Global stock markets are riding high — not just in price terms, but in valuation. In many regions, equity markets are hovering near record levels, and in the third quarter, the US market even surpassed its pandemic-era valuation peak.
While starting valuation is not a reliable predictor of exactly how long a bull market will run, forward-looking investors are asking an important question: What do today’s elevated valuations imply for future returns?
It’s a question worth exploring, and one we aim to shed light on in six charts, grounded in nearly one hundred and fifty years of historic data.
Using CAPE Yield to Assess Market Outlook
In our September report, we explained why we use the CAPE Yield — the inverse of the cyclically adjusted price-to-earnings ratio — as our preferred valuation metric. It offers consistency across time and geographies, and has historically shown a strong relationship with long-term equity returns.
During the third quarter, the US stock market surpassed the recent valuation peak set during the pandemic. At quarter end, it traded on a CAPE yield of just 2.6%, more expensive than at any stage since records began, apart from the 2.3% yield in reached at the peak of the technology bubble in 1999-2000. Our analysis of more than a century of data suggests that average annual returns over the next 10 years are likely to be below 3%1.
Chart 1 – Relationship between CAPE Yield and subsequent 10-year real return 1871 – 2025
Beyond Average Returns: Understanding the Spread
While the average return over time provides us with a useful benchmark, it doesn’t always tell the full story. Consequently, a thoughtful client recently asked: “It’s all very well to look at the average returns, but what about the range of outcomes?”
To answer this question, we prepared our second chart. It shows the distribution of 10-year returns around the mean and median at different starting CAPE Yields, incorporating more than a century of stock market returns from 1881-2014.
The results reinforce the strong relationship demonstrated in our initial work between starting CAPE Yield and future returns. A starting CAPE Yield between 2–4% – the current level of the MSCI World benchmark – suggests a 75% chance of failing to achieve a 6% per annum return over the next decade.
Chart 2 – Distribution of 10 year real returns from initial CAPE Yield investment*
* The boxes show the middle 50% of scores (i.e., the range between the 25th and 75th percentile). The upper and lower whiskers represent scores outside the middle 50% (i.e., the lower 25% of scores and the upper 25% of scores).
Looking at Recent Market Action
Eagle-eyed readers will notice that the mean and median returns for the most expensive CAPE Yield bucket (2–4%) on Chart 2 differ by a significant margin. Focusing on the most expensive markets (Chart 3) shows why: historically, very high valuations have often led to large losses, pulling down the average and highlighting the downside risk investors face at today’s levels.
Chart 3 – Comparison of Starting CAPE Yield and Subsequent 10 Year Real Return
However, something remarkable happens when we extend the dataset to include the most recent decade (2015–2025). As Chart 4 reveals, despite starting from high valuations in 2015, the following decade – indicated by the red dots below – delivered the strongest returns this group has ever recorded. The returns are, quite literally, off the previous chart:
Chart 4 – Comparison of Starting CAPE Yield and Subsequent 10 Year Real Return
What drove the exceptional outcomes in the decade following 2015? This decade was characterised by the dominant performance of the biggest US tech ‘hyperscalers’. This performance is commonly attributed to the strong earnings growth achieved by this small group of exceptional companies over the period.
At its simplest, finance theory tells us there are only two possible sources of equity market returns: fundamentals and revaluation. The first is grounded in company performance, including dividends and profit growth, as well as inflation and currency movements. The second stems from changes in market sentiment, or what Keynes famously referred to as “animal spirits,” which drive valuation shifts independent of the underlying fundamentals.
As the vertical axis in Chart 5 demonstrates, the contribution of fundamental return from a starting CAPE yield of between 2 -4% is typically in a relatively narrow band of between 4-6% per annum.
The chart shows that, despite claims of US exceptionalism and the benefits of technological advances, returns between 2015–2025 – again, indicated by the red dots below – were primarily driven by revaluation. Fundamental returns were towards the higher end of the historical range but far from exceptional. Expensive stocks became even more expensive, rather than profits soaring:
Chart 5 – Disaggregation of 10 Year Total Return When Investing at 2-4% CAPE Yield
Putting Today’s Valuations in Perspective
The current CAPE Yield for the US market stands at 2.7%, placing it in the 98th percentile of expensiveness. Since 1881, the US market has traded in a CAPE Yield range of 2.6-2.8% on only eight occasions. The outcomes from those starting points have been sobering. The best 10-year return achieved was just over 1% per annum, between 1998 and 2008. The mean and median returns from such starting points were -0.5% and -0.4% per annum, respectively.
In other words, nearly 150 years of history suggests that investing in the US market with valuations similar to today’s has yet to reward investors with significant positive returns.
It’s tempting to dismiss long-term data as irrelevant, arguing that today’s technology and productivity gains are unique. Yet this data spans epoch-defining advances: electricity (1879), radio (1895), airplanes (1903), mass automobile production (1913), computing (1940s), mobile phones (1980s) and the internet (1999).
To suggest these were minor developments compared to AI risks a kind of chronological snobbery. And yet, despite these transformative shifts, the pattern is clear: extreme valuations mostly appear in recent history, clustered in four distinct periods of heightened excitement:
- The roaring 1920s
- The tech bubble of the late 1990s
- The goldilocks economy and debt-fuelled boom c. 2007
- Today
When we identify these periods in our final chart, we can see that, apart from the present era (so far), each of the previous high-excitement, high-valuation epochs was followed by downward revaluations as the market’s exuberance evaporated.
Chart 6 – Disaggregation of 10 Year Total Return When Investing at 2-4% CAPE Yield
When we identify these periods in our final chart, we can see that, apart from the present era (so far), each of the previous high-excitement, high-valuation epochs was followed by downward revaluations as the market’s exuberance evaporated.
It’s worth highlighting a subtle but important point from the chart. Even when valuations are historically high, there can be brief periods of continued valuation increases before mean reversion takes hold.
Take the mid-2000s as an example: valuations continued to rise in 2006–2007, creating a “Goldilocks” market for a short period. But once mean reversion took hold, the market experienced a -49% decline over just two years.
The lesson: initial upward moves in expensive markets don’t eliminate the risk of significant correction, and understanding historical patterns helps frame expectations.
A Reason for Optimism
We believe today’s elevated valuations suggest poor returns ahead for broad market equity indices. However, the good news for investors is that at Brickwood, we have been able to construct portfolios with CAPE yields significantly higher than their relevant benchmarks. For example, the TM Brickwood UK Value Fund has a CAPE yield which is 300 basis points higher than the FTSE All-Share and the TM Brickwood Global Value fund has a CAPE yield 900 basis points higher than the MSCI All-Country World Index.
Our funds’ positioning offers low valuation with a balanced and diversified exposure across both sectors and geographies, towards companies that are fundamentally strong, with robust balance sheets. History suggests this gives investors a meaningful edge.
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