You are currently viewing Portfolio Update – May 2021 – Indicators of an Overvalued Stock Market and What You Can Do About It

Portfolio Update – May 2021 – Indicators of an Overvalued Stock Market and What You Can Do About It

Contents of this month’s post include:

  • Has the stock market reached a permanently high plateau, or can we expect lower return the coming decade?
  • Monthly Update for May 2021 with a fresh set of charts

Happy summer, and good to see you back here for another monthly update!

I hope you are sitting comfortably and have fetched a nice cup of coffee or something more refreshing, because before we get into the monthly development for May 2021 of my portfolio, we have an elaborate analysis of the value of the stock market in front of us.

There has been a couple of things that have been bugging med lately. That is the current high valuation of the stock market regardless of metric used, and the fact that many non-professional investors’ inability to understand that an average annual return of 7-8% on the stock market is just an average rather than something you can expect every year to come.

I think that many have been trapped in a recency bias that will catch up with them eventually, unless retail investors choose to diversify from an all-stock portfolio to something more similar to an All Seasons Portfolio.

I will explain why I think so in detail in this article, so let’s just dive into it.

I recently bought the book Adaptive Asset Allocation by the team at ReSolve Asset Management. While the main focus of the book was risk parity and a different view thereto than what the more static All Seasons Portfolio strategy offers, there was one part in the background section that really resonated with me, and which I perceive that many investors, and especially non-professional savers, miss.

In this article I will be referencing to Adaptive Asset Allocation a lot, and if you haven’t picked it up yourself yet, I highly recommend that you do as it is a great read for better understanding the value of risk parity investing.

Buy it on

It was a section about the sequencing of returns that made me stop and think. This is the concept of the comparison between the average return of the stock market vs. in what order those returns fold out.

There is a great difference in your experience as an investor if you each year earn 7% yield on your investments, which is the average return in equities, as opposed to if the size of annual returns fluctuate a lot of come in the “wrong” order.

Financial markets do not give you 7% yield per year every year, but rather, the returns vary a lot from year to year, and there may also be “clusters” of similar yields along the data set. For example, good years for the performance of stocks tend to be grouped over a period of prosperity with several years of positive return in a row. This has been the case for the decade from 2010-2019.

During other periods, however, there may be sequences of several years of poor performance on the stock market. See for example the 1970s with high inflation or from the top of the dot-com bubble.

Regardless these uneven distributions of returns, the average annual return of equities for the past hundred years is around 7%. Therefore, it is commonly believed that if you are a long-term investor saving for your retirement or for periods of 20+ years, you should not have to worry. Over time, bad years will be compensated by good years. “Therefore, you will always be rewarded for taking more risk, especially if you are young.”

The latter statement is true only if you are given a bag of money at day 1, and then make no further contributions to you nest egg. Are you lucky enough to have inherited a decent fortune to look after so that you no longer need to save from your salary to fund a good life and a rich pension?

It is common knowledge that compound interest is a strong force that will help you grow your wealth, and that a long-term average return of 7% will be awarded in many cases. There are, however, two factors that are commonly forgotten, and for most savers, these two factors are more important than the 7% average return when considering portfolio construction and risk exposure.

Firstly, it is vital to understand that while 7% average annual return are achieved over very long periods, your investment horizon is most likely too short for the 7% average to have any serious significance. That figure – the 7% – is the average returns over the last 100 years. For most of us, our investment horizons are significantly shorter than that period. Our life expectancy is about 80-85 years, we most commonly begin investing in our 20s and usually begin withdrawing around the age of 65. At best, our time in the market is much less than 100 years, and thus the number of annual data points affecting our portfolios will be much fewer than make up the measurement period that “promises” 7%.

Sub-periods within the long-term measurement period that holds all historical data points, will have different outcomes. For example, rather than an expected 7% average return, the 10-year period 2010-2019 yielded an average annual return of 13.6% for the S&P 500, i.e. almost 100% higher than the long-term average. But conversely, that will also mean that over the long-term, there will have been longer periods with significantly longer annual return than the long-term average.

