There’s a well-known saying in science the correlation does not equal causation. We know this to be true. Just google “spurious correlations” and you’ll find endless examples of two completely unrelated data points that appear to move together.
For example, here’s a fun one: U.S. per capita cheese consumption almost perfectly tracks the number of people who die tangled in their bedsheets. Is eating cheese in bed really deadly? Of course not.
But in the case of this week’s indicator, the correlation has both a strong track record and a logical explanation. The chart compares the average investor equity allocation (blue line, left scale) with the subsequent 10-year returns of the S&P 500 (orange line, right scale, inverted).
The relationship is quite strong. Since 1951, the two series have had a correlation of nearly -0.9. That means changes in investor equity allocations almost perfectly negatively match the subsequent 10-year returns of the stock market. (A negative correlation means increases in equity allocations lead to lower stock market returns, and vice versa, hence why we’ve inverted the S&P 500’s scale for easier viewing).
And there are good reasons this isn’t just statistical noise. Think about it. When investors are already heavily committed to stocks, there’s less new money left to drive prices higher. When allocations are light, there are fewer sellers to keep prices down. That’s the liquidity story. From a sentiment perspective, it also makes sense. Contrarianism—one of our core investment principles—holds that the crowd tends to be wrong at extremes, and this chart seems to capture exactly that dynamic.
So where do we stand today? The average investor’s equity allocation is sitting at a record high, around 53%. If history is any guide—and if this relationship holds—that implies the S&P 500’s rolling 10-year return could sink to as low as -3% annually. That’s a big swing from the +13% annualized return we’ve just experienced.
That’s a sobering claim, and one that we as investors need to contend with. But here’s the key: this isn’t the kind of indicator we use directly in our models. It isn’t actionable in a near-term sense. Instead, it serves as a guidepost—a long-term roadmap of where markets may be headed.
In short, it helps us set expectations. Does that mean we’re locked into a decade of negative returns? Not necessarily. But it is a reminder that markets move in cycles. Stocks don’t just go up forever. History shows long stretches of disappointing returns, like in the 2000s or the mid-20th century. And this chart is a clear warning that we may be entering another one of those periods.
This is intended for informational purposes only and should not be used as the primary basis for an investment decision. Consult an advisor for your personal situation.
Indices mentioned are unmanaged, do not incur fees, and cannot be invested into directly.
Past performance does not guarantee future results.
The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S.