Do We Need to Farm an Asteroid For Stocks to Keep Rising?

On this week’s podcast we discussed what would have to happen for stocks to continue doing well over the next 5 years or so:

Short of an asteroid discovery that will change humanity and the stock market forever1 it would seem the most logical path from here would be lower than average returns. Typically, that’s what happens after periods of higher than average returns.

But it’s not always so easy to make return forecasts even going 5 years out into the future.

Here’s how often the S&P 500 has been up 8% annually over 5 years going back to 1926:

In roughly 66% of all rolling 5 year windows, stocks were up at least 8% or more on an annual basis. That means 34% of the time stocks failed to rise 8% or more annually. That’s risk for you.

BUT many will point to the fact that valuations are much higher now, making it easier to forecast lower than average returns from here. And I would agree that investors should rein in their expectations from here.2

However, even with the knowledge of higher valuations, it’s still tricky to predict what will happen because it’s impossible to forecast investor behavior.

For example, last week I shared the following chart showing the historical yield on a 60/40 portfolio3 going back to 1915:

The 60/40 yield is about as low as it’s been over the past 100+ years, not a great sign for forward returns in U.S. financial assets.

What I didn’t do was follow this up with how the 60/40 actually performed from these starting yields. I don’t have total return data back to 1915, but here are the subsequent 5 year annual returns for a 60/40 portfolio going back to 1926 overlaid on top of the starting yield in the portfolio:

You can see some massive divergences here between starting yields and subsequent returns. 5 years may not be enough time for fundamentals to take over so let’s take a look at 10 year forward returns from these same starting yield levels:

There is a positive relationship between starting yield and forward returns (0.57 over 5 years and 0.73 over 10 years) but you can see even the 10 year numbers are all over the map.

I’m sure you could poke holes in my simple valuation metrics used here. You could find lines that match up much better if you tortured the data a little more. But the point here is that fundamental analysis can only take you so far.

If fundamentals dictated exactly what’s going to happen going forward everyone with an Internet connection could pull up the current CAPE, P/E, P/S, P/FCF or whatever other metrics you want to use to predict the future.

But fundamentals don’t dictate exactly what’s going to happen. Mood and sentiment play a role in asset returns. How investors choose to allocate their assets can change return dynamics. And what people’s views are about the future can have an impact, even going out 5 to 10 years into the future.

A reasonable person would logically conclude U.S. financial assets should see lower returns from current levels.

But good luck predicting when those lower returns start, how long they last, and when investors begin to pay attention to fundamentals yet again.


More highlights from this week’s show on the streaming wars:

Subscribe to the Animal Spirits playlist to watch these highlights every week.

Now here’s what I’ve been reading lately:

1Are you thinking what I’m thinking — Armageddon 2: Saving the Stock Market with Ben Affleck, Owen Wilson, Steve Buscemi, Billy Bob and Liv Tyler? Who says no?

2An argument that could have been made for the past 7 years or so but still.

3Using the earnings yield on the S&P 500 CAPE ratio and the 10 year treasury yield.

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

The Compound Media, Inc., an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here:

Please see disclosures here.