Rising valuations and lower expected returns may appear to hurt investors, but they actually force capital into riskier, more innovative ventures, ultimately driving economic progress. While a "50x world" of ultra-high multiples seems dystopian, it could democratize opportunity and reward genuine risk-taking over passive wealth accumulation. Along the way environment, blockchain technology enable investors to express personalized risk preferences and hedge uniquely — beyond what traditional finance allows.
Introduction
Most instinctively see rising asset prices — whether in stocks, bonds, or real estate — as a looming negative. After all, higher prices mean lower expected forward returns. These concerns often blend into the larger social critique that higher asset prices exacerbate inequality. The logic goes that if asset owners get richer while others get left behind, the result is a more divided society. While it’s true that asset inflation can temporarily widen wealth gaps, this narrative overlooks a key second-order effect: high valuations push investors to take real economic risks, funding ventures that might not otherwise see the light of day.
When expected returns are high and "safe" yields are plentiful, there’s little incentive to back new ideas. Why bother taking venture risk when you can clip a steady 8% coupon on government bonds? But when those yields collapse, investors start chasing returns wherever they can find them — and that chase often leads directly to funding the frontier of innovation: early-stage startups, experimental biotech, advanced manufacturing, climate tech, and beyond.
In other words, high asset prices don't just inflate balance sheets. They drive capital into the riskiest, most imaginative parts of the economy, indirectly spurring technological progress and long-term economic growth.
This system-level dynamic mirrors an important shift individual investors should consider. Many young investors focus almost entirely on protecting against big losses (the "left tail") — worrying about avoiding catastrophic drawdowns. But in a world where passive 1 beta exposure is unlikely to deliver eye-popping returns, it becomes equally important to think about maximizing the "right tail": the rare, large, asymmetric payoffs that define real wealth creation. In the end, rising asset prices might not be a curse. They might be the very catalyst that forces capital (and individuals) to embrace risk in ways that ultimately drive innovation, economic growth, and — paradoxically — create new opportunities for future generations.
How Tails Affect Allocations
Nassim Taleb’s The Black Swan is widely regarded as essential reading on Wall Street. The lesson it hammers home is simple but profound: consistently underestimating small probabilities can have an outsized impact on portfolio outcomes and capital allocation. Yet, despite widespread acknowledgment of "fat tails," many investors — even sophisticated ones — still lack a strong intuition for how these rare, extreme events fundamentally constrain the size and aggressiveness of their allocations.
Despite this, most investors still lack strong intuition for how these "fat tails" — rare but severe downside events — actually constrain how much risk they can (and should) take. Suppose you’re doing well as a finance professional and save $500,000 each year after taxes and expenses. You set a mental threshold: $500,000 is the most you’re willing to lose in the market, since you can replenish that loss in a year.
The strictest way to guarantee never losing more than $500,000 is to invest no more than $500,000 in stocks. But you quickly realize this is overly conservative. Instead, you’re willing to tolerate losing $500,000 once in a generation — say, once every 20 years, or with roughly a 5% chance in any given year (yes I know that isn’t how math works, this is just an approximation). So, the question becomes: how much can you invest in the market if your "acceptable" 5% worst-case loss is $500,000?
Under the simplest (and unrealistic) assumption of normal, iid returns with 7.5% expected drift and 15% volatility, the 5th percentile annual return corresponds to about a 15% loss. This means you could allocate up to roughly $3.33 million ($500,000 / 0.15) to equities.
However, real-world markets don’t behave like smooth Gaussians. If you look at options market data — for example, the price of 1-year, $5-wide put spreads on SPY from Yahoo Finance — the market-implied distribution suggests there’s about a 5% chance of a 40% drop over the next year (at time of writing). Using this implied tail risk, your maximum allocation shrinks dramatically: $500,000 / 0.40 = $1.25 million.
Of course, market-implied probabilities are risk-neutral, not "true" physical probabilities; they embed risk premiums demanded by investors hedging severe downside. In practice, these estimates may overstate the actual probability of extreme losses. Nonetheless, they provide a concrete — and sobering — illustration of how accounting for fat tails sharply reduces feasible allocation sizes for any risk-averse investor.
Upside Tail Risk: An Analysis of US Equity Valuation in the Extreme Case
Most young investors (myself included) spend far too much time worrying about market crashes. In reality, I argue that rational long-term savers should be equally — if not more — concerned about the "risk" of permanently higher valuations.
To be clear, this is not a prediction. By definition, I call this a tail risk precisely because it has a low probability of occurring. Yet for anyone whose primary cash flows (salary, future savings, etc.) lie far in the future, the truly worst-case scenario isn’t a temporary drawdown — it's a world where valuations rise to some absurdly high level, say 50x earnings, and stay there permanently.
