Chart of the week

Valuations near highs – and investors expect more

Stock valuations and investor expectations have risen together over the past decade. Our chart looks at why this pattern is unlikely to continue.

October 16, 2020 | 2 minute read

Stock valuations and investor expectations

  • In January 2020, the FOMC first noted its concerns about asset valuation pressures having increased in recent months to an “elevated” level.1 After the January meeting, of course, U.S. equity markets plunged approximately 33% at record speed as the pandemic took hold. Fast forward to the third quarter, when the S&P 500 hit a new all-time high in early September.
  • The market’s rapid whipsaw this year has led more than a few seasoned analysts to question how much economic or market fundamentals still matter. These questions seem particularly relevant again today as one measure of stock valuations has climbed back to its January peak – but this time within a significantly more uncertain macroeconomic environment.
  • The chart compares stock valuations with investor expectations. It highlights that investor expectations have historically aligned pretty closely with equity valuations.2 For example, valuations and investor expectations both fell significantly during the 2008–09 global financial crisis (GFC).
  • In the decade since the GFC, however, stock valuations have risen steadily along with investors’ expectations. This is counterintuitive because periods of elevated valuations, as we see today, have historically coincided with lower future returns.
  • Of course, forecasting returns based on valuations can be an imprecise exercise even in the best of times, and it’s made notably harder by today’s uncertain environment. Regardless of specific valuation metrics, the broader S&P 500 appears to be valued well over its long-term average. With this in mind, investors may be wise to adjust their return expectations, as stock valuations seem unlikely to continue rising through the coming decade as they did over the past 10 years.

  • Federal Reserve,

  • Market valuation based on the Shiller cyclically adjusted price-to-earnings (CAPE) ratio. Investor expectations measures the percentage of investors who believe the stock market will increase in the next year, as reported by the University of Michigan Surveys of Consumers.

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