A “Lost Decade” Ahead For Markets?
2022.05.25 04:36
Is a ahead for markets? We and many others have discussed a topic regarding financial market valuations and forward returns. Now, halfway into 2022, all of a sudden, the of valuations seems a lot less crazy as bear markets growl.
However, it wasn’t that long ago the mainstream media discounted valuations and forward returns. For example, in December 2021, recounted a presenter at a 2010-2011 conference who discussed valuations for a 60/40 allocation in the 95th percentile. Historically, that suggested investors were doomed for a low-return environment of roughly 2-3% over the next decade. As he states:
Decade Returns For Last 10 Years
Valuation and forward return assumptions were wrong then.
Or were they?
Real Market Returns
Over the last 120-years, valuations have consistently proved to be a strong predictor of future returns with lost decades a common occurrence. However, as we discussed previously in
The chart below shows valuations and rolling 10-year total real returns. The obvious conclusion is that overpaying for value leads to lost decades.
SP-500 Total Rolling Returns 10-Years
However, let’s go back to Ben’s comment above. In 2009, valuations had corrected significantly, not only from the peak but also from the preceding bubble. Therefore, investors should have expected forward returns on equities to be higher over the next decade.
The chart below shows this more clearly. I highlighted the three previous points for reference.
- The “Dot.com” bubble peak
- January 2009 (Start of the current bull market cycle)
- Ending valuation for 2021
Valuations 10-Year Returns
From 2000 through 2010, a lost decade, annual returns after inflation were indeed negative. Such is what 43x earnings predicted at that time.
An Artificial Support
The Wall Street Journal recently discussed the last decade’s stellar returns.
WSJ Source Of S&P 500 Returns
While the Wall Street Journal then tries to make the case that profit margins were responsible for the bulk of the gains, the reality is most of the excess returns came from just two unique sources.
- A decade of monetary interventions and zero interest rate policies; and,
- A massive spending spree by corporations on share repurchases.
S&P 500 Decompostion Returns Buybacks
Given the low growth economic environment, low rates, and weak inflation, a market return significantly lower over the last decade is logical. However, given the injections of over $43 Trillion in liquidity, corporate stock buying, and the artificial suppression of rates, the outsized returns were not surprising.
The question is whether those artificial influences can be sustained for another decade?
Lost Decade Ahead?
is one of the most powerful forces in finance, The importance of which often gets lost during a raging that seemingly defies all logic. Such was a point made by David Leonhardt previously:
Market Cap To GDP Ratio
What does such mean for future equity returns?
Vanguard-Forward Return Estimates
Notably, while such commentary is often cast as such forecasts are a reflection of:
- Math and
- Reversions
The second is critically essential.
The Most Powerful Force In Finance
Throughout history, whether it is valuations, prices, profits, or any other metric, eventually, and always, deviations revert to the mean. Such was a point discussed in “The Market Is Disconnected From Everything.”
SP-500-Cumulative Price Vs Profits
Markets are not cheap by any measure. If earnings growth fails to achieve high expectations, interest rates rise, or profit margins shrink due to inflation, the bull market thesis will collapse as collide with
A Lesson To Be Learned
Such is not a dire prediction of doom and gloom, nor is it a forecast. It is just a function of how “ However, during a investors always lose sight of long-term realities. As :
For investors, understanding potential returns from any given valuation point are crucial when considering putting at risk. Risk is an essential concept as it is the expectation of
The more risk investors take within a portfolio, the greater the destruction of capital when reversions occur.
This time is The only difference will be what triggers the subsequent valuation reversion and when it eventually occurs.
Two previous bear markets taught many this lesson. Unfortunately, a whole generation of investors are learning this lesson the hard way.
