Asset Bubbles and Forward Returns
The comments below are an edited and abridged synopsis of an article by Lance Roberts
There have been asset bubbles throughout history. Whether it was tulip mania in the 1600s, the South Sea bubble of the 1700s, or the dot.com bubble of 2000, they were all a result of excessive investor speculation.
Of course, the other side of inflation was the long unwinding of those bubbles as valuations mean reverted from their previous extremes. Such reversion led to long periods of low returns for investors.
Another way to look at valuations and forward returns is with a scatterplot. The real total returns over the next decade are near zero at current valuations.
While none of this is news, it is a good reminder of where we are currently in the financial cycle. While many hope the last decade’s bull market will continue, history suggests that may be a challenge.
However, valuations are a terrible market timing indicator. In the short term, valuations tell you everything about market psychology. In the long term, they tell you everything about expected returns.
Currently, every measure of valuation suggests investors have thrown caution to the wind.
As noted, valuations are a reflection of investor psychology. As such, it is not surprising that investors’ allocations to equities are at record levels.
Not surprisingly, since asset bubbles are a function of investors’ buy-high, sell-low syndrome, allocations also tell us much about future returns.
Up for discussion: Investor allocations and future returns, and this time likely won’t be different.