If you had invested $100 in an S&P 500 index fund on January 1, 2020, it would have been worth…
- $81 the next month
- $121 by January, 2021
- $147 (approximately) by November, 2021
- $119 by September, 2022
- $146 (July, 2023)
Which raises the question: Is this kind of volatility normal?
Maybe we need to define “normal.” One wag has suggested that the only normal people are the ones you don’t know very well yet. The same might be said of the stock market.
Yes, the market’s present behavior is quite normal. It just isn’t the normal we want.
Perhaps the real question behind the question is “What keeps the market going up?”
Short answer: The same three things it has always taken to make the market go up: an alignment of earnings, events, and emotions.
- Earnings. Nothing happens in capitalism until somebody makes a profit. The good news is this happens most of the time. According to Standard and Poor’s, since World War II, the profits of corporate America have grown at a fairly steady clip of about 6% annually.
If that were the only determinate, we would have a stock market that would grow at 6% per year, and that would be that.
But as anyone knows, that’s hardly what happens! The next two elements of stock market growth explain why earnings are never enough.
- Events. Life happens. Wars break out. Terrorists attack. Nations default on their debt. Consumers borrow too much money. Hurricanes hit population centers. Political regimes are overturned. An oversized generation retires.
For the most part, events are short term in nature and in effect. Markets move dramatically when, say, a novel virus shuts down whole economies, but the markets quickly regain their equilibrium.
The reason most events do not have a long-lasting impact is because they do not significantly affect the corporate world’s ability to make a profit. No impact to earnings, no long-term effect.
Other events, however, are not so short term in their impact. Events like the financial crisis of 2007, the U.S. governments’ growing unfunded liability from Social Security and Medicare—these can all affect the long-term viability of corporate earnings, directly or indirectly. The markets know this and don’t overlook such events quite so sanguinely.
- Emotions. Human beings evaluate both earnings and events through a filter called “emotions.” Those fickle emotions process the facts of earnings and events and attach to them a magnification factor that is somewhere up or down the “optimism / pessimism” scale.
In the late 1990s, investors in the American stock market had experienced a nearly 20-year run of growing profits and upward market movement. Such factors can become self-fulfilling prophecies.
In 1980, investors felt pessimistic about the future and would only pay about ten times the earnings of the average stock. So, if a company earned $5 a share, investors were willing, due to their emotional evaluation of the future, to pay $50 per share for the company’s stock.
Nineteen years later, in 1999, the same average company could earn $5 per share, and command $150 per share of stock, or 30 times earnings. It got so frothy that stocks of technology companies were selling for hundreds of dollars per share, while earning zero—and, yet, we were optimistic about the future!
Such “earnings multiple expansion” is always a function of growing or shrinking optimism about the future. In other words, emotions.
As of today, the market is trending up. How long will this last? Will we have a downturn soon?
As soon as I get the word, I’ll pass it on to you!
One final question around the idea of emotions…Have you settled on a plan for turning your retirement assets into retirement income—a plan you feel good about?
If not, email me at email@example.com. I’ll send you a free link to take the RISA® Profile. This simple, ingenious quiz takes mere minutes, and it can help you create an income plan that makes fiscal sense and is a good fit emotionally. (So that you don’t spend life’s next chapter fretting 24/7!)
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