It's been a splendid run for the market, so emphatically excellent that in the first three months of the year alone, the S&P 500 rose to record levels in 22 separate days.
Most people who have examined their stock portfolios this year have had the pleasant experience of seeing increases in their holdings, and countless news reports and analyzes from financial gurus have spoken optimistically about the market's powerful bullish momentum.
But what most reports and commentary have failed to point out is that because inflation has also risen sharply in recent years, the value of stock prices has eroded, along with almost everything else in the economy. . When inflation is taken into account, the stock market did not actually reach new highs.
That's finally changing, as market gains outpace the ravages of inflation enough to push real stock valuations near a new peak, according to calculations by Robert J. Shiller, a Yale professor and Nobel laureate in economics. . In a phone conversation, he said: โOn a monthly, inflation-adjusted basis, it appears the S&P 500 is now near a record high.โ
Professor Shiller won't be able to be more precise for another month or two because the consumer price index is calculated retrospectively, while stock prices are virtually instantaneous. At his Yale website publishes monthly data on stocks, bonds, and inflation-adjusted earnings. The S&P 500's last inflation-adjusted peak was in November 2021.
We are certainly close to that inflation-adjusted peak (or may have already reached it) and that is a big deal. It means the market is finally starting to break real records, driving stock returns ahead of the eroding effects of inflation.
It's also a sobering reminder: Despite all the good news in the stock market over the last year, once inflation is taken into account, it hasn't really gone anywhere since the end of 2021. money illusion โthe common human failure to pierce the veil imposed by inflationโhas obscured that reality.
What's more, the stock market rally isn't all that good for truly long-term investors. The recent gains come after a long and periodically interrupted trend of rising stock prices, which have outpaced increases in corporate profits. This reminds Professor Shiller of the protests of the 1920s and the dot-com boom, which ended badly. When prices outpace earnings too much, there will eventually be a reckoning, and, he says, there's a good chance that U.S. stock market returns will be lower over the next decade than they were in the last.
That makes it imperative for long-term investors to diversify their holdings. Take the same investing approach recommended in this column: use cheap index funds to hold all stock and bond markets, and hold on for decades.
Some good news
Inflation aside, the start of the year has been bright for stock investors. Most quarterly portfolio updates will reflect recent gains.
Tech stocks like Nvidia, the chip designer, have shot straight into the stratosphere, fueled by enthusiasm for artificial intelligence. But the rally in the stock market has also been broad-based, with mainstream mutual funds and exchange-traded stock funds posting strong returns during the first quarter.
For bond funds, the story was different. Interest rates rose when it became clear that the economy was strong, inflation was persistent, and the Federal Reserve would not cut rates until later this year, if at all. Bond prices and interest rates move in opposite directions, and mutual fund and ETF bond returns are a combination of yields (interest rates) and price changes. In the first quarter, most bond funds eked out profits, but barely.
Below are some representative average results from Morningstar, the independent financial services company, for stock and bond funds, including dividends, through March 31:
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US stocks, 8.7 percent in the quarter and 24.1 percent in 12 months.
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International stocks, 4.3 percent in the quarter and 11.8 percent in 12 months.
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Taxable bonds: 0.7 percent for the quarter and 5.6 percent for 12 months.
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Municipal bonds, 0.4 percent in the quarter and 3.9 percent in 12 months.
Among the national funds specialized in stock market sectors, technology funds stood out, with an average return of 13.6 percent in the quarter and 42.6 percent in 12 months.
Notable gains
It is always possible to outperform the average by investing all your money in the best performing stock or stocks. Risk takers who bet on Nvidia stock, for example, gained 82.5 percent in the quarter and 235 percent in the 12 months through March.
Why stop there? From October 19 it is possible to buy an ETF: the T-Rex 2X Long NVIDIA Daily Target ETF โ which uses leverage and derivatives with the goal of producing double the return on Nvidia stock. It did even better than the stock in the first quarter, with a gain of 205 percent. But if Nvidia falls for an extended period (and, like every other stock in history, it will), its losses will be staggering.
Nvidia produces solid and growing profits. The fundamental question for investors is whether its earnings can grow fast enough to justify its share price.
Bitcoin is another matter. Its value is based solely on what people think it is worth.
Since January 11, fund investors have found it easier trade cryptocurrency. That's when new ETFs that track the spot price of Bitcoin began trading. One of these funds, the iShares Bitcoin ETF, gained 52 percent through March. Nothing bad!
But Bitcoin could just as easily crash and make your money evaporate. That happened in 2022, when the huge fraud behind FTX it was discovered. Clients lost billions of dollars and Sam Bankman-Fried, the founder of the cryptocurrency exchange, was sentenced last month to 25 years in prison. Speculative appetite decreased in 2022, but has evidently become voracious again.
I would love to have tripled my wealth in the last 12 months, which would have happened if I had put it all in Nvidia stock, or increased by more than 50 percent, which Bitcoin ETFs could have achieved in just over two months . .
But those moves seem too risky for the money I'll need someday. Instead, I took the long-term diversified approach, which doesn't look so good in the short term.
My personal returns, split between stocks and bonds, are close to those reported by the pure Vanguard index. Life Strategy Moderate Growth Fund, which contains approximately 60 percent stocks and 40 percent bonds. It gained just 4.4 percent in the quarter. But over the 12 months to March, it returned 14.2 per cent. And since its inception in 1994, it has earned an annualized return of 7.4 percent, meaning the value of investments has roughly doubled every decade.
However, even this long-term diversified approach carries risks and should not be attempted by those who cannot or will not endure losses.
In our conversation. Professor Shiller reminded me that while the stock market has always, eventually, recovered, there is no guarantee that it always will. And his research shows that, at current valuation levels, the US market is historically overvalued, given the level of corporate profits.
That doesn't necessarily mean there are imminent problems. But his conclusions about the relationship between prices and income (for which he received a prize Nobel โ suggests that the S&P 500 is less likely to produce stellar returns over the next decade than it was when the market bottomed in early 2020, during the Covid-19 recession. Global markets outside the United States have better valuations now and are more likely to outperform. These statements are probabilities, not forecasts. You may not want to trade with them, but keep them in mind.
In some ways, he said, the current period reminds him of the boom of the 1920s. The enthusiasm for artificial intelligence is reminiscent of the popular enthusiasm for innovation of the time, which he said was radio. "RCA was the big deal then," he said. "That's what I think when I look at Nvidia."
Like the rest of the market, RCA stock crashed in 1929 (the company survived and prospered in many incarnations, before becoming part of General Electric in 1985).
While there is no reliable way to forecast market declines or long-term returns, Professor Shiller said, it is wise to be cautious with the money you have.
This argues for holding high-quality corporate and government bonds, which are likely to retain their value in the worst of times. Diversify globally and avoid the temptation to go all-in on riskier investments, even if they may generate greater short-term gains.
Now that we're back to late 2021 levels, I'm continuing this slow and relatively steady approach. It has worked for decades. With any luck, it still will be.
