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Why Stocks Still Make Sense

Even if the S&P doesn't regain its 2000 peak until 2010, stocks will still outperform bonds.

Just for argument's sake, let's say that the current decade ends up being a dead one for equity investors, and that when the big ball drops in Times Square on New Year's Day 2010, the stock market has only just recaptured the levels it hit in early 2000.

If that's the case, now would be a good time to buy stocks.

The benchmark

S&P 500

has fallen 30% since its late March 2000 peak of 1527. To get back there from where it is now, it would need to climb 42%. Over the space of eight long years, that doesn't seem like much of a gain.

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But throw in a dividend yield of 1% (less than the 1.6% it is now), and you end up with a 54% return. Maybe that's not enough to sate the appetites for growth we all got during that string of 20%-plus years in the latter half of the 1990s, but it's definitely better than what you'll get from the Treasury market this days. The 10-year bond yields about 4.6% annually these days, giving a 45% total return by the close of 2009.

If you expect the stock market to have recovered by then (not an unreasonable expectation since the only recovery that took longer than 7 1/2 years was during the depression years), maybe doing some long-term investing in the stock market now makes sense.

"You can't be as concerned about valuations now as you were in 2000," says Salomon Smith Barney economist Steve Wieting, who's lately been comparing what bonds and stocks might yield by the end of the decade.

Wieting concedes that the S&P's price-to-earnings ratio, which has fallen from a peak of 31 to the current 20, could go even lower -- yet he still thinks the long-term allure of stocks is compelling. Let's say you knock the S&P's P/E down to 18. Let's say you're also really pessimistic about earnings growth; figure that the index will match its 2000 12-month earnings peak of $56.34 per share by the end of 2003 (when the consensus of strategists is for it to earn north of $60) and then grows at the long-term average of 7%. Then the S&P will have recovered by 2010.

Rich Bernstein, the bearish Merrill Lynch quantitative strategist, pretty much agrees with this theory. It's entirely plausible, he says, that stocks will recover by decade's end. And yes, given current yields, stocks will then have ended up giving investors a better return than bonds.

In fact, the only thing that really bugs him about this notion is that people believe in it. That belief, he says, is one reason stocks have performed so poorly. When everybody is in it for the long term, stocks never reach the truly cheap valuations they carry at the start of a meaningful move higher. "The good old-fashioned bull market," says Bernstein, "will start when we kill the notion of 'I'm in it for the long term.' "