What if stocks don't always go up? Advice for millennials

By Chris BryantWhen the history of the modern financial era is written, there’s one comment that’s almost certain to merit inclusion: “Stocks only go up!”Sports-blogger turned day-trader Dave Portnoy’s pithy observation this summer was designed to both amuse and provoke. But if you’ve put money into US stocks since the market bottomed out in 2009, the chances are you think Portnoy is basically correct. Plenty of professional asset managers would concur.Perhaps the most important question for those considering investing savings today, when stocks are by some metrics among the most expensive they’ve ever been, is whether Portnoy’s philosophy is about to be turned on its head. In other words: “what if stocks don’t always go up?”There are reasons to think this fantastic period for the US stock market might soon be followed by a prolonged hangover, possibly lasting a decade or more. Such a stretch of disappointing equity returns would have profound implications for millennials and generation Z. The standard advice around financial planning and retirement saving that’s worked so well lately — put your money in an index fund that tracks the market and forget about it — might no longer work so well.In the past decade, investors who bought an index fund that mirrors the S&P 500 Index and reinvested dividends have enjoyed a 13% average annual return, according to Bloomberg data.Even a deadly global pandemic that’s triggered a deep recession and widespread unemployment only briefly interrupted the ascendancy of US stocks. The Federal Reserve rode to the rescue once more, and the S&P 500 hit fresh record highs (though lately investors have since grown cautious again).Young investors may conclude that bumper returns are all but guaranteed in the years ahead. If only steadily rising stock prices were always the case.Consider the FTSE 100, an index of some of Britain’s preeminent pharmaceutical, energy, mining and consumer goods companies. In price terms (ignoring the impact of reinvesting dividends for a second), the UK benchmark is lower now than it was two decades ago. It’s not alone.The Stoxx Europe 600 benchmark also remains beneath its dot-com-era peak while the MSCI emerging markets index topped out in 2007 and has yet to recover. The market that really refutes Portnoy’s assertion though is Japan: The Nikkei 225 index remains about 40% below its 1989 peak, when a massive financial bubble burst. 78967501Could the US market face a similar fate? There’ve been bleak periods before, most famously in the two decades that followed the 1929 Wall Street crash. 78967507As recently as 2012 the S&P 500 was below its 2000 peak. Value-orientated asset managers like GMO’s Jeremy Grantham think something similar could happen again, but it’s not just well-known Cassandras who worry. Hedge fund billionaire Ray Dalio of Bridgewater Associates and Blackstone’s vice chairman Tony James have both warned about a “lost decade” for equity investors.If you’d followed GMO’s advice in 2013 to steer clear of American large-cap stocks and load up on emerging market shares, you’d have missed out on seven years of stellar returns. So what’s different now?1. Extreme valuationsEquity valuations have grown even more extreme. During the pandemic, they have become completely divorced from economic fundamentals thanks to the Federal Reserve’s largess. A stock market bubble pulls forward expected returns from the future, setting investors up for probable disappointment later on. “It’s exactly when past returns are most glorious that future prospects are most dismal,” investor John Hussman, another famously bearish investment manager wrote recently. He’s described today’s menu of choices for passive, long-term investors as “the worst in history.” 789675152. Ultra-low interest ratesLow interest rates are often portrayed as bullish for stocks because they boost the value of future corporate cash flows in today’s money and reduce the cost of servicing debt. But with US short-term rates now at zero, the Federal Reserve may find it harder to juice the stock market. Ultra-low rates also reflect pessimism about future economic prospects. “When real rates are low, future returns on equities and bonds tend to be lower rather than higher,” Elroy Dimson, Paul Marsh and Mike Staunton wrote in Credit Suisse’s 2020 compendium of past market returns. “Investors should assume a sober view of the likely excess returns equities can generate from here.”3. Profit margin reversionA key determinant of equity returns, profit margins have been unusually high over the past couple of decades. But corporate profits have now suffered a massive hit due to the pandemic. Even without the virus, those oversize earnings should eventually dwindle as competitors spy an opportunity. Monopoly power may hinder this, but dominant tech companies are starting to face more competition and stricter antitrust enforcement. Globalization is also in retreat and workers are demanding are a fairer split of the rewards of capitalism.4. An aging populationThis is often considered a key reason for Japan’s prolonged stock market slump. Although the US is aging less rapidly, the demographic changes underway are bound to have an impact on future equity returns. An aging population may be less productive, lowering potential economic growth. Furthermore, by 2030 the large and asset-rich US baby boomer generation will all be over the age of 65, and they may need to cut their exposure to risky stocks or sell financial assets to fund their retirement, weighing on prices.While this all sounds bleak, it’s some comfort that over the very long term stocks have tended to go up. In nominal terms, one dollar invested in the US market in 1900 was worth $58,000 by 2019, according to the Credit Suisse market returns study, or an annualized 6.5% return when adjusted for inflation. In the meantime, there are a few things young investors can do to avoid being caught out by a duff decade for US stocks.For starters, if returns are lower I’m afraid you’ll also need to save more to build wealth. Consider adding some exposure to non-US equities, which may at last be due a period of outperformance relative to the US And by reinvesting dividends you can still obtain decent returns even if stock prices go nowhere. (The FTSE 100 has fallen 19% since the turn of the millennium, but investors who reinvested dividends received a 63% return in that period.)Hopefully, the gloomy scenario I’ve painted won’t materialize and US companies will develop new technologies that power the economy and the stock market to new heights in the next decade. But if that doesn’t happen, you’ll be prepared.

from Economic Times https://ift.tt/37VyZIz