Will We Experience a "Lost Decade" of Returns?
The prospect of another "lost decade" for U.S. stock market returns has been getting a lot of attention in the media recently. Late last year, Barron's, Morningstar and MarketWatch all published articles about the possibility of the S&P 500 generating little or no returns during the next 10 years.
And although our stock market has generated an average annual return of about 10% during the last century, we have occasionally experienced lost decades. The most recent one occurred between the beginning of 2000 and the end of 2009, a period during which the S&P 500 lost about 1% per year, an even more painful experience if you take inflation into account.
The catalyst for much of the recent press and commentary about another lost decade was a prediction by Goldman Sachs analysts that the S&P 500 will only return 1% per year above inflation during the next 10 years. This gloomy forecast, unusual for a Wall St. firm, is based on a measure of the current valuation of our stock market.
By now, the inverse relationship between current stock market valuations and future stock market returns should be very familiar to you. I wrote about it in the Spring 2024 issue of Seasonal Musings, and it has been an ongoing theme in my Articles on Wealth Management Topics blog. But a picture is worth a thousand words, so here once again is an insightful graph showing the strong negative correlation between the valuation of the S&P 500 at various points in time in the past and subsequent 10-year returns.
Financial journalists, both national and here in Utah, frequently enlist NAPFA-Registered Financial Advisors to contribute to their stories in the knowledge that Fee-Only financial planners are a reliable source of objective, professional financial advice for their readers. A journalist recently asked the membership about steps that retirees and near-retirees could take in light of the prospects for subdued returns going forward on the S&P 500. In case you find it useful, here was my written response to him:
"1. Diversify away from U.S. stocks as an asset class.
Most of the firms who generate projections of future long-term returns on a variety
of asset classes (e.g. Goldman, GMO, Research Affiliates, etc.) have much more
optimistic views on the prospects for returns in stock markets abroad. And in this
market environment, it's not difficult to find investment-grade bonds and bond
funds yielding 5% or so, which make a pretty compelling (i.e. less volatile, yet still
real-return-generating) alternative to the S&P 500 if you're worried about a "lost
decade" in the latter. And for retirees or those soon to be retired (say, within 2
years), it could be argued that a "cash bucket" should be part of the portfolio
equation, especially with money market funds and CD's still offering positive real
returns. And if inflation is to be the cause of this "lost decade", then it makes
sense to have some exposure to commodities, since this asset class has had a
strong correlation historically with inflation (see the year 2022 as a recent example).
2. Gain exposure to the U.S. stock market that isn't market-cap weighted and/or
that is tilted away from the stocks that make the S&P 500 look so expensive.
The primary reason for current forecasts of a "lost decade" in the S&P 500 is its
current valuation, and its current valuation is being skewed by its significant
market-cap-weighted exposure to the so-called Magnificent Seven. So it stands to
reason that if investors are concerned about a "lost decade" on this basis, then
they should find exposure to the U.S. stock market that isn't market-cap weighted
(e.g. equally-weighted or fundamentally-weighted) or that is market-cap weighted
but focused on less expensive parts of the market (e.g. value and/or small-cap
funds)."
About the Author
Paul Winter, MBA, CFA, CFP® is a Fee-Only financial advisor and fiduciary in Salt Lake City, UT. His independent wealth management firm, Five Seasons Financial Planning, provides professional portfolio management and objective financial planning services to individuals and families, and to their related entities including trusts, estates, charitable organizations, and small businesses.