Common Sense on Mutual Funds: Fully Updated 10th Anniversary Edition

Appendix II. Some Thoughts about the Current Stock Market as 1999 Begins

Looking back on the decade of the 1990s holds many lessons for the intelligent investor. But most of us will want to look at the full range of possibilities that may lie ahead. So I have written this appendix to add some further thoughts to those expressed in Chapter 2 on the challenging task of considering stock returns in the years ahead. I also want to contrast the range of stock returns I set forth in that chapter for the coming decade—which might strike some readers as exceedingly modest—with today's prevalent "new-era" thinking about the stock market, which has gained currency as the market has risen even higher.

As the stock market soared through 1998, the ranks of skeptics who declared that the stock market was overvalued continued to dwindle. Equity mutual fund cash positions, for example, were at an all-time low. It is ever thus in the financial markets. When the bull market began in 1982, with stocks priced at eight times earnings, caution was the order of the day. Sixteen years later, with a multiple of 27 times earnings, exuberance calls the tune. With this one change alone, the speculative element of stock prices added eight percentage points per year to the fundamental return of 12.1 percent—the initial dividend yield of 4.5 percent, plus unusually robust earnings growth of 7.6 percent—accounting for fully 40 percent of the market's remarkable 20 percent annual return during the past 16 years. ...