“Those who cannot remember the past are condemned to repeat it.”
With that in mind, let’s review the past so that we might catch a glimpse into the future.
The three best 12-year annualized forward returns for the S&P 500 (including dividends) going back to 1928 were:
- 19.0% (1988-2000)
- 18.3% (1950-1962)
- 18.2% (1944-1956)
An annualized return of 19% implies a $100,000 portfolio grows to over $805,000 in twelve years!
The three worst 12-year annualized forward returns were:
- -2.8% (1930-1942)
- -2.4% (1929-1941)
- 0.5% (2000-2012)
An annualized loss of 2.8% implies a $100,000 portfolio declines to about $71,000 in twelve years.
For context, the very long-term annualized return for the S&P 500 is around 10%. So we observe there is tremendous amount of volatility in even 12-year periods.
Note: These 12-year periods are rolling calendar year returns as opposed to rolling monthly returns. For example, January 1st, 1988 through December 31st, 2000.
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We notice something very interesting if we look at stock market valuations at the beginning of each of these notable 12-year periods:
“…rich valuations are followed by poor returns and depressed valuations are followed by elevated returns.” – Dr. John Hussman from “Measuring The Bubble”
In other words, at the outset of the three best 12-year periods, stock market valuations were very low (i.e. stocks were cheap).
Conversely, at the outset of the three worst 12-year periods, stock market valuations were very high (i.e. stocks were expensive).
So, do we think valuations are low, high or about right today? Let’s look…
The market capitalization of the U.S. stock market is roughly $50 trillion today. Meanwhile, GDP of the U.S. economy is about $28 trillion. Therefore, the market cap to GDP is approximately 1.8, or 180% (thanks to Samantha LaDuc).
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We see from the chart above that the current level is extremely high. We notice the prior peak was 2000, the start of the the third worst 12-year period for U.S. stocks in history.
But that ratio doesn’t mean much to us unless we have a history of data along with subsequent market returns.
Fortunately for us, Dr. John Hussman recently shared a chart plotting the intersection of Market Cap / GDP and actual subsequent 12-year annual total returns so we can clearly see the relationship that high starting valuations are followed by low subsequent returns and vice versa.
It makes sense, after all, that paying a higher price for an asset reduces your return while paying a lower price increases your return (for a given cash flow).
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We notice on the chart that the current Market Cap / GDP of 1.8 has never been registered before and implies about a -2% annualized loss for the S&P 500 over twelve years, which is roughly equal to the two worst 12-year period returns in history.
Market Cap / GDP is referred to as the “Buffett Indicator” because at one point Warren Buffett touted it as “probably the best single measure of where valuations stand at any given moment.”
But let’s look at two more valuation metrics from Dr. Hussman. These are overlaid on the same chart. I like these because they go back to the early 1900s and are highly (inversely) correlated to actual subsequent returns as well.
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Notice where these valuations stood at the outset of the three best 12-year periods (1944, 1950, 1988). Hint: Stocks were cheap.
More relevant to today, notice where these valuations stood at the outset of the three worst 12-year periods in history (1929, 1930, and 2000) and now where they stand today. Hint: Stocks were / are expensive.
It appears we may be in the third great bubble of the 20th and 21st centuries, which implies the potential for very low (maybe negative) returns for the S&P 500 over the next twelve years.
Please remember when it comes to markets, this is not precision science, and it is absolutely not applicable, helpful or meaningful for short-term price movements and forecasts.
The purpose here is to reflect upon a general condition of extreme overvaluation that’s been building for years and accelerated as a result of trillions of stimulus during COVID.
The extremely overvalued conditions have now created the potential for very poor returns over the next decade. This should at least be considered when building financial projections and modeling planning scenarios that drive important financial decisions and investment strategy.
Reach out to me to learn more about how this information is applied.
If you’re already a client and reading this, please share it with anyone you care about and have them reach out to me for a complimentary portfolio analysis.
Disclosures:
Past performance is no guarantee of future results. All investments maintain risk of loss in addition to gain.
Data from third-parties is believed to be reliable but accuracy is not guaranteed. Much of the data used to interpret the markets and forecast returns are often at odds with each other and can result in different conclusions. Many different factors impact prices including factors not mentioned here.
This is not investment advice but merely a general commentary. Individualized investment advice cannot be provided until a thorough review of your unique circumstances and financial goals is completed.
Views provided here are current only as of the moment of posting and are subject to change at any time without notification.