How this can play out, can be further explained by the below graph. The red and blue lines show year over year returns of similar averages: 8.55% for the red line and 7.1% for the blue line.

The end portfolio value (y axis) is similar for both lines, but the red line is much more volatile. To illustrate how important timing becomes for hitting the right moment on the red line, we have added the red and yellow lines that show your average annual returns if you would hit the interim top or bottom: 1.5% and 18.75% respectively.

Chart 1: Simulated average return over time

This means, that if you invest near an interim top before a new bottom, your expected average return will be much lower than the long-term average (1.5% vs. 8.5%). That will have significant impact on your future wealth.

Of these lines, the red line can be said to imitate a portfolio 100% allocated to stocks, and the blue line a risk balanced and diversified portfolio.

A similar story can be told about real life. Below is the annual development of the S&P 500 in blue, with its average annua return shown in red.

Notably, between 1 January 2000 and 31 December 2013, your return from the stock market was essentially non-existent: 1.55% per year on average 8see the yellow line). This is dismal return for a 13-year period.

Similarly, if you only invested in December 2008, near the bottom of the great recession and the global financial crisis, you could have expected an average annual return of 12.75% until end of 2020.

The average over this whole period of 20 years remains about 6% but depending on which sub-period you are looking at, the average annual return you as an investor could have expected varied greatly between 1.55% and 12.75%.

Chart 2: S&P 500, 2000-2020

Nothing has happened to the data or statistical tracing of the market, but it matters when you enter and exit the market and you become part of it as one of the many data points. If you are lucky, you would bring a pile of money to the market for investing near a bottom and expect high returns when the values go up again.

Of people living today, most have been lucky enough to have had exposure to the stock market the past decade and been able to enjoy the strong trend, but there are no guarantees that the decades of 2020-2029 or 2030-2039 will be as good. Be mindful of recency bias and prepare your portfolio accordingly.

Maybe we are currently near a top of the red line in the first graphs shown above, where we can only expect meager return from stocks in the coming decades? We will be looking at this more closely further below.

Secondly, it matters in what order the stronger and weaker stock market hits your portfolio as a regular saver. If you have inherited a lump sum to invest, you do not need to read further, but if you, just like me, save on a monthly basis, you do not only need to consider compound interest for your starting capital, but also for each of you monthly contributions to your portfolio.

To illustrate, if you save €300 every month for five years, the aggregate return is the sum of the compound interest applied to each of the 60 contributions made to your portfolio (five years * twelve months). Likely, some months you will be buying stock at market lows, and this money will grow much more than money that you invested near a top. On average, you should be fine, as the highs and lows over the normal cycle will more or less even out, but there may be a huge impact if you zoom out a bit.

This issue is thus the opposite of what we discussed in the first point above (zooming in on a sub-period from the 100 years of historical stock market data), as we stretch out monthly contributions over a longer period than just one market cycle that usually lasts 7-10 years. Here, we will be considering longer-term cycles of 20-40 years.

Most importantly, we need to consider how our savings rates look throughout a lifetime. When we are young, our incomes are lower and we have thus less to save for our pensions. When we grow older, we usually have higher salaries and have already bought our homes, not needing to save for the investment of buying a home.

This means that our aggregate cash savings are unevenly distributed over our lives – less in the beginning and more the nearer we get retirement. See the below snip from Adaptive Asset Allocation as an illustration were the aggregate saving grow slowly in the beginning of an investor’s life, but then picks up speed later in the career.

Adaptive Asset Allocation (2016), Butler et. al.

How does this impact our total wealth? Well, it depends on how the annual returns are distributed over the subperiod that we invest.

