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No. of Recommendations: 11
To me the problem isn't that high valuations mean prices are going to tank.
That's a bold prediction---it's pretty hard to know for sure what valuation multiples will do next, or ever, with any precision.

What's a more hidden danger is that forward returns will be crummy for the average stock even if valuation levels don't ever fall.

There are only so many earnings to be had in the next 20 years.
If you pay twice the price for the same stream of future earnings, you'll get half the amount of earnings back as a percentage of your dollar investment.

Imagine the S&P 500 were a single company. What would you pay for it?
It's trading at a multiple of about 36-37 times cyclically adjusted earnings.
Their sales are growing at at a pretty steady inflation+1.5%/year in the last 5-10-15-20 years.
So far, not so good.
Earnings generally don't rise faster than that, though they've managed a (probably unsustainable) rate close to inflation+4%/year in recent years.
What would you expect from an investment in that company?
Whether it's a stock or a bond, if a thing is earnings about 2.75% on your purchase price, rising very slowly, it's hard to see how you can expect a return higher than that.

But that assumes valuations won't ever fall, which does seem a bit optimistic at this juncture.
My forecasts are that the S&P 500 will have a negative real total return in the next 7-or-so years (average ending date 4-10 years out).
That assumes (with limited solid justification) that average valuation multiples a few years from now will
be similar to the historically lofty average seen since 1995, which has been 25.3 times cyclically adjusted earnings.
With current valuation levels 47% above that notional future average multiple, we'd need to see real earnings rise 47% just to see the index flat in real terms.
That will take quite a few years with sales growing at inflation+1.5%/year. But there would be dividends.

Jim
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