What Current Valuations Tell Us About Future Returns

The first quarter was a bumpy ride for both stock and bond investors as concerns around inflation and Ukraine led to increased volatility. Whenever we are in a period of volatility and re-pricing in many asset classes, one of my favorite charts to review is this one by JPMorgan.

The data above shows us that since 1997, when price-to-earnings (P/E) ratios are around the current level of 19.5, future 1-year returns have averaged about 8% and 5-year annualized returns have averaged about 3-4%. However, in many cases, average returns can be misleading when trying to time the market. For example, the future 1-year return has varied from –20% to +40% and the 5-year –3% to +12% with roughly the same valuations. 

As many readers here know, I am an advocate for creating diversified portfolios based on personal financial goals that are rebalanced regularly based on rules - not on market timing. I don’t think it’s helpful to use data like this to decide whether you should sell or buy more – only your investment plan should tell you that.  

However, data like this is great for financial planning purposes. When valuations are higher than average, it’s prudent to expect slightly lower future returns so that you don’t overspend or undersave. When valuations are lower, the opposite is also true.  

Thank you for reading, 

Alex 

This blog post is not advice. Please read disclaimers.