Here below you see two graphs with the return of Dow Jones index over a 32-year period with the monthly contributions described above, with one difference between the two graphs. The first graph is the actual development of the DJI, but for the second graph, the returns of the first and second half of the 32-year period have been flipped.

This means that for the second graph, the stronger return of the last 16 years for Dow Jones were placed first, and the weaker return of the first 16 years put at the end. Why we do this exercise will soon become evident.

The impact on total wealth is significant. If you encounter a stronger return period later in life as opposed to early, you would have had time to accumulate more aggregate cash savings. With later strong returns, more of your money can compound and benefit from the stronger return, as opposed to if the strong return come early in your investment life before you have been able to put aside as much money.

Adaptive Asset Allocation (2016), Butler et. al.

Do you recall chart 2 from further up of the last 20 year performance of the S&P 500? Here we can see a similar pattern as has been used by the authors of Adaptive Asset Allocation for showing why sequencing matters. The two halves of the last 20 year period of the S&P 500 were distinctively different: the first half with weak performance and barely positive average annual return, and then the second half which makes up for all the total return from 2000 to 2019.

Chart 2: S&P 500, 2000-2020

Is the stock market overvalued?

What if we are in the middle of a new such 20-year period, but that we have the stronger half behind us, and can now look ahead toward a weaker decade on the stock market? This is not at all implausible but let us examine a couple factors that may support this idea.

Let us look at three different and important indicators that may give us a view of the current health of the stock market. Perhaps we can use these as a tool for forecasting expected returns going forward.

Price-to-Earnings / CAPE / Shiller PE

Beginning with the most common indicator, being the measure for enterprise value relative to earnings: the PE ratio. This is a good measurement for determining the investor’s share of the corporate earnings. Typically, the PE ratio is a mean reverting measurement, meaning that it commonly fluctuates in a certain interval.

While the PE ratio is most commonly used for individual stocks, how do we quantify if the aggregate market is expensive or cheap? Here, we will use a derivative of the PE ratio introduced by Nobel prize laureate Robert Shiller – the Shiller PE – also known as Cyclically Adjusted PE Ratio (or “CAPE ratio” for short).

This measure is based on average inflation-adjusted earnings from the previous rolling 10-year period and is a highly regarded indicator as it smooths away spike and throughs in earnings caused by short-term business cycles.

Where are we today when looking at the CAPE ratio from a historical perspective?

Here below is a graph of the CAPE ratio of the American stock market since 1870.

Chart 3: CAPE ratio 1870-2021

Notably, a CAPE ratio of 37 as of 11 June 2021 is a historically high number, only triumphed by the period leading up to the dot-com bubble some 20 years ago.

There are valid reasons why we see these levels, such as ultra-low interest rates and zero-interest rate policy accompanied by excess central bank liquidity, meaning that future earnings are discounted with lower discount rates, pushing up prices.

However, even the slightest increases in interest rates will have a noticeable impact on discounted future earnings. Hence, these elevated CAPE levels, regardless the explanation behind them, is a worrying sign. Have we entered a new paradigm and reached an infamous permanently high plateau?

Buffett Indicator (market cap to GDP)

Another popular indicator of the value of the stock market is comparing the market cap to Gross Domestic Product (GDP). This indicator is also commonly referred to as the Buffett Indicator, as it has been promoted by Warren Buffett.

The charm with this indicator is that is shows the fairness of the stock market value. One can reasonably not expect neither earnings nor corporate valuations to indefinitely outpace the growth rate of the economy, but for the last 10 years, the growth in market value has been completely detached from GDP growth rate.

Hence, the Buffett Indicator now stands at record levels, at 233% as at June 2021.

Chart 4: Buffett Indicator 1950-2021

Q ratio (stock value relative to replacement value of assets)

The third and final indicator we are reviewing here is Tobin’s Q Ratio, or just the “Q Ratio”. While the other above indicators focus on earnings and corporate value, the Q Ratio tells us more about a corporate’s assets and the balance sheet. The reason for this is that the Q Ratio measures how expensive a company is relative to its assets’ replacement value.

