From May 2009 through January 2020, the S&P 500 climbed at a 15.1% annualized rate. In contrast, U.S. GDP averaged only about 2% in the last decade. Popular notion is that equities can only keep appreciating at 15-20% a year while GDP grows at 2-3% annually for so long. A major reason for this performance gap can be attributed to the fact that stocks, in particular, were amazingly cheap in 2009. That combined with slow growth has provided corporate America with fewer investment opportunities which has prompted companies to focus on dividends and buybacks. Probably the single biggest reason for the runup in stocks over the past decade has been the price investors are willing to pay i.e. valuations.
After a decade in which U.S. equities have trounced their foreign counterparts and risk of recession largely written off, the prospect of slower growth in 2020 appears to not be shaking the faith of investors of continued rise in the stock market. And so, we find ourselves in the same situation as 1997 – equities are in a position similar to where they were – expensive and headed towards bubble territory.
Future Wealth’s View
The recent rise of Tesla stock, and rise and fall of stocks from companies like Beyond Meat are cautionary tales that are reminiscent of bubble territory trades. Investors’ penchant for “not being left behind” is what causes bubbles and for those who missed the run up in the stock market, it is time to take a deep breath and take a look at the fundamentals of the market, their own risk profile and time frame. For those who stayed invested and have enjoyed the decade of phenomenal returns – it is time to do the same – take a deep breath and take a look at the fundamentals of the market, their own risk profile and time frame.
The appetite for higher valuations can only go so far. So, what would it take for U.S. stocks to post another decade like the last one? Higher interest rates are necessary for higher returns and higher growth. And that, invariably, would mean an extended period of painful adjustments.