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Stocks have had a 'normal' decade. Is that a relief or a worry?

·Michael Santoli
Stocks have had a 'normal' decade. Is that a relief or a worry?

The past 10 years brought a credit boom and bust, the most damaging financial crisis in decades and $12 trillion in money creation by desperate central banks – all of which made for a pretty average decade.

Rather average, that is, in terms of the returns produced by big U.S. stocks.

Through Dec. 31, the average annual total return for the Standard & Poor’s 500 stock index was 7.6%, according to FactSet. That’s up sharply from negative 1% five years earlier, when the market was winding up a “lost decade.” This measure of the past decade’s gains is now approaching long-term average yearly return.

Since 1926, big American stocks have delivered just over 10% a year, and Jeremy Siegel’s study on stock performance dating back to 1871 pegged the average at 6.8% after inflation, which is slightly above the pace of the past 10 years.

So the market took a messy, dramatic, sometimes scary and then euphoric path to a respectable, if pedestrian, performance since the end of 2004. It barely nosed above its 2000 peak in late 2007, then was cut in half within 18 months, and since the March 2009 low has surged more than 200%.

The question now -- especially for those who haven’t participated in the past few years’ ascent -- is how much life this bull market might have left in it, both in terms of duration and upside.

A glance at this long-term chart of rolling 10-year stock returns would lead many to the conclusion that this uptrend is really just getting in gear. Throughout history, this gauge has spent far more time at levels well above the current one.

Believers in this idea endorse the “new secular bull market” theme that the break to fresh all-time highs in 2013 launched a new, durable climb similar to those that took hold in the 1950s and 1980s.

S&P 500
S&P 500

Yet it’s worth noting how rapid the upside progress has been in just the past few years -- and how this 10-year measure will keep rising in coming years even if stocks stall out or merely trudge higher. The S&P 500 has appreciated at an average of more than 17% annually the past six years.

Financial advisor and Yahoo Finance contributor Ben Carlson calculates that if stocks stay right where they are for the next four years, the trailing 10-year return will rise to 9.9%; if stocks shuffle ahead by a modest 5% a year over that time, the 10-year average will jump to more than 12% by the end of 2018.

In those terms, it might appear that the market doesn’t exactly owe investors much in coming years.

Yet there’s that chart again, which shows the 10-year rate of gains rose through 10% in 1950, 1983 and 2003, In the first two instances, this happened near the very start of stupendous bull markets. In the decade after this measure broke above 10%, stocks added an average of around 15% a year for the next decade.

On balance, though, strong bull markets have tended to persist long enough that they overshoot the average rate of gain for a substantial stretch of time.

Strategists at JP Morgan Asset Management point out that in the current bull run and those that began in 1991 and 2002, the indexes were at or within 5% of an all-time high on about 80% of all trading days. The firm further notes that in the 1982-87 advance, stocks went up another 49% after they had reached the long-term average valuation relative to corporate earnings; in the ‘90s, they ran another 83% higher after crossing the average valuation.

So if the present escalation of the indexes feels extended and tenuous, this has frequently been the case in the latter phase of long bull markets. A bright-side looker might further point out that with this low-tempo economic expansion drawn out longer than usual, and rewarding capital far more than labor, why would the current market renaissance not eventually grow to be among the gaudiest?

The main argument against this is that equities have already been granted lofty valuations for this point in the market cycle, and that the drivers of this burgeoning of paper wealth (such as extremely low corporate borrowing costs) have little room to improve much from here.

Of course, some cycles stop short of truly giddy times. The last time the 10-year average market gain nosed above 10% in 2003, the ensuing experience was less generous. There was a 7.3% average return through 2013, but it was “enjoyed” only by those who sat tight through a breathtaking meltdown in the months before and after Lehman collapsed.

And stocks’ price-to-earnings valuations in that phase never got above the long-term average, the credit bust foreclosing on the possibility of an upside overshoot for stocks.

Jim Paulsen, strategist at Wells Capital Management, this week noted that beneath the indexes, the typical stock is now about as expensive as it has ever been.

Sure, the S&P 500 as a whole trades at 18-times the past year’s operating profits, and a bit more than 16-times forecast earnings for 2015 – modestly but not alarmingly above the long-term average. But this aggregate multiple is dragged lower by a relative handful of mega-cap stocks that appear quite cheap statistically, such as Apple Inc. (AAPL), Exxon Mobil Corp. (XOM) and Bank of America Corp. (BAC).

Using an academic screen performed each summer of all New York Stock Exchange issues, Paulsen says the median stock P/E ratio is around 20 -- roughly as high as it’s been since 1950 -- which should make big continued gains for the typical stock challenging.

This, in a way, is the reverse of the market at the height of the tech bubble, when the S&P 500 was fabulously overpriced thanks to richly valued blue chips and nearly all big technology stocks, while the median company sported a multiple no higher than the historical norm.

While providing nice context for today’s market prospects and return expectations, these slow-moving cyclical and valuation gauges are of little help in handicapping the immediate fortunes for stocks.

One of the few ways to escape much concern about how these forces sort themselves out is to have at least a couple of decades to work with. The market has never been down over any 20-year period. Indeed Carlson offers the reminder that the worst trailing annual 20-year return after the crisis was 7.7%.

Patience, then, is a comfort as well as a virtue – for those who enjoy the luxury of lots of time before they’ll need to convert a portfolio into living expenses.