Hence, the Q Ratio is used to examine how much intangible value there is impeded in the price of stocks compared to the depreciated replacement value of a company’s actual assets.

Like both previous graphs shown, we are currently (as at June 2021) at record levels also when looking at the Q Ratio. The below chart shows the Q Ratio since 1900, which provides us with 120 years to compare with. The previous top from the dot-com bubble has been exceeded by almost 50%.

Chart 5: Q Ratio 1900-2021

Taken together, these indicators capture a wide variety of information about markets, as they look at earnings statements, balance sheets, corporate values as a proportion of the size of the economy. This means that regardless of what we examine for the stock-listed companies – their earnings, their assets, their values compared to the size of the economy – there is no other way of putting it than that we are at a vulnerable place for stocks.

When the authors wrote Adaptive Asset Allocation in 2016, their view was that already then, the future potential for the stock market was weak. Since then, all of these indicators have climbed even higher. Even though the authors (also the ReSolve Asset Management team) may have been wrong so in their predictions of a reversal, perhaps they were only early?

I do not know about you but if I was purely invested in stocks (which I am not), I would feel a bit of vertigo by now.

Returning to chart 1 (further up and reinserted below), it is impossible to know whether we are currently near an interim top or bottom when looking at the stock market, or in other words, near the yellow or the green diamond. But considering what the Shiller PE, the Buffett Indicator, and Q Ratio all tell us, I find it more likely that we are closed to the yellow diamond than the green one. Otherwise, all of these indicators must worsen further for values to keep climbing.

Chart 1: Simulated average return over time

How can you protect and grow your future wealth in this uncertain environment?

In this article we have discussed several points that should make you reconsider being solely invested in stocks. The 7% annual average return is just that, an average, and all the data points can be both higher and lower than that, and commonly come in clusters when considering their timing.

Looking at key value indicators, we seem to be nearer a top than a bottom, and hence we should expect that the stock market will return below-average results in the coming decades, unless we are at a permanently high plateau (famous last words spoken by the in 1929, just before the Black Tuesday that marked the beginning of the Great Depression).

What you should do, to protect your purchasing power and grow your wealth, is to diversify your portfolio in a way that detaches your investing success from the expected return of the stock market.

During different market environments, different assets are favoured. Stocks love low inflation and high economic growth, but there are no guarantees that we will see this environment continue for the coming decades. We should therefore diversify between other asset classes that do well also in environments of higher inflation and lower economic growth paradigms. Additionally, to avoid unnecessary volatility or that we remain highly exposed to one asset class or a certain market environment, we must make sure that we balance the risk of the portfolio to all of the potential seasons of the economy.

I will therefore continue to promote the All Seasons Portfolio strategy, as I am convinced that more savers would benefit from better risk management and avoiding the recency bias of the stock market the last decade. To achieve this goal, I value your input and discussions, as well as you to spread the word about a more sensible way of investing and the All Seasons Portfolio strategy.

It is hundreds of millions of people’s retirements and savings that are at stake when being careless about diversification and risk. Any collapse in investment portfolios will increase polarization, populism, and dissatisfaction. The rich are already diversifying their portfolios with several asset classes, also including art, real estate, etc., so it is the less-than-rich that will suffer if the stock market delivers sub-average returns the coming decades.

Begin with taking responsibility of your portfolio, and make sure you avoid too high exposure to individual asset classes. I am not a permabear, but rather someone who recognizes that future returns cannot be predicted and that it is more important that we prepare for any eventuality. Do you agree?

In summary, it is important that you have a portfolio which balances the risk exposure to different environments. For me, the rules I have or myself is the All Seasons Portfolio strategy which I rebalance annually or when an asset deviates from its target weight by more than 30% (e.g. if stocks go from 30% of the portfolio to less than 21% or more than 39%). If you have not already built your own All Seasons Portfolio to really diversify your portfolio and balance your risk, I strongly suggest that you begin preparing for whatever market environment that may come as soon as possible, to better manage the risk and volatility in your portfolio, while still not forfeiting return. If you need inspiration, check out my post on How to get started with the All Seasons Portfolio strategy or check out some example portfolios.

