All-Time Market Highs: Why They Don't Predict Future Returns

The Canadian and US stock markets reached new all-time highs in 2026, which can make investors nervous. This apprehension often stems from a cognitive bias known as the gambler's fallacy, the belief that past random events influence future ones. However, stock returns are largely random, meaning that a series of positive returns leading to an all-time high doesn't predict future returns.

Understanding All-Time Highs in Stock Market Indices

Stock market indices, such as the S&P 500 for US large-cap stocks or the S&P TSX Composite for Canadian stocks, are groups of stocks weighted by the market value of their constituent companies. They are designed to represent a stock market or a segment of it. To track performance, each index has a base level (e.g., the S&P 500 started with a base level of 10 in 1941-1943). Daily returns are calculated based on the performance of the stocks within the index, and a new index level is recorded. This level increases with positive returns and decreases with negative returns.

Today, the S&P 500 is over 7,000. Media outlets frequently report when a major index surpasses its previous all-time high, but the index level itself can be somewhat misleading due to several factors:

• Price-Only Indices: Index levels are typically calculated based on stock prices only, excluding dividends. If dividends were included (as in total return indices), there would be more reported all-time highs. Academic research indicates that this price-only presentation can negatively influence public perception of the stock market, as price drops after a dividend payment are often viewed negatively, despite the investor receiving the dividend.
• Inflation: Index levels are nominal figures. Inflation alone should cause index levels to rise over time, even without real stock returns.
• Expected Long-Term Returns: Stocks generally have positive expected long-term returns. Therefore, indices reaching all-time highs should be expected, not news.

Analysis of Total Return Indices

To provide a more accurate picture, it's crucial to use total return indices, which include the reinvestment of dividends. This analysis examined 10 developed stock markets and the world stock market from 1970 through May 2026, using monthly returns and index levels.

• Frequency of All-Time Highs: On average, across the 10 individual countries, 20% of months were all-time highs. In the US market, 30% of months were all-time highs, and in Canada, 23%. Italy, with a struggling stock market, had the lowest at 9%. The World Index experienced all-time highs in 31% of months, partly due to diversification.
• Clustering of All-Time Highs: All-time highs tend to cluster. This aligns with a momentum effect, where recent strong performance often continues for a period. All-time highs are more frequently followed by further all-time highs than by market drops. Conversely, periods of high volatility and lower returns also tend to cluster.
• Returns Following All-Time Highs:
  • US Market: Returns following all-time highs were actually higher than returns following all other months at the 1, 3, and 5-year horizons. At the 10-year horizon, they were similar, though slightly lower.
  • Canada: Returns were mixed at shorter horizons and even closer to other months at the 10-year horizon.
  • Global Trend: The one-year average return following all-time highs is consistently higher than other months, supporting the momentum effect. At the 10-year horizon, returns following all-time highs are slightly lower, likely due to higher stock valuations at those times.
  • World Index: Similar returns across all horizons, with significantly higher returns at the one-year horizon following all-time highs, again consistent with momentum.

Historically, investing at all-time highs has, on average, resulted in positive returns.

Market Valuations and Expected Returns

While the level of a stock market index doesn't strongly predict future returns, market valuations do. The Shiller cyclically adjusted price-to-earnings (CAPE) ratio is a common metric for assessing how expensive a stock market is. When investing, you are essentially buying the discounted future cash flows (future earnings) of businesses. A higher stock price relative to earnings implies a lower expected return, all else being equal. Therefore, high stock valuations generally suggest lower expected returns.

An analysis of 10 developed markets from 1982 through 2024, sorting 10-year stock returns by their starting CAPE ratio, showed a clear relationship: higher starting valuations led to lower realized returns on average. However, there is significant variability, meaning that even with high starting valuations, some periods can still yield high future returns. This wide distribution of outcomes makes market timing based on valuation ratios very difficult.

It's important to consider markets beyond the US. While high CAPE ratios in the US market have historically often preceded periods of low or negative returns, including other countries in the analysis presents a more nuanced picture.

Conclusion

All-time highs in the stock market are common, occurring in roughly 30% of months when using total return indices. Average returns following all-time highs tend to be higher in the short term (due to momentum) and slightly lower in the long term (due to higher valuations). However, both expected and realized stock returns generally remain positive after all-time highs.

Stock valuations have a more direct relationship with expected future returns, but the relationship is noisy, limiting its practical use for making precise financial decisions.

The most effective strategy is to remain invested and adhere to your long-term plan, even when market indices reach new all-time highs. Attempting to time the market by selling at perceived highs and buying back in at lows is extremely challenging and often leads to losses.