Last week I mentioned yields on Treasuries hitting (or even exceeding) 4% now. So, let’s bring this full circle.
Two weeks ago I wrote a note titled, “No, Stocks Are Not Cheap Yet.” And in that note I provided a range of returns for the U.S. stock market over the next twelve years under a variety of good, average, and bad conditions (see below).
The range of returns from this analysis was -5.4% to +3.5% annualized. That means even an optimistic case for U.S. stocks (at least for the conditions in the matrix above) is about a 3.5% annualized return over the next 12-years with an average expected return of about 0%.
So, if we were to invest money today but were not allowed to adjust the investments for the next decade, the 10-year Treasury bond yielding around 3.8% has a better than 50/50 chance at outperforming the U.S. stock market.
Certainly, on a risk-adjusted basis the 3.8% yield on a Treasury is far superior to the projected returns of the U.S. stock market because the stock investment would have far more risk and volatility embedded so with stocks you’d be taking on far more risk for a lower expected return if bought and held for 10-12 years.
Now, luckily, we’re not forced to buy and maintain investments for decades at a time without adjustments. One way to potentially overcome the low return expectations is to increase stock exposure when the valuations (i.e. expected future returns) are far more attractive.
For example, let’s say stocks are trading lower in twelve months than they are today so that the range of future returns look more like 2009 when this same analysis showed a potential return range of +4.5% to +14.2% annualized (see below).
Well, in that case, we might make a decision to increase our stock exposure at that point in time when the forward returns look more attractive and appear to better compensate us for the risk we’d be taking on. Even if 10-year treasuries are still yielding 4% at that time (which I doubt), the potential stock market returns in that hypothetical scenario might still be superior and perhaps worth the additional risk.
Note: Investment strategy and allocation decisions are made in the context of each clients’ unique circumstances, goals and risk tolerance.
The ranges of returns provided are only for the specific given set of conditions listed, which does NOT include all the potential conditions.
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. Any forecasts made are the opinion of the author. Markets are famously difficult to predict precisely because so many factors are involved…particularly over short time periods. And many folks don’t have the patience to see long-term forecasts play out because so much can happen in the interim..
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.
