Ten
years
ago,
there
were
three
schools
of
thought
about
how
American
stocks
would
fare
during
the
next
decade.
The
mainstream
belief,
widely
held
by
everyday
investors,
was
that
US
equities
would
gain
an
average
of
10-12%
per
year.
After
all,
that
was
their
long-term
annualised
rate
of
return,
according
to
the
popularly
cited
data
from
Ibbotson
Associates,
which
dated
to
1926.
Why
doubt
the
track
record?
Most
investment
experts
thought
differently.
Those
were
the
recorded
numbers,
all
right,
but
conditions
had
changed.
By
historical
standards,
the
yield
on
stocks
was
low,
their
prices
were
high,
and
the
nation’s
gross
domestic
product
growth
was
sluggish.
Best
to
shave
that
annual
estimate
to
7%-8%.
Warren
Buffett
believed
that,
as
did
Jack
Bogle,
as
did
Wharton’s
Jeremy
Siegel.
The
third
group
was
the
pessimists.
Largely
guided
by
statistics
such
as
the Shiller
CAPE
ratio,
they
argued
that
US
equity
valuations
had
already
crossed
that
line.
Yes,
stocks
had
briefly
become
cheap
after
the
2008
global
financial
crisis,
but
by
2014
they
had
fully
recovered.
Stocks
were
due
for
a
comeuppance.
Schiller
CAPE
Ratio
Robert
Schiller
Data
as
of
June
16
2024
Only
twice
in
the
previous
half-century
had
the
CAPE
ratio
been
higher
than
in
spring
2014:
during
the
late
1990s
and
the
mid-2000s.
As
with
bars
at
2am,
nothing
good
happened
after
either
of
those
occasions.
Perhaps
equities
would
not
crash
this
time
around,
but
they
surely
wouldn’t
thrive.
At
best,
they
would
eke
out
a
humble
nominal
annualized
gain,
say,
2%-3%.
The
Results
To
the
surprise
of
the
experts
and
the
utter
dismay
of
the
pessimists,
US
equities
ignored
the
concerns
and
proceeded
on
their
merry
way.
The
chart
below
shows
the
annualized
total
return
for
the
S&P
500
from
June
2014
through
May
2024,
along
with
the
outlooks
from
the
forecasting
schools.
Total
Returns
Morningstar
Direct
Data
as
of
June
16
Even
better
than
before!
That
said,
the
picture
is
incomplete
because
it
considers
only
nominal
returns.
What
matters,
of
course,
is
after-inflation
performance.
To
what
extent
did
owning
a
US
equity
portfolio
increase
a
shareholder’s
purchasing
power?
I
redid
the
exercise
using
a
2.25%
expected
inflation
rate
for
the
forecasters.
(That
was
not
only
a
common
prediction,
but
also
the
prevailing breakeven
inflation
rate on 10-year
Treasury
Inflation-Protected
Securities.)
Real
Returns
Source:
Morningstar
Direct,
author’s
calaculations,
data
as
of
June
16
2024
Incorporating
inflation
slightly
shrinks
the
victory
margin
because
actual
inflation
was
modestly
above
the
marketplace’s
expectation.
But
the
essential
story
remains
unchanged.
High
valuations
and
slowing
economic
growth
notwithstanding,
equities
performed
better
than
almost
anybody
envisioned.
(Note:
Real
returns
plus
inflation
do
not
necessarily
sum
to
nominal
returns
because
the
components
of
investment
performance
are
multiplicative,
not
additive.
For
example,
a
stock
that
records
a
4%
capital
gain
while
paying
a
4%
dividend
has
an
8.16%
total
return.)
What
Happened?
So
far,
I
have
decomposed
equity
returns
into
two
factors:
a)
before
and
b)
after
inflation.
But
they
can
properly
be
separated
into
four
components:
1)
inflation,
2)
dividends,
3)
earnings-per-share
growth,
and
4)
valuation.
In
other
words,
a
stock’s
real
performance
equals
the
dividends
that
it
pays,
multiplied
by
its
change
in
earnings
per
share,
multiplied
by
the
change
in
price
multiple
that
the
stock
commands –
to
which
inflation’s
effect
must
be
considered.
To
determine
the
experts’
estimates
for
those
items,
I
tracked
down
a 2014
report from
J.P.
Morgan
Chase
(JPM).
Although
its
figures
are
proprietary,
they
closely
match
those
suggested
by
Buffett,
Bogle,
and
Siegel.
