Take Away the Bubbles and the Stock Market Is Trading Right at Its High

The Stock  Market BubblesInvesting in stocks hasn’t been great over the last decade or so. The stock market is basically trading around the same level it was this time last year. It’s the same as it was in 2008, 2006, 2000, and 1999. Without dividends, you would have lost money owning the S&P 500 Index over the last 12 years due to inflation, which highlights how important it is to get the business cycle right if you are investing in stocks.

Of course, before the last dozen years or so, it was a golden time investing in stocks. Individual stock selection wasn’t even necessary to make big capital gains; you just needed to own the stock market through an index. The last half of the 1990s was a particularly great time for investing in stocks, as the Internet technology craze fueled a wild period of speculation. But if you strip away the bubbles and the bursts, I believe the stock market (as measured by the S&P 500 Index) today is following the natural progression of earnings growth. Ignoring the big swings, the stock market, in my opinion, is exactly where it should be.

Investing in stocks is all about getting the timing right, because the business cycle exists, and it’s very powerful. If you pull up a very long-term chart of the S&P 500 Index and strip away the huge volatility of the last dozen years, you’ll notice that the stock market, as measured by this index, is trading just a hair below its all-time record high. It’s the volatility in the stock market that’s been crazy over the last 12 years. Given the earnings growth, stocks are trading appropriately.

So this begs the question, should you be investing in stocks now, with the main large-cap index trading right near its all-time high? My answer is no, and it’s for no other reason than the business cycle isn’t right. We are still coming down from a period of major excesses, and while consumer debt is stabilizing, sovereign debt is not. There is no catalyst for the stock market to begin a new upward swing with the fundamentals of the U.S. economy the way they are now.

There is plenty of evidence to support the theory that investing in stocks for the long-term generates a meaningful return on investment. If someone gave you 100 shares of PepsiCo, Inc. (NYSE/PEP) in 1995, 2000, 2005 or 2010, you’d have to be happy with the result, because the shares have gone up consistently over this time and have paid a good dividend. (See “My Favorite Benchmark Stocks That Lead the Stock Market.”) The key, as PepsiCo’s share price performance illustrates, is to build positions in the right businesses and manage your expectations on the returns.

I think the next U.S. recession (likely next year) will present an excellent entry point to consider investing in stocks at the cusp of a new upward business cycle, buying great stock market performers when they’re down. The U.S. economy still has a long way to go in correcting itself, but for the world’s largest economy, it has proven to be incredibly nimble at doing so.

Investing in stocks is all about good timing, and this takes patience. The volatility the stock market’s experienced over the last 12 years is what’s rattled investors the most. If you strip away this volatility from the long-term charts, you might see what I see, and that is that the stock market is at its high, exactly where it should be.