Both professional and individual investors must recognize the relationship between risk and reward (i.e., returns).  Indeed, as fiduciaries, investment advisers are duty-bound to protect their clients’ interests and elevate them above their own.  We’ve been writing for some time that current market valuations are very high and, when the market is at these excessive levels, returns are typically reduced.

On August 31, the S&P 500 median price-to-earnings (P/E) ratio was 23.7.  (Think of “median P/E” (which is based on actual, reported earnings and current share price) as the middle P/E (250 stocks have a lower P/E and 250 have a higher P/E).)

I’ve shared the chart above previously.  It shows that returns are highest when the market is most favorably priced (low median P/Es) and lowest when the market is least favorable priced (high median P/Es).  We are in Quintile 5 today.  The next chart shows that not only were returns lowest when P/Es are high, like they are today, the risk is actually the highest.

In fact, some investment managers, are further lowering forward return expectations for equities.  GMO recently revised its real return forecast for large-cap equities to -3.2% from -1.9.

For charts, analysis, and commentary, see the rest of the story in On My Radar: Why? Because We Need the Eggs

The current opinions and forecasts expressed herein are solely those of Steve Blumenthal and are subject to change.  They do not represent the opinions of CMG.  CMGs trading strategies are quantitative and may hold a position that at any given time does not reflect Steve’s forecasts.  Steve’s opinions and forecasts may not actually come to pass. Information on this site should not be used as a recommendation to buy or sell any investment product or strategy.