As I noted a couple of days ago, if you look at average future stock returns from our current valuation level of 26.3 on a Shiller P/E basis, they don’t seem all that bad. Historically, 10-year returns should be in the range of 7.5 percent and 5-year returns around 5 percent, on average. Not too shabby.

Averages conceal a multitude of sins, though, so let’s look a little closer. One question I have is whether the return spreads are consistent over time. If not, we have to ask whether the overall results are applicable to today.

After the decline in the stock market yesterday, the question on many people’s minds is whether this is the correction we’ve been waiting for. It could be. But even if it’s not, we may well be in for a turbulent month.

Let's look at what could be behind the market drop and where the market might be going from here.

Following up on yesterday’s post about what kind of returns we can expect from bond investments, today let’s look at stocks. With the market recently bouncing off all-time highs, it seems like a good time to consider what the future holds.

Are we poised for more of a run-up over the next several years, or is the market likely to disappoint in its returns?

One of the reasons investors fail to achieve their goals is that they have unrealistic expectations. When those expectations aren’t met, for whatever reason, they tend to sell.

Consider the well-known tendency to chase performance—that is, to buy a fund or stock that has been doing well. In doing so, the investor believes, he or she can expect future performance like that of the recent past. This leads to the momentum effect, which can drive prices up further, but ultimately may not be sustainable. When investors realize they won’t be getting the returns they expect, they sell, leading to downward momentum.

The S&P 500 is a solid benchmark for the stock market. Tracking 500 large companies, diversified by industry and sector, its movements can give you a good feel for what’s going on in the U.S. financial markets and the real economy. These are blue-chip companies with strong balance sheets and market position, and they should continue to grow and make money over time.

Good investments, right?

How much money companies make—their earnings—is a key factor in analyzing how expensive the stock market is. Depending on what you expect earnings to do in the future, you might decide that the market is either:

1. Very expensive (my own conclusion, based on longer-term valuation measures), or
2. Quite reasonable, if you assume current earnings trends are stable and likely to accelerate.

I am headed to New York today to speak at a conference on liquid alternatives. These types of alternative investments are often thought of as hedge funds for the masses; the idea is to take hedge fund-like strategies and wrap them in mutual funds. Ideally, this makes the expertise and money-making capabilities of all those hedge fund wizards available to mom and dad, so we can all get rich.

In the past couple of days, I’ve read several articles in the newspapers and in professional forums denouncing the notion of market timing. They say, quite correctly, that no one can time the market and call the ups and downs. Very true. They also say that various market timing tools won’t generate higher returns consistently. Again, very true. They conclude that it makes no sense to step back from the stock market occasionally to assess market conditions.

Let’s put this analysis in a different context, though, and see if that conclusion makes sense. Forget the stock market, let’s talk about the weather—specifically, hurricanes.

The S&P 500 has set another record, closing above 2,000 for the first time yesterday. Hooray.

I want to be excited, I really do. But I just can’t get there, and I don’t seem to be alone. The press has noted it, without much fanfare. The market itself doesn’t seem all that jazzed.

Why the ennui? I suspect it’s because this may not be a real rally, but one driven by low volumes, senior staff on vacation, and other less-than-exciting factors. After Labor Day, we should get a better look at what investors really think.

Looking into the relationship between interest rates and stock market valuations, I’ve found two very interesting points that have a direct bearing on our investments.

First, the valuation metric you use matters. As you may remember, I prefer a cyclically adjusted price/earnings ratio, or Shiller P/E, over a P/E based on only 12 months of data. When you compare the relationships with interest rates, among other factors, it’s very clear that the Shiller P/E has the better economic foundation; not only is it more intuitively sensible, it’s also a better analytical tool.