Investing Without a Crystal Ball: How Probabilities Should Shape Portfolio Decisions
By Robert Koscik with Jason Phipps
Clients know that when I make individual security decisions—what I call my best ideas—I’m not guessing. I try to model history. Specifically, I ask: When have we been in a situation that looks a lot like today, and what actually happened next?
From there, I look for causation. If we’ve seen similar setups before, what were the outcomes, and what does that say about the probability that a given investment works in our favor now? Investing, at its core, is a probability exercise—not a prediction contest.
I’m writing this as a follow-up to last quarter’s lead article on U.S. stock valuations. Since then, I’ve brought the discussion into our one-on-one meetings, where it naturally opens up an important conversation around rebalancing. Over time, strong performance in one asset class can skew an allocation far beyond what was originally intended. That’s normal—but it needs to be addressed.
I also suggest taking the conversation a step further by allowing valuations to influence whether we are overweight or underweight in certain areas. Let me be very clear: this is not market timing. It’s more nuanced than that. If your takeaway from last quarter’s article—or this one—is that we should pull all our money out of the market because it’s about to crash and then jump back in later, you’ve missed the point. I’ll argue forever that emotions play far too large a role in investing, and that successful outcomes come from a measured, disciplined approach.
Why Valuations Matter Right Now
So, back to probabilities.
On a macro level, U.S. stocks—whether measured by traditional price-to-earnings ratios, the Shiller PE, or my personal favorite, price-to-sales—are at or near historical highs. No matter which metric you prefer, the message is consistent.
I had my team do the initial research, and then I went back and checked their work myself. I wanted to identify periods when valuations ranked among the 10–15 most expensive of all time, without the subsequent market decline being driven by an external shock. That eliminates 2007 from the discussion. First, valuations weren’t in the top tier of historical extremes, and second, the market decline was caused by the housing crisis—not valuations.
Here’s what history shows:
- 1929 and 1937: Speculation was rampant. On a Shiller PE basis, the market was the second most expensive ever (behind only 1999). The result? Drawdowns of 64% and 42% over the following decade, ushering in the Great Depression.
- 1961: Traditional PE ratios were at their highest level in 30 years—and wouldn’t reach those levels again for another 30. The drawdown: 28%.
- 1973: Traditional PE again reached levels not seen for 20 years. This period may qualify as more event-driven due to inflation, but the result was still a 48% drawdown.
- 1987: The highest traditional PE ever at the time. A 33% drawdown followed.
- 1999: The highest Shiller PE ever recorded. A 37% drawdown followed.
- Today: The second-highest Shiller PE ever—and the highest price-to-sales ratio in history.
Momentum Is Real—but So Is Math
Given that backdrop, the probability of experiencing a meaningful pullback—defined as greater than 25%—within the next 15 months is, in my view, rather high.
Are there examples where warning signs showed up years too early and acting on them immediately would have been a mistake? Absolutely. Remember the phrase irrational exuberance? Alan Greenspan coined it more than two and a half years before the internet bubble finally burst. If you had pulled out of the market at that moment, you would have missed one of the greatest bull runs in history. But if you had started rebalancing then, you would have positioned yourself to survive the tech crash far better than most.
Momentum is very real—and it has never been stronger than it is now. Technology and growth stocks have led this market since 2008. And that’s a mighty long time.
What This Means for Your Portfolio
To summarize what we’ve been discussing in our one-on-one meetings, I see three realistic paths forward:
Option One: Maintain Current Allocation and Risk
My responsibility doesn’t change—to keep you invested in what the market is rewarding and away from what it’s punishing. As discussed in our December video, this approach generally makes sense for investors 45 and under, as well as some more mature investors who are comfortable staying fully invested.
Option Two: Reduce Risk and Hold the New Allocation
There are two primary reasons to pull back risk:
- You’re getting closer to needing the money, and…
- The market has experienced a concentrated period of excess returns, which historically increases the probability of a pullback.
We all get older every day, and returns have certainly been concentrated—over the last three years, and six out of the last seven. In this scenario, reducing risk and maintaining the new allocation makes sense. Most people become more conservative as they age anyway, so now may be as good a time as any.
Option Three: Reduce Risk, Then Reinvest on Pullbacks This option is similar to the second, but with the intention of using future pullbacks to reallocate back into stocks over time.
The Bottom Line
The probabilities strongly suggest that we will experience a reset in valuations—what’s often called a reversion to the mean. Unfortunately, even Tom Brady didn’t complete 100% of his passes, so I still don’t have a crystal ball. There are no guarantees in life or in markets
What we do have are probabilities, history, and disciplined decision-making. That’s what we’ll continue to rely on—and I look forward to deepening this discussion with you.
Sources: https://www.investopedia.com/timeline-of-stock-market-crashes-5217820