The lust we’re talking about, of course, is money lust. The market has risen so far so fast–the 30-stock Dow Jones industrial average up 23 percent for the year through Friday, the broader Standard & Poor’s 500 up 29 percent–that almost anyone who’s been in the market has made a ton of money this year. Including dividends, the gains through last Friday work out to a rate of around 45 percent a year. If things get a little hotter, 1995 could become the best year in market history, topping the S&P’s 53 percent return in 1933. This kind of thing makes investors with a sense of history very jumpy, because it’s too good to last. You’re afraid to pull your money out of the market and miss the rest of the fun, but you’re also afraid of getting caught with your money exposed if the market crashes. You don’t dare be in the stock market at these prices, but you don’t dare not be in. What’s a greedy investor to do?
The short answer: no one knows. Even though stock prices are very high by important standards like dividends, the market isn’t necessarily heading for a fall. But there are warning flags flying. The two most worrisome signals: dividends are at their lowest level relative to stock prices in at least 70 years, and the four most dangerous words in finance, “This time it’s different,” are abroad in the land.
Dividends matter because they have historically accounted for almost half of investors’ returns. If you own stocks, you make money from price increases and from dividends. If dividends are lower than usual, then stock prices have to rise more than usual for you to make the normal return. And over time, that tends not to happen. Let’s look at the numbers, provided by Ibbotson Associates, a Chicago investment consulting firm. From 1926, when Ibbotson starts counting, through last June 30, the S&P 500 stocks earned investors an average of 10 percent a year. Of this, only 5.4 percent came from increases in stock prices; the other 4.6 percent came from dividends. Today the S&P’s dividend yield–dividends divided by the stock price–is under 2.5 percent, the lowest level in history. Think about it. If dividends yield 2.5 percent, stock prices have to rise 7.5 percent a year for investors to make their normal 10 percent. To make 12 percent, stock prices have to rise 9.5 percent consistently. Good luck.
Bad timing hurts: Why is this troublesome? Even though on average you make more money in the stock market than in any other investment available to the average person, you can get killed if you buy at the wrong time. Especially if you’re close to retirement or getting ready to open your veins to pay for college. For instance, in the 1974 bear market, stock prices were 35 percent below their 1965 high. If you bought just before the 1929 crash, you were underwater until the 1950s. Buying heavily when stocks drop has worked great since the current bull market started in 1982. But that doesn’t mean it always will.
Bulls argue that the stock market has changed fundamentally because millions of investors know they can’t trust their employers to pay for their retirement, and will be living on cat food unless they sock money into stock funds. So these folks will pour billions into stock mutual funds, which will keep the market going up forever. But people used to make that argument in Japan in the late 1980s, saying that even though stocks were absurdly high, they would rise ever higher because Japanese investors had so much money to play with. Surprise! The Japanese market is down 62 percent (in yen) from its high and seems unlikely to regain it any time soon.
For whatever it’s worth, I’m pretty much fully invested in stocks, as are some of the smart, conservative people I talk to. Who can resist? I love watching computer screens and reading newspaper stock pages and counting my profits. Stocks seem high to me, but not terribly excessive. Am I right? Who knows? What I do know is that the way for the average person to make money in stocks is what it has always been: invest for the long term, don’t try, to outguess the market, don’t pour in every spare penny when prices rise or sell in despair when prices fall. Keep your greed under control. And never, never, never put money you can’t afford to lose into a soaring market like this one because your financial lust is running away with your brains.
