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The Market Is Up Big. Valuations Aren't.

The S&P 500 is up 55% in the last three years. Investors who three years ago prayed for a rebound to replenish their retirement accounts have now found a new reason to worry: Stocks going too high. 

Take this, from a recent USA TODAY article:

Investors watching the market's steady march higher can only start to wonder when stocks will finally get too expensive.

The stock market's rise is pushing stocks to never-before-seen levels. The Standard & Poor's 500 index rose another 2 points Monday to 1683, rising for eight straight days and notching all-time records on a daily basis. Investors have scored more than $13 trillion in wealth since the market bottomed on March 9, 2009, Wilshire Associates says ... The rally "is making some investors nervous because they think it is too expensive," says Craig Johnson of Piper Jaffray.

I understand the nervousness. Investors burned twice in the last decade don't want to get clobbered again. But it's important to separate price from value.

As Buffett says, "Price is what you pay, value is what you get."

And while the price of the S&P 500 has surged in recent years, its value is another story.

Both earnings and dividends are at an all-time high. More important, earnings have been increasing faster than stocks over the last decade. Over the last 10 years, the cyclically adjusted P/E ratio, which averages together 10 years of earnings adjusted for inflation, has declined slightly even as the market nearly doubled in price:

Source: Robert Shiller, author's calculations.

In part because they're shellshocked from the bubbles of the 2000s, I think investors automatically associate all-time-high stock prices as a sign of a new bubble. But new all-time highs is what you should expect over time. In a May interview on CNBC, Warren Buffett was asked about the Dow Jones passing 15,000 and responded:

I can remember when it was a big time when the Dow Jones crossed 100, and I certainly remember well when it hit 1,000. So, probably in my lifetime, and certainly in your lifetime, you will see markets that are far higher than this. The retention of earnings by American industry, the growth of the country, will cause stocks to go higher over time.

A few months ago, I made a matrix with different assumptions about earnings growth and P/E ratios to guide you where the S&P 500 will be in 10 years. The index currently trades at about 1,650. Choose your own adventure: 

More big-picture stuff
Interested in more on the economy? My new report, "Everything You Need to Know About the National Debt," walks you through step-by-step explanations about how the government spends your money, where it gets tax revenue from, the future of spending, and what a $16 trillion debt means for our future. Click here to read it. 


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