If that sounds implausible, it should! But let’s illustrate how it could technically happen. If US equity markets simply repeated their performance of the past decade over the next 10 years, that’s exactly the multiple we would end up with.
For this analysis, I draw on data and frameworks from AQR’s Driving with the Rear-View Mirror. To isolate the role of valuation multiples in driving returns, recall that US equity excess returns can be decomposed as follows:
- Real total returns on the S&P 500 (with dividend reinvestment),
- Minus real returns on short-term Treasuries (with reinvestment).
Further, real stock returns can be broken down into three key components:
1️⃣ Dividend yield paid to investors,
2️⃣ Real growth in earnings per share,
3️⃣ Changes in the price-to-earnings (P/E) ratio (i.e., valuation expansion)
Importantly, this decomposition is purely an accounting identity — not an economic forecast. By construction, changes in the P/E ratio account for all price movements not explained by dividends or earnings growth.
Over the past decade, excess compounded returns on the S&P 500 averaged an astonishing ~12% per year, with a risk-adjusted Sharpe ratio of 0.82. Relative to both historical data and other equity markets globally, this is truly extraordinary. Considering the staggering amount of wealth created, it would not be an exaggeration to say that we’ve just witnessed the greatest bull run in the history of capitalism.
Non-U.S. developed equities (MSCI World ex U.S.) performed much worse than their American counterparts, delivering only about 4.4% annualized returns over the same period. Much of the U.S. market's outperformance has been driven by the explosive growth of a handful of mega-cap technology companies that now dominate the S&P 500, as well as investor euphoria over the potential transformative impact of artificial intelligence on corporate earnings and productivity.
The following decomposition illustrates the key drivers behind the exceptional performance of U.S. equities. Real earnings growth was indeed robust, surpassing the post-war historical average, while negative real returns on cash further boosted excess equity returns. Although dividend yields were somewhat lower (around 2.1%), this was more than offset by a substantial expansion in valuation multiples, contributing approximately 3.6% per year to total returns.
As a result of multiple expansion and widespread stock buybacks, the cyclically adjusted price-to-earnings ratio (CAPE) rose from 24 to 30 over the past decade — and has reached 34 as of June 17, 2024.
Using this return decomposition, we can now estimate what level of valuation would be required for equities to repeat their last decade of spectacular performance. Let’s consider each contributing factor to excess equity returns. According to the Fed’s internal projections, the median estimate for the real federal funds rate is 0.5%, a sharp contrast to the –1.7% real rate of the previous decade. Currently, the dividend yield sits at about 1.5%. The remaining returns must therefore come from real earnings growth and further multiple expansion.
Assuming an ambitious 11.9% annual excess equity return going forward, we can plot the required combinations of earnings growth and valuation expansion needed to achieve this — revealing just how aggressive these assumptions would have to be.
We observe that even under the aggressive assumption of 6% real earnings growth, companies would still need to trade at over 50x earnings to repeat the performance of the last decade. While 6% real earnings growth might sound extreme, it is not entirely impossible: over the past 10 years, real earnings growth has averaged around 4.5%, and if we exclude recession periods, we approach that 6% figure.
Moreover, although markets have never sustained a 50x multiple, they did reach 44x during the peak of the dot-com bubble. In short, repeating the last decade’s equity performance would require both historically unprecedented non-recession earnings growth and the market trading at its richest valuation levels ever. While this scenario is highly improbable, it is not impossible — and as Taleb would remind us, low-probability tail events can carry profound implications that deserve consideration.
The Path to a 50x World
A world where markets sustain 50x earnings multiples does not have to be a temporary bubble. In fact, if we think carefully, there is no fundamental law of nature that entitles a passive index fund investor to 10% annualized returns simply for doing nothing. That return only exists because the global economy needs savings — and because savings are relatively scarce. But several slow-moving structural trends suggest we may be moving into a world where both of these conditions weaken.
First, the nature of economic growth today is far less capital intensive than in past industrial eras. Manufacturing economies historically required heavy upfront investments in fixed assets and real estate — think steel mills and factories. In contrast, a modern service- and tech-driven economy often requires dramatically less capital. This is obvious if you look at the balance sheets of companies like Google or Meta, whose value creation relies far more on intangible assets than on physical infrastructure.
Moreover, technological advancement is inherently deflationary. For example, Wikipedia is vastly superior to Encyclopedia Britannica as an information source, but it generates far less revenue — and thus, in pure GDP accounting terms, "destroys" economic output even while providing more societal value.
