There is no compelling reason to think such outperformance will continue into the future.
The market disagrees with you.
the US was then a wild frontier economy recovering from a ruinous civil war, and no-one would make a big bet on that… predictions are hard to make, especially about the future.
which is why you hold a globally diversified portfolio. You don’t place ‘bets.’
You definitely shouldn’t expect the US stock market to perform as well over the next year as it did on average over the last 100 years. (Nor for the world to perform as well as the US did.)
To first order, equity returns are driven by a combination of earnings and price changes. Here is the S&P 500 P/E ratio over the last 100 years, a reasonable measure of the “price” of stocks. The price has more than doubled, which generated 1% of the return, earnings have generated 6% average return, for a total return of 7%.
Given that the price is now very high relative to historical levels, a pessimist might expect them to go down on average—in general, if something has done well because the price has gone up a lot, that’s a reason that future returns will be low rather than high.
But even setting that aside, and assuming that prices will keep increasing at ~1%/year, you should expect the 6% average return from earnings to go down to 4%, since you are now paying $25 for a company that makes $1 in earnings (rather than $15). So that would take total real return down to 5%.
In fact things are even worse than that, since $25 are earnings while at full employment, and you want to average over the next 20 years which includes recessions. This adds some more drag, getting you down to maybe 3% returns before price changes.
(I think realistically prices should be expected to go down rather than up, based on any kind of reasonable historical extrapolation. I’d estimate >1% per year price drop over the next year in expectation. So now we are down to <2% real return.)
If you mean that the market predicts the US to outperform the rest of the world, that’s also not really right, it expects the rest of the world to have higher returns than the US (but also to have higher volatility).
If you spend $100 to buy an asset that produces $4/profit per year, all else equal you should expect to make less money than if you had spent $100 to buy an asset that produces $6/profit per year. I think this is pretty straightforward, and (unsurprisingly) it’s consistent with the historical data. If you try to generalize from few enough datapoints with enough noise you can manage to lose the signal in the noise.
ie, why do you expect what you said not to be priced into current expectations?
What does that mean? Which asset price would you expect to be different if in fact smart investors expected equities to have low returns?
Are you willing to bet on <2% expected real returns?
How would you operationalize that bet? At the end of the year, I give you market returns on $1, and you give me $0.02 + inflation?
You’d be a fool to make such a bet, and (other than the risk that you’d default) I’d be a fool not to take it. It’s a pure arbitrage: I take the bet with you, then borrow $1 for a year at the going interest rate (which is about 0.3%+inflation), then buy $1 of equities, and I make 2% per year with zero risk.
The problem is that betting odds don’t reflect probabilities, they reflect the probabilities of possible worlds weighted by how much I value money in each world. To the extent that markets are efficient, everyone’s betting odds ought to imply a 0.3% real return for the market over the next year, because that’s the risk free interest rate.
You could instead bet something other than money, something that isn’t more valuable to me in worlds where I have less money. In that case I’d still be happy to sell market returns at 2%+inflation. (In fact I’m basically making that bet every day I decide not to be leveraged in the current market.)
Given that there are big institutions that rather put money into government bonds with negative interests rates then putting the money on the stock market, what exactly do you mean with “The market disagrees with you”?
I would be interested in any evidence for this. The existence of compelling reasons for outperformance at current prices would suggest that current prices are wrong.
which is why you hold a globally diversified portfolio. You don’t place bets
OP was I think suggesting that the SP500 performance was something that one could expect ongoing by investing in the US market. Or you could diversify.
I agree that betting it all on one market is probably foolish. (But may do very well)
There is no compelling reason to think such outperformance will continue into the future.
The market disagrees with you.
What market instruments express opinions on the future returns of US equity investments? Everything I can think of serves to express an opinion on present prices of equity investments or on things like the future risk-free rate of return, not the future return on, e.g., the S&P500 index.
The market disagrees with you.
which is why you hold a globally diversified portfolio. You don’t place ‘bets.’
You definitely shouldn’t expect the US stock market to perform as well over the next year as it did on average over the last 100 years. (Nor for the world to perform as well as the US did.)
To first order, equity returns are driven by a combination of earnings and price changes. Here is the S&P 500 P/E ratio over the last 100 years, a reasonable measure of the “price” of stocks. The price has more than doubled, which generated 1% of the return, earnings have generated 6% average return, for a total return of 7%.
Given that the price is now very high relative to historical levels, a pessimist might expect them to go down on average—in general, if something has done well because the price has gone up a lot, that’s a reason that future returns will be low rather than high.
But even setting that aside, and assuming that prices will keep increasing at ~1%/year, you should expect the 6% average return from earnings to go down to 4%, since you are now paying $25 for a company that makes $1 in earnings (rather than $15). So that would take total real return down to 5%.
In fact things are even worse than that, since $25 are earnings while at full employment, and you want to average over the next 20 years which includes recessions. This adds some more drag, getting you down to maybe 3% returns before price changes.
(I think realistically prices should be expected to go down rather than up, based on any kind of reasonable historical extrapolation. I’d estimate >1% per year price drop over the next year in expectation. So now we are down to <2% real return.)
If you mean that the market predicts the US to outperform the rest of the world, that’s also not really right, it expects the rest of the world to have higher returns than the US (but also to have higher volatility).
What does the outside view say about that claim? https://www.bloomberg.com/view/articles/2017-10-10/cape-has-a-dismal-record-as-predictor-of-stock-performance
ie, why do you expect what you said not to be priced into current expectations?
Are you willing to bet on <2% expected real returns?
Which claim?
If you spend $100 to buy an asset that produces $4/profit per year, all else equal you should expect to make less money than if you had spent $100 to buy an asset that produces $6/profit per year. I think this is pretty straightforward, and (unsurprisingly) it’s consistent with the historical data. If you try to generalize from few enough datapoints with enough noise you can manage to lose the signal in the noise.
What does that mean? Which asset price would you expect to be different if in fact smart investors expected equities to have low returns?
How would you operationalize that bet? At the end of the year, I give you market returns on $1, and you give me $0.02 + inflation?
You’d be a fool to make such a bet, and (other than the risk that you’d default) I’d be a fool not to take it. It’s a pure arbitrage: I take the bet with you, then borrow $1 for a year at the going interest rate (which is about 0.3%+inflation), then buy $1 of equities, and I make 2% per year with zero risk.
The problem is that betting odds don’t reflect probabilities, they reflect the probabilities of possible worlds weighted by how much I value money in each world. To the extent that markets are efficient, everyone’s betting odds ought to imply a 0.3% real return for the market over the next year, because that’s the risk free interest rate.
You could instead bet something other than money, something that isn’t more valuable to me in worlds where I have less money. In that case I’d still be happy to sell market returns at 2%+inflation. (In fact I’m basically making that bet every day I decide not to be leveraged in the current market.)
>In fact I’m basically making that bet every day I decide not to be leveraged in the current market.
that’s what I was curious about.
Given that there are big institutions that rather put money into government bonds with negative interests rates then putting the money on the stock market, what exactly do you mean with “The market disagrees with you”?
I would be interested in any evidence for this. The existence of compelling reasons for outperformance at current prices would suggest that current prices are wrong.
OP was I think suggesting that the SP500 performance was something that one could expect ongoing by investing in the US market. Or you could diversify.
I agree that betting it all on one market is probably foolish. (But may do very well)
What market instruments express opinions on the future returns of US equity investments? Everything I can think of serves to express an opinion on present prices of equity investments or on things like the future risk-free rate of return, not the future return on, e.g., the S&P500 index.