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What Do Today’s Stock Prices Imply For Future Returns?

What Do Today's Stock Prices Imply For Future Returns?

As the bull market approaches its seventh anniversary next March, many investors are increasingly nervous.

Partly, this anxiety stems from a deterioration in fundamentals, given the decelerating global economy. But years of unconventional monetary policy have also pushed valuations to heightened levels.

With U.S. stocks trading at a premium to other markets, as well as their historical norm, investors are reasonably wondering: Has the U.S. bull market run its course?

Key Stock Valuation Metrics That Predict Future Returns

In answering this question, as my co-author Terry Simpson and I write in the new Market Perspectives paper, “Assessing the Value of Valuations,” it’s helpful to look at what today’s valuations can tell us about the possible distribution of future U.S. stock market returns.

One popular valuation metric, the Equity Risk Premium (ERP), can be useful in assessing both relative returns and the right mix of stocks versus bonds. However, according to my team’s analysis of S&P 500 returns and valuations from 1924 to 2014, using data accessible via Bloomberg and Robert Shiller’s Web site, the ERP doesn’t provide much information as to the future return of U.S. stocks.

However, a simple price-to-earnings (P/E) ratio, whether based on a snapshot in time or a smoothed measure of earnings, can be more useful, providing some indication of the possible distribution of future returns, our analysis shows.


Whether you’re looking at a basic P/E measure or a cyclically adjusted price-to-earnings (CAPE) ratio, over a one-year horizon, higher current U.S. stock market valuations are generally associated with lower future returns, and returns have generally been higher when the starting valuation is lower. Put differently, as intuition would suggest, below median P/E multiples typically lead to higher average returns while above median multiples have historically been associated with periods of below-average returns.

At longer time frames, the basic relationship generally still holds: Higher U.S. stock market valuations are associated with lower future returns. In addition, the downside risk is more pronounced. When U.S. stocks are cheap, even bad periods have typically yielded positive longer-term returns. In contrast, high valuations have been much more likely to lead to bad outcomes.

To be sure, valuation tells you very little about returns over the short term, i.e., a horizon less than one year. And even at longer horizons, future returns don’t neatly correlate with past valuations.

In fact, according to our analysis, though higher U.S. valuations were associated with lower future returns, there were numerous instances in the past, particularly in the mid-to-late 1990s, when very high U.S. valuations coincided with strong returns over one- and three-year horizons. In other words, markets have shown a remarkable ability to levitate for prolonged periods, when valuations are highest and momentum is strong.

What Investors Should Make of Today’s Stock Prices

The takeaway for investors is that while U.S. stocks are perfectly capable of turning in a stellar year or so, over the longer three- to five-year time frame, we believe investors should expect significantly lower U.S. returns than they have become accustomed to over the past six years. At the very least, today’s stretched valuations suggest a multi-year period of subpar U.S. returns and that investors should proceed with caution.

This post originally appeared on the BlackRock Blog.

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China just lost over trillion of stock value, what this means to you, your house, your money, your future and your chances for true economic and political freedom.

After more than doubling in value over the last year despite a slowing economy and weak corporate earnings reports – the stock market in China is in a freefall. While the eyes of the world are on Greece and the European Union - China's economy is imploding.

Since June 12th, 2015, the Shanghai Stock Exchange Composite Index has fallen 31.2% – wiping out over .2 trillion USD of the markets total value – and there seems to be no immediate end to the market plunge in sight. There Will Be No Economic Recovery. Prepare Yourself Accordingly.

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    • Sara Von.M
    • October 25, 2015

    China may not fall now actually the money and production is now more focused there than ever, but it will collapse in the future after the collapse of EU and US because of its socialist system.

    If it wasn't for the capitalist methods China would have fallen into oblivion ages ago. Now their economy is "booming" because with injecting capitalism into their socialistic economy they have actually created a huge cronyism.

