MONEY
mean they can’t go much higher. High valuations are a symptom of a stock market peak... But they are not the cause of a stock market peak. Let me walk you through my personal experience with this... By the end of 1994, stocks had gone up for 12 out of the previous 13 years. Said another way, you would have lost money on stocks during only one calendar year since 1981. As you might guess, after that 13-year boom in stocks, measures of valuation showed that stocks were getting expensive. Any rational person in 1994 would think stock prices couldn’t go much higher. But then something irrational happened in 1995. Stocks did go higher... They soared 38%. That drove valuations to crazy heights...
Those two previous peaks were significant – and so were the losses that followed... The Great Depression followed the 1929 peak. And stocks lost a fortune in the 1970s after the late 1960s peak... shedding nearly half their value from 1973 to 1974, adjusted for inflation. So in 1994 and 1995, any rational person would have said that valuations were extreme – hitting levels that had preceded the two greatest stock market busts in the 20th century. Buying then would have seemed foolish... Except it wasn’t. It was exactly what you should have done. After soaring 38% in 1995, stocks jumped 23% in 1996. Astonishingly, that STILL wasn’t the end of it... The market soared another 33% in 1997. -9.7% -10.2% -13.1% -9.8% 5,200 4,700 4,200 3,700 3,200 2,700 2,200 1,700
Nasdaq Composite Index
The Nasdaq fell 10% five times during the last Melt Up
-10.4%
Stocks had only been THAT expensive two times in history – in 1929, and in the late 1960s. You can see this by looking at the cyclically adjusted price-to-earnings (or CAPE) ratio, one of the most popular ways to measure value in the markets over the long term. Take a look at the chart on the right...
Jul
Sep
Nov
1999
Mar
May
Jul
Sep
Nov
2000
Mar
S&P 500 CAPE Ratio 1918-1996
30
Stocks reach extreme valuation levels in 1995
25
20
15
10
5
1924
1930
1936
1942
1948
1954
1960
1966
1972
1978
1984
1990
1996
S&P 500 CAPE Ratio 1919-1997
American Consequences 19
Stocks hit all-time expensive levels in 1997
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