Last week, while raising their year-end target for the S&P, BofA suggested US equities might be in for a lost decade.
On the face of it, that sounds ironic — getting more bullish while projecting negative returns. But recall that the bank’s updated S&P forecast was a mark-to-market exercise, and a somewhat begrudging one at that. Savita Subramanian’s new target still suggests downside for the US benchmark into year-end.
One of the key points was that, as Subramanian wrote, valuation “is almost all that matters for long-term stock returns.” Specifically, the R-squared of normalized P/E versus subsequent S&P returns rises steadily to 80% (or higher) as the holding period increases beyond a decade (figure below, from BofA).
Valuations are, of course, stretched on virtually every metric.
BofA’s long-term valuation model currently projects negative annualized returns for the S&P over the next decade. It’s the first time that “sobering stat” (as the bank’s Jill Carey Hall put it this week) has popped up since 1999. A handful of readers were happy to point out that it’s not the first time someone has suggested as much this year, though. Apparently, everyone from journalists to peddlers of sundry investment “services” to various Bobs down the street, think returns might be negative out through 2030.
So, what is one to do when Savita Subramanian, journalists, newsletter writers charging exorbitant rates for the privilege of sending you their thoughts once or twice a month and even your neighbors all see a potential lost decade for equities?
Well, Carey Hall has an idea: Buy small-caps.
“Valuations for the Russell 2000 suggest mid-to-high single digit annualized returns over the next decade, and the relative forward P/E of large versus small caps also suggests small should beat large over the next 10 years,” she said, in a follow-up note to the bank’s S&P target update.
One problem with this thesis is just that intuitively, small-caps aren’t as amenable to blanket statements about what drives long-term returns, something Carey Hall readily admitted. Nevertheless, she noted that the “explanatory power of P/E on 10-year returns is still high,” at around 50%, compared to the above-mentioned 80% for large caps.
I won’t tell you I’m completely on board with any of this, and the scatterplot (above, from BofA) doesn’t suggest anything like a slam dunk. But that’s not really Carey Hall’s point. Rather, having suggested that the S&P faces a lost decade, folks doubtlessly wanted to know where they might hide to escape such a dismal fate.
The forward P/E for the Russell 2000 is well off the highs, but still above the historical average. Relative to large caps, though, small-caps are historically cheap.
Food for thought, even as I doubt it’ll sate anyone’s appetite.
I think our political landscape helps set the stage for a lame duck-like clogged sewer era. Covid, as a barometer, points towards a really screwed up society that has no interest in anything but fighting — that’s not conducive for growth. The concept of a lost decade or quarter century is foreseeable when looking at Japan example — but Japan has been able to manage and manipulate its economic position so as to not be a total disaster. It’s complicated.
I mean it really seems like we’ve been in the clogged sewer for decades now. We’re getting ratcheted into facism and making hardly any progress in the occasions we get anyone left of center or even centrish in control. It’s like we’re just got the right and the far right with a little leftist wallpaper over the right’s offices. However remarkably the far right is not actually interested in pulling off some kind of 4th Reich where we rebuild American productivity and take control of the world but rather just erode every last vestige of public good or public trust into a full blown return to Feudalism. As long as we can make a few thousand ferrari’s, jets and iphones a year the rest can burn apparently. No grand designs just plantation Earth with the population as chattel.
My understanding is that the FTSE Russell does not include companies in the calculation of the PE ratio if the company is losing money. If the negative earning companies were included, the PE ratio may well be many multiples higher. So if one wonders why the R-squared is not higher, consider the data on which it is based. Often enough, a majority of the 2000 companies do not make a profit.
If one thinks equities broadly writ will return 0% for the coming decade, there are some approaches to consider, singly or in combination.
Selection: focus on the subset of equities that you think will have an acceptable return. Could be small-caps, ex-US, dividend, etc.
Allocation: focus on something other than equities. Could be fixed income, real assets, private assets, real-world (Main St) projects, etc.
Timing: returning 0% by flatlining for a decade is not the same as going negative for some years and positive for the rest. We’ve discussed QQQ from 4/2000 to 2015 – zero return for the period, but lots of gains after the brutal wipeout.
Money is there to be made in stock picking. Valuation multiples for some sectors and stocks have been beaten down so much that they are in a bear market. Looking at the top 5 stocks in the S&P 500 and they are trading on a weighted forward earnings multiple of 37. As has been stated before these stocks have become a safe haven for all the liquidity sloshing around.