WASHINGTON — We now know the promise and peril of paper wealth. In the last 15 years, the stock market's convulsions ought to have rattled even hardy investors. Twice — after the popping of the "tech bubble" in 2000 and after the financial crisis in 2008 — the market lost half its value. It then struggled for years to regain its previous peaks; this happened again last week when the Dow Jones industrial average exceeded its 2007 high. Past turmoil and present uncertainty (the sequester, Europe's crisis) might have convinced most individual investors to quit the market. It hasn't. Main Street hasn't abandoned Wall Street.
This is the larger — and largely missed — story behind the market's new high. Americans gravitated to stocks in the 1980s and 1990s as never before. There was a cultural and financial upheaval; owning stocks was increasingly popular with the middle class. In 1983, only 19 percent of households owned shares, a Federal Reserve study found; by 2001, that was 52 percent. Because more people were connected to the market, their confidence, their spending and the economy's performance depended more on the market. That's still true.
People flocked to stocks for two reasons. First, skyrocketing prices. A great bull market began in 1982, propelled by declining inflation and interest rates. Rates on 10-year Treasury bonds dropped from 13 percent in 1982 to 5 percent in 2001. Over the same years, the stock market rose by a factor of nearly 12 — from about 880 on the Dow to about 10,200. And second, growing numbers of IRAs and 401(k)s. From 1984 to 2000, 401(k) plan participants went from 7.5 million to 39.8 million. This, too, drove stock investment.
To be sure, stock ownership remained concentrated among the rich and upper-middle class, notes economist Edward Wolff of New York University. He finds that in 2010, the wealthiest 1 percent of Americans owned 35 percent of households' stocks, including retirement accounts and mutual funds, and that the next 9 percent had 46 percent.
Still, it might have all unraveled. After 2008, Wall Street was besieged for its role in the financial crisis. Worse, investors' average returns were dismal.
Shellshocked investors, horrified by retirement-account losses, were said to flee the market in droves. Stock-only mutual funds suffered more than $500 billion of outflows from 2008 to 2012, reports the Investment Company Institute (ICI), the mutual funds' trade group. Meanwhile, inflows to bond funds, deemed safer by many investors, topped $1 trillion for the same years.
But what seemed a purging of stocks was mainly a lightening up. Outflows from stock-only mutual funds were partially offset by purchases of stock "exchange-traded funds" (ETFs), a new type of mutual fund with lower fees. The Fed's latest survey found that 49.9 percent of households in 2010 still owned stocks, down three percentage points from 2007; though other surveys show slightly larger declines, none approach the low levels of the early 1980s.
"We've seen no increase in the number of investors who have no stocks," says ICI economist Brian Reid, who examined 401(k) investment patterns. "What we're finding is that people who had 80 percent in stocks, now that's closer to 60 percent."
In 2013, the market's 9 percent increase has produced a wealth gain of about $1.5 trillion, reports Wilshire Associates. If investors spent only 5 percent of the gain, the extra $75 billion would give the economy a nice nudge. Their decisions may depend on whether they think the market's advance is real or artificial.
One valuation yardstick is the price-earnings (P/E) ratio: the ratio of stock prices to profits. Since 1935, the P/E for the Standard & Poor's index of 500 stocks has averaged 16.9, says S&P's Howard Silverblatt. The market's current PE is 17.6, close to the average; this suggests that stocks are fairly priced. On the other hand, the Fed has been pumping $85 billion into financial markets a month by buying Treasury securities and mortgage bonds. Some of it may help prop up stocks.
Stocks' continuing allure for many Americans reflects the conventional belief — probably correct — that they offer the best long-run return for most individuals. But the "long run" isn't what it used to be. In the 1990s' boom, stocks were widely seen as a one-way ride to riches. The last decade has been an costly lesson in realism. Many analysts warn investors not to expect the breathtaking gains of the 1990s anytime soon. The wonder is that, despite the muted outlook, so many Americans remain invested.
Robert J. Samuelson is a Washington Post columnist.