Investors opening their year-end brokerage statements are likely in for a treat because 2019 generated big returns.
Joy is evident across the many asset classes tracked by Norbert Schlenker, the president of Libra Investment Management. Stock markets gained with the S&P/TSX Composite up 22.9 per cent, the S&P 500 up 25.2 per cent and the MSCI EAFE up 16.8 per cent – all in Canadian dollar terms, all total returns including dividends. But even bonds fared surprisingly well with the FTSE Canada Long-Term Bond Index up 12.7 per cent and the FTSE Canada Universe Bond index up 6.9 per cent.
It was pointed out to me by a sharp observer that simple balanced funds also fared quite well last year. For instance, the Vanguard Balanced ETF (VBAL) gained 14.9 per cent in 2019 thanks to its portfolio with about 60 per cent in stocks and 40 per cent in bonds.
If you want to delve into the past, you can download Mr. Schlenker’s yearly asset-class return spreadsheet at the Libra Investment Management website. It contains market returns in Canadian dollar terms going back to 1970. I’ve enjoyed playing around with the data.
I confess my reaction to the year-end review of my own portfolio wasn’t one of joy. Don’t get me wrong, I did quite well in 2019. Rather the big returns prompted worries that storm clouds may be on the horizon.
Money manager Patrick O’Shaughnessy, chief executive of O’Shaughnessy Asset Management, warned in his year-end letter that his firm’s estimate for the U.S. market’s nominal total return over the next decade is about 1.5 per cent annually. If that’s right, the market would gain a total of about 16 per cent over the entire 10 years. (When you read his letter, you’ll discover he’s bullish on value stocks.)
Money manager David Merkel, founder of Aleph Investments, is similarly glum. He recently suggested that the U.S. market is poised to gain about 2.5 per cent annually over the next decade. He noted it was possible to do better with a portfolio of investment-grade bonds.
Mr. Merkel’s observation got me thinking about a feature I noticed in Mr. Schlenker’s data.
Thing is, the Canadian long-bond index climbed at an average annual rate of 9.5 per cent from the start of 1970 through to the end of 2019. The S&P/TSX Composite Index climbed by an average of 9.1 per cent annually over the same period. Stocks trailed bonds by about 0.4 percentage points a year on average.
The similarity of long-term returns isn’t a new thing. The accompanying table shows the decade-by-decade returns of the bond and stock indexes. They don’t follow each other exactly, but I expected a wider divergence.
Generally speaking, Canadian stock investors haven’t been paid a big premium to take on the risks of stock ownership for decades.
If the long-bond and stock indexes continue to walk, roughly, hand-in-hand then the outlook for Canadian stocks isn’t great. That’s because yields provide a fairly good guess at the future returns of bonds and the 10-year Government of Canada Bond Yield Benchmark clocked in at just 1.45 per cent as of Jan. 22, according to the Bank of Canada.
Broader indexes offer slightly better yields. For instance, the iShares Core Canadian Long Term Bond Index ETF (XLB) portfolio had a weighted average yield to maturity of 2.4 per cent on Jan. 22, according to BlackRock. The iShares Core Canadian Universe Bond Index ETF (XBB) offered a 2.1-per-cent yield.
Many investors will be disappointed with the roughly 2-per-cent annual returns bonds will likely offer. But stocks would have to break a multidecade-long pattern to do much better. There is a fair chance we’re in for a period of modest long-term returns for both bonds and stocks alike.
So, enjoy opening your brokerage statements while you can. Despite everything, I still prefer stocks over bonds. But I am getting a little fearful of what the future may bring.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.