However, this deflationary effect does not act in isolation. It is counteracted by aggressive monetary and fiscal policy, particularly by central banks like the Federal Reserve that actively aim to generate positive inflation. Yet the distributional effects of these policies are deeply unequal. In monetary policy, asset purchases benefit holders in direct proportion to their existing wealth — those who own more assets benefit more. In fiscal policy, even if funds are initially distributed progressively, the ultimate income and consumption flows still reflect the underlying structural inequalities of the economy.
Inequality is unlikely to “get better.” As Paul Graham writes in The Refragmentation:
“The form of fragmentation people worry most about lately is economic inequality, and if you want to eliminate that you're up against a truly formidable headwind that has been in operation since the Stone Age — Technology. Technology is a lever. It magnifies work. And the lever not only grows increasingly long, but the rate at which it grows is itself increasing.”
It’s well known that high earners save a larger share of their income. We also know that aggregate savings are elevated, and not just because of COVID stimulus. Structurally, rising wealth and income inequality directly increases private-sector savings, making capital less scarce. While this effect depresses returns for investors, it is a boon for entrepreneurs: higher valuations mean cheaper access to capital.
Indeed, the relationship between capital supply, technological progress, and inequality can become self-reinforcing. Cheap capital fuels companies like Uber and Carvana, enabling them to disrupt traditional industries, often increasing both efficiency and inequality. All else equal, inequality exerts a deflationary force on the economy (wealthier households spend proportionally less), which in turn depresses the cost of capital further through both excess savings and the monetary policy interventions needed to spur inflation.
Beyond technological advancement, another structural force may permanently lower the cost of capital: society’s collective learning and improved understanding of financial markets. From 1871 to 1940, U.S. equities returned about 6.8% per year after adjusting for dividends and inflation. But no investor at the time could have known this — the first comprehensive historical compilation of U.S. equity returns (Shiller’s dataset) wasn’t published until 1989. What now feels obvious — “just buy the index” — only seems obvious because we have decades of data, accessible computing power, and hindsight.
Moreover, for most of financial history, it was nearly impossible for the average household to gain broad market exposure. According to Vanguard, in the early 1940s only 4.2% of the U.S. population owned stocks, and among them the median investor held just two individual stocks. It took decades for the securities industry to build and popularize cost-effective mechanisms to diversify away idiosyncratic risk, culminating in the rise of index funds.
Today, passively managed assets have surpassed 50% of total equities, and the trend shows no signs of slowing. Some active managers find this so concerning that they’ve called indexing “worse than Marxism” — a humorous, if telling, sign of how far capital market access and knowledge have come.
Typically, economists agree that when a product’s risk is reduced, the excess return it needs to offer should also decrease. For example, it is widely acknowledged that the development of efficient methods for securitizing mortgage lending reduced the cost to lenders of diversifying, thereby lowering borrowing costs for homeowners.
Yet when we make a similar argument for equities — that the development of efficient methods to “securitize” equities via index funds should justify higher valuations (and thus lower future returns) — people often object.
Economists have long puzzled over the so-called excess equity risk premium. But it may well be that this premium was simply a temporary market inefficiency, gradually eroded by financial innovation. We now know that “stocks” and a “stock market index” are fundamentally different: one is a raw asset class, the other is a systematically diversified investment strategy. They do not share the same return or standard deviation.
The fact that an equity risk premium historically existed in indices may simply reflect that too few people were diversifying effectively — and as more investors pile into index strategies, it’s natural that the premium would compress or even disappear.
How to Hedge Upside Risk?
The path to a 50x earnings multiple would certainly generate short-term euphoria for investors already holding stocks. However, it would not imply any real increase in future cash flows from companies. Investors buying in at 50x multiples can only expect around 2% annualized returns — all while bearing significant equity risk.
Interestingly, bond investors tend to understand reinvestment risk far better than stock investors. Callable bonds, for example, offer higher yields because the issuer has the right to refinance if rates fall, exposing the lender to reinvestment risk. Mortgage rates are similarly set well above Treasuries due to this embedded optionality. In equities, investors often fail to recognize that a permanently lower cost of capital is analogous: future buyers face the risk of only being able to “lock in” meager future returns. For those of us who expect the majority of our wealth to come from future cash flows, the prospect of a permanently lower cost of capital is actually a major risk.
However, pure linear delta exposure is a very blunt instrument. Current valuations (34x as of mid-2024) are already near historical extremes, suggesting ample room for the market to fall as well. Both tails of the return distribution remain fat. On the surface, it might seem like far out-of-the-money (OTM) long-dated call options would be a perfect hedge for this right-tail risk. But there are several practical problems:
- Listed call options only go out ~4-5 years, far shorter than most young investors’ true horizons (10–30 years).
- The upward-sloping term structure and skew make long-dated far OTM calls extremely expensive, even if you source them OTC.
