Aswath Damodaran: beware the past performance of US stocks

Aswath Damodaran, professor of finance, Stern School of Business, New York University0

Aswath Damodaran, professor of finance, Stern School of Business, New York University

Past performance is no guide to the future, as we’re always told in the small print on financial products. Yet it’s what we’ve used to shape our long-run forecasts for returns from various asset classes. New York University professor Aswath Damodaran is not sure that this is a good idea.

For example, he tells Victor Haghani of robo-adviser Elm Partners, Past performance is no guide to the future, but many of our investment strategies are shaped by the history of the US stockmarket over the past century or so. Yet the trouble with using the US experience as the basis for saying that you should always own stocks for the long run, for example, is that “you’ve got a survivor market… the most successful market of the 20th century.”

These strategies rely on “mean reversion” – the idea that while variables such as share price valuations or corporate profit margins may deviate widely, they will always return to a long-term average. And yet we know that sometimes things do go badly wrong or change radically, and that as a result, sometimes markets never revert. But you won’t find “evidence of catastrophe” in the US data – “you’re going to have to go look at the Austrian market to find it”.

So we extrapolate from what was, in fact, an unusual market in an unusual period – “the most mean-reverting, stable market of all time.” The risk now, he says, is that this might change. “For me, 2008 was the dividing line where I think there was a structural break in the global markets. I am less and less trusting of mean reversion on a daily basis.”