 2000. Here’s what they’re saying now.

At the beginning of July, i wrote thatFrom a value investor’s long-term perspective, stocks looked cheap. The S&P 500SPX,
it rose 10% over the next five weeks, before falling back close to where it was in early July. Let’s review the question, again from a value investor’s perspective, this time using three benchmarks I outlined earlier. MarketWatch Columns.

John Burr Williams, the original value investor, showed that the long-term return on stocks is approximately equal to the dividend yield plus the long-term growth in dividends. For example, a dividend yield of 2% plus a growth rate of 5% implies a long-term stock return of 7%. One way to think of this is that stock returns consist of dividends plus capital gains, and if dividends grow at 5% per year, we can expect stock prices to grow at about 5% per year in the long run as well. .

On March 11, 2000, I spoke at a conference on the stock market boom and the widely publicized “36K” prediction that the Dow Jones Industrial Average DJIA,
it would soon more than triple, from less than 12,000 to 36,000. At the time, the S&P 500 dividend yield was 1.16%. Adding a 5% long-term growth rate for dividends, John Burr Williams’ approach implied a 6.16% long-term return for stocks, which was below the 6.26 interest rate. % of 10-year US Treasuries TMUBMUSD10Y,
Taking into account two other benchmarks that I will discuss below, I concluded my presentation with the warning: “This is a bubble and it will end badly”.

In December 2008 I was interviewed about the stock market. The S&P 500 is down 40% since March 2000 and the US unemployment rate was 7.8% rising as the economy plunged into the Great Recession. Who would be crazy enough to buy shares? It was. The S&P 500 dividend yield was 3.23% and a growth rate of 5% implied a long-term return on the stock of 8.23%, which was 5.81% higher than the 2.42% of the stock. 10-year Treasury rate at that time. I said this was a once-in-a-lifetime buying opportunity.

What do you think now? The S&P 500 dividend yield is currently 1.63% and a dividend growth rate of 5% implies a long-term stock return of 6.63%, compared to a 10-year Treasury rate of 3.20%. The difference between stocks minus bonds at the close of September 7 was 6.63% – 3.27% = 3.36%, roughly halfway between the difference of –0.10% in March 2000 and the difference of 5.81% in December 2008, halfway between a bubble and a buying opportunity of a lifetime

A second benchmark is Shiller’s CAPE. I invert CAPE to give what I call CAEP = 1/CAPE. This benchmark, the cyclically adjusted earnings yield, is an estimate of the long-term real (inflation-adjusted) return on stocks and can be compared to the real return on Treasury bills. In March 2000, the CAEP was 2.31, 1.45% below the 3.76% real yield on 10-year Treasury bonds (using a 2.5% inflation rate). This reinforced my conclusion that the market was in a bubble at the time.

In December 2008, the CAEP was 6.61%, 6.59% above the -0.08% real yield on Treasuries, reinforcing my view that this was a rare buying opportunity. . Now CAEP is 3.40%, which is 2.7% above the 0.7% real yield on Treasuries (again assuming a long-term inflation rate of 2.5%). If you assume a higher inflation rate, stocks look even more attractive.

My third benchmark uses John Bogle’s idea that the percentage change in stock prices equals the percentage change in earnings plus the percentage change in the P/E ratio. I use the Bogle view with a variety of assumptions for future P/E values ​​and won’t go into detail here for March 2000 or December 2008; can be found in my book, “Money Machine: The Surprisingly Simple Power of Value Investing.” Suffice it to say that they reinforced my conclusions at the time that March 2000 was a bubble and December 2008 was a big buying opportunity.

Currently the dividend yield is 1.63% and the S&P 500 P/E is 19.84. If dividends and earnings grow, on average, 5% per year and the P/E ratio 10 years from now is still 19.84, the S&P 500’s annual return will be 6.63%. If instead the P/E of the S&P 500 in September 2032 is 15 or 25, the annual return of the S&P 500 will be 3.88% or 8.97%, respectively, which again can be compared to the current 10-year Treasury rate of 3.27%.

The proverbial end result. The John Burr Williams approach indicates that the long-term return on equities is currently 3.36% above the long-term return on 10-year Treasuries. CAEP indicates that the difference is 2.70%. Bogle’s approach gives a range for the difference from 0.55% to 5.64%.

You can use these three frameworks with your own assumptions to draw your own conclusions. My conclusion is that stocks look like a substantially better long-term investment than 10-year Treasuries, but not by a once-in-a-lifetime amount. From that perspective, the US stock market certainly doesn’t look remotely bubbly.

Gary Smith is the Fletcher Jones Professor of Economics at Pomona College. He is the author of “The Money Machine: The Surprising Power of Value Investing(AMACOM 2017), author of “AI Deception,(Oxford, 2018), and co-author (with Jay Cordes) of “The 9 pitfalls of data science(Oxford 2019).

Plus: Bill Ackman says stocks will soon be a ‘buy’ now that the Fed is ‘doing what it has to do’ to fight inflation

Plus: Preferred stocks can offer hidden opportunities for dividend investors. Just look at this example from JPMorgan Chase.

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