Vanguard recently issued an investment outlook with expectations that US stocks will generate a 4-6% annualized return over the next 10 years. Bank of America is targeting 4-5% and Charles Schwab chips in with a 6% return over the same timeframe. However, historical evidence suggests these expectations are much too conservative.
“Recency bias” tends to be pervasive in the forecasting business. When the market goes up, most observers expect it to keep going up. For example, in late 2021, the median forecast made by 17 strategists for 2022 assumed that the market would post a modest advance after three consecutive years of gains. Instead, the S&P 500 Index declined 19%. On the heels of this decline, many observers have become less optimistic about the long-term outlook for the stock market.
Many investors attribute concerns about high inflation, rising interest rates, and possible recession as underlying causes for the bear market. However, a less conspicuous factor, the regression-to-the mean phenomenon, also played a role in pushing the market down last year.
One simple observation foretells a forward return of 8%. The trailing 10-year S&P 500 annualized return for the end of 2022 declined from 16.6% one year earlier to 12.2% by the end of last year. If one simply assumes that additional regression will take place over the next ten years, this implies a forward 10-year return of 8%, which is higher than all forecasts. However, there are other factors to consider when addressing this question.
A look at history suggests even higher returns are within reach. On a calendar basis, the S&P 500 decline of 19% last year ranks as the 4th worst since WWII. The other three are shown below along with respective 10-year recoveries.1 It can be observed that high double-digit loss years have been followed by strong market recoveries in past cycles.
Until the 1970’s, corporate profits used to grow in line with nominal GDP growth of 7% per year on average. The 1970s marked an inflection point in the economy due to the emerging impact of technology on our economy. Microsoft was founded in 1975 and Apple in 1976 and both went on to become two of the top five most profitable companies in the world. Since 1972, S&P profits have grown at a 12.4% clip due to an acceleration of technology sector profits and also due to the ballooning volume of corporate buybacks.
In 1982, the Securities and Exchange Commission passed a rule allowing corporations to buy back their shares. By reducing the number of shares in circulation, per share earnings can be increased by a commensurate amount. Hence, a 5% reduction in shares outstanding will lead to a 5% bump in eps. During the years 1982-2005, the volume of buybacks remained under $200 billion and then started to grow rapidly. The total volume of buybacks exceeded $1 trillion for the first time in 2022. Annual buybacks now dwarf annual dividend payments of some $500 million a year.
In summary, bear markets often weigh heavily on investors’ minds, making them less optimistic about the future. At this moment, many investors are looking at the proverbial glass not as half full, but as half empty. With regard to the 10-year outlook for the stock market, we consider most forecasts as being too modest. Using history as a guide, we view a forward return of 7-10% per year as being more realistic.
Vanguard recently issued an investment outlook with expectations that US stocks will generate a 4-6% annualized return over the next 10 years. Bank of America is targeting 4-5% and Charles Schwab chips in with a 6% return over the same timeframe. However, historical evidence suggests these expectations are much too conservative.
“Recency bias” tends to be pervasive in the forecasting business. When the market goes up, most observers expect it to keep going up. For example, in late 2021, the median forecast made by 17 strategists for 2022 assumed that the market would post a modest advance after three consecutive years of gains. Instead, the S&P 500 Index declined 19%. On the heels of this decline, many observers have become less optimistic about the long-term outlook for the stock market.
Many investors attribute concerns about high inflation, rising interest rates, and possible recession as underlying causes for the bear market. However, a less conspicuous factor, the regression-to-the mean phenomenon, also played a role in pushing the market down last year.
One simple observation foretells a forward return of 8%. The trailing 10-year S&P 500 annualized return for the end of 2022 declined from 16.6% one year earlier to 12.2% by the end of last year. If one simply assumes that additional regression will take place over the next ten years, this implies a forward 10-year return of 8%, which is higher than all forecasts. However, there are other factors to consider when addressing this question.
A look at history suggests even higher returns are within reach. On a calendar basis, the S&P 500 decline of 19% last year ranks as the 4th worst since WWII. The other three are shown below along with respective 10-year recoveries.1 It can be observed that high double-digit loss years have been followed by strong market recoveries in past cycles.
Until the 1970’s, corporate profits used to grow in line with nominal GDP growth of 7% per year on average. The 1970s marked an inflection point in the economy due to the emerging impact of technology on our economy. Microsoft was founded in 1975 and Apple in 1976 and both went on to become two of the top five most profitable companies in the world. Since 1972, S&P profits have grown at a 12.4% clip due to an acceleration of technology sector profits and also due to the ballooning volume of corporate buybacks.
In 1982, the Securities and Exchange Commission passed a rule allowing corporations to buy back their shares. By reducing the number of shares in circulation, per share earnings can be increased by a commensurate amount. Hence, a 5% reduction in shares outstanding will lead to a 5% bump in eps. During the years 1982-2005, the volume of buybacks remained under $200 billion and then started to grow rapidly. The total volume of buybacks exceeded $1 trillion for the first time in 2022. Annual buybacks now dwarf annual dividend payments of some $500 million a year.
In summary, bear markets often weigh heavily on investors’ minds, making them less optimistic about the future. At this moment, many investors are looking at the proverbial glass not as half full, but as half empty. With regard to the 10-year outlook for the stock market, we consider most forecasts as being too modest. Using history as a guide, we view a forward return of 7-10% per year as being more realistic.
Manager of the Golden Eagle Growth Strategy
