I came across an interesting analysis in Dr. John Hussman’s recent commentary that I’d like to briefly share.
In the commentary he talks about the primary driver of market returns throughout the various cycles since 1982. It’s very important to understand this if you want to understand the potential return outcomes for the duration of the market cycle…emphasis mine
“…from 1982 to 2000, the S&P 500 enjoyed an extraordinary period of total returns averaging just over 20% annually. The primary driver of those gains wasn’t growth in revenue or earnings (though the combination of 4.6% average annual S&P 500 revenue growth and a high starting dividend yield certainly helped). No, the primary driver was expansion in the S&P 500 price/revenue ratio, which rose from a profound low of 0.3 in 1982, to an offensively extreme 2.2 by the 2000 peak.
Conversely, in the 9-year period from 2000 to 2009, the S&P 500 lost half of its value despite positive overall growth in revenue and earnings. The reason was that the S&P 500 price/revenue ratio collapsed from 2.2 to less than 0.7 over that period – a retreat that even 9 years of 4.7% annual revenue growth was wholly unable to offset.
From 2009 to 2018, the S&P 500 price revenue ratio advanced from less than 0.7 to a breathtaking multiple of 2.4 early this year – the highest level in the history of the U.S. stock market. Extrapolating the market gains of these past several years, as if they are somehow a birthright of passive investing, is likely to have brutal consequences for investors.”
I’ve written at length in these commentaries about how the market is priced for perfection and is setting up to disappoint. Dr. Hussman reinforces that view with the analysis above. The price / revenue ratio early this year was higher than it was at the peak of the dot-com bubble in 2000. In fact, it was the highest its ever been in history. Basically, future potential returns have likely been pulled forward and now lie in our past. To extrapolate returns of the last nine years over the next nine years is a grave mistake and will likely cost investors dearly.
Hussman also points out that, historically, “Extended periods of extraordinary returns accompany moves from low valuations to elevated valuations. Extended periods of flat returns accompany moves from elevated valuations to low valuations.” Since we’re currently in a period of extremely elevated valuations it’s quite reasonable to assume flat returns for the next 10-12 years in U.S. stocks.
However, there are opportunities in other assets and flat returns in U.S. stocks for the next 10-12 years does NOT mean a flat return every year for the next 10 years. It more likely means a sharp dropped followed by a recovery so that the cumulative returns may be flat for a decade. So that may create opportunities for outperformance as well.
Portfolios should be managed accordingly but only AFTER robust financial projections have been completed that incorporate your unique circumstances. The projections will serve as the blueprint for all major investment and financial decisions.
Past performance is no guarantee of future results. This commentary is not intended as investment advice but general education. Always consult an advisor, like me, who will take the time to thoroughly understand your unique circumstances before making investment decisions.