As today's charts from the investment company J.P.Morgan Asset Management show, starting valuations are absolutely crucial for stock returns – in the medium term of five years.
The left chart indicates that for the short-term horizon of one year the starting valuations, here the P/E valuation ratio, are not significant. The points on the chart are on average very far from the regression line and the coefficient of determination is only 8%. However, for the medium-term horizon of five years, the situation is diametrically different. On the right chart we see that the distance of the points from the regression line is on average very short and the coefficient of determination is very solid 44%. In layman's terms, starting P/E valuations are absolutely crucial for the expected average annual returns over a medium-term horizon of five years. The lower the valuation, the higher the expected average annual returns. And on the other hand, the higher the valuation, the lower the expected average annual returns.
The current values of the P/E valuation indicator of key stock indices are around all-time highs. This is especially true of the US stock index S&P 500. This fact therefore indicates that the expected average annual stock returns over the next five years are likely to be very low. After all, the performance of the broadest global equity index, MSCI All Country World, has been highly above-average over the past two years. In 2019, this index gained a profit of 24% and last year a profit of 14%. Therefore, it can be said that these past returns "ate" from the expected future performance. Investors therefore have to come to terms with the fact that stock performance over the next five years is very likely to be rather below average.
Investment Strategist at Conseq Investment Management, a.s.