    The only reason American companies go to China now it's because it has less regulations and restricting policies on the private sector and a VERY gullible population. Millions and millions and millions are simply in permanent poverty without any opportunity to gain anything. That is what's keeping their middle class up.

    Now just imagine EU and US collapse and money go to Asian countries and especially in China. There wont be long before those millions and millions of people start demanding a middle class life and then the mixed economy of China will collapse harder than EU and US.

    No socialistic economy can stay forever. China will fall, you just have to wait to see it just like you have to wait to see US and EU fall.

    View Comment
    • Bruce Me (Fed Marshal)
    • October 25, 2015

    Why is this the only guy saying china's imploding? All other models have china Owning the north american continent within 20 years (having been sold out by our crooked politicians) Somethings wrong here either all the others are lunatic or this guy is. Lets see, 95% of the products on the shelves of stores and warehouses in north america are chinese. And a BIG FAT ZERO % of american products are on shelves in china. (Thank you crooked politicians!) And mister Stefan "Here's your sign" Moron

    View Comment
    • Patrick Tay
    • October 25, 2015

    The Chinese stock market crash is caused by panic selling not due to poor fundamentals anf poor direction and media attacks.
    What can be done. China can control the market but in the right way.
    Release the right to sell. BUt stop ban sell short whch does nothing but drive prices down.
    China must proof to the Chinese Mom an Pop that the govrernment can prop up prices.
    Announce the counter and show thenm that the government can prop the price up.
    Chinese by nature like to gamble. MOre they like to win. when they find that following the government price direction. when they get the confidence. It will be freewheeing. THe government can rely on them to push prices up better than the government.Alloe margin trading. Funds and credit relxing will help. but it is not a problem. They savings pool is 00 of trillions. The governement will chose one stock at a time that makes up the shanghai composiit index. One by one and let the prople do the rest after a couple of weeks.
    Treat God's people well. relax christian worship. God wii bless those who bless its people and God will curse those who curse its people. This is not Joke.

    View Comment
    • Yiming Yang
    • October 25, 2015

    China collapse! China Crash !!!….
    Yeah, why not……And yet, China still stands..and gets better…
    Next time, when you predict China crash, make sure it counts… LOL

    View Comment
    • Bright Eyes
    • October 25, 2015

    'Stay away' from the Chinese stock market: Trader

    View Comment
    • Bright Eyes
    • October 25, 2015

    alot of investors are staying away from the chinese market cause there illegal activity in the sprattley islands!! The only thing that the chinese government can do to make the chinese market stable is to GET OUT OF THE SPRATTLEY ISLANDS!!

    View Comment
    • Joshua Cheng
    • October 25, 2015

    dude you predicted the future

    View Comment
    • Terrance “Wowz”
    • October 25, 2015


    View Comment
    • Brad Striver
    • October 25, 2015
    • GEZZA1
    • October 25, 2015

    it is bizarre how china has lasted this long with most of their billions of people unhappy and/ or poor.
    it is very difficult to imagine how the chinese ways can last for too much longer.
    The USA will never pay loans back to china, and they will always be enemies.
    it is just as difficult to imagine how chinese military technology can match USA.
    Chinese are always trying to steal USA tech secrets because they know that USA can nullify any chinese missile attacks and reply with nuclear devastation of the whole of China in one day. e.g japan 1945x 10000.

    View Comment
    • David Istre
    • October 25, 2015

    Economies like this don't just "fall" in one event, they fall through a series of events slowly and consistently. National declines of countries like China and the U.S. don't happen over night, they gradually drop.

    View Comment
    • Jonathan Black
    • October 25, 2015

    The peak in the shanghai stock index was 5166.35 traded on June 12th (the highest since 2007) the last peak was 5954.77 traded on October 1st 2007. But the peak of 5166.35 was the highest this year, then the lowest was 2927.29 traded on August 26th. right now the Shanghai stock index is at 3183.15.

    View Comment
    • Jude Huang
    • October 25, 2015

    Well, we've been under "sustainable collapsing" for 25 years. Thank you for caring~

    View Comment
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