Seeking Alpha

Bill Gates Says Stocks Will Deliver Lower Returns Over The Next Decade - Here's Why He's Wrong

Includes: DIA, IVV, SPY
by: Kyle Fishman

In a recent appearance on CNBC's Squawk Box On May 7th, Microsoft Co-founder Bill Gates said that he expects stocks to deliver lower returns during the next decade.

This prediction lies on the theory that that the 10-year-Treasury yield is too low.

As a historian, I'd like to examine prior periods in history where the 10-year-Treasury yield was at this level or lower, and see how stocks performed during those times.

Microsoft (OTCPK:MFST) Co-founder, Bill Gates, said in a CNBC interview Monday morning, "Absolute returns are predicted to be lower over these next ten years than they've been in most ten-year periods." He clarified that he was referring to absolute returns of "all asset classes" (including stocks). He described the 10-year Treasury yield as a force that "sets the rules, the strength of gravity."

Right now the 10-year Treasury yield is around three percent. Bill Gates figured that since three percent is your "risk-free rate in dollars," then investments that involve "some level of risk" shouldn't be able to return much more than three percent.

He noted that most investors and state pension funds have an expectation to earn 7.5% to 8% annual returns, and he called this "an unrealistic expectation."

Sitting next to Bill Gates in this joint-interview, was Berkshire Hathaway (BRK.A) (BRK.B) Chairman, Warren Buffett alongside Berkshire Hathaway Vice Chairman Charlie Munger. Charlie Munger was asked about what he thinks of this statement made by Bill Gates, and he said that he agrees with Mr. Gates.

As an investor in index funds (SPY), (IVV), and as someone who admires Mr. Gates and tends to give him the benefit of the doubt when making predictions such as these, I was disappointed to hear him make this call. However, I questioned how he figured that there is a link between the 10-year Treasury yield and how stocks perform.

As a historian by nature, I examined prior years where the 10-year Treasury yield was around 3% or lower, and I used an online calculator to view the historical returns of the Dow Jones Industrial Average (DIA).

In July of 2010, the 10-year Treasury yield was at 3.01%. From July 2010 to April 2018, the Dow returned 12.58% annually (adjusted for inflation and reinvested dividends).

In January of 1950, the 10-year Treasury yield was at 2.32%. From January 1950 to January 1960, the Dow returned 15.97% annually (adjusted for inflation and reinvested dividends).

In January of 1940 the 10-year Treasury yield was at 2.21%. From January 1940 to January 1950 the Dow returned 3.15% annually (adjusted for inflation and reinvested dividends.)

In January of 1930 the 10-year-Treasury yield was at 3.29%. From January 1930 to January 1940 the Dow returned 1.51% annually (adjusted for inflation and reinvested dividends).

In January of 1900, the 10-year Treasury yield was at 3.15%. From January 1900 to January 1910 the Dow returned 6.8% annually (adjusted for inflation and reinvested dividends).

For the record; 6.8% is the long-term historical average annual return for the Dow from 1897-Present (adjusted for inflation and reinvested dividends).

So from this data, it looks like the way stocks have performed during the 1930's and 1940's may have validated Bill Gates' point. However, there are several other periods where this is not the case. 1900-1910 delivered historically average return for stocks. The 1950's delivered above-average returns. Even in recent years, stocks have delivered above-average returns despite the 10-year-Treasury yield dipping below 2% around 2012-2013.

So there is still valid reason to expect decent returns for stocks over the next decade, and there is no proven link between stock performance and 10-year-Treasury yields.

I would also add that the Federal Reserve is starting to raise interest rates, and the Treasury yield may rise with it, as they are strongly correlated, and it wouldn't make sense for the Treasury yield to stay low while higher returns (for zero-risk) are being offered in other places such as Certificates of Deposit.

The 10-year Treasury yield may have several useful functions. It is used as a proxy for mortgage rates and a measure of investor confidence. The 10-year Treasury yield falls when investor confidence is low. However, it is easy to see that investor confidence is high because the 10-year Treasury rate has been rising during the past few years. It was less than 2% for much of 2016. It was less than 3% for much of 2017. Now it is finally approaching 3% in a rising-interest-rate environment. As interest rates normalize to historically-average levels, the 10-year Treasury yield may soon follow. So even Bill Gates should agree that with a higher Treasury yield, we can expect higher returns.

Disclosure: I am/we are long SPY, DIA, IVV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.