It’s useful to remember that long-term returns represent not only trough-to-peak advances, but peak-to-trough resolutions as well. Buy-and-hold investors don’t get the trough-to-peak return. They get the full cycle return. Not surprisingly, the higher the valuation at the bull market peak, the longer the subsequent period of disappointing returns, in several instances extending more than a decade, though not without intermittent failure-prone bull market rallies to add excitement. This is what I often call ‘going nowhere in an interesting way.’

– John P. Hussman, Ph.D.
Risk Management is Generous, December 2004

Find a point in market history where reliable valuation measures were somewhere near their historical norms, and another similar point decades later, and you’ll generally find that the S&P 500 posted a fairly run-of-the-mill total return on the order of roughly 10% in the interim. But choose a start-date where the market was at historically elevated valuations, and an end-date featuring normal or depressed valuations, even a decade or more later, and you’ll typically find that the market went “nowhere in an interesting way” in the interim. Given current valuation extremes, that observation matters.

At extreme valuations, it’s important to remember that the completion of a hypervalued market cycle can wipe out every bit of the stock market’s total return over-and-above T-bills, going back not just a few years, but for over a decade. Despite all the gains that the stock market enjoyed during the “tech bubble,” and during the subsequent “mortgage bubble,” the decline to the March 2009 market low erased the entire total return of the S&P 500 over-and-above T-bill returns, all the way back to May 1995. Notably, the 2009 low occurred at valuations that were only moderately below their historical norms, and still nearly twice the levels observed at deep secular lows like 1949 and 1982.

The chart below shows the cumulative total return of the S&P 500, in excess of Treasury bill returns, from May 1995 to the March 2009 low. Once market valuations stand well above their historical norms, additional market returns have invariably been transient. As Kenny Rogers sang, “You never count your money when you’re sittin’ at the table.”

Indeed, while broad market internals have lagged the backward-looking exodus by investors into passive, large-cap indexing in recent quarters (especially among small-capitalization and value stocks), the S&P 500 itself has done no better than T-bills since its January 2018 pre-correction high. Market action has featured increasing dispersion and volatility, but little in the way of net progress.

At extreme valuations, it’s important to remember that the completion of a hypervalued market cycle can wipe out every bit of the stock market’s total return over-and-above T-bills, going back not just a few years, but for over a decade.