- Most importantly, what we actually want to hedge is the expansion of multiples — and this can occur even if earnings decline. In fact, macro forces that lower the cost of capital might intensify during a recession, driving multiples up even as fundamentals deteriorate. There is no option contract on index multiples.
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The "best" theoretical hedge would be a custom structured product that pays off if multiples expand, but such products require significant size to persuade a dealer to structure them — and they come with opaque pricing and high fees.
Alternatively, one could imagine an algorithmic strategy that dynamically replicates a call option on multiples, constantly adjusting delta. However, this approach implies high turnover, potential short-term capital gains taxed as ordinary income, and sensitivity to liquidity and execution costs. Whether this kind of dynamic hedge makes sense depends heavily on your tax situation and overall risk tolerance. In practice, such a strategy likely resembles a long momentum strategy on valuations — effectively "buying high and buying higher" — which is somewhat similar to what leveraged ETFs do, albeit in a less precise and more volatile way.
Back to the idea of a structured product that would allow us to hedge such a risk; it is unfortunately the case that traditional brokers and banks are not allowed (nor incentivized) to offer these deeply customized payoff structures to most retail investors. Regulatory regimes prioritize investor protection through suitability rules, product restrictions, and paternalistic limitations on "complex" or "leveraged" strategies — regardless of an individual's actual sophistication, long-term horizon, or personal utility function. Ironically, this often forces investors into blunt, one-size-fits-all exposures, or pushes them to chase speculative short-term bets rather than thoughtfully engineered risk profiles.
Financial regulation, while well-intentioned, ends up suppressing true financial expression: the ability to shape one's risk and reward precisely to match future income streams, career path, or deeply held beliefs about markets and the world.
Crypto rails and on-chain smart contracts present a radically different possibility. By design, they are permissionless and programmable — allowing anyone to create or access bespoke payoff structures, automate dynamic strategies, and transparently enforce risk parameters without centralized gatekeepers or opaque intermediaries.
Moreover, on-chain transparency and real-time margin management ensure that counterparties are fully collateralized or properly hedged at all times. Instead of relying on opaque dealer balance sheets or taking institutional credit risk on faith, you can directly verify whether your counterparty is genuinely managing their exposures or holding sufficient margin to honor payouts. This dramatically reduces counterparty risk and allows for automated, trust-minimized settlement — something impossible in traditional finance.
In this framework, it becomes possible to hedge specific right-tail risks (like permanently higher valuations), engineer targeted convexity, or optimize for outcomes far beyond what any standard ETF, mutual fund, or brokerage margin account can offer. In essence, the crypto-native approach opens the door to a new era of "financial self-expression" — one where investors can finally align their exposures not just with a generic benchmark, but with their actual lives.
Living in a 50x World
The conclusion that right-tail risk is difficult to hedge may feel unsatisfying, but it’s worth emphasizing: this scenario is still extremely unlikely. The probability that markets revert to long-run historical multiples in the near future remains much higher. Even if I am directionally correct about the structural forces driving down the cost of capital, I am almost certainly wrong about the speed — these forces are more likely to unfold over decades rather than years.
Moreover, a 50x earnings multiple world, while seemingly catastrophic for investors seeking high returns, could be broadly positive for the real economy and society. In such a scenario, the cost of capital would collapse, making it vastly easier for businesses to access funding for growth and innovation. This could supercharge investment in R&D, infrastructure, and new technologies — ultimately driving major productivity gains and long-term economic expansion.
A lower cost of capital also encourages entrepreneurship and the formation of new ventures, as barriers to entry are dramatically reduced. More new businesses means more competition, more job creation, and the emergence of innovative products and services that benefit consumers.
Furthermore, a world of persistently high valuations could paradoxically have positive effects on inequality and social mobility. In a 50x world, the value placed on ideas and human capital would increase relative to physical capital, potentially creating a more meritocratic society. Companies able to access cheap capital might be more willing to invest in employee training and share productivity gains with workers through higher wages.
If the thought of a new aristocracy sitting back and compounding wealth passively for generations sounds dystopian, then ironically, you should be rooting for the 50x world. In this environment, there is no return without substantial risk. Nassim Taleb has argued that the true measure of inequality is not static wealth gaps but mobility — the ease of moving up or down the ladder.
A 50x world would make it both easier for a college kid to fund a startup and harder for any individual or family to cement a risk-free dynastic fortune. In such a world, the advantages of inherited wealth diminish sharply: with capital cheap and risk-free yields near zero, compounding without skin in the game becomes nearly impossible.
In short, while such a world would pose challenges to traditional investing paradigms, it might also create an economy that is more dynamic, innovative, and inclusive — one where success is determined more by courage and creativity than birth alone.
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