Stocks have been delivering strong, positive gains consistently over the past decade. The Covid-19 bear market was a sharp and scary drawdown in 2020, but that year still finished in positive territory despite it. What’s more, the positive returns of the last decade have been accompanied by relatively low volatility – a welcomed outcome for just about every long-term equity investor.1
This period of high returns and low volatility has unearthed a familiar theory – those good returns are usually followed by mediocre returns, while low volatility periods are usually followed by high volatility periods. This theory suggests that if equity investors look ahead to the next five or ten years, we shouldn’t expect much.2
Here is some data I came across recently that was used to support this theory:
Date
Average Annual Return
Volatility
2008-2021
+14.2%
11.6%
2000-2008
-3.3%
20.0%
1978-2000
+13.9%
12.7%
1969-1978
+0.8%
19.9%
1946-1969
+9.2%
16.0%
1930-1946
+2.7%
28.2%
Source: Bloomberg3
Readers can view the seesaw between high returns and low returns, though I would argue the case for high and low volatility is somewhat less compelling. The data tells the story, but I think there are some obvious problems with the way the data is presented.
For one, the periods are virtually all different, meaning that the data is arguably cherry-picked to support the thesis. In some cases, the date range is bookended with bear markets, which would of course blunt the average annual return. And finally, if there is a case to be made here, it should probably be that equity investors can benefit greatly from having long investment horizons. There is no 20+ year period that doesn’t deliver strong annualized returns.
In the current environment, I have seen news sources claiming that U.S. stocks should be expected to return less than 5% annually (after inflation) over the next five years or more. The current valuation of the stock market – coupled with elevated inflation readings – seals this fate, apparently.
I don’t buy it. Not because I believe stocks will surely do better, but because no one can know what to expect from the equity markets more than 12 months into the future. Forecasting returns for the next five years means making major assumptions about how corporate earnings will evolve, where interest rates will move, how inflation expectations will change, and how much economic growth will be generated. These are all factors no one can truly know.
We can be reasonably sure that the U.S. economy will continue to move through cycles of growth, recessions, bursts of innovation and productivity, crisis periods, and everything in between. But over time, there is simply no denying that economic growth, rising corporate profits, and innovation have far outweighed the adverse economic impacts of recessions and crisis periods. Assuming the next five or ten years will be weak ones for growth and equity market performance ultimately means betting against the U.S. economy, which I would strongly advise against.
Bottom Line for Investors
Assumptions about lagging future growth and weak equity market returns often inspire investors to seek alternatives to stocks. The thinking is that investors need to move further out onto the risk curve (alternatives, private debt, hedge funds, etc.) in order to achieve the desired level of return since stocks are likely to underdeliver.
But I take major issues with economic or market forecasts that look too far out into the future. For one, they are almost always wrong. But more importantly, making assumptions about future profits, interest rates, and inflation seems to lack appreciation for how dynamic and unpredictable the U.S. and global economy can be. At Zacks Investment Management, we look out 12 to 18 months when forecasting, and we think in terms of 20+ years when determining asset allocations for retirement and long-term investment planning.
Disclosure
1 Forbes. March 9, 2022. https://www.forbes.com/sites/michaelcannivet/2022/03/09/three-reasons-why-2021-was-a-risky-year-to-retire/?sh=714d67133615
2 Wall Street Journal. April 15, 2022. https://www.wsj.com/articles/the-stock-markets-future-aint-what-it-used-to-be-11650037777?mod=markets_major_pos7
3 Bloomberg. March 9, 2022. https://www.forbes.com/sites/michaelcannivet/2022/03/09/three-reasons-why-2021-was-a-risky-year-to-retire/?sh=714d67133615
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