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Beyond the bull?

I was born in 1982. The year Michael Jackson released Thriller and E.T phoned home. The U.S. was in the midst of a deep recession, the second since 1980, with unemployment above 10%. 10-year Treasuries started the year at ~15%. Inflation, trending down, had peaked at close to 15% in 1980. U.S. stocks were trading at their cheapest levels since the Great Depression (as a multiple of 10-year trailing earnings).

A lot has happened since 1982. The Japanese equity and real estate bubbles in the 1980s. The fall of the USSR. The rise of China. The U.S. housing bubble and the Global Financial Crisis. A global pandemic. Not a complete list! Even so, the 40 years from 1982 to 2021 (inclusive) were extraordinary to U.S. investors.

Interest rates on 10-year Treasuries declined from ~15% to ~1% in 2021. U.S. equity valuations increased five-fold. In 2021, investors were paying 37x trailing earnings (average Shiller P/E), up from 7x in the early 1980s (average Shiller P/E for 1982). Sure, there have been bad years and even one bad decade for stocks (following the peak of the U.S. internet bubble). But most pullbacks were short-lived, with prices bouncing back and then continuing their 40-year ascent. Through 2021, at least.

Few investors today were also investing in the 1960s and 1970s. Most U.S. investors only know the last 30 or 40 years, a long-term bull market in bonds and equities. You bought bonds, you did well. You bought equities, you did even better. You bought equities with leverage (private equity), you made a fortune.

Some believe the good times will continue, perhaps after a brief interlude. There are others who think the sky is sure to fall in the next year or two. Over the next 30-40 years, the answer seems pretty clear to me. We are unlikely to see a repeat of the exceptional returns of the 40 years through 2021 (after inflation, the S&P 500 returned ~9% per year and 10-year Treasuries returned nearly 5% per year).

As of September 2023, U.S. stocks are trading well above their long-term average valuation (and more than 4x the bargain levels of the early 1980s). Interest rates are higher today than they’ve been since 2007, but they are still below “average.”* Anyone who needs a repeat of the 1982 to 2021 returns to “make the math work” is sure to be disappointed. Investors should prepare for so-so returns, not exceptional.

*current nominal interest rate for 10-year Treasuries vs. average 1982-2021

Sources: FRED, Robert Shiller’s Stock Market Data

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