Low Future Returns Requires A “Real” Bear Market

In “Do You Feel Lucky,” Michael Lebowitz compiled a series of valuation metrics and their correlation to future returns. To wit:

“The average of the 10-year expected returns from the four gauges is -0.75%. When the Fed backs off, whether by its design or due to inflation, slower economic growth, or massive debt overhead, rich valuations will matter.”

Low Future Returns, Low Future Returns Requires A “Real” Bear Market

The mistake many investors make is assuming that such means every year, over the next decade, returns will be near zero. As we will discuss, it is not every year, but one or two awful years, impacting the whole.

Fun With Math

 

The vital point to understand is that over the long-term investing period, “value” and “returns” are both inextricably linked and opposed. As shown above, forward return expectations are lower than the long-term average given current valuation levels.

Let’s review what “low forward returns” does and does not mean before looking at different valuation measures.

  • It does NOT mean the stock market will have annual rates of return of sub-3% each year over the next 10-years.
  • It DOES mean the stock market will have stellar gains in some years, a big crash somewhere in between, or several smaller ones, and the average return over the decade will be low. 

“This is shown in the table and chart below which compares a 7% annual return (as often promised) to a series of positive returns with a loss, or two, along the way. (Note: the annual average return without the crashes is 7% annually also.)”

Low Future Returns, Low Future Returns Requires A “Real” Bear Market

“From current valuation levels, two-percent forward rates of return are a real possibility. As shown, all it takes is a correction, or crash, along the way to make it a reality.”

Such isn’t a prediction; it is just statistical probability and simple math.

Most importantly, as stated above, none of these factors or measures mean the markets will produce single-digit rates of return each year for the next decade. The reality is there will be some strong return years during that period. Unfortunately, the bulk of those years will get spent making up previous losses. 

That is the nature of investing in the markets. It is just part of the full-market cycle.

Why A 50% Correction Is Required

One of the essential issues overhanging the market is simply that of valuations. As Goldman Sachs (GS) pointed out recently, the market is pushing the 89% percentile or higher in 6 out of 7 valuation metrics.

1 2 3 4
View single page >> |

Disclaimer: Click here to read the full disclaimer. 

How did you like this article? Let us know so we can better customize your reading experience.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.