S&P 500

Stocks: what the “lost decade” is and why it threatens returns

The recent declines recorded by the stock market have fueled the fear among experts that 2024 could prove to be a less profitable year than expected, increasing media speculation around the much discussed 'lost decade'.
While many wonder whether 2024 will be another year of an uptrend or not, some analysts have shifted their focus to the next decade.
Based on some market analysis models, they hypothesize that we may have entered a period of 'large laterality' of the markets, where years of strong euphoria alternate with moments of panic, which tend to neutralize each other, ultimately leading to a decade of lateral returns on the stock market.
Stocks: what is the «lost decade»? In finance, the term 'lost decade' refers to a ten-year period during which investors or the overall economy do not experience significant gains.
This term is frequently used to describe a prolonged period of stagnation or decline in stock markets, in which the value of stocks or indices remains stable or declines, leading to very little or no overall return.
The 'lost decade' can be caused by various factors, such as economic crises, bursting financial bubbles, high inflation, ineffective economic policies, or other geopolitical events that negatively impact economic growth and investor confidence.
For example, the period following the 1929 stock market crash in the United States and the Japanese financial crisis of the 1990s are often cited as examples of 'lost decades'.
What are the arguments in favor of the beginning of a "lost decade"? January is often considered a month of rebalancing, during which we frequently witness sudden and sudden movements in the markets which, historically, have potentially generated rather significant reversal trends.
Faced with this fear, many are wondering whether the S&P 500 has reached an excessive valuation that could fuel profit-taking in the market.
It is indisputable that the prices of the securities that support the value of the S&P 500 and other American indices, such as the Nasdaq100, are discounting very high multiples, significantly higher than the historical average, even just considering the last 20 years.
The P/E ratio of the S&P 500 in this specific market phase appears to be a non-sensical quantity.
This hypothesis is supported by theories well received by analysts, such as Peter Lynch's 'Rule of 20', according to which the sum of the annual inflation rate plus the price/earnings (P/E) ratio of the stock market should approach 20 , while it currently exceeds 30.
In the past, the achievement of levels of 'extremism' like the current ones was often followed by a period of 'lost decade'.
Although some question these considerations, due to the structural change that has occurred in the US financial market in recent years, they represent a fairly clear example of excess.
The US stock market therefore shows clear signs of extreme overvaluation, even in comparison to the performance of global markets, which present a decidedly lower Price/Earnings ratio.
This is due to the strongly bullish trend recorded in recent years by the largest capitalization companies, the so-called FAANG, recently renamed 'the Magnificent 7'.
In summary, according to some, it may take more time to consolidate the growth prospects discounted by traders on company prices, which have grown exponentially over the years, before continuing in the typical cycle of stock markets.
Does it make sense to expect new increases instead? Based on these considerations, the defeat of the American index seems almost imminent.
However, it is important not to come to this conclusion too quickly, as completely opposite views exist.
According to these, disposing of one's actions at this time could prove to be a difficult mistake to remedy.
Indeed, although the P/E of the S&P 500, adjusted for inflation, has reached extreme levels, it is necessary to ask ourselves the reasons for this appreciation.
Although the idea of a 'lost decade' is worrying, looking at the reality outside the markets, the world is experiencing a period of strong technological evolution, which has historically acted as a catalyst for the growth of stock valuations, providing a valid reason for anticipate even higher growth expectations on company earnings.
The advent of artificial intelligence could, in fact, have a positive impact on share prices, creating new profit opportunities not previously anticipated or, at least, not considered by the market.
This perspective contrasts with the idea of a lost decade, introducing a variable that, at least theoretically, could neutralize the extremisms of the moment.
Of course, it is necessary to contextualize the situation; for example, in 2000, the advent of dot.com was clearly destined to revolutionize the world and create new profit opportunities, but the market first had to adjust valuations with the bursting of the dot.com bubble, and then return to discount new increases with the growth of earnings expectations.

Author: Hermes A.I.

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