Estimating Future Stock Returns, March 2021 Update

Image Credit: Aleph Blog || Recently I was talking with a younger pastor friend of mind who is pretty bright. I have known him since he was a teenager. He said to me, “I have concluded the the stimulus actions of the Fed and the Government benefit the rich predominantly.” I told him that he was certainly correct.

Sorry for being late with this update. Have you ever considered the idea that trying to avoid depressions encourages cronyism — the government favors the rich through QE and deficit spending? QE inflates assets and commodity prices. The rich benefit from the first, and the poor are hurt by the second. The same applies to most government spending programs. The rich employ accountants and lawyers, and find ways to benefit from changes in the law, and lobby for exceptions to policies that seem to favor “soak the rich.”

The main thing supporting the market as a whole is low interest rates. And as the Fed suggested they are thinking of tightening policy two years from now, short rates rose and long rates fell. Markets anticipate. I can tell you that if the yield curve gets very flat, the Fed won’t do much tightening, unless they are nuts, which is occasionally true.

On March 31st, the S&P 500 was priced to return 0.07%/year over the next 10 years. Today, that figure is -0.67%. At the close on Monday, that figure was -1.03%. These figures do not take account of inflation, so it indicates real annual returns between negative 2 and negative 3 percent.

The only period that compares with this is the dot-com bubble. If we want to hit new valuation records, 4450 on the S&P would exceed the valuations of the dot-com bubble. Thus when I hear investment banks call for 4800 on the S&P 500 in 2022, I think they are just doing what profits them. They push people to take on more risk, particularly near market tops. If ordinary people get more aggressive here, some of the investment banks will take the opposite side of the trade, so they can profit as the market falls. Those at r/wallstreetbets are being the dumb money that the investment banks will eventually profit from.

Investment banks make a lot of money from offering the shares of speculative firms during a bull market. Then they run for cover faster than retail clients can during the transition to a bear market.

In he past, valuation levels like the present have always led to losses 10 years out. Unless your portfolio is vastly different from the market as a whole, you will suffer these losses. Only if you buy the stocks that have not done well over the past 5 years do you have a chance of producing positive returns. It is exactly parallel to the dot-com bubble. You must avoid large cap growth.

At some point in time the S&P 500 will have a value under 3000. The more interesting question is whether it will have a value under 2000. I don’t think it will ever reach three digits again, unless we get significant deflation.

This is an ugly situation. Pare back risk positions. Focus on undervalued companies in industries that will not go out of fashion. Add investment grade bonds to your portfolio to lose less in real terms than you will get from investing in the S&P 500 index.

Just as no one thought they would lose in late 1999, so it is now. Be aware, and reduce exposure to large cap growth stocks. Replace them with value stocks or investment grade bonds.