Diminished Investment Returns Forecasted for Long-Term Index Funds
Investing in index funds for the long term has historically resulted in substantial growth, with $100 invested in the S&P 500 in 1990 increasing to $3,220 today. However, current market valuations indicate the potential for lower returns over the next decade. The Shiller cyclically-adjusted price-to-earnings ratio (CAPE), currently at 35.7, predicts annualized returns of around 3% for the next decade, a significant decrease compared to the 10.9% annualized returns since 2008. Furthermore, the total market cap of non-financial stocks-to-gross value added metric, favored by John Hussman, forecasts a -6% annualized return over the next 12 years. These elevated starting valuations could lead to extended periods of minimal growth in the stock market, potentially resulting in stagnant returns for investors.
Supporting this view, research shows that when the CAPE ratio is high, like today, long-term returns have historically been subdued. For example, after CAPE readings above 25, five-year returns averaged only 3.4% annually, with performance being positive barely half the time.
On the other hand, some argue that despite elevated CAPE levels, the market could continue to deliver solid returns. This optimism is partly driven by changes in monetary policy and the impact of new money creation by central banks, which could sustain higher market valuations for longer periods than historical trends would suggest. Additionally, while the CAPE ratio is a useful indicator, it has its limitations, especially given the evolving nature of global markets and accounting practices.
In conclusion, while the Shiller CAPE ratio points towards lower expected returns, some experts believe that current market conditions might allow for continued gains, albeit with higher risks.
Key Takeaways
- Historical data shows significant long-term returns from investing in the S&P 500.
- Current market valuations suggest diminished returns over the next decade.
- The Shiller CAPE ratio predicts a low annualized return of approximately 3% for the next 10 years.
- Hussman's market cap-to-gross value added metric forecasts a -6% annualized return over 12 years.
- Elevated starting valuations can lead to prolonged periods of minimal stock market growth.
Analysis
The high Shiller CAPE and Hussman metrics indicate reduced returns for long-term index fund investors. Overvaluation and economic cycles are direct contributors to this trend. In the short term, investors may encounter decreased growth, impacting retirement plans and market confidence. In the long term, reduced investment inflows could potentially slow down economic expansion, consequently impacting entities such as pension funds, retail investors, and financial advisors, prompting a reshaping of asset allocation strategies.
Did You Know?
- Shiller Cyclically-Adjusted Price-to-Earnings Ratio (CAPE):
- The CAPE ratio, developed by economist Robert Shiller, is a valuation measure utilizing real earnings per share over a 10-year period to mitigate short-term earnings fluctuations.
- It assesses stock market valuation by comparing current prices to average earnings over a longer period, rendering it less sensitive to temporary earnings changes.
- A higher CAPE ratio indicates that stocks are relatively expensive compared to historical earnings, signifying potential lower future returns.
- Hussman's Market Cap-to-Gross Value Added Metric:
- This metric, proposed by economist John Hussman, compares the total market capitalization of non-financial stocks to the economy's gross value added (GVA).
- GVA measures the value of goods and services produced in an economy, aiding in the understanding of companies' economic contributions.
- When the market cap significantly surpasses GVA, it suggests overinflated stock prices relative to economic output, potentially leading to lower future returns or even losses.
- Annualized Returns:
- Annualized returns represent the average returns over a specific period, expressed as a compound annual growth rate (CAGR).
- They offer a standardized performance measure across different timeframes, facilitating comparisons between investments.
- A positive annualized return signifies growth, while a negative annualized return indicates a loss over the specified period.