Stock market returns are often subpar after a strong 3-year streak, history shows

SimCorp's Melissa Brown said four consecutive years of >15% market returns have been rare since 1926, suggesting 2026 could deliver a below-average return, likely in the single-digit range. She noted that when a strong three-year run is followed by a fourth year, the average return has been just 3.9% versus an 11.8% long-run average. The message is broadly cautionary for equities, though AI-linked stocks could still extend the rally in the near term.

Analysis

The key implication is not simply “mean reversion,” but a likely rotation in leadership and a lower equity beta regime. After a multi-year, breadth-narrowing advance driven by a small set of duration-sensitive growth winners, the marginal dollar is more likely to migrate from index beta into idiosyncratic earnings and balance-sheet quality where valuation support is stronger. That favors defensives, quality cash compounders, and selective value over broad-market exposure, while making passive long-only index exposure a worse risk-adjusted trade than it has been for the last several years.

The second-order risk is to crowded factor exposure rather than the headline index. If the AI complex is still the primary incremental source of upside, the market can remain elevated even as the median stock underperforms; that creates a fragile tape where earnings misses, capex disappointments, or any sign of slower AI monetization can trigger sharp de-grossing. In that setup, semis, hyperscalers, and software names with stretched multiple support are vulnerable to multiple compression even without a broad macro drawdown.

The catalyst window is months, not days: the market can drift higher into year-end if flows remain supportive, but the probability distribution shifts toward low-single-digit returns and higher dispersion. The biggest upside surprise would be a broadening of earnings growth beyond AI and a mild disinflationary backdrop, which would let multiples hold even if growth cools. Absent that, expect rallies to be sold and index-level upside to be capped by positioning and valuation inertia.

The contrarian view is that the market may be underestimating how sticky passive and systematic inflows can be, especially if volatility stays contained. A flat-to-slightly-up year is still consistent with elevated multiples if earnings continue to compound, so the better expression is not an outright index short but a relative-value trade against crowded growth leadership. In other words, the risk is less a crash than a narrow, grindy market where breadth deteriorates while benchmarks mask the damage.

Key Decisions for Investors

• Initiate a pairs trade: long XLP/XLU and short QQQ for 3-6 months. Thesis: lower-beta defensives should outperform if index returns compress into the low-single digits; target 5-8% relative outperformance with defined beta neutrality.
• Trim outright SPY/IVV exposure on rallies and replace with higher-quality active baskets. Use any 1-2% index strength to reduce passive beta; the skew now favors upside-capped, range-bound performance rather than trend continuation.
• Buy put spreads on SMH or QQQ 4-6 months out, financed by selling shorter-dated upside calls. This expresses the risk that crowded AI leadership de-rates without requiring a full market break; aim for 2:1 or better payoff if multiple compression starts.
• Overweight quality balance-sheet compounders versus unprofitable growth, with a bias to healthcare and staples. If the market enters a lower-return regime, companies with pricing power and FCF durability should command a premium over long-duration cash flow stories.
• Set a trigger to add index hedges if breadth weakens further while the S&P grinds higher. If leadership narrows to fewer names and equal-weight underperforms by another ~2-3% vs cap-weight, use that divergence to increase protection rather than chase the index.