Earlier this week, we discussed some of the academic literature surrounding historical versus current valuations as a metric for forecasting future returns. We learned that because there’s so much variation over time in the equity risk premium, there isn’t any methodology that will produce highly accurate forecasts of stock returns. Stocks are risky investments, no matter the horizon.
However, we do know that starting valuations clearly matter—a whole lot. We also know they are a far more accurate predictor of returns over the next decade than historical returns. The correlation between historical returns and the next 10 years of actual returns even had the wrong (negative) sign.
Furthermore, we know higher starting values mean future expected returns are lower, and vice versa. But we also know there’s still a wide dispersion of potential outcomes for which we must prepare when developing an investment plan.
Read the rest of the article on ETF.com.