Stocks Are Forever. That Doesn’t Mean Now Is the Time to Buy.

If you’re finding it hard to remember the pandemic, you’re in good company: Investors have already consigned the Covid chaos to history.

Someone who put $1,000 in the S&P 500 in December 2019—when the first infections occurred in Wuhan, China—and reinvested dividends would have made 6.8% annualized after inflation and had $1,299 by the end of last year. That return is bang in line with the annualized return investors have received in the stock market since 1802.

Gross domestic product is expected to have finished last year all but identical to the official forecasts made in 2019, despite the virtual shutdown of the economy. Someone who slept through it all would be shocked only that economists got something right, for a change.

This all feels wrong. Surely the economy can’t just be closed down without any repercussions for growth or share prices? Surely more than a million American dead can’t be irrelevant to finance?

There’s a positive spin: Perhaps the stock gains were just a natural catch-up from the shutdowns, a reversion to normal returns. Over long periods, stocks have tended to return 6.5% to 7% a year after inflation, including dividends but ignoring taxes, as Wharton finance professor Jeremy Siegel set out in his popular book “Stocks for the Long Run.” Hold for long enough, and gains above inflation have been assured—with long enough being a bit under 20 years. Just buy and hold, pandemics be damned.

There are a few flaws in the argument. First of all, even the strongest supporters of Siegel wouldn’t expect four-year returns to match long-run averages except by chance, because there can be wild swings over such short periods.

Second, it takes the returns from the peak, or close to the peak (U.S. stocks actually reached their pre-Covid high in February 2020). The idea that when you buy doesn’t matter is obviously wrong, and even more wrong for short periods; buy just before a huge fall, and it can take a really long time just to get back to the average return.

An investor who bought U.S. stocks in January 1973, before the Arab oil embargo knocked half the value off the S&P 500, has made 6.6% a year in the half-century since, again after inflation and including dividends, fractionally below the super-long-term average. One who bought in the autumn of 1974, when stocks reached their low, has made a whopping 8.5% a year—a difference that compounds to turning $1,000 into $54,347, rather than only $25,545.

Third, the 19th-century data used by Siegel was incomplete. Edward McQuarrie, a retired business professor at Santa Clara University, found that when missing stocks, dividends and other data were added in, the U.S. return wasn’t much changed—although bond returns were changed significantly, and bonds beat stocks over the 19th century as a whole.

Even his revised data still exclude Confederate stocks and the collapse and recapitalization of the New York insurance sector after the great fire of 1835, so it’s plausible that investors could have lost money over more than 20 years.

Stocks didn’t reliably outperform bonds, either, the opposite of what Siegel’s earlier data showed. Plus, McQuarrie found that stock prices, excluding dividends, were lower at the end of the century than at the start, which isn’t great for those who fail to reinvest payouts.

Readers might reasonably respond that obviously losses are possible over long periods. Russia and China’s thriving stock markets went to zero after their communist revolutions, and Japanese stock prices (excluding dividends) are still below their 1989 bubble peak.

London academics Elroy Dimson, Paul Marsh and Mike Staunton say that from 1900 on, 16 years was enough to guarantee positive real returns—but only in the U.S. Their work on other markets showed it was possible to lose money after inflation and dividends for 98 years in Austria and more than half a century in Japan, France, Italy, Germany, Spain and Belgium, some without losing major wars.

Coming back to the short term, it’s safe to say that the past four years were highly unusual. The gains from the pre-Covid peak were the best for any four-year period in the past half-century from a pre-bear market peak, and the past four years included two bear markets. Four years after the peak of stock-market cycles in the 1970s, 2000 and 2007 investors were still nursing real losses, with even 1987’s crash—hardly a bear market—offering smaller gains four years past the precrash high.

Some of the unusually rapid return to form this time is thanks to the rapid recovery of the economy from lockdowns, which was itself in part because of pent-up demand.

But much of the rebound in both economy and markets was thanks to massive government deficit spending, which isn’t sustainable. Some of the rest is because stocks are even more highly valued than at the prepandemic peak. The S&P 500 reached 19.1 times the estimate of forward 12-month earnings in February 2020, the highest since the dot-com bubble of 2000. The multiple is now slightly higher, at 19.3 times, suggesting investors expect earnings to grow even faster than they thought back then.

For real returns to continue at historic levels from here, the economy will have to start delivering profit without so much government help, or valuations will have to rise even higher—both big asks.

This doesn’t mean stock prices are sure to fall, or that the U.S. will break its long-term record of no real losses over two decades. But even bulls should plan for lower returns ahead.

Write to James Mackintosh at [email protected]