1Q26_ Quarterly Outlook Report_Final_EN - Flipbook - Page 23
T H E P LUMB LI N E | A RETU RN TO F I RS T PRI N CI PL ES
High starting P/Es tend to lead to lower forward returns for the cap-weighted index
20%
10-yr annualized fwd returns
15%
10%
5%
0%
-5%
We are here
-10%
10
15
20
25
12-mth fwd P/E – market-cap-weighted S&P 500 index
Source: Bloomberg Finance LP, Scotia Wealth Management
However, valuations become less predictive of returns for the equal-weighted S&P 500 index,
multiples for which are roughly in line with their long-term average. When the equal-weighted
benchmark’s forward P/E is plotted against 10-year forward returns, the relationship becomes
more dispersed pointing to an uncertain set of outcomes ahead.
The point of this exercise is not to advocate for investing in an equal-weighted benchmark. After
all, over-diversification can have adverse effects by diluting the potential impact of highconviction ideas, leaving portfolios with fewer opportunities to outperform. Instead, portfolios
that actively manage concentration risk – by trimming positions that have had a strong run or
that screen less attractively on a risk‑reward basis – can better mitigate downside risks without
sacrificing return potential. This underscores the importance of active management over simply
buying the index, which leaves investors fully exposed to the concentration risks embedded in
today’s market leadership.
On an equal-weighted basis, valuations are hovering around the historical average.
28
12-mth fwd P/E
24
20
16
12
2015
2018
S&P 500 - Equal weighted
2021
+1 std.dev
2024
-1 std.dev
10-yr avg
Source: Bloomberg Finance LP, Scotia Wealth Management
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