A Valuation Warning

Stocks opened slightly lower this morning, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow (DJINDICES: ^DJI  ) down 0.24% and 0.11%, respectively, as of 10:34 a.m. EST.

The week ahead
This is a heavy week with regard to earnings and economic data. More than one-fifth of the companies in the S&P 500 will release quarterly results, including six Dow components:

Monday: Caterpillar

Tuesday: Pfizer

Wednesday: Boeing

Friday: ExxonMobil, Chevron, Merck

The big number of the week is, of course, U.S. nonfarm payrolls, which is released on Friday morning.

On Friday, the S&P 500 closed above 1,500 for the first time since 2007. On this day in 1965, the Dow index closed above 900 for the first time, less than a year after it had broken 800. Over the next 12 months, the index managed to rise another 6%, but longer-term returns were not good: Over five years, the index declined 16%, and over 10, it lost 23%.

Is there a lesson here? Over that 10-year period, the market experienced the oil crisis and "stagflation" -- the unusual combination of slow economic growth and inflation. We were in a very different environment from today's. Still, one of the most important factors in determining stock returns was not dissimilar: valuation. On Jan. 28, 1965, the cyclically adjusted price-to-earnings ratio of the S&P 500 was 23.6; as of Friday, it stood at 22.7. That doesn't imply that investors should expect to suffer losses over the next 10 years, but current valuations are more likely to act as a drag than a tailwind on future returns.

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