Once again the market is breaking into record territory and once again pundits and talking heads are shouting about the S&P 500 (NYSEARCA:SPY) being in a bubble and giving reasons for a new market crash.
Although the stock market has had a monumental recovery from its March 2009 lows and it's easy to think we've gone "too far, too fast", I find it best to take a longer-term perspective. At the beginning of this year I wrote about this topic, putting the market's rise into perspective and forecasting normal returns going forward. With the S&P 500 up just under 25% year-to-date and reaching all time highs, it makes sense to once again revisit the topic.
The charts below show the distribution of historic returns for the S&P over a range of time frames. Each time period shows the minimum and maximum returns earned over that time frame (e.g. looking at the 50 year level shows the maximum return earned over any 50 year period was about $90, the minimum return was about $12 and the median was just over $30). Results are divided into percentiles with the orange line representing the best performance for each time frame, the red line representing the worst performance, and the purple line showing the median performance, with the light blue and green lines showing the 25th and 75th percentiles, respectively.
Over time the S&P 500 tends to revert to the mean, with periods of outperformance often followed by average or below average performance, and periods of underperformance followed by average or above average results. This helps bring medium and longer term results closer to the market's historic norms (as shown below) and means that if longer term results are far from these norms it could be either a buying or selling signal.
Adding in a line with the S&P's most recent performance (e.g. The 10 year level shows the returns of $1 over the last 10 years) to the previous graph allows us to look at the markets current performance in light of these past results, granting us a better perspective vs. "normal" results.
This graph shows that despite being at or above the 75th percentile mark for the last 5 years or so, we are at normal or below average levels of market returns between the last 5 and 20 years. This shows us how the recent rally has helped to somewhat mitigate the effects of the "lost decade" of minimal returns caused by the tech bubble and subsequent collapse.
We can look back as recently as the early 2000's to show how a bubble looks significantly different, with new highs being made over nearly every time period.
Conversely, this type of graph can be used to evaluate market lows for opportunity, as significant declines will also have a tendency to revert to the mean, with the low point of 2009 showing this clearly.
The current performance of the S&P, although above average in the short term, is within normal levels and is far from bubble levels. The market's P/E ratio has grown to the high teens but is far from the unreasonable levels seen during the tech bubble. Although it is possible that there will be a pullback in the future, I don't believe the market is at "greater fool" levels where buyers are simply hoping to sell to a greater fool at a higher price. I personally believe that the market is somewhat overvalued and should experience below-average, low single digit returns going forward, but that it is highly unlikely that there will be a significant decline.
Despite the market making new highs every day and experiencing extraordinary returns in recent years, the S&P is within its normal return range and is not in bubble territory. Don't panic.