To The Moon

With the recent record highs in U.S. stocks, there has been widespread concern about market valuations. While high valuations do not necessarily mean that the market will pull back, they do increase the probability as well as the magnitude of a pullback.

Recently, $Goldman Sachs(GS)$ released a report predicting that the annualized return of the $.SPX(.SPX)$ over the next ten years will fall to 3% from 13% over the past ten years. Atthe same time, there is a roughly 72% probability that S&P 500 returns will lag behind U.S. bonds and a 33% probability that they will lag behind inflation.

The report notes that the current trend of overconcentration in the S&P 500, where the top 10 companies account for 36% of market capitalization and most of the earnings growth, is unsustainable.

To analyze the future yield of U.S. stocks in more depth, we can use the Shiller CAPE Ratio (Shiller P/E Ratio).

This is a measure of stock market valuation proposed by economist Robert Shiller to determine whether the market is overvalued or undervalued.The Shiller P/E ratio provides a longer-term view of market trends by adjusting for cyclical fluctuations in corporate earnings, and is calculated by averaging the past ten years of inflation-adjusted earnings per share (EPS).

Currently, the Shiller P/E ratio stands at 36.32x, a level that has only been reached twice in history: once during the dot-com bubble and once during the bull market following the COVID-19 epidemic.

While it is not currently possible to calculate annualized returns over the next ten years, during the Internet Bubble, when the CAPE exceeded 36.32, annualized returns over the next ten years averaged -2.63%.

This suggests that investors tend to face greater risk of a pullback during periods of high valuations.

• Historically, the Shiller P/E ratio has a significant negative correlation with annualized returns over the next ten years: the higher the CAPE, the lower the future returns.

• Therefore, if the current stock market valuation pivot has not moved up significantly, then the market is indeed in the "expensive" state.Goldman Sachs forecast of 3% annualized return is already considered relatively optimistic.

It is worth noting that the valuation pivot of the stock market has indeed increased since 1981.This trend is partly attributable to the decline in long-term interest rates, which has made fixed-income investments less attractive, thus raising the discount rate and valuation pivot of the stock market, and to the fact that quantitative easing and accommodative fiscal policies may also have contributed to this change.

Combining these factors, we can draw several conclusions:

• Current stock market valuations are high, second only to the Internet bubble and the epidemic bull market. As a result, the odds are that annualized returns over the next decade will be less than the 13% of the past decade.Conservative estimates are likely to be -3% and aggressive estimates +5%.

• In this case, the price/performance ratio of U.S. bonds stands out.If the annualized return on equities is only 5% and the risk-free rate is above 4%, then U.S. bonds become a relatively attractive option.

• Market timing is very difficult.For example, if one had sold stocks in April 1998, one might have missed the highs of 2000 and then experienced a sharp decline.

• For investors nearing retirement or already retired, relying solely on a "buy and hold" strategy is not advisable, as it may result in a prolonged period of inability to recoup capital.

• In the long run, both bearish U.S. bonds$iShares 20+ Year Treasury Bond ETF(TLT)$ and long U.S. stocks is unreasonable, because there is an inherent contradiction between the two.

However, the relatively optimistic $JPMorgan Chase(JPM)$ put forward a different point of view: the next 10 to 15 years in U.S. dollars in the traditional "60/40 stock-bond portfolio" is expected to return 6.4% per annum, a slight decline from last year, but still higher than the long-term average.

The world's largest sovereign fund Norwegian sovereign fund for the future direction of U.S. stocks also issued a warning that: the usual configuration is 70% of stocks and 30% of bonds, it is time to be cautious.