A Decade Of Unexceptional Returns

by: Michael Schulman, CFA

Summary

We could be in slow growth into the next decade without a major crisis.

Markets go up because not everybody is in; and markets go down because not everybody is out – we are in the middle.

Expect unexceptional returns over the next ten years on a buy-and-hold balanced portfolio of equities, bonds, commodities, and cash.

The demise of the stock market has been called for almost a year with different reasons cited: an earnings recession, a real recession, expectations of declining margins, Chinese yuan depreciation, rising Donald Trump polls, Brexit, Trump's win, valuation metrics, upcoming European elections, trade tariffs, [please fill in your personal reason here], and other rationalizations. The term "uncertainty" is cited often as a motive for caution though finding periods of investment certainty are few and far between. Rising inflation expectations, prospects for less loose monetary policies, and stabilizing global growth will keep bond yields under modest upward pressure, but this should not stem global growth.

U.S. corporations have been resilient over the last few years. If the Trump administration lowers taxes and regulatory hurdles, allows for cheap repatriation of $2.6 trillion of corporate earnings held overseas, and fiscally spends more, companies should post higher profits, leading to more jobs and a stronger economy. However, the groundswell of market euphoria that usually accompanies a peak in such prospects is absent, probably because of investor unease towards the new administration's potential trade, political, and social executive orders. Nonetheless, the global economic footing is sounder now than at any time in the last few years. The main downside risk is that the global economy lurches towards stagflation over the next few years. The upside is that we could be in slow growth into the next decade without a major crisis.

Markets go up because not everybody is in; and markets go down because not everybody is out. Little optimism is discounted in today's equity market; thus there is plentiful upside to US economic psychology and to US stocks prices. Until we see a recession coming, our view is that this trending market will continue to be a series of panic-attack sell-offs followed by relief rallies to new highs. S&P 500's earnings this year could be $142 if Trump's tax-cuts are implemented and retroactive to the start of the year, though it shouldn't matter much to the market if tax-cuts start in early 2018 since the market is usually forward looking.

Over the long term, however, with yields still relatively low and equity valuations above average, expect middling returns over the next decade on a buy-and-hold balanced portfolio of equities, bonds, commodities, and cash. The primary drag on performance will stem from low returns on bonds. Managing around this reality will be the biggest challenge for most investors over the next ten years.

  • A G7[i] 10-year government bond portfolio will probably produce near 0% real (inflation adjusted) returns over the period
  • Global equity returns will be moderate, bolstered by solid dividends and reasonable earnings growth, but held back by current mid- to late-cycle valuations
  • Some emerging market equities will see terrific growth, but the performance dispersion amongst different countries will vex portfolio managers and may make trading them as one group disappointing; e.g., India and South Africa look and perform very differently
  • The outlook for commodities is mixed; they will probably outperform government bonds - but with much greater volatility - while lagging other risk assets
  • Overall portfolio returns will be poorer as interest rates normalize (i.e., rise)

We believe that one way to diversify away from public stocks and bonds yet still take advantage of opportunities in credit is through specialized private equity and loan deals. These investments can take advantage of privileged access to management, financial records, and/or board or advisory roles, with equity- or debt-like positions that have discounts, protection, or insight.

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[i] G7 refers to the International Monetary Fund's Group of 7 major advanced nations, consisting of Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.