In examining the history of U.S. stock market performance, one theory that often gets floated is that the overvaluation observed from the 1980s to the early 2000s stemmed from a surge in first-time investors. Fueled by the rise of 401(k) plans, an increasing awareness of equity as a tool for wealth accumulation, and the tailwind of booming economic growth, the flood of new participants in the market created excessive demand for stocks. This led to inflated prices, and as a result, returns during this period arguably outpaced what might have been warranted by fundamentals.
Proponents of this theory argue that since the early 2000s, the market has finally found some balance. According to this view, the mass influx of retail investors has slowed, and markets have become more efficient, meaning that stock returns now better reflect underlying business performance and earnings growth. In other words, we’ve reached a new equilibrium where returns should be more modest, in line with fairer valuations.
However, recent data throws a wrench into this tidy narrative. If we look back at the U.S. market’s performance from 1930 to 1980, the compound annual growth rate (CAGR) for the S&P 500 was roughly 7%. This period, bookended by the Great Depression and stagflation, was far from smooth sailing, but it’s often viewed as a baseline for “normal” long-term returns. Now, fast forward to the 2010-present period, and we see something quite different: a striking 13.7% CAGR, nearly double the historical average.
This outsized return over the past 14 years raises significant questions about whether the market has truly “equilibrated.” While the theory suggests that we’ve moved into a phase of more rational pricing, the data paints a different picture. A 13.7% CAGR hints at either a continued overvaluation of equities or the presence of other powerful factors at play.
One possible explanation is that monetary policy has played a significant role in juicing returns. Since the 2008 financial crisis, the Federal Reserve’s aggressive use of low interest rates and quantitative easing has undeniably influenced stock prices. With yields on bonds and other fixed-income assets remaining low for much of the last decade, investors have had few alternatives to stocks. This scarcity of attractive investment options could easily inflate equity prices, driving the kind of returns that we’ve seen.
But even with these factors in mind, there’s the nagging question of sustainability. While monetary policy has played a crucial role, it’s unclear how much longer this can continue. The Fed has already begun tightening, and further rate hikes could alter the investment landscape. If valuations are still stretched, we could see a correction. Alternatively, if economic growth and corporate earnings accelerate, today’s prices may still be justified. Either way, the notion of a return to equilibrium feels premature, if not optimistic.
In some ways, the 1980-2000 era and the 2010-present period share a common thread: both have seen sharp gains, driven by forces that may not be sustainable in the long run. In the former case, it was the flood of new retail investors. In the latter, it’s been central bank policy. What remains to be seen is whether the market can continue to deliver above-average returns, or if we’re on the cusp of another recalibration—this time, one driven by fundamentals rather than an influx of demand or extraordinary policy support.
For now, it’s hard to argue that stock market returns have “normalized” when we’re still seeing such striking performance relative to historical norms. While valuations may no longer be as extreme as they were during the dot-com bubble, they’re still high by many metrics. Whether or not that’s justified depends on factors that may not be fully understood for years to come.