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A man walks by a giant electronic sign at the Toronto Stock Exchange in Toronto on Nov. 5, 2020.

Mark Blinch/Globe and Mail

Two people I haven’t seen since high school e-mailed me this past month to ask when the stock market is going to crash.

The same question appears to be on many minds. To cite just one example, Vanguard Canada, the giant money manager, published a commentary this week titled, “Why talk about a market downturn now? Why not?”

Exactly: Why not? Depending on which sectors you examine and which gauges you choose to use, share prices register as mildly frothy to outright giddy by historical standards.

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Consider Warren Buffett’s favourite way of measuring the market’s animal spirits. His method compares the total market value of all the stocks on a nation’s exchanges to the size of the underlying national economy, as measured by its gross domestic product. This comparison shows both U.S. stocks and global stocks have now surged to unprecedented levels of exuberance.

the buffett indicator

Ratio of the total value of U.S. stocks to GDP

200%

180

160

140

120

100

80

60

40

20

0

1950

1960

1970

1980

1990

2000

2010

2020

JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: advisor perspectives

the buffett indicator

Ratio of the total value of U.S. stocks to GDP

200%

180

160

140

120

100

80

60

40

20

0

1950

1960

1970

1980

1990

2000

2010

2020

JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: advisor perspectives

the buffett indicator

Ratio of the total value of U.S. stocks to GDP

200%

180

160

140

120

100

80

60

40

20

0

1950

1960

1970

1980

1990

2000

2010

2020

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: advisor perspectives

This will come as no surprise to anyone who follows the market. A weird exuberance has swept across the investing landscape, especially over the past couple of months.

Just look at the mob of people who played Hacky Sack with GameStop shares a couple of weeks ago, or the true believers now worshipping at the corner of bitcoin-and-Tesla, or the endlessly hopeful crowd chasing cannabis stocks – again! – despite knowing how brutally this game ended in 2019.

The public’s willingness to pile into one warmed-over speculation after another suggests the end of this frenzy could be drawing nigh. But attempting to time the stock market is just about always a mug’s game.

As stretched as stock valuations now look, several indicators – such as rising bond yields and surging oil prices – signal the immediate outlook for economic growth is actually brightening. Furthermore, there is no obvious place for nervous investors to run to for shelter. With fixed-income yields still so low, bonds are about as attractive as that month-old chili you just found at the back of your fridge.

So what should a saver do? One good place to start is by assessing your own tolerance for risk. If the thought of a 25-per-cent plunge in the market terrifies you, it is time to ease back on your portfolio’s stock exposure.

Another fine idea is to reframe an unanswerable question with a more reasonable alternative. Will the stock market crash over the next few months? No one knows. Will it crash at some point in the next five years? Nearly certainly. That is what stock markets do.

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As a rule, market results become more predictable the further ahead you look. So rather than attempting to catch the next twitch of the market, investors might want to ask themselves how prepared they are for what the next few years are likely to bring.

For a quick tour of this future terrain, look at the capital markets assumptions published by AQR Capital Management, the quantitative investing icon in Greenwich, Conn. Every year, the company’s number crunchers publish their estimates of the five-to-10-year returns they expect from a wide variety of asset classes. This year’s forecasts make for interesting reading.

Canadian stocks are poised to produce returns of about 4.2 per cent a year after inflation, AQR figures. U.S. stocks are set to do considerably worse, with an expected “real” return (that is, returns after inflation) of only about 3.8 per cent a year.

In contrast, emerging-market stocks appear capable of generating 4.9 per cent real returns. British stocks look like an even better bet, with 5.1 per cent expected real returns.

To be sure, investors should take these projections with a big grain of salt. As AQR rushes to acknowledge, market projections involve big doses of conjecture and extrapolation. The AQR researchers employ two methods to arrive at their forecasts – one based on earnings, one based on dividends – then averages them. But there is still a wide band of uncertainty around the results.

The chief takeaway from AQR’s exercise in medium-term forecasting is that all the expected returns, imprecise as they may be, fall considerably short of the 6-per-cent to 7-per-cent real returns that many investors have come to expect from stocks. Couple that with today’s dismally low bond yields and the likely payoff from a conventional balanced portfolio is lacklustre.

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A portfolio of 60 per cent U.S. stocks and 40 per cent U.S. bonds is set to produce real returns of only 1.4 per cent a year over the next few years, according to AQR. Investors who hold a more globally mixed assortment of investments can probably boost their results, but they will likely still fall short of the 5-per-cent real return that a balanced portfolio has typically produced in the past.

AQR is not alone in such projections. Many other forecasters, including GMO LLC and Research Affiliates LLC, see a similar downbeat decade ahead. To repeat: The uncertainty around such projections is large. But investors should not ignore the central message that returns over the next few years are unlikely to be as generous as they have been.

This is not reason for despair. But it is reason to keep expectations in check. Investors can do a lot to forestall the possible damage: They can maintain a globally balanced portfolio, they can keep a lid on their investing costs, they can make sure their exposure to stocks is aligned with their risk tolerance and they can save more to offset the potentially lower returns.

All of that is likely to stand you in better stead than attempting to guess when the next market crash will happen. The only downside? If markets perform better than predicted, you may wind up richer than you expected.

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