Whenever the S&P 500 makes new highs, ‘bubble’ talk returns. Valuations are undeniably rich—CAPE in the high 30s and forward P/Es above long-run norms, but ‘high’ is not the same as ‘irrational’. A lower and more stable inflation/real-rate backdrop, an economy heavier in intangibles, accounting changes, curated index construction, and easier market access can all support a higher equilibrium multiple than in earlier decades. The takeaway is that from rich starting points, long-run returns tend to be lower.

Investing is about more than just chasing returns—it’s about understanding the risks that you’re taking to get them. Financial ratios grounded in Modern Portfolio Theory (MPT) help investors evaluate performance in a structured way, accounting for both total volatility and market sensitivity.

From standard deviation and beta—which capture different types of risk—to the Sharpe ratio, alpha, and the information ratio—which assess how efficiently returns are earned—these metrics offer powerful insights into the true quality of an investment.

Used together, they don’t just measure performance, they help investors make better, more informed decisions.

Traditional theory holds that stock prices reflect fundamental value, adjusting efficiently as rational investors incorporate new information. But recent research by Ralph Koijen and others turns this view on its head. Their findings reveal that markets are far more sensitive to shifts in investor demand than standard models predict—and retail investors play a much bigger role than previously assumed.

In theory, buying 1 per cent of a stock should move the price by just 0.02 per cent. In reality, Koijen shows it moves by roughly 1 per cent—a 5,000-fold difference. The reason? Demand is far more inelastic than standard models assume. And when Koijen examines who is actually driving this volatility, he finds that retail investors and smaller institutions—not large institutions—are the key contributors to cross-sectional price movements.

This inelasticity has profound implications. Prices can deviate significantly from fundamentals for prolonged periods, and arbitrage is often too constrained to correct them quickly. The result is a market that may remain efficient over the long run—but behaves far more irrationally, noisily, and sentimentally in the short term than traditional finance theory would suggest.

It’s tempting to think that rising stock prices reflect improving fundamentals—stronger earnings or higher dividends. But research by John Cochrane and John Y. Campbell suggests otherwise: most price movements are driven not by changes in expected cash flows, but by changes in expected returns.

If dividends are relatively stable but prices are volatile, the discount rate must be moving. In other words, prices often rise because investors are willing to accept lower returns for holding stocks.

This helps explain why valuation ratios like the price-dividend ratio tend to predict long-term returns—not dividend growth. When prices are high relative to dividends, future returns are typically lower.

The implication is clear: expected returns vary over time, and valuation matters. But whilst these signals can inform long-term asset allocation, they’re noisy and best used cautiously.