Stock Shock! Why Your Returns May Plunge By Half

All good things eventually must end, and that includes bull markets in U.S. stocks.

Based on 146 years of stock market history since 1871, investors should expect sharply lower returns in the upcoming years, Barron's reports. Given that U.S. stocks have posted recent gains that are well above historical averages, Barron's warns, "That record increases the odds of below-average gains over the next five years." In fact, Barron's continues, "the odds also favor below-average gains over the next decade."

Exceptional Bull Market Returns

From 1871 through the end of 2017, U.S. stocks delivered an average annual return of 8.92%, or 6.80% on an inflation-adjusted basis, per research provided to Barron's by Jeremy Siegel, a finance professor at the Wharton School known for his studies of the equities market. The average annual returns were dramatically higher in the last five years, a nominal 15.52% and an inflation-adjusted 13.81%. That would be enough to make most investors very happy. For the most recent 15 years, the respective figures are lower but still solid,10.82% and 8.54%.

Today, though, many investors worry about weaknesses in the bull market and that torrid economic growth may be not be sustainable. And a number of respected analysts and investors wonder whether today's lofty valuations may be setting the stage for a bear market similar to the one that included the devastating 1929 stock market crash.

The 1929 crash is a clear lesson on how investors can be lulled into overconfidence. The best five-year period ever in the U.S. stock market - in the 1920s - overlapped with the worst five-year period. The five years through 1928 had an average annualized nominal gain of 27.02%, while the five years through 1932 suffered an annualized nominal loss of 15.6%. The Stock Market Crash of 1929 was during this time span. (For more, see also: Why The 1929 Stock Market Crash Could Happen in 2018.) 

Besides the 1929 crash and its aftermath, there have even longer periods of low stock market returns. During the worst 30-year period in the study, stocks had an average annual return of 4.12%; in the worst 20-year period, returns averaged 2.77%; and in the worst 15-year period they averaged just 0.21%.

Regression Towards The Mean

The upshot of all this is that investors should expect regression towards the mean, or subpar returns in the future that balance out the recent outperformance by historical standards, as Barron's cautions. Given that returns over the past 15 years, and also the most recent five years, have been among the best ever, historically below-average stock gains may persist for quite some time. Mutual fund giant Vanguard has been among those advising investors to brace for a stock market correction, followed by an extended period of lower gains. (For more, see also: Vanguard Sees 70% Chance of Correction, Erasing 2017 Returns.)

Law of Gravity 

Besides historic trends, there are other reasons for worry about the direction of stock prices. The recent World Economic Forum in Davos, Switzerland has been marked by a number of participants airing concerns over high stock valuations, frenzied buying, and complacency among investors, The Wall Street Journal reports. "Over the long term the laws of gravity will come back," as the Journal quotes Michael Sabia, CEO of the $300 billion pension, insurance and investment fund belonging to the province of Quebec, Canada.

Meanwhile, two measures of U.S. investor optimism have hit peak levels, pointing to higher stock market volatility and lower yields on 10-Year U.S. Treasury Notes, according to Bloomberg. The Citigroup Economic Surprise Index for the U.S. is dropping after reaching a peak in December, indicating that economic data is exceeding analysts' expectations by smaller and smaller amounts, per Bloomberg, which adds that lower T-Note yields historically follow such weakening of the economic outlook. 

The Monetary Policy Uncertainty Index from the Federal Reserve is showing historically high public confidence that inflation will remain low and that the Fed will stay the course and not opt for dramatic rate increases, according to Bloomberg. However, as Tony Dwyer, equity strategist at Canaccord Genuity Inc. tells Bloomberg, periods of low monetary policy uncertainty often precede bouts of "more volatility and drawdowns," though these often are temporary.

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