Estimating Future Stock Returns, June 2020 Update

Image Credit: Aleph Blog || Really, do you want to earn 3 1/2% for the next 10 years?

At present, the S&P 500 is priced to return 3.51%/year over the next ten years. Now if you were buying some ten-year investment grade corporate bonds, you might expect something around 2%. Is that 1.5% over corporates worth it?

Truly, I don’t know. That said, you have choices. The most overpriced segment of the market now is the large cap growth FANGMAN stocks, which accounts for around 25% of the S&P 500. You can choose safer areas:

• Small cap stocks
• Value stocks
• Cyclical stocks
• Foreign stocks, including emerging markets
• Financial stocks, and maybe if you dare, energy stocks

Now I know that what I said here embeds an idea that GDP will start to grow again. Even with the lousy economic policy at present, over the next twelve months, under most conditions, the economy will grow as government reactions to the C19 virus decrease.

That said, the actions of the Fed in providing credit zoomed through the markets, and pushed stock prices up. Good for the wealthy, less good for ordinary people. Remember, I don’t think it is proper for the Fed to target the stock market. But that is what they are doing through QE.

The graph above shows what returns typically come when expected return level are as low as they are today. You shouldn’t be expecting much here. What?! You think the market will rise to the heights of the dot-com bubble and beyond?

Look, even if the big tech companies are profitable, having the S&P 500 in the mid-4000s is not sustainable. The companies will never grow into those valuations even if the economy recovers.

This is a time to lighten risk positions, or at least to move to stocks that have not been the leaders. Take this opportunity, and lessen your risks. Don’t drive through the rear-view mirror. Look to the mean-reversion that will come, as it did in 2000-2001.