Liz Looks at: Wrong Calls

By: Liz Young Thomas · August 03, 2023 · Reading Time: 5 minutes

Too Early or Too Wrong?

It’s no secret that bears have found themselves on the wrong side of the market — and in many ways, the economy — so far this year. I count myself as one of them, and nobody likes feeling wrong. It’s my job to use a combination of data, experience, theories, intuition, and history as a basis for making calls, and it’s been endlessly frustrating and humbling to watch things happen differently than I expected. For many months.

The conundrum of this situation is multi-layered. If you believe there will still be trouble ahead and hold your line, the more time that passes without said trouble, the more people will say you’re wrong, not early.

If you change your mind too soon, people will say you’re a flip-flopper who lacks conviction. If you change your mind too late, people will say you capitulated, followed the herd, and gave in.

If you’re a bear for six months and wrong, people will call you stubborn and a permabear. If you’re a bull for six months and wrong, people will call you delusional and say you’re talking your own book.

If you’re right, you’re a hero. But you have to be right at the exact right time. And even when you are, your moment in the spotlight is fleeting.

All of this has brought me to the conclusion that there is no such thing as a state of right or wrong. Even if you’re “right” in one moment, you could be wrong in the next. And there will always be people who think you’re wrong, no matter the circumstances. So we might as well get used to it.

The Right Kind of Trouble

I try to stay out of trouble as much as possible, but if I’m going to get into it, I want it to be good trouble. Good trouble to me is having a somewhat controversial opinion I have strong conviction in, that comes from a place of intellectual honesty and can be backed up by data. It gets me in “trouble” with those who disagree, but it’s good trouble because I believe in the logic of it and am willing to be patient as it plays out.

One of those opinions I currently hold is that the outlook for returns from this level of valuations is grim. I am certainly not the only one who thinks this, but the number of investors who believe valuations are justified seems to be growing by the day.

Justified or not, the reality of the chart below is that a forward P/E ratio of nearly 20x suggests that the next 10 years of returns on the S&P 500 will be below average.

The average annual return on the S&P is ~7%. Rarely does a year finish at or around the average, but the long-term expectation for an investor to realize on an annualized basis is generally in that range.

Getting to that average occurs with a combination of ups and downs, some more violent than others, all of them unpredictable. Point being, if from this level of P/E we can only expect a 3.6% annualized return over the next 10 years, there’s more likely to be a pullback in our near future than a blistering rally. Especially after YTD returns of nearly 18% already.

The opinion I stand by in this period is that the price you pay for stocks matters. In fact, I believe it matters more now than ever given where the fed funds rate is, and the sharp rise in borrowing costs as a result. It costs more to finance growth today than it did one year ago. If growth costs more, it needs to offer comparable opportunity.

But has the opportunity really increased that much? Sure, AI gives us a new set of opportunities to follow over the coming years, but does it justify 40% return over seven months? The Nasdaq 100 is up over 40% YTD, much of which was driven by AI-related enthusiasm. Even if that serves as a forward looking mechanism, it suggests that AI has to produce 40% more strength/growth/innovation for those companies (in aggregate) over the next six-to-12 months.

I just don’t think themes materialize that fast.

The Wrong Kind of Time

Regardless of the fact that I think market risks are simply delayed, not dead, the current state of affairs looks less risky than I expected.

When we look at common risk indicators such as credit spreads and the VIX index, things look decidedly cool, calm, and collected.

In times of increased uncertainty, the VIX tends to hover above 20. In times of certain stress, the VIX tends to spike to 40 or higher. Since the end of March, the VIX has bounced around in a range from 13-18, hardly screaming “stress.”

High-yield credit spreads can be used as a proxy for risk appetite. The tighter the spread, the higher the appetite, and vice versa. In times of stress, HY can exhibit a spread over the 10-year Treasury yield of 1000 basis points or more. This measure has been under 600 basis points all year. If you’re expecting a stressful credit event to rock markets, there’s no sign of it in spreads at this point.

My intuition and knowledge tells me to bend, not break. There are imbalances and inconsistencies in this market that don’t allow me to become a bull and still feel honest with myself. But I recognize that there are multiple indicators telling me I’m wrong. And I very well may end up being “wrong” in the end. The end is coming, and we’ll find out. When we do, and if it becomes clear that we can re-normalize policy, re-steepen the yield curve, and re-start the growth engine without resetting valuations…I will admit defeat. I still don’t think this is the end.


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