What do you think will be the average annual return of the S&P 500 for the period 2020-2029?

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What will be the average annual return of S&P 500 from 2020 to 2029?
14 votes

May 2021 Portfolio Update

Alright then, with that analysis out of the way, let us have a leisurely review of my All Seasons Portfolio for the month of May 2021.

I have done no changes to the portfolio since April 2021, so nothing has been sold or bought.

Instead, my portfolio looks the same as it has done for the biggest part of 2021 so far.

As I have repeated for many months already, I am overweight in gold and commodities, being prepared for a jump in inflation, and being underweight in long-term US Treasury Bonds.

For the last few weeks, gold seems to be at the end of consolidation and ready to pounce upwards again above $2,000 during the second half of 2021.

At the same time, the rally in commodities have taken a pause, where futures contracts such as in lumber no longer limits up in trading, but has fallen a bit from its highs earlier in May. It remains to be seen if we are currently consolidating ahead of a further bull market driven by higher inflation expectations. US inflation is rising, and hit 5% Year-on-year in May 2021.

Bitcoin and cryptocurrencies have, for the first time in a while, retraced some of its gains in 2021 and BTC is currently trading at around $32,000 by mid-June, having fallen from its top of almost $65,000 in April 2021.

If you are looking to invest in Bitcoin or other cryptocurrencies directly instead of exchange-traded certificates, consider using Coinbase – the most trusted cryptocurrency exchange with more than 43 million registered users, where you can securely trade more than 30 different cryptocurrencies directly in your own wallet.

The last 12-month performance of my portfolio has been in line with my expectations, as you can see in the below data to the right. 8-10% annual return of an unlevered risk parity portfolio is exactly according to plan, and at less than half the volatility of the S&P 500.

With the above graph and data in mind, I am very happy with how the All Seasons Portfolio strategy is playing out for me. It is giving me exactly what I am after: same returns as stock market long-term average return but with much lower volatility.

Moreover, I am still beating a traditional 60/40 portfolio on all fronts, even though interest rates stabilized in May and fell from previous highs earlier this year.

In May 2021, most assets saw positive development, except for two: Bitcoin and long volatility (VIX).

Bitcoin fell off a cliff, trading down 33% from end of April until end of May. Even though this asset class only made up 5% of my portfolio, when it loses a third of its value, that will have a few percentage points’ impact on the overall monthly performance.

The same goes for VIX, even though this “only” lost 9%.

Lastly, as usual, here is the table of my ETFs and the changes laid out in table form.

ETFNameAsset Class2021-04-302021-05-31Change
IUS5iShares Gl Infl Lnk Govt Bd UCITS ETF USD AccTIPS€600.16€610.241.68%
DTLEiShares $ Treasury Bd 20+yr UCITS ETF EUR Hgd DistLong-Term Government Bonds€780.78€786.940.79%
IGLEiShares Global Govt Bond UCITS ETF EUR Hedged DistLong-Term Government Bonds€632.10€633.390.20%
M9SAMarket Access Rogers Int Com Index UCITS ETFCommodities€430.33€439.532.14%
VGWLVanguard FTSE All-World UCITS ETF USD DisStocks€1,442.40€1,448.700.44%
VOOLLyxor S&P 500 VIX Futures Enhcd Roll UCITS ETF C-EVIX€111.65€101.21-9.35%
Added cash€0.00€0.00

Thank you yet again for following my blog about risk parity investing and the All Seasons Portfolio. If you haven’t done so already, make sure to subscribe to the newsletter via the form in the page footer, and to drop any comments you may have on the content with the comment section or via email to The greatest value I have received from upkeeping this blog is the fantastic conversations with great people, such as yourselves, about ideas on investing and strategies. Thanks for that!

