Will the future be another "lost decade" for the U.S. stock market?

I. Review: The "Lost Decade" of the 1970s

From 1968 to 1982, the nominal growth of the U.S. S&P 500 index was almost nonexistent; when accounting for inflation, investors faced real losses of up to 60%. This period is referred to as the "lost decade" in the U.S. market.

During this decade, the price-to-earnings ratio (PE) of the S&P 500 fell from about 19 times to a low of 7 times. In other words, the market decline was primarily driven by a contraction in valuations. The core driver of this valuation contraction was the continuous rise in the federal funds rate—from about 4% in 1968 to 20% in 1981.

High interest rates mean a higher discount rate, which means the multiple (PE) that investors are willing to pay for future earnings will decrease; this is the basic logic of investment 101.

But why must interest rates rise? The answer is to suppress persistently soaring inflation.

The root of inflation lies in the long-term overvaluation of the dollar and its subsequent return to value.

In 1971, the Nixon administration announced the decoupling of the dollar from gold, leading to the collapse of the Bretton Woods system. The reason was that the U.S. faced fiscal deficits and excessive money supply due to the Vietnam War and "Great Society" welfare spending, resulting in the dollar's issuance far exceeding its gold reserves. Countries began to panic and sell off dollars in exchange for gold, leading to a "double loss" of gold and dollars.

After the dollar was unpegged, it quickly depreciated, causing the prices of imported goods to rise and resulting in imported inflation. This series of reactions ultimately forced the Federal Reserve to aggressively raise interest rates to curb inflation, thereby depressing asset valuations.

Thus, this "lost decade" was essentially a process of credit re-evaluation following the structural overvaluation of the dollar.

II. Is today's dollar overvalued?

Although today's dollar is no longer pegged to gold, it is even "harder to detect whether it is overvalued." In the past, one could simply observe the ratio of gold reserves to currency issuance to determine if the dollar was overextended. However, today's dollar is a completely fiat currency, and its overvaluation must be assessed through a comprehensive evaluation of structural confidence, capital structure, and global usage preferences.

An analysis article by Reuters in April 2025 pointed out that the current real effective exchange rate (REER) of the dollar relative to a basket of major currencies is overvalued by about 19%, nearing the levels seen before the 1985 "Plaza Accord" and the peak of the 2000 internet bubble.

But what is more dangerous today is:

The net holdings of U.S. assets by foreign investors have reached about 80% of U.S. GDP, far exceeding the levels of 1985 and 2000. This means that if the dollar experiences a structural depreciation, the resulting capital shock and financial repricing will far exceed any historical instances.

Additionally, the gap between the nominal GDP share of the U.S. in the global economy (about 26%) and the share of PPP GDP (about 15.5%) continues to widen. By 2024, this ratio will reach 1.68 times, the highest in history.

This gap indicates that:

The global capital preference for U.S. assets and the financial inflows brought by "dollar pricing power" are systematically pushing the dollar into an overvalued range.

III. What could trigger a dollar re-evaluation and capital reversal?

If in the past 30 years, the U.S. was able to "expand the money supply without fear of inflation" partly due to globalization suppressing commodity prices and input costs; then today’s trend of "de-globalization"—including supply chain repatriation, geopolitical fragmentation, technological blockades, and tightened immigration—is raising the prices of goods and services.

Especially during the Trump era and its continued political logic, the U.S. is actively "dismantling" the free order it built globally, including withdrawing from the TPP, sanctioning multiple countries, implementing tax protections, and restricting immigration. This policy path may activate a potential negative feedback loop:

🔁 Dollar—Assets—Inflation Negative Cycle:

1️⃣ Rising U.S. inflation → Cost push, corporate profits under pressure

2️⃣ Overvalued stock market declines → Davis double whammy triggers valuation correction

3️⃣ Foreign capital withdrawal → Dollar depreciation, financial market turbulence

4️⃣ Imported inflation returns → Imports become more expensive, further pushing up inflation

If this feedback loop is activated, the credit of the dollar, U.S. stock valuations, and global capital allocation will all face structural re-evaluation. This is not just a financial event; it could potentially constitute a framework similar to the "institutional stagflation" of the 1970s.

IV. Are risks already apparent?

Since April 2025, there have been signs of partial market reactions: U.S. stocks, U.S. bonds, and the dollar have all declined, while gold and European stock markets have strengthened, indicating that some funds are beginning to "withdraw from the U.S." and seek alternative anchors. Although short-term market sentiment remains volatile, from a mid-term perspective, this may be an early signal of the "dollar faith system" loosening.

🔚 Conclusion:

Today's dollar is not pegged to gold, but it is anchored to something even more fragile—the overall trust in the U.S. system, economy, fiscal, and financial systems.

When trust begins to waver, value will be re-evaluated. At that time, we may look back at today, just as we did when reflecting on Nixon's decoupling in 1971, realizing: "That year, history quietly turned." (ps, this last phrase is a cheeky addition by chatgpt 😂)

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