Disclosure: This article is written for entertainment purposes only and should not be construed as financial or any other type of professional advice.
This article is a guest post by Joseph Hogue, Chartered Financial Analyst (CFA), with whom I partnered for the series of chapter-by-chapter reviews of The Intelligent Investor.
Investors may consider tempering their expectations for stock market returns and get back to the basics
I’ve been investing since 1999 and worked as an analyst for more than ten years before creating my online business. In that time, I’ve seen two major bubbles and a lot of investing fads.
But never have I seen investors as delusional as they are right now.
I answer emails and video comments daily from investors wanting to know what the next stock is to double or if I think shares of Tesla will surge another three-fold this year. The answer is never what they want but maybe a little of what they need to hear.
The historic bull market has opened up a dangerous time for investors and it’s time for a reality check.
What a Great Ride It’s Been!
The bull market that started in March 2009 is now officially the longest on record, nearly 11 years of a rising market that has seen only a few temporary corrections. In fact, the bull market has gone for so long that many investors have never experienced a significant decline.
Over the past 11 years, the S&P 500 index has produced a 15% annualized return. That’s nearly double the longer-term average of 8% annualized over the past three decades.
Now there are two reasons that could be very dangerous for investors.
First is the fact that FOMO is NOT your friend! The strong market has taken some stocks to ridiculous highs and triple-digit gains. Investors see these high-flyers, get dollar signs in their eyes and jump into the next fad they hear on CNBC.
Chasing quick stock picks you hear on TV is NOT an investing strategy.
Another reason the historic bull market is a problem for investors is that mutual fund companies are now able to hide more realistic returns behind a period of euphoria. You see, standard reporting for an investment fund is to display three-, five- and ten-year returns on the fund. Normally at least that 10-year period would include a recession and the annualized return would look more like those long-term returns we saw on the market.
But when you have a bull market of 10+ years, those returns advertised by fund providers start to look really persuasive. In fact, who cares about a little higher expense ratio when the fund is able to produce double-digit returns so consistently?
Will the Real Stock Market Please Stand Up
Data from Invesco, studying bull and bear markets since 1956, shows the average bull market return at 153% and lasting 55 months. That’s a far cry from the 377% and 131 months in the current bull market since March 2009.
To be fair, the current bull market returns have been slower to build than the average. If you take that 153% average bull market return over the 55-month average, the average annualized return of 22% is higher than the 15% annual return we’ve seen over the last 11 years…then again we’ve had a very long time to compound that lower annualized return.
That same Invesco study reports an average 34% drop in stocks when the bull finally succumbs to a bear crash. If that were to happen tomorrow, the S&P 500 would drop to around 2200 and investors will have booked an 11% annualized return since that happy day when stocks started rebounding in 2009.
That’s still a pretty darn good return over more than a decade!
It’s over the 8% average market return on small cap stocks over the last 15 years and more than double the 4.15% return on investment-grade bonds.
But some market analysts are warning that the future may not be so bright.
How Not to Be a Disappointed Investor
While stock prices haven’t reached the peak valuation seen during the dot-com bubble, they’re certainly not cheap. Data from Factset Earnings Insight puts the S&P 500 at a forward price-to-earnings ratio of 18.6-times. That’s 18-times the earnings analysts expect to hear out of companies over the next twelve months.
So let’s ignore the fact that this 18.6-times PE ratio is based on high expectations for earnings, analysts expect those earnings to surge 9% over the next year despite the fact profits barely budged in all of 2019. Even if earnings do improve…that 18.6-times price multiple is 24% higher than the 10-year average of 15-times forward earnings.
That means stocks are 24% more expensive than they have been on average over the last decade.
Starting from that point, some market watchers don’t see much upside left.
Blackrock, the world’s largest asset manager, is forecasting an annual return of just 5.2% for U.S. stocks over the next decade and a return of just 1.8% a year for bonds.
I’m not going to try forecasting the market or predict when the next crash will come, only to say that it WILL come eventually. What I will say is that investors should not expect to get rich on stocks as they have over the past 11 years.
Not only will tempering your expectations for stocks help keep you from panic-selling when the next recession does come, this kind of reality check can help you get your mind back to the basics.
- Hold a mix of stocks, bonds and real estate in your portfolio to smooth out the pain of the next stock crash.
- Hold some diversified funds as well as individual stocks.
- Understand how much you need for retirement and how much you need to invest regularly to get there at a realistic rate of return…then make sure you’re investing that much.
- If you’re not able to save much on your current income, look for ways to make money or a side hustle rather than chasing returns in stocks.
I don’t mean to rain on your parade. I love stock investing and there’s no other asset class with as much potential. It’s a particularly dangerous time for investors, expectations are high and that leaves them open to all kinds of scams and just bad investing decisions. Know the facts, know the reality of stock market returns and be ready.
How do you plan to handle any declines in stock market returns?