The other two key parts of a healthy market—dividends and earnings—also look a bit unappealing. During the '20s and '30s, dividend yields averaged 5 percent to 9 percent. They are much less generous now. The current 12-month dividend on the S&P is just 3.42 percent, which is below its historical average, and dividend payouts are expected to fall through 2010. And while first-quarter earnings were indeed better than many analysts expected, often gains came from cost cutting (including job reductions) rather than meaningful revenue growth. In an average recession, Citigroup says, global earnings historically fall 25 percent from peak to trough. As of April, earnings had already passed that mark with a 29 percent drop, but the severity of this downturn could push global earnings down by 50 percent. If markets do moderate for a long time, companies will be forced, at the very least, to come to terms with less access to capital. Start-ups entering the market with lucrative initial public offerings dried up almost entirely this year, and they are unlikely to return to lofty levels soon. Liquidity may have returned to precrisis levels by some measures, but the sort of lending that spurs outsize growth is still a ways off. "Companies have historically thrived thanks to cheap credit. Because that's been taken out, we have to expect more modest returns from equities," says Matt Rubin, director of investment strategy at wealth adviser Neuberger Berman.
With the onset of boomer retirement, pension funds would face some tough choices in a weaker market. The funds—the aircraft carriers of the financial fleet—are already wrestling with the troubling prospect that returns may not be as generous as they had hoped. That could spawn more risk-taking by funds, not less. MIT's Lo, who manages a hedge fund, says many will return to hedge funds, private equity, and other alternative investments in a scramble to boost their returns. He predicts a wave of money pouring out of mundane stocks and bonds and into riskier assets that promise higher returns will add another strain to stocks. "Over the next year or two, we may see more financial market gyrations because of these assets sloshing around from one segment of the investment industry to another," he says.
A more rational view of risk. In some ways, a tamer stock market could be a good thing. There is a sort of indirect benefit from an end to equity mania. For companies, reliance on funding outside of the stock market could mean less frantic scrambling to manage their businesses under the yoke of unrealistic pressure to meet quarterly earnings projections. For everyday investors, a realization that the idea of equities producing highly stable profits is simply naive will hopefully prompt more Americans to rethink debt and risk.