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Tuesday, January 3, 2022
After a brutal 2022, investors are thrilled to see the calendar flip over to 2023.
And while some investors are still licking wounds from one of the most challenging years in a generation, others may see a market full of opportunities to buy great companies at big discounts.
As the investment world spends the next few months — or more — figuring out just what went wrong in 2022, there's little doubt we'll hear reminders about the positive long-term track record of the stock market.
And why wouldn't we?
As one of our favorite charts from JPMorgan Asset Management shows, stocks usually go up: Since 1980, the S&P 500 has been positive in 32 of 43 years.
Now, after a year that saw conservative investment portfolios like the 60/40 mix of stocks and bonds lose more than 15%, it's little comfort telling a client years like this are outside the norm.
And when making references to history showing time is on the side of the patient investor, you've got to be sure to choose the right timeframe to back up the case for buying stocks for the long run.
And the "right" timeframe is 20 years.
In a note to clients published last week, Nicholas Colas, cofounder of DataTrek Research, flagged the historical record for the S&P 500's rolling compounded annual growth, which shows the benchmark index returns an average of 10.8% per year, or 7.1% annually when adjusted for inflation.
And over that stretch, stocks have never been negative over a 20-year period.
Again, stocks usually go up.
"History shows that 20 years of continuous investment is the bare minimum to be assured of a positive real return for the S&P 500," Colas wrote. "One can do very well over a shorter period if all the stars are aligned, of course. But … two decades is the 'right' long term timeframe to use in a mental model of how long it can take for US equities to generate value for investors."
Of course, not all 20-year periods are created equal.
For periods ended in 1961 and 1999 — which capped the post-World War II boom and the post-Volcker inflation crush, respectively — the S&P 500 showered investors with annualized returns of 13.3% and 13.7%, respectively, after adjusting for inflation.
Nice work if you can get it.
On the flip side, the deleterious effects of inflation that plagued the economy in the '70s and '80s — as well as the aftermath of the tech bust that began in 1999 — saw 20-year average annual returns after the impact of inflation fall to a mere 0.9% and 3.4%, respectively, for periods ending in 1982 and 2018.
Eagle-eyed readers will also notice these good and bad periods follow one after the other. In markets, as in life, there's a time to reap and a time to sow.
Another conundrum Colas' work shows investors facing today is how to proceed after a year that punished equity investors — but one that appears to fit within an improving long-term trend for patient investors.
"Stock returns drive asset allocation," Colas wrote. "Ever wonder why we've seen a veritable explosion of interest in venture and private equity over the last 10-12 years, or several virtual currency bubbles in the same timeframe?"
Institutional investors today are looking at equity allocations, which have underperformed that average annual return of 10.8% and 7.1% before and after inflation, and are looking for alternatives. No wonder the broad umbrella of private equity, real estate, and venture is literally called "alts."
But what ultimately drives stock prices higher is earnings. And what drives earnings, in Colas' view, is "a happy confluence of macro factors and coincident booms in consumer spending."
They don't call them "Baby Boomers" for no reason. And though the tech bubble ultimately overstated the promise for investors, steady innovation through the '80s and '90s — along with another demographic surge as Millennials were born — powered the economy.
And if there is a continued push higher in average stock returns over the next decade, it will have to be powered by some force, some "happy confluence" of real improvements in the economy.
Perhaps some promises of the crypto industry are fulfilled as technological leaps for the consumer economy.
Perhaps another demographic boom brought on by Millennials having children powers growth in the years ahead.
But whatever the details, the broad outline is clear. As Colas wrote: "Any increase in structural returns now will require the same ingredients, stirred vigorously with human ingenuity unhampered by external forces."
What to Watch Today
9:45 a.m. ET: S&P Global Manufacturing PMI, December Final (46.2 expected, 46.2 during prior month)
10:00 a.m. ET: Construction Spending, month-over-month, November (-0.4% expected, -0.3% during prior month)
No notable reports scheduled for release.