Stock investors could be in for a wild ride this month, given that two of the most momentous market turning points in U.S. stock market history occurred in March.
The first was on March 10, 2000, when the internet-stock bubble burst. Many investors were wiped out in the ensuing bear market, and more than just a few had to postpone their retirement. Their trauma continues to affect investor behavior today.
Second, on March 9, 2009, the Great Financial Crisis-induced bear market — the worst since the Great Depression — came to an end. The S&P 500 index
, assuming dividends were reinvested, has gained more than 350% since that fateful day.
It’s important to remember both of these anniversaries in tandem, since it’s difficult not to draw the wrong conclusion when focusing on either of them in isolation. A focus on the bursting of the internet bubble could lead you to avoiding equities altogether, for example, while a focus on the March 2009 beginning of the bull market could lead you into a too-high allocation to stocks.
The truth is somewhere in the middle. Consider first what we can learn from the bursting of the internet bubble. Believe it or not, as you can see from the chart below, the Nasdaq Composite Index
currently is almost precisely where it stood in March 2000, adjusted for inflation. In other words, the bull market since 2009 — powerful as it undeniably has been — has done little more than recover the carnage wrought by the bursting of the internet bubble.
The most important investment lesson of this sobering result:
• Valuations matter. Stocks in March 2000 were more expensive, according to almost all valuation metrics, than they had ever been before. Their disappointing returns over the subsequent two decades shouldn’t have come as a surprise.
Now shift your attention to the investment lessons of the March 2009 market turning point. The most important lesson I draw from it:
• Valuations matter. Stocks in March 2009 were cheaper, according to several different valuation ratios, than they had been in several decades. The strength of equities’ subsequent bull market shouldn’t have come as a surprise.
In other words, the same investment lesson can be drawn from these otherwise diametrically opposite market turning points.
To be sure, this lesson is difficult to put into practice, since valuations have relatively little impact on the stock market’s shorter-term direction. Stocks were way overvalued in the years leading up to the bursting of the internet bubble, for example, and yet the stock market continued rising. Then Fed chairman Alan Greenspan’s famous “irrational exuberance” speech took place in late 1996, for example — more than three years prior to that stock market party finally coming to an end.
Of course, no one should be surprised that valuations exert an extremely weak gravitational pull on the market’s short-term direction. Throughout history, valuations have had their biggest impact only over many years.
My favorite analogy for making this point comes from Ben Inker, head of asset allocation at Boston-based investment manager GMO. Likening the market to a leaf in a hurricane, he says “you have no idea where the leaf will be a minute or an hour from now. But eventually gravity will win out and it will land on the ground.”
This would be an important lesson to draw in any month of the year, of course, not just March. But it’s especially important right now, since equity valuations currently remain far closer to the March 2000 extreme than they do to their March 2009 levels. In fact, the stock market today is by many measures more overvalued than at any time in U.S. stock market history except prior to the 1929 stock market crash and prior to the bursting of the internet bubble.
Beware the Ides of March.