digest
Short Summary
Main recommendation: Do not treat high overall US stock market valuations as a reason to exit stocks; instead, consider global diversification and a tilt toward value stocks, and avoid trying to time the market based on valuation ratios. High US valuations are concentrated in a small group of large growth stocks, so the broader market and international markets look less expensive. Ben Felix argues that simply staying invested in a broadly diversified portfolio is more effective than timing.
Key Points
- Valuations are high in the US, and high valuations have historically been associated with lower future returns, though the relationship is noisy and can persist for long periods.
- The CAPE ratio reached peaks in 1929 and 1999 before major US crashes; current levels are said to hover near the 1929 peak, implying an expected real return of about 3% for the S&P 500.
- The expensiveness is driven mainly by a handful of mega-cap stocks, the "Magnificent 7" (Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, Meta). Value stocks look less expensive.
- International developed and emerging market stocks have more attractive valuations than the US, and US outperformance may have been driven partly by rising valuations.
- Felix warns against "rear-view mirror bias," assuming past US returns will continue regardless of current valuations.
Details Worth Noting
- Concrete instructions: Diversify globally across international developed and emerging market stocks rather than concentrating in the US market alone. Tilt toward value stocks (lower price relative to fundamentals), which Felix notes is what providers like Avantis and Dimensional Fund Advisers do. Stay invested in a broadly diversified portfolio with exposure to multiple priced risks, rather than attempting to time exposure based on valuation ratios.
- Historical examples cited: From 1968 to 1984 the S&P 500 returned an annualized 7.24%, barely beating inflation at 7.22%, while the Dimensional US Market-Wide Value Index returned 12.31% annualized over that period. From 1990 through 2023, Japan's market returned about 1.22% annualized, while Japanese value stocks returned 4.27%.
- For the 10 years ending February 2010, the S&P 500 lost an annualized 0.31%, the NASDAQ 100 lost 7.86%, and the MSCI US Investable Market Value Index returned 4.56%.
- Felix says valuation-based timing strategies rarely generate reliable excess returns and are highly sensitive to the time period and design tested.
Bottom Line
Felix's view is that high US valuations are a concentrated, not market-wide, problem, so the response is broader diversification and value exposure rather than exiting or timing the market.
