Financial Market Outlook: Compounding Growth in a World of Worries

Jul 30, 2018 | News, Perspectives

Long-term US stock annualized returns, by definition, tend to be close to their 100-year average of 10%.  This included many horrible time periods, including the Great Depression and world wars.  As such, someone predicting future long-term stock returns might use 10% as a starting point.

On the other hand, future long-term bond returns can be much more accurate.  Buying (and holding until maturity) a 10-year US Treasury Note or a 30-year US Treasury Bond with rates (i.e. yields to maturity) of 2.85% and 2.98% will provide 10 and 30-year annualized returns of 2.85% and 2.98% respectively.

If a long-term investor were to believe that history repeats itself, then the choice of buying (and holding) stocks over bonds would appear clear.  However, there will always be numerous concerns.  A person who never invests in stocks due to constant worries will not benefit from the power of compounding.

If one invested at a 10% annualized rate, their portfolio would double over seven years, quadruple after 14 years, and be eight times the original size after 21 years.  Thus, giving $10,000 stock portfolio to a new-born grandchild could result in over a $10 million portfolio when reaching age 70. A twenty-one-year-old receiving the same gift might see it turn into $1.28 million by 70.

Yet there are some professionals who state everyyear that “now is a bad time to invest,” which means it is never a good time to invest.  These permanently bearish prognosticators are called “perma-bears.”  Their followers have paid a very steep price and missed out on investors’ best friend, the power of compounding.

Some of today’s top perma-bear concerns include: market valuation, length of economic cycle and trade wars. Due to market volatility, strong sales and pre-tax earnings growth, and a record cut in the corporate tax rate, by several metrics stock valuations are near their 25-year averages.

Most sceptics include the majority of the Great Recession when counting the length in time for this economic recovery. When measuring the amount of time since the last bear market (20% pullback), statisticians also ignore the 19.9% correction in 2011, as it did not reach 20%. 

Some claim the US economy has now grown as much as it can in an economic recovery.  While the US economy (GDP) has grown about 15% cumulative in nine years, bull markets in the 1980s and 1990s coincided with about 34% and 50% GDP growth respectively.  Since the current economy has experienced a prolonged period of little to no growth, there may be room for years of stronger growth.

A trade war where the US imposes tariffs on $275 billion of automobile imports and $450 billion of Chinese imports sounds ominous.  However, US GDP is $18.6 trillion.  Thus, a 10% tariff on $725 billion of imports should have an economic impact of 0.4%. The precise effect might never be known as buyers substitute a non-tariff item for a tariffed good. Also, several countries with trade surpluses have strong motivation to conclude successful trade negotiations quickly.

After a few years, many prior concerns are forgotten as they actually had no lasting effect on US investors. For example, the Greek financial crisis had no measurable impact on the US economy.  Economically, Greece represents less than 1% of the European Union’s (EU) GDP which itself is less than US GDP.  Likewise, in a few years many of today’s distressing headlines might be remembered as passing noise.