Fisher Investments Explains | Do Valuations Predict Returns?

Transcript

Do valuations predict returns? Well, we've sliced the numbers in many ways over the years, and regardless of which valuation metric you use, none reliably tell you where the stock market is going to go over the next 12 to 18 months, or really any time period that's relevant to investors today. When valuations are elevated, it's common for investors to grow fearful that stocks are overvalued or that a market downturn is imminent. But we don't think investors should be overly worried about elevated valuations. History shows us that whether high or low, valuations don't provide much information about the future direction of the stock market. For example, we mapped out roughly 100 years of S&P 500 Price-to-Earnings Ratios, or P/Es, alongside forward 12-month performance. Looking at this data, you would be hard pressed to find a clear trend. For example, R-squared is a measure of how much the outcome in one variable is explained by another variable. When it comes to P/Es predicting future 12-month performance, the R-squared suggests no causation. To us, this illustrates perfectly why investors shouldn't try to use P/Es To us, this illustrates perfectly why investors shouldn't try to use P/Es or other valuation metrics as near-term stock market timing tools. As we have long said, identifying what you and others believe to be true but is actually false can be a very powerful tool for investing. So, when the talking heads in the media fret about high market valuations, know that this tends to be just another one of what we call a "false fear". Valuations are just one of the ways in which Fisher Investments views markets differently. And though valuations aren't predictive—we have found that they can provide a helpful snapshot of investor sentiment, which can be used alongside analysis of economic and political drivers to better determine where we are in the market cycle.