Taking advantage of long-run returns
From J.P. Morgan Asset Management
Despite a U.S. business cycle that is in its sixth year of expansion, many are still skeptical about investing in the stock market. While such skepticism is a sign of a healthy market, it also means that investors are likely underweight equities—and could miss out on stocks’ potential returns over the long run.
Investing when the market dividend yield and term spread—financial proxies for sentiment—are high historically has resulted in strong returns over long horizons. The current levels of these measures suggest that the expected excess return for stocks is still attractive.
Meanwhile, surveys of sentiment show that while consumers and investors feel better about the economy and markets, sentiment levels are still well below prior peaks.
Investors have to overcome their behavioral biases—including herd behavior, the availability heuristic, and loss aversion—in order to invest when others are skeptical. This requires discipline and has historically been rewarded.
With the U.S. business cycle maturing, geopolitical risk rising and stocks close to record highs, many investors are skeptical about the market. This skepticism, reflected in financial measures and sentiment surveys, is a sign of a healthy market that is far from the irrational exuberance that often characterizes market peaks. At the same time, this means that many investors are failing to achieve proper equity allocations in their portfolios.
For most investors, stocks are not an all-or-nothing proposition but instead are important across all phases of financial planning. What changes over time is the expected return from the stock market, which depends crucially on investor sentiment and risk tolerance.1 By definition, market valuations around average levels imply that subsequent returns will be lower than they were earlier in the cycle. However, we estimate that expected long-run returns continue to be attractive.
As a result, investors who are underweight equities should continue to strive toward a proper portfolio allocation based on their goals. What prevents many investors from doing this are behavioral biases that lead to a fear of current market levels, above-average valuations and the sense that they missed their opportunity to invest. The evidence we will consider suggests that stocks at current levels can continue to perform well over the long run, benefiting investors who have the discipline to overcome these biases.
