There is a bleak prediction taking hold in financial circles that a very long winter is about to descend on the stock market.
A new report from the big brains at Goldman Sachs set the investment world abuzz this week with a forecast that calls for miserly stock returns for years to come.
Suddenly, there’s talk everywhere of a “lost decade” about to engulf the stock market.
For anyone with money in equities, this would be cause for alarm. It would mean an end to a golden era for U.S. stocks that arose from the global financial crisis, delivering average returns of 15 per cent a year – every year – over a 15-year span.
For a generation of investors accustomed to boom times, the new paradigm being contemplated would be harsh and unfamiliar.
Lost decades in stocks are sort of like the financial version of 50-year storms – they’re so severe as to be highly improbable at any given point in time.
But as rare as they are, lost decades seem to be predicted with great frequency. A sampling:
September, 2022: “I wouldn’t be surprised – in fact, it’s my central forecast – the Dow won’t be much higher in 10 years than it is today,” said billionaire investor Stanley Druckenmiller. It’s only been two years, but the Dow Jones Industrial Average has gained 45 per cent in that time.
July, 2018: “Our expectation at the moment is that you won’t have any real return from U.S. equities over the next 10 years,” said Dan Kemp, Morningstar strategist. More than six years later, the S&P 500 Index has gained about 135 per cent after dividends, which translates to 14.6 per cent annualized.
November, 2013: “The prospect of dismal investment returns in equities is an outcome that is largely baked-in-the-cake,” said John Hussman, an economist and founder of Hussman Funds, explaining how he expected negative returns for the S&P 500 over the decade to come. Instead, the index ended up generating average annual total returns of 11.8 per cent over the following 10 years.
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February, 2009: “There will be blood,” said historian Niall Ferguson of the economic carnage to come. “We may be looking at a lost decade.” The economy promptly rebounded, and the S&P 500 then gained an average of 16.6 per cent a year over the ensuing decade. Someone who sunk $500 a month into the market over that time would be sitting on roughly $120,000 after 10 years – doubling their money contributed.
And on and on.
Heeding any of those portents of doom would have been a terrible idea. Should we be listening now?
There are certainly big names that have recently pushed some version of a lost decade: Bank of America, J.P. Morgan Securities, Apollo Global Management, Stifel and GMO.
The argument usually hinges on the idea that after 15 years of rising valuations, stocks are due for a long painful period of reversion to historical norms.
There’s no denying that U.S. stocks are expensive. The Goldman report puts the cyclically adjusted price-to-earnings ratio for the S&P 500 at 38 times. That ranks in the 97th percentile, meaning that, in the past century, U.S. stocks have been pricier than they are now only 3 per cent of the time.
Market concentration is an even bigger outlier. Not since the 1930s has the U.S. stock market been as reliant on so few stocks to generate the bulk of returns.
Top-heavy and frothy is not a great starting point for the decade to come. The Goldman team forecasts average returns of just 3 per cent a year over that time.
Now, 3 per cent may not sound disastrous. But stock returns that poor over a decade-long stretch have only arisen from the worst economic events of the past century, such as the Great Depression, or the oil shocks and economic stagnation of the 1970s.
The episode most investors would remember when they think of a lost decade, however, is the 2000s.
Bookended by the dot-com bubble and the global financial crisis, this was one of the two 10-year stretches to see negative total returns in the S&P 500 in the past 100 years. A $10,000 investment in the index at the end of 1999 would have turned into about $9,100 by the end of the next decade.
It was indeed a lost decade for U.S. stocks in aggregate, but not by other measures.
Pockets of the U.S. market did well, such as small cap stocks. The bond market also had a solid decade, with investment-grade American bonds posting annualized returns of 6.3 per cent.
Nor was the decade lost outside the United States.
European stocks grew by 2.4 per cent a year, on average. Canadian stocks were driven higher by 5.6 per cent annually on the back of still-booming global demand for natural resources. And emerging markets’ stocks shot the lights out with double-digit gains.
“Lost decade” is a scary term that’s being thrown around a lot these days. But history has shown that in those incredibly rare instances when decades have been lost, diversified investors have found their way just fine.