That said, investors looking out 12 months or more may need to have modest expectations for U.S. stocks. While domestic fundamentals are solid, there are headwinds. Margins are at record highs and are likely to come under pressure as wages firm and rates creep higher. A strong dollar is proving problematic for U.S. companies that sell abroad. But arguably the biggest headwind is valuation. According to Bloomberg data, U.S. large cap equities, as represented by the S&P 500, trade at roughly 17.5x trailing earnings and more than 25x cyclically-adjusted earnings. Both measures are comfortably above their long-term averages. In the past, similarly high valuations have been associated with below-average returns over the longer term.

To be sure, markets have staged big rallies from high valuations—stocks had a number of stellar rallies in the late 1990s when valuations were already high, for instance. However, valuations have mattered in the past, particularly when you look at time horizons of a year or longer using data from Bloomberg. Looking at annual price returns over the past 60 years, Bloomberg data show that annual price returns have been roughly 5 percent when the starting valuation on the S&P 500 was above the long-term median, roughly 16.5x trailing earnings. In contrast, according to the data, when the starting valuation was below the median, annual returns were generally in the low- to mid-teens. Investors should also take note that poor years—those in the bottom quartile of returns—tended to be worse when starting valuations were more elevated over the long-term average.

For investors the main takeaway is that while U.S. stocks are still likely to outperform U.S. bonds, neither may provide particularly exciting returns over the next few years.

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.