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Stocks: The Great Paradigm Shift

Perhaps it's due to monetary inflation, or changes in the legal requirements around corporate earnings reports, but the US stock market is different today than it was a century ago. There are two major shifts evident in the longest run S&P500 index data:

Long run S&P 500 index adjusted with the Consumer Price Index. Note that the first 50 years of the data are constructed using quotes and earnings of large cap companies as the first S&P index was launched in 1926 with 90 firms. Source: Shiller, Standard Poor's.


Quick Non-legal Disclaimer: This information is for readers who manage their own investments as well as those who entrust that role to a financial advisor. In my view, most people should have a financial advisor. Just as I do not have the expertise to repair my own engine or perform surgery on my own organs, most people do not have the knowledge or time to manage their own nest egg in an intelligent way. This content will help you to ask your advisor the right questions. Professionals in this sector should always have a thesis on whether assets are cheap or expensive, and should be equipped to get you greater diversification than the two most heavily invested asset classes: broad market stock indices and bonds. Like a doctor, they should also be abreast of the latest research in the field.


During the postwar bull market (1949-1969) the price of the market reached levels only seen in the last gasp of the late 1920s bubble, more than doubled the 1929 peak before burning out. What makes this a shift is that during the 13 year downtrend that followed, the market bottomed where it had been in 1928. The lows of the prior bear market were never seen again.

The shift into the current bear market, nearly 40 years old at this point, is even more dramatic. The bottoms of the three major corrections we've seen do not even breach below the top of the post war bull market. The great crash of 1987, the biggest single-day draw down of stock prices in US history, appears as but a blip on this bull run. We roughly peg the years of these shifts at 1954 and 1985.

The Inflation adjusted market price is used because, much like a thousand year chart of the human population or of Economic Growth, we would expect seismic shifts and exponential growth in unadjusted data. Of course, there may even be exponential growth in inflation-adjusted stock prices, too. What happens if we ground these prices in the long run earnings-per-share of the companies in the index?


The Shiller Price-to-Earnings Ratio is equal to the level of the S&P 500 index divided by the average of the most recent 10 years' earnings-per-share of the companies in the index

The post-war seismic shift of 1954 disappears; the shift of 1985 remains. The range of Shiller P/E ratios that persist before and after 1984 are completely different. The average Shiller P/E through 1984 is 14.6, and about 83 percent of all the data points over that period are between 9 and 20 (in other words, within one standard deviation of the average).

The average Shiller P/E after 1984 is 24.7, and 78 percent of the data points in those 38 years are between 17 and 32 (in other words, within one standard deviation of the average). I've illustrated that by overlaying the long run Shiller P/E chart with these distinct ranges:

From 1880 to 1984, the equity investor paid an average of $14.60 per dollar of long run corporate earnings of S&P Index companies. Since 1985, the equity investor has had to pay an average of $24.70 per dollar of long run earnings. There are a few lessons about equity investment to be learned here:


  • First, basing one's investment decisions solely on historical fundamental ratios is probably too defensive, and will cause the investor to forego opportunities to build wealth.

  • While these high valuations (marked by high P/E ratios) persist, we should limit direct historical comparison to include the years since 1985.

  • How earnings ratios compare to other investment vehicles is probably a better guide than historical statistics.

Benjamin Graham recommended comparing earnings to the current yield paid on AAA rated corporate bonds. This provides a nice on-ramp to my next short piece on investments that are a better deal than US stocks in 2023.

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