The term “mean reversion” assumes that numbers will tend to converge or normalize to the long-term average over time. In economics mean reversion is often referred to GDP growth, interest rates and inflation. In finance it is often referred to earnings growth and valuation multiples, such as price-earnings (P/E), price-to-book (P/B) and price-to-sales (P/S). The S&P 500 12-month forward P/E ratio currently trades at 22.3x. Looking from a historical perspective at the subsequent 10-year equity returns with the 12-month forward P/E ratio trading between 20-23x (chart blue shaded part), investors are likely to have to adjust their annualized long-term return expectations to a historical range between 0% to 5%.
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Long-term equity return expectations
- Equity, P/E ratio
