Viewpoints
The current market environment, layered with global instability, has been as interesting and challenging as any period we’ve faced. What makes it especially difficult today is the noise. We’re bombarded daily with contradictory reports on inflation, jobless claims, and growth–numbers that can be spun in completely opposite directions depending on the headline or the source. It’s tempting to latch onto whatever narrative fits our hopes, but the reality is that markets don’t reward stories in the long run, they reward discipline. And that discipline requires staying grounded in fundamentals and risk management rather than headlines.
A story from NASA’s early space program offers a useful illustration of discipline and risk.
When NASA set its sights on the moon, every step was engineered, tested, and tested again. Before rockets carried astronauts beyond Earth’s atmosphere, NASA used high-altitude balloons to push the boundaries of human survival. On May 4, 1961, American test pilot Victor Prather and his colleague ascended to 113,720 feet, skimming the edge of space, in a balloon designed to prove out NASA’s new pressure suit. The mission was flawless. The suits performed exactly as planned.
As Prather descended, confident he was low enough to breathe unaided, he cracked open his helmet faceplate for a bit of fresh air. Soon after, he splashed safely into the ocean, where a rescue helicopter moved in to lift him out. As he was climbing the ladder, he slipped into the water while clipping onto the rescue line, but no one panicked because the suits had been designed to be watertight and buoyant. He should have floated easily. Instead, with the faceplate open, the ocean rushed in. Despite all the planning, Victor Prather drowned.
NASA is the most meticulous, risk-averse organization in history and had planned for everything. Thousands of experts had mapped out Plan A, Plan B, and Plan C. And yet, catastrophe came from the one human action no one had thought to consider: the seemingly harmless decision to crack open a faceplate. That small fallible choice, so ordinary it never occurred to thousands of NASA scientists, proved fatal. As financial advisor Carl Richards reminds us: “Risk is what’s left over after you think you’ve thought of everything.”
In Other Words: Risk is What You Don’t See
It’s impossible to plan for what you can’t imagine, and the more certain you are that you’ve imagined everything, the more surprised you’ll be when something you hadn’t considered inevitably happens. A better way to think about risk is the way California thinks about earthquakes. No one knows when, where, or how powerful the next one will be, but everyone knows it will come. Emergency crews prepare in advance despite the lack of a forecast, and buildings are designed to withstand shocks that may not occur for a century. In the same way, investing prudently is not about prediction, but about preparedness -aiming to build portfolios resilient enough to endure whatever shocks may come.
Setting Realistic Expectations for Future Returns
If Prather’s story teaches us anything, it’s that risk rarely appears where we expect it, often it hides in the overlooked detail. In investing, one of the greatest blind spots is not a market crash or a geopolitical shock, but the quieter danger of unrealistic expectations. When we assume that yesterday’s returns will carry on indefinitely, we leave ourselves exposed to disappointment, and to plans built on shaky ground. To manage risk properly, we must not only diversify assets but also reset expectations. That’s where the discipline of bond investors offers a useful lesson.
When people talk about markets, they often do so through the lens of the recent past. If stocks have been strong, the mood is buoyant and expectations for the future rise in tandem. If the market has struggled, pessimism sets in just as quickly. Bond investors, however, tend to see the world differently. They are often described as contrarians, not because they enjoy swimming against the current, but because their discipline forces them to look forward rather than backward.
Bond markets are built on the principle of mean reversion. When yields are high, investors know the future path of returns is likely downward, since yields will eventually compress. When yields are low, they expect the opposite - that over time they will climb back toward long-term averages. In short, bond investors rarely extrapolate the recent past in a straight line. They understand that markets cycle, and that today’s conditions are temporary.
Equity investors, by contrast, often fall into the trap of linear thinking. After a long bull market, optimism reaches its peak, and expectations of double-digit returns harden into something close to dogma. After downturns, the opposite takes hold: gloom deepens and investors expect nothing but losses as far as the eye can see. Yet history shows equities, like bonds, ultimately mean-revert. The cycle of returns is not a straight line, and assuming otherwise sets investors up for disappointment.
Anchoring to Objective Measures
So how can equity investors reset their expectations? The answer lies in building blocks that are observable, measurable, and grounded in long-run data. Historically, three components drive equity returns:
• Dividend yield, which today stands near 2+% for dividend investors.
• Real earnings growth (meaning after adjusting for inflation), which has averaged about 2% over the long run.
• Valuation change, which tends to mean-revert. With valuations currently stretched, this factor is more likely to be a drag than a tailwind.
When combined, these elements suggest future equity returns in the range of 4% real, or roughly 6% nominal, per year. This is not guesswork. It is consistent with historical evidence across geographies and eras. By contrast, the 8–10% real returns many investors cite from U.S. history were flattered by four decades of unusually favorable valuation expansion and persistently low interest rates - an anomaly unlikely to repeat.
Valuations Matter
Among the most reliable long-term predictors of returns is the Shiller CAPE ratio. The Cyclically Adjusted Price to Earnings ratio, or CAPE, is a valuation measure that compares stock prices to average corporate earnings over the past ten years, adjusted for inflation. By smoothing out temporary booms or busts, it provides a clearer signal of whether markets are cheap or expensive relative to history, and therefore a useful guide to long-term return potential. The relationship is clear: when valuations are high, forward returns are low. As seen above in Figure 1, U.S. equities sit near historically elevated CAPE levels, which points to more modest returns ahead.
Why Expectations Stay Inflated
If the evidence is so clear, why do surveys consistently show investors expecting 8–10% returns? The answer lies in psychology. Several behavioral biases feed this optimism:
• Recency bias: projecting the strong returns of the past decade indefinitely forward.
• Home bias: concentrating in U.S. equities, despite their elevated valuations.
• Overconfidence: underestimating the power of cycles and the inevitability of mean reversion.
Time and again, these biases have set investors up for disappointment. Think of the late 1990s, when expectations for tech stocks seemed boundless. Or the optimism of 2021, when speculative excess was at its peak. Today’s mood, shaped by more than a decade of U.S. outperformance, carries the same potential risk.
Planning with Realism
The lesson for long-term investors is straightforward. Future equity returns are unlikely to match the exceptional run of the past several years. A more realistic outlook is in the ballpark of 4% real (6% nominal), not 8-10%.
This does not mean abandoning equities–far from it. Equities remain central to growth and wealth compounding. But it does mean grounding our assumptions in objective reality rather than wishful extrapolation. A portfolio designed for 4% real returns will be durable, resilient, and far less vulnerable to disappointment than one designed on the hope of another decade of double-digit gains.
In Conclusion
In the end neither NASA nor investors fail because they don’t plan, they fail when they anchor to the wrong assumptions. In today’s world, where headlines contradict and narratives shift by the hour, the only durable path forward is discipline: preparing rather than predicting, grounding expectations in fundamentals, and aiming to build portfolios designed to better withstand potential shocks that may come next. If we do that, we don’t need perfect foresight–we just need resilience.
Michael P. Moeller, CIMA®
Portfolio Manager & Director of Research