Are Recent S&P 500 Returns Excessive? Part III

Earlier this month I profiled the US stock market’s performance in search of context for deciding if recent returns have gone off the deep end.


By James Picerno

The results suggest that on a rolling 10-year basis, the numbers look middling. Next question: how does the S&P 500 stack up after adjusting for risk via several metrics?

Let’s start by looking at the Sharpe Ratio (SR), Sortino Ratio (SORT), and Adjusted Sharpe Ratio (A-SR) via annualized calculations. A brief summary of each:

Sharpe Ratio: a performance metric that adjusts returns based on volatility.

Sortino Ratio: similar to the Sharpe ratio except that this metric only penalizes volatility associated with negative returns whereas SR treats all volatility equally.

Adjusted Sharpe Ratio: a variation of the standard Sharpe ratio that adjusts for skewness and kurtosis by penalizing returns for negative skewness and excess kurtosis. The metric was outlined in Pezier and White (2006).

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For this simple review I used monthly S&P 500 returns published by Professor Robert Shiller. The start date for this test is 1900. Note, too, that the risk-free rate hasn’t been subtracted from the performance data, i.e., the results are based on S&P returns rather than risk premia. The main takeaway: the market’s current risk-adjusted performance still looks average, based on a rolling 10-year window.

In all three cases, the risk-adjusted performance metrics currently rank as modestly above their respective median results relative to the historical record for the past 100-plus years. The current 10-year Sharpe ratio, for instance, is 0.46 vs. the median 0.38. The current Sortino ratio: 0.68 vs. the 0.60 median. The Adjusted Sharpe Ratio is currently 0.40 vs. a median of 0.38. Here are the historical results at the quartiles:

     Sharpe Ratio Sortino Ratio Adjusted Sharpe Ratio
0%          -0.37         -0.36                 -0.32
25%          0.07          0.22                  0.15
50%          0.38          0.60                  0.38
75%          0.84          1.35                  0.69
100%         1.70          3.81                  1.56

The relatively middling risk numbers don’t preclude the possibility of a correction or even an extended bear market. But from the perspective of a 10-year window, this trio suggests that the market’s current risk-adjusted performance ranks as modestly above average.

Tomorrow I’ll expand the analysis by running the S&P’s returns through an alternative set of risk metrics.