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What Happens After a Stellar Decade?

Last week, I came across an article in the Wall Street Journal by James Mackintosh entitled "Speak No Evil of the S&P 500’s Neverending Records." The subtitle reads: “Investors buying stocks no matter what shouldn’t fool themselves that the future will deliver the chunky returns of the past decade.”

Before I present a few counterpoints, let me begin by acknowledging that he’s right: no one should expect the S&P 500 to average 12.8% (adjusted for inflation) per year over the next decade. For one thing, the price-to-earnings ratio of the S&P 500 in September 2011 was 13.5. Today, it’s closer to 35. Investors today are paying nearly three times more for every dollar of earnings than they were ten years ago.

Additionally, if we look back over the last century at every conceivable rolling 10-year period, the average annualized real return of the S&P 500 was approximately 7% per year. By historical standards, the last decade was exceptionally profitable (~80% higher than average).

Mackintosh outlines a series of legitimate concerns that could adversely impact future returns, from rising inflation, to geopolitical risks, to pending federal tax hikes, to how long it’s been since the market experienced a correction. For the record, I think these issues (not to mention ongoing pandemic-related trends) are concerning, too.

However, I also think it’s important to remember that while the returns of the last decade have been phenomenal, that doesn’t mean that, ipso facto, the returns of the next decade will be terrible.

To illustrate this point, with the help of Baird’s market guru Ross Mayfield, I surveyed stock market return data from 1921 to the present day. Specifically, I looked at every 10-year monthly rolling period from 1921 to 2021 for the S&P 500 (i.e. January 1921-December 1930, February 1921-January 1931, etc.), and isolated the decades in which the S&P 500 exceeded 11% per year (which is close to what the S&P 500 has returned over 10-year rolling periods since the Great Recession, and the root of Mr. Mackintosh’s warning).

Having isolated the decades with the highest returns (namely, the 1920s, 1940s/50s, and 1980s/90s), I then looked to see how the market performed over the next 10 years. Here’s what I found:

  1. 10-year returns following stellar decades averaged 5.4% per year (~8.4% not adjusted for inflation), roughly a quarter less than the long-term historical average return of 7%.
  2. The dispersion of annualized returns was significant, from as low as -6% to as high as 15% (see chart below).
  3. Looking again at the chart, you’ll notice a tapering effect following stellar decades, particularly since the 1940s. That is, the decades that immediately follow stellar decades tend to be pretty stellar, too. As time passes, the returns start to diminish, but these secular bull markets can have a 20- to 30-year life span. My takeaway here is that it doesn’t pay to overreact: when the good times have been rolling for 10 years, they may well keep on rolling for another 10+ years.

It’s also worth remembering that, while the past decade was a great time to be invested in the stock market, the decade before that was pretty nasty. If you had invested $10,000 in the S&P 500 on January 1, 2000 and sold your shares on December 31, 2009, your account would have been worth $9,090 (which actually seems fairly mild, considering that the market lost ~50% of its value, not once, but twice during that span). This 10% total loss is why market historians refer to the start of the new millennium as The Lost Decade.

If we double our time frame and survey returns from 1/1/2000 to 12/31/2019, we find that the market averaged 3.8% per year – approximately 40% lower than the long-term average 20-year return figure of 7% (you can take a look at this chart from Crestmont Research to see these 20-year rolling periods in a visual format). This lends further support to the argument that there could still be plenty of room for this bull market to run.

In closing, the subtitle of Mackintosh’s article implies that “buying stocks no matter what” is a sign of indiscriminate and irresponsible behavior. However, as the data above shows, if your time horizon is long enough, “buying stocks no matter what” today and in the years to come might not be such a bad idea.

And Now For Something Completely Different...

In case you missed it, the men's and women's 400m hurdles finals were incredible at this year's Olympics.  Here's the women's race, and here's the men's. As a former 400m runner and hurdler, these performances are beyond my comprehension.