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Are stocks on sale?

Well, it depends. If something was insanely expensive and declined in price, it is cheaper than it was. But that doesn’t mean it is cheap. Perhaps now only ridiculously overpriced. Or if something is a Ponzi scheme (e.g., cryptocurrencies), then it doesn’t matter how much it falls in price. It is expensive at any price.

Equities and bonds (and many other markets) have had a tough start to 2022. Yes, stocks and bonds are cheaper than they were last year. But the only way they would now be cheap is if they were at or near “fair value” last year. And they weren’t. Not even close. So, future (expected) returns are still very low over the next 10-20 years. The outlook for investors – especially in the U.S. – is pretty weak all around.

Here is an example*:

Let’s say the S&P 500 returned 13.9% (after inflation) per year for the last 10 years through 2021. What’s your estimate of a “fair” return (after inflation) over 20- or 30-year periods? If it is 6.5% per year (the U.S. long run average), then real returns need to be zero the next 10 years to achieve 6.5% per year over 20 years. If over 30 years, then real returns for the next 20 years would need to be 3% per year. Not great.

But there are reasons to believe future real returns will be lower than they were over the last ~100 years (improved market access, lower trading costs, etc.). If your estimate is 5% instead of 6.5%, look out. That would mean negative 3% per year for the next 10 years to achieve a 5% 20-year average. If over 30 years, real returns would be only 1% per year for the next 20 years. How many long-term investors are factoring those types of returns into their saving and spending plans?

You might think this could never happen. But it has. Not that long ago. In the 1990s, S&P real returns were 14.5% per year (1991-2000). Over the 20 years ending in 2010, real returns were 6.4% per year. So, what happened in that second decade? A negative real return of 1% per year. Sound familiar?

You can have great returns now or great returns later. But you can’t have great returns forever. If that were the case, markets wouldn’t be risky (or, at least, they would be offering too much return for their risk). And, over long periods of time, markets must be risky to offer a risk premium.


*partly inspired by John Hussman’s examples in Making Friends with Bears Through Math. I know this is a simple example – ignores starting valuations, interest rates, etc. – but it still makes the point…I think.

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