The study was then repeated with the PEs divided into smaller groups, i.e. deciles or 10% intervals.


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This analysis strongly confirms the downward trend of the average 10-year forward real returns from the cheapest grouping (PEs of less than 6) to the most expensive grouping (PEs of more than 21).

The second study also shows that any investment at PEs of less than 12 always had positive 10-year real returns, while investments at PE ratios of 12 and higher experienced negative real returns at some stage.

A third observation from this analysis is that the ten-year forward real returns of investments made at PEs between 12 and 17 had the biggest spread between minimum and maximum returns and were therefore more volatile and less predictable. Interestingly, given that the current ten-year normalized PE of 14.9 falls in the middle of this range, the exceptional volatility being experienced at the moment is consistent with historical patterns.

As a further refinement, holding periods of 1, 3, 5 and 20 years were also analyzed. The research results (not reported in this article) for the 1-year period showed a poor relationship with expected returns, but the findings for all the other periods were consistent with the findings for the 10-year periods.

Although the above analysis represents an update to and extension of an earlier study by Jeremy Grantham’s GMO, it was also considered appropriate to replicate the study using dividend yields rather than PEs as valuation yardstick. The results are reported in Diagrams B.1, B.2 and B.3 and, as can be expected, are very similar to those based on PEs.


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Based on the above research findings, with the S&P 500 Index’s current 10-year normalized PE of 14.9 and 10-year normalized dividend yield of 3.1%, investors should be aware of the fact that the market is by historical standards still only in “average value” territory. As far as the market in general is concerned, this argues for unexciting long-term returns, possibly a “muddle-through” trading range for quite a number of years to come.

Although the research results offer no guidance as to calling market tops and bottoms, they do indicate that it would not be consistent with the findings to bank on above-average returns based on the current ten-year normalized valuation levels. As a matter of fact, there is a distinct possibility of some negative returns.