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A recent article summarized the predictions of 500 advisors for the 10-year returns for a number of asset classes. If advisors construct portfolios based on those forecasts, they will destroy significant portions of their clients’ wealth.
Specifically, advisors expect large U.S. stocks to average 5% over the next 10 years (half of the long-term average of 10%). Fewer than 5% of advisors expect the next 10-year return to be equal to or greater than the 10% long-term performance of the stock market. (I will use nominal returns – before inflation – throughout this article.)
To further put this in perspective, for the nearly 70 years from 1950 through 2017, the stock market has experienced eight (14% of the total) rolling 10-year periods in which returns averaged less than 5%. Four of these were driven by the stagflation of the 1970s (none were negative) and four were prompted by the Bernanke-driven 2008 market crash (two were small negative and two were small positive).
On the other hand, 21 (36% of the total) of the rolling 10-year periods averaged returns greater than 15%. That is, it is nearly three times more likely to earn a 10-year return greater than 15% than it is to earn a return of less than 5%. Yet advisors are, on average, forecasting a 10-year return of 5%!
This begs the question of what horrific economic and market events do these advisors foresee to justify such a dour 10-year outlook for the stock market.
It’s the economy!
The history of stock returns reveals that regardless of whether we are primarily agrarian (early to mid-1800s), industrial (late 1800s to mid-1900s), or service/information (mid 1900s to present), the average annual return has been right around 10%. The reason is that during each of these periods, economic growth varied little, allowing stocks to generate the same average return in each of these dramatically different time periods.
Economic growth provides the guidewire around which market prices fluctuate. The stock market goes up over time because the economy grows over time. Furthermore, the most economically successful companies generate the highest long-term returns. An investment in the stock market is a bet on the future success of the underlying economy.
What do advisors see regarding the economy that would lead them to believe the next 10 years will be so dismal? It turns out not much. The economy is booming, with strong growth as indicated by both purchasing manager indices (PMIs) at or above 60 and inflation remaining low. Interest rates are expected to rise, but this is normal for a strengthening economy. The current quarter saw the largest uptick in expected earnings in a decade, driven by a tax reduction and technology tailwinds. This strong earnings growth will more than offset the negative impact of rising rates on stock prices.
Many point to the currently high CAPE and overall average P/E ratio as an indication that the market has gotten ahead of the economy. At AthenaInvest, we focus on the median-forward P/E, as it avoids the well-known problems associated with including 2008 in 10-year earnings estimates and the bias from including high P/Es for companies with earnings near zero when calculating an average P/E. The current S&P 500 median-forward P/E is a bit above its long-term average, indicating some but not worrisome overvaluation.
At AthenaInvest, we also focus on behavioral market measures. Our three market barometers, which capture deep behavioral currents in the U.S. large-cap, U.S. small-cap, and international developed stock markets, are all indicating expected returns of approximately 10%. Our technical measures, which capture short-term behaviors, are showing normal strength as well.
Based on current economic, valuation and behavioral data, I am hard-pressed to come up with a narrative to support the pessimistic return outlook captured by the advisor survey. Unless advisors are anticipating major, adverse events years in advance, there is little in the current environment that justifies anything other than a normal return forecast for the next 10 years.
Figure 1: S&P 500 Annual Returns: 1926-2017
Read the full article here by by C. Thomas Howard, PhD – Advisor Perspectives
