“How do we know when irrational exuberance has unduly escalated asset values,
which then become subject to unexpected and prolonged contractions?”
— Alan Greenspan, former Federal Reserve chairman

Gee, what a downer. Former Federal Reserve chairman Alan Greenspan made this speech on Dec. 5, 1996.

S&P 500 returns for the next three years were +32%, +27% and +20%. The tech-heavy NASDAQ enjoyed even more impressive returns for the period of +21%, +39% and +85%.

In fact, it took four years to see losses as the tech bubble finally burst. The S&P 500 lost -8% in 2000, -12% in 2001 and -21% in 2002. NASDAQ declines were scarier with losses of -39% in 2000, -21% in 2001 and -31% in 2002.

Most remember the collapse of so many “dot coms.” Clearly, Greenspan wasn’t wrong; he was just very early with his comments.

Using figures as of Dec. 4, 2024, both stocks and crypto have been setting new records all year.

The S&P 500 is up 27% year to date, the NASDAQ is up 31% YTD, Bitcoin is up 136 YTD and foreign stocks (MSCI ACWI ex-US) are up 6.4% YTD.

And these impressive returns are coming after big double-digit returns in four of the prior five years, with only 2022 having sizable negative stock returns.

And not surprisingly, the U.S. FHFA House Price Index hit an all-time high, up 238% over the past 20 years. Most of us here in Santa Barbara have seen house prices triple over that same period.

Despite all the amazing past growth, perhaps a closer look “under the hood” is warranted.

• The S&P 500 is selling at more than 27 times earnings compared to a median value of about 18 times earnings.
• The NASDAQ is selling at 48 times earnings compared to a median value of 20 times earnings.
• Non-U.S. stocks seem like a bargain at just 13 times earnings, with a median value of just under 10 times earnings.
• Bitcoin has no underlying earnings, reminding me a bit about the Dutch tulip mania in the 1600s. 

So, by most measures asset values are expensive. History would suggest thinking about “reversion to the mean” — a statistical concept stating the extreme data points in a set will tend to be closer to the average value when measured again.

Translation: What goes up may well come down.

Note this does not mean that we’ll see a big price decline for risk assets right away, as predicting big market swings with any accuracy might well be considered a fool’s errand.

Yet in a time when nearly everyone is enthusiastic about taking investment risk — and most “experts” are predicting a continuation of the good times — I find that little voice in the back of my head issuing a mild caution alert.

Add geopolitical risk (Russia/Ukraine, China/Taiwan and the Middle East), talk of tariff wars and a massive U.S. budget deficit, and there’s certainly a lot of uncertainty to consider.

There are, of course, also some positives with the prospect of lighter regulatory and tax policy, an accommodative Federal Reserve, and maybe even some government efficiency benefits. We’ll see. 

Please note that all of this doesn’t mean making substantial changes to your investment strategy, but rather a good time to look at your financial goals, your time horizons and honestly assessing your tolerance for risk.

It’s easy to say how risk-tolerant you are when markets are soaring, but will you be able to handle a significant downturn?

A look back provides a good reminder of how scary losses for even a well-diversified 60% stock/40% bond portfolio have been: down -24% in 2008 and down -15% as recently as 2022.

And the recent big gains in stocks over the last few years may have left your portfolio with more risk than you intended, making it a good time to look at whether some rebalancing would be prudent.

Those of you with big single-stock positions that have enjoyed a meteoric rise will have some serious thinking to do: whether to hang on and hope for the fun to continue or to take some profits off the table.

I am reminded of an old saying, “bulls make money, bears make money, pigs get slaughtered.”

It’s worth noting that Warren Buffett has been taking some profits off his biggest holdings — Apple (AAPL) and Bank of America (BAC) — likely to add to his huge cash reserve and pick up some bargains when prices look good.

Just remember that bull markets don’t tend to die of old age — they are usually eliminated by something that is not easy to anticipate in advance.

Just like Greenspan, my caution may be early, but I’m sure it won’t be wrong. And keeping a long-term perspective can help you live with the ups and downs that are just part of investing.

History would argue that it’s the sticking with it that produces the best results.