Such
was
the
informed
consensus.
Below,
I
display
the
paper’s
“10-
to
15-year”
projection
for
the
four
equity-return
components,
along
with
what
actually
occurred.
Return
Components
Sources:
Morningstar
Direct,
Robert
Schiller,
JPMorgan
Chase,
author’s
calculations,
data
as
of
June
15,
2024
(Note:
as
you
may
have
noticed,
the
numbers
in
J.P.
Morgan
Chase’s
paper
do
in
fact
sum,
rather
than
multiply.
Not
everybody
is
pedantic.)
Let’s
grade
the
accuracy
of
each
prediction,
from
best
to
worst.
1) Inflation:
A-. The
forecast
slightly
exceeded
the
stated
target
before
the
postpandemic
spike,
then
finished
slightly
below.
In
either
case,
both
the
experts
and
the
TIPS
marketplace
proved
trustworthy.
2) Dividends:
C+.
At
1.87%,
the
dividend
rate
fell
well
short
of
the
paper’s
3%
estimate.
Its
authors
were
on
the
right
track,
writing
that
companies
would
“favour
payouts
over
new
investment.”
But
those
payouts
increasingly
consisted
of
stock
repurchases
instead
of
dividends.
3) EPS
Growth:
C-.
The
error
was
larger
yet
with
earnings
growth,
which
surpassed
expectations
for
two
reasons.
One,
the
stock
buybacks
reduced
the
number
of
outstanding
shares,
thereby
shrinking
the
calculation’s
denominator.
Two,
as
I
mentioned
in last
week’s
column,
the
nation’s
politics
helped
investors.
Populism
rose,
but
the
anger
was
aimed
largely
at
the
federal
government,
not
corporations.
4) Valuation:
D.
Perhaps
that
grade
is
overly
generous.
At
any
rate,
very
few
investment
experts,
if
any,
believed
that
the
stock
market’s
price/earnings
ratio
would
increase
over
the
next
decade.
In
anticipating
that
the
ratio
would
remain
flat,
rather
than
revert
toward
the
historic
mean,
the
paper’s
authors
were
relatively
optimistic.
Looking
Forward
My
grades,
I
must
confess,
were
harsh.
On
their
own,
neither
the
predicted
dividends
nor
real
EPS
growth
was
especially
accurate.
When
evaluated
together,
though,
the
forecasts
were
almost
spot
on.
J.P.
Morgan
Chase’s
paper –
which,
again,
is
an
apt
summary
of
the
institutional
consensus –
expected
those
two
factors
to
deliver
a
combined
5.25%.
The
true
figure
was
5.69%.
While
economic
disaster
is
always
a
possibility,
it’s
reasonable
to
expect
a
similar
figure
over
the
next
10
years.
Let’s
say,
to
be
slightly
conservative,
it’s
5%.
If
inflation
were
to
average
3%,
that
would
make
for
an
8%
nominal
return
if
price/earnings
ratios
remain
constant.
(This
time,
I
will
not
be
pedantic
and
multiply
the
figures;
after
all,
this
is
merely
a
back-of-the-envelope
musing.)
Of
course,
the
price/earnings
ratio
for
US
equities
might
slide.
I
will
not
predict
that
event,
because
I
have
watched
too
many
such
prophecies
fail.
Should
that
decline
occur,
though,
the
nominal
annualised
return
for
US
equities
through
the
next
decade,
assuming
a
5%
contribution
from
dividends/EPS
growth
and
a
3%
inflation
rate,
would
be
6.9%
if
the
market’s
price/earnings
ratio
falls
by
10%
over
that
period
and
5.7%
if
the
ratio
drops
by
20%.
That’s
a
far
cry
from
the
previous
decade’s
12.6%
but
still
above
what
bonds
will
provide.
To
answer
this
column’s
opening
query:
yes,
stocks can repeat
their
feat,
although
I
do
not
think
they
will.
Perhaps
a
better
question
is
whether
US
equities
should
remain
an
investment
cornerstone,
not
just
for
American
investors,
but
for
shareholders
worldwide.
I
don’t
see
why
not.
The
author
or
authors
do
not
own
shares
in
any
securities
mentioned
in
this
article. Find
out
about Morningstar’s
editorial
policies
The
opinions
expressed
here
are
the
author’s.
Morningstar
values
diversity
of
thought
and
publishes
a
broad
range
of
viewpoints
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