30-year outlook for US stocks


Look to the front
Tuesday's column dealt with the main lesson in investing over the last 30 years: own actions. Possess as much as possible as long as possible. As a first approximation, he was never wrong to buy shares and never sell them.

Today's slice addresses the more difficult task of looking to the future. It's one thing to appreciate the success of the actions. It's another thing to determine if their wonderful results will continue.

We have already come here. In 1989, as I can personally testify, the message for starters was that past performances had been great, but unsustainable. Over the past three decades, the S & P 500 had gained an annualized average of 5.5% after inflation. (All total returns in this column are expressed in real terms.) Naturally, this figure would decrease in the future. The secret of the actions was hidden: they had become too expensive.

This was not the case. Indeed, while US equities posted slightly lower nominal returns over the next 30 years, their real gains higher. Inflation during the second period being only half that of the first period, their annualized real return has improved to reach 6.5%. The good advice for novices on equity in 1989 was not to be wary. Instead, it would have been: "The good news will only improve."

My point being that quick judgments are useless. Neither suppose that history repeats itself, nor instinctive contrarianism are the correct approaches.

High CAPE ratio
The best starting point is the price. How much do stocks cost? And the best measure of price, in my opinion, is the CAPE Ratio Shiller, developed by Nobel laureate Robert Shiller. The CAPE ratio assesses the average cost that equity investors pay to keep the company's profits (calculated on an average of 10 years). A ratio of 20 means that placing $ 10,000 in a stock index will actually yield gains of $ 500.

Good-hearted people have calculated and published the S & P 500 CAPE Ratio over time. This allows us to situate current stock prices in a certain perspective. Compared to the previous two starting points, 1959 and 1989, are the current stock valuations high, medium or low?

– Source: mltpl.com

Without a doubt, they are high. In 1959, the CAPE ratio was about 20, in 1989 it was 16 and now exceeds 28. According to the widest and most comprehensive dashboard ever, the S & P 500 is expensive. This is partly explained by changes in accounting standards that have improved the quality of corporate performance and partly by greater overall financial stability. Modern economic cycles are longer than in the past. In parallel with inflation at rest, this justifies a more abrupt stock market valuation.

But the current assessment seems to exceed the target. A CAPE ratio of 28 implies a "payback" of 3.5% on the S & P 500. Although higher than a 10-year Treasury yield, which stands at 2.7%, this amount is not comforting. Not only are stocks more risky than government bonds and their payments are mostly notional rather than real (apart from paying dividends), but the profits used to calculate today's CAPE ratio have occurred almost entirely during an economic expansion. They are likely to decrease in the short term.

High expectations
James Montier of the GMO fund management company explains why stock prices are so bullish. That's because Wall Street researchers have become so tired. In a letter dated December 2018, Montier stated that the expected average growth rate of five-year US listed companies' earnings, as calculated by I / B / I / S, has changed over time. The painting is very amusing.

– Source: Grantham, Mayo and van Otterloo

A sick wind blows. From 1985 to 1997, Wall Street equity analysts consistently opined on five-year earnings growth. Then, in the late 1990s, when real growth exceeded the expected 12%, analysts' estimates became increasingly optimistic, peaking at 18% at the start of the new millennium. Profits registered then declined, prompting them to reduce their long-term estimates to 9% by the end of 2009 and seven years later.

Unfortunately, Wall Street analysts have been a reliable indicator, in both directions. They have fallen behind in increasing their estimates as their current economies are getting stronger, and they have been shouting "Left!" before the market turns right. Their long-term forecast was at its peak in 2000. By contrast, their earnings prospects were steadily reduced during the big bull market of this decade – until recently.

Deflate optimism
I therefore agree with the experts brought together by Morningstar's Christine Benz that US stock returns are likely to lag behind their long-term averages over the next few years. The forecasts for the annualized performance of large companies' shares from Christine's seven sources range from 4% (BlackRock) to 0%, negative 4% (GMO), with a median of 1%. Six of the seven sources expect similar or better results from investment grade bonds.

(Technically, BlackRock expects a 7% nominal return, to which I applied a 3% inflation discount.)

These forecasts, which cover periods ranging from seven to fifteen years, implicitly assume that the stock market conditions will return to "normal" at the end of the time horizon. The way in which actions will behave from these points is, of course, speculative. It depends greatly on global macroeconomic conditions. But it seems reasonable to me that once normality is restored, equities will return to something like their average of the last 60 years.

Thus, my stylized perspective is to accept the expert's perspective of 1% average annualized inflation-adjusted earnings over the next 10 years, then 6% annualized for the next 20 years. If this is the case, the annualized average for the entire 30-year period would be 4.3%. According to this forecast, US equities from 2019 to 2048 will have annual real returns of about 1 point less than those of my parents 'generation and about 2 points less than what I' d expect. I appreciated.

It's good to be me. That said, although the early years may be tough, the analysis of the background of this column suggests that the stock should remain the purchase of choice for the patient, the investor in the long term, especially if this investor suffers losses serenely. Some might be coming.

John Rekenthaler has been researching the investment fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is eager to point out that, while Morningstar generally shares the views of the Rekenthaler report, his views are his.