The current bull market in U.S. stocks has delivered strong gains over the course of nearly a decade, "but we are coming off 20 of the worst years for compounded returns since the Great Depression," according to Nicholas Colas, co-founder of DataTrek Research. Through the end of 2018, the S&P 500 Index (SPX) delivered a compound annual growth rate (CAGR) of 5.52% during the past 20 years, versus an average CAGR of 10.7% in all 20-year periods since 1928, Colas told Barron's recently.
20 Years of Miserable Returns
(Compound annual growth rate for S&P 500)
- 1999 through 2018 (20 years): 5.52%
- Average 20-year period since 1928: 10.7%
Source: Data Trek Research, as reported by Barron's
Significance For Investors
Much of the reason for subpar stock market performance during the last 20 years lies in the fact that this period included two severe bear markets. The Dotcom Crash of 2000 to 2002 sliced 49.1% off the value of the S&P 500, while the bear market of 2007 to 2009, which included the financial crisis of 2008, sent the index plummeting by 56.8%.
Some optimists, including Colas, are counting on reversion to the mean, in which future stock market returns will be closer to the higher historic averages. Meanwhile, various pessimists see even worse returns in the years ahead. Among the most bearish prognosticators is John Hussman, a hedge fund manager, economist and market watcher. Looking at stock valuations, Hussman finds them to be excessive by historic standards. In his take on reversion to the mean, he warns that valuations are bound to fall sharply, sending U.S. stocks plummeting by 60% or more from their highs set in 2018.
The late John Bogle, founder of The Vanguard Group, had projected that U.S. stocks would have average annual price appreciation of about 4% to 5% during the next decade or so, per an interview with Morningstar in October 2018. He based this on a combination of expected corporate earnings growth of about 5% annually and a slight contraction in the market's P/E ratio. He anticipated that the overall dividend yield for the market would remain about 2%, for a total return in the range of roughly 6% to 7% annually.
"The reality is that the fundamental return, the dividend yield plus the earnings growth of companies, drives the long term return of the stock market," Bogle said. He added, regarding the impact of valuations: "The only thing that gets in the way in the short term is a speculative return; are people going to pay more for stocks? Are people going to pay less for a dollar of earnings, in essence?"
Projections based on historical trends, patterns, and averages can vary greatly depending on the baseline period chosen and other key assumptions. For example, other analysts argue, also on the basis of anticipated reversion to the mean, that the next 10 years should have low stock market returns because there have been high returns by historic standards during the most recent 10 years.
Moreover, Colas may have come to different conclusions if he had structured his analysis differently, such as by choosing a different start year than 1928, or by calculating average annual returns across the entire baseline period, rather than by breaking history into discrete 20-year segments. Indeed, future stock market returns actually will be driven by macro factors such as economic growth and interest rates. Forecasting based on those drivers is much harder than extrapolating from historic returns.