Remember also to check out the Resources page which I will be filling up with useful tools and resources for managing an All Seasons Portfolio. If you have any suggestions for any particular spreadsheet or tool that you are after, let me know in the comments below and I will see what I can do to have it included.

I have also set up a Patreon site, to cover hosting costs, which reach a couple hundred euros annually. If you find any content here at all useful and feel that you can treat me for the equivalent of an espresso, read more about what this means on the Support page here on the website. My annual hosting bill for running the website is around EUR 140, so any support is extremely helpful, as the monetization of this blog is very limited.

We’ll catch up soon for the June update!
Nicholas Ahonen

Book tip: Adaptive Asset Allocation by Adam Butler, Michael Philbrick and Rodrigo Gordillo

In a recent article I posted, I recommended three great books for better understanding risk parity investing. As a comment, a reader gave me a great tip for another useful book on the same topic, namely Adaptive Asset Allocation.

As I extensively referred to this book in this article, I will keep it as this month’s book recommendation, even if I gave you the same tip last month.

The authors are the guys behind ReSolve Asset Management, which is one of the few firms offering risk parity funds, such as the ReSolve Adaptive Asset Allocation ETF. They also publish a great variety of useful research on the area, which I recommend you to read as well – all available for free on ReSolve’s website.

By reading Adaptive Asset Allocation, you will learn how to build an agile, responsive portfolio with a new approach to global asset allocation

Adaptive Asset Allocation is a no-nonsense how-to guide for dynamic portfolio management. Written by the team behind ReSolve Asset Management, this book walks you through a uniquely objective and unbiased investment philosophy and provides clear guidelines for execution. From foundational concepts and timing to forecasting and portfolio optimization, this book shares insightful perspective on portfolio adaptation that can improve any investment strategy. Accessible explanations of both classical and contemporary research support the methodologies presented, bolstered by the authors’ own capstone case study showing the direct impact of this approach on the individual investor.

Financial advisors are competing in an increasingly commoditized environment, with the added burden of two substantial bear markets in the last 15 years. This book presents a framework that addresses the major challenges both advisors and investors face, emphasizing the importance of an agile, globally-diversified portfolio.

  • Drill down to the most important concepts in wealth management
  • Optimize portfolio performance with careful timing of savings and withdrawals
  • Forecast returns 80% more accurately than assuming long-term averages
  • Adopt an investment framework for stability, growth, and maximum income

An optimized portfolio must be structured in a way that allows quick response to changes in asset class risks and relationships, and the flexibility to continually adapt to market changes. To execute such an ambitious strategy, it is essential to have a strong grasp of foundational wealth management concepts, a reliable system of forecasting, and a clear understanding of the merits of individual investment methods. Adaptive Asset Allocation provides critical background information alongside a streamlined framework for improving portfolio performance.

Or check out other great books on the topic on the Book recommendation page.

Buy it today on Amazon (affiliate link):

Buy it on

This Post Has 3 Comments

  1. Louis

    Hi Nicholas,

    Great post! Our risk parity portfolios will let us sleep much better…

    By the way, in your ETF list, as far as I know, IGLE is not a Long-Term Government Bonds, but just a Government Bonds.

    Best regards,


  2. Tomas

    Hi Nicholas, these are interesting thoughts. But would it be possible to find some graph that compares the performance of All Seasons and S&P 500 in the last 50 years? It can even have the end date set to the bottom of 2008 crisis to see the worst-case scenario.

    1. Nicholas

      Hi Tomas,
      I began writing a response to your excellent question but it turned out too long for a comment. Instead, I will make it the topic for the next monthly update which I plan to publish the coming weekend at the latest. Hope you can wait for feedback a little longer and we’ll continue the discussion then! ?
      Sincerely, Nicholas

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