How long do you wait to find a “bargain” priced security? You don’t know when stocks will be irrationally priced on the downside. You know it’ll happen eventually, you just don’t know when.
What I’d like to know more about, is what I’m currently calling “The 1996 Problem”. On December 5th, 1996, Alan Greenspan coined the term “irrational exuberance”. The S&P 500 was at the level $744 and a PE of 19, vs. the 23.5 of today. If you decided stocks were too pricey on the date of that speech, then you are still waiting to invest, over 25 years later. The tech bubble came, popped and yet never descended all the way back to $744. The structural growth of the economy still happened between 1996 and 2002 and if you owned no stocks, you sat out that growth.
A good counter argument would be that between 1996 and 2002, we still had interest bearing accounts, something we don’t have right now. Over those six years, you only needed 2.1% interest to break even between Greenspan’s speech and the bottom of the dot com crash. Short term interest rates were near 5% during that time span, so even after taxes you should have made the 2.1% you needed.
Today we don’t have the same luxury. If the markets stay irrationally priced, but the underlying economy keeps growing, I believe sitting on the sidelines could be a bad play, as we don’t have interest bearing accounts.
If we assume a fairly priced S&P 500 would be a PE of 17. And the current PE is 23.5. And structural growth of the economy is 7% a year. Then it will take five years of no growth for the S&P 500 to be priced at a PE of 17. Or a crash of 27%. To me, this is the bullish case. This assumes that government stimulus is not driving the recent record earnings. This assumes 7% structural growth. This assumes corporate tax rates are not going to go up. This assumes interest rates are not going to rise. The only way to make this argument more bullish is to assume either “a permanently high plateau” or assume innovation lifts earnings growth even faster than 7% and everything else holds true.
What to do? If you don’t invest today, you risk the 1996 problem. If you do invest today, you are paying at least 38% too much for equities.