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Long-Run Market Expectations

May 9th, 2019 by Nyle Bayer

Preface: When we think about long-term market returns and expectations, it is always with a varying degree of uncertainty as financial forecasting becomes less accurate the further out it goes. There is a great quote from author Terry Pratchet which states, “if you do not know where you come from, then you don't know where you are, and if you don't know where you are, then you don't know where you're going.”

Using this framework as a guide to the future opportunities as investors we can hypothesize that while we don’t know exactly where financial markets are going in the future, we certainly know where we are and where we have come from. In other words, it is prudent to first look at historical returns as a significant source of data when thinking about markets and economies of the future. However, past performance does not guarantee future results.

Four major platforms must be considered when considering future returns of 1-3 years, which on a broad base include equities, fixed income, economic growth, and politics. Each of these categories has their own set of risks attached, and the further down the calendar we look, the more one small change today can snowball into a drastically different investment climate tomorrow. Considering long-term historical data allows us to smooth over some of these variables, as median characteristics of each asset class can act as a loose benchmark. However, they serve more as a frame of context than a guide to the future. One example of how historical averages can be deceptive is good-timing and bad-timing scenarios. Consider an investor in 1982 used the prior 30-year average to create a baseline for expected returns in 1985. For the Dow Jones Industrial Average, the average annualized total return between 1952 and 1982 was ~8.5%. However, the return for 1985 was ~29.8%.

When comparing the 30-year periods of 1952-1982 to 1982-2012, we find the DJIA total returns are 48% greater in the era of 1982-2012. To make things even more interesting, if you stopped in 2012 and used the 60-year average return as a future projection, you would have learned that the 60-year average underperformed 2012-2018 by 20%.

Although history and the underlying human behavior tends to repeat, the details are never identical. Therefore, it is not “different this time,” it is different every time.

After we look back at long-term historical performance, add unique attributes of today, and compute some room for deviations, we can arrive at a rough picture of what the future may hold. However, conditions of each of the four major platforms outlined above and reference in the 2019 Outlook Presentation, can change fast and sharp, which would cause data points in the 2019 Outlook Presentation to need revision, all of which affect equity price.

Below you will find a chart we created using a calculation made famous by Jack Bogle, founder of Vanguard. In the chart below, you will see anticipated future total returns of the S&P 500 in color as the result of the following calculation:

Total Return = Dividend Yield + (Earnings Growth + Change in P/E Ratio)
For the calculation, we assumed that the S&P 500 is priced at 2850, with a P/E Ratio of 21 and a dividend of 2%.

A simple way to use this chart is that if you feel that corporate earnings will increase by 10%, while dividends stay at 2%, and the multiple of what the market is willing to pay for earnings growth (P/E) expands to 23x, then we could anticipate a 22% total return from today’s price. However, if you think that a recession will hit in three years where a -20% cut in earnings takes place, then you would want to consider the amount of earnings growth you would anticipate until the next recession, then add it to the -20% recessionary cut in earnings. For instance, you could anticipate a cumulative increase of 18% in corporate earnings over the next three years, then add -20% for a total of -2% earnings growth.

If the P/E ratio declines by 20% as well, then you would be in the range of 16-17 P/E (close to its mean), which in this chart shows a decline of -14% to -19% total return, which is typical market volatility during a recession. However, don’t forget that the -14% to -19% decline came after three years of 6% growth at a P/E of 21 which would equal a 24% cumulative return between today and the hypothetical recession three years from today. Therefore 24%-14% or 19% = a range from 6%-10% total return from now until the end of the hypothetical recession. 

In addition, here are three scenarios in which we can use Bogle’s calculation to help us build a frame of reference for future returns.

• Earnings growth of 6% over 3-years
• P/E reverts to mean of 16
• S&P 500 Total Return of -16% or -5.33% annualized

Neither pessimistic or optimistic:
• Earnings growth of 12% over 3-years
• P/E stays at 21
• S&P 500 Total Return of 14% or 4.7% annualized

• Earnings growth of 20% over 3-years
• P/E grows to 25
• S&P 500 Total Return of 41% or 13.7% annualized

As you can see, there are many useful applications of the chart above, as one can measure many different scenarios which vary in total return. It is important to remember that although earnings, dividends, and multiples are important variables in market return, they are not the only variables and the chart should not be used as a crystal ball, but as a tool to build the context of a future that can be fuzzy and difficult to grasp.

The most recent expansion, which rivals that of 1991-2001, sits close to ten years removed from the end of the Great Recession. When we reference the table to the right, which details the S&P 500 Total Returns during times of economic expansion, we can see that the current expansion is late in its cycle compared to its peer group.

Most Recent Expansions



Total Return






















Investing late-cycle can be difficult for several reasons, including practical and psychological challenges. From a behavioral perspective, knowing that the US economy is late-cycle can cause many investors to become overly sensitive towards negative economic or market data. Many times, investor sensitivity is due to the simple reason that a future recession is inevitable and it has been a considerable amount of time since our previous one. However, there are no rules for when an economy ends an expansion, as every scenario is unique to attributes of its modern environment.

Counterbalancing late-cycle sensitivity is the practical perspective which shows that historical late-cycle returns tend to be very rewarding. These increased late-cycle returns are typically due to the many years of compounding growth an expanding economy can enjoy. Unfortunately, missing out on these critical late-cycle returns can be detrimental to the sustainability of a portfolio.

Due to the tug-and-pull nature that behavioral and practical challenges create for late-cycle investors, we believe that a rules-based approach to managing a portfolio has become extremely valuable during the today’s stage of the economic and market expansion.

At HQR, our rules-based approaches include three key areas, and it’s here we can put forward our thoughts on the next few years:
  • Investments
    • As mentioned, we are likely in the later stages of the economic cycle – but that doesn’t mean we cannot see great returns in many individual companies, sectors or countries. We expect domestic US equities to have a higher risk-adjusted performance relative to international equities for the foreseeable future.
    • We expect government bonds to have a 5-year annualized total return in-line with the starting yield 1-year yield. However, we expect greater volatility in corporate bonds as the economic cycle moves forward.
  • Global markets
    • We expect domestic equity markets to move higher over the next year, despite recessionary warning signs such as the yield curve inversion. However, political decisions made across the globe will decide what happens to markets in 2020 and beyond. Our biggest concerns are the Brexit, US trade relations, US interest rate policy and the risk of contagion from struggling economies.
    • Over the next three years, we reasonably anticipate at least one correction of greater than 10% in US equity markets per year as volatility normalizes.
  • Economic activity
    • Although economic data is slowing, most data points are still within a normalized range that show a higher probability of the economy growing than receding. This is a major reason why we expect markets to move higher in the next year. Over the next three years, there is a growing probability of a recession taking hold… but that is *far* from a guarantee. If the yield curve were to sustain an inversion or if credit markets lack liquidity for supply growth, then we would expect an accelerated timetable for a recession.
Unfortunately, future market returns are extremely difficult to predict and do not follow a historical schedule. In our opinion, applying a predetermined methodology to your investment decision-making is the best way to navigate unpredictable events. By doing so, we can drastically reduce behavioral and practical challenges, while letting our investments align with their intended purpose on an ongoing basis.
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