The cumulative gain on the S&P 500 for 1995 and 1996 was 69.2 percent, the best two‐year period in a generation and one of the best in the history of stock market returns (only four other consecutive two‐year periods were better as measured by the S&P 500). The geometric mean of approximately 30 percent a year for the years 1995 and 1996 was slightly more than three times the annual average gain for common stocks over many years.

Do investors form unrealistic expectations about future returns as a result of such activity? In the four previous cases of two‐year cumulative returns averaging 30 percent per year or more, the average annual return for the next five years was negative in two cases (−7.5 percent and −11.2 percent), and positive but less than 9 percent in two cases. Moreover, most observers believe that stock returns tend to “revert toward the mean” over time—that is, periods of unusually high returns tend to be followed by periods of lower returns, and the opposite is also true.