When Predicting Future Stock Market Returns—Expect the Unexpected [Market Insight]

Steve Dixon, CFA® CSRIC®
Aug 26, 2021 9:54:21 AM

Market Insight - August 2021

Expect the unexpected might be good advice in many areas of our lives. Don’t get too rooted in what you expect to happen, and you may find that the unexpected generates less anxiety or conflict or hasty decision-making. Take prudent precautions to avoid the unexpected from causing avoidable inconvenience or expense. When the consequences of unexpected outcomes are significant enough, we tend to seek ways to protect ourselves from those consequences.

In 2019, a global pandemic was certainly not expected in the near future. Double-digit stock market returns were also generally not expected in the following year. While surely there were some market analysts or pundits that may have accurately projected double-digit stock market returns in 2020, I have yet to find the intrepid prognosticator that forecasted those lofty returns along with a global pandemic.

Setting Investment Expectations

Having our own expectations for future investment outcomes is very important when we are designing or re-evaluating your portfolio. Perhaps even more important though is the understanding that those expectations are almost surely inaccurate. If we had abundant confidence that our expectations for future investment returns were accurate, we would simply allocate your assets to the investment with the highest projected return and only make a change when another investment was found to provide a higher expected return. But, as Mark Twain said, “it ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

We know that investment expectations are likely doomed to be incorrect, but it’s still important to evaluate different investment options and assess our expectations for risk and return over a long enough period of time to overcome short-term noise and cyclicality. Knowing that these expectations are not sure things, we seek to build in ways to protect a portfolio from the unexpected. Diversification is a central tenet of prudent investing. You can be undiversified and do extremely well with your investments, but for every Dogecoin instant millionaire, there are droves of others that learned a heart-breaking, costly lesson on the risk of being undiversified when something unexpected happens.

By many measures, the global stock market is currently expensive. The global bond market also appears expensive. As a result, many market analysts have very somber expectations for the return on stocks and bonds over the next decade. BlackRock expects the U.S. stock market to return 6.4 percent over the next 10-years1. J.P. Morgan expects U.S. stocks to return about 4.1 percent2 and MFS offers that U.S. stocks will provide no appreciation of value to investors in the coming decade3. In the past 70 years, the actual average annual return of U.S. stocks over a 10-year period has been 11.3 percent4.

Expectations for bond market returns are similarly pallid, but with substantially less variability. BlackRock expects bonds to return 1.4 percent1, J.P. Morgan is at about 2 percent2 and MFS at 2.4 percent3. Historically, bond returns have averaged about 5 to 6 percent annually over 10-year periods5.

Expectations for the next decade

It’s safe to say that expectations for investment returns over the next decade are well below historic averages. As with all expectations, these projections are based on some broad assumptions. Assumptions are made for economic growth, inflation, interest rates and how much investors are willing to pay for a piece of a company’s future earnings, among other things. While anyone with any knowledge of how these expectations are generated could poke and prod the models and cast doubt on the assumptions, that is not a helpful exercise for this letter. You can see though that these expectations are built on best guess assumptions. Different interpretations of the data can lead to vastly different expectations.

Over the past eighty years, only one ten-year period left investors in an average stock and bond portfolio with a negative return6. An unfortunate circumstance befell the individual that started investing in a blended portfolio of stocks and bonds in March of 1999. Over the next ten years, that investor stood a decent chance of having ended up right about where they started. They would have started investing nearly at the peak of an epic stock market bubble and then found themselves in the throes of a global financial system meltdown ten years later. In other words, this particular ten-year period, since dubbed the “lost decade”, happened to represent a near perfect peak to trough scenario.

We understand the paltry expectations for capital market returns over the coming decade. As such, we have incorporated expectations for lower than historic long-term average investment returns in our planning process for you over the past several years. Additionally, our investment selection and portfolio construction process analyzes how different types of investments tend to behave in different market environments. We use this information to try to build a well-diversified portfolio that attempts to provide a strong long-term return for your level of investment risk. To help understand why diversification is so important, below are the average annual returns for various investments during the aforementioned “lost decade”. Had an investor been more broadly diversified, they may not have suffered as much as a less diversified investor.

Table 1
Market Indices (As Of 2/28/09)

Ten Years

U.S. Large Company Stocks -3.4%
U.S. Mid Company Stocks +3.6%
U.S. Small Company Stocks +3.6%
Non-U.S. Large Company Stocks -1.6%
Non-U.S. Small Company Stocks +2.7%
Emerging Market Stocks +7.0%
Real Estate Stocks +3.4%
U.S. Investment Grade Bonds +5.6%
U.S. High Yield Bonds +2.1%

Including lower than average investment returns in your financial plan and building a broadly diversified portfolio are important steps to take in the current market environment. It’s also very important to be ready to adapt and adjust along the way. While lower market returns over the next decade are the prevailing expectation, we ought to know by now that capital markets are oft to do the unexpected. Additionally, we know that we aren’t managing portfolios in ten-year increments. We are managing your portfolio of investments with the objective of meeting your financial goals and we will continue to adapt and adjust to the market environment in our best effort to do just that.

Table 2
Market Indices (As Of 6/30/21) 2nd Quarter One Year
Dow Jones Industrial Average +5.1% +36.3%
NASDAQ Composite +9.7% +45.2%
S&P 500 Index +8.6% +40.8%
Bloomberg Barclays Capital Aggregate Bond Index +1.8% -0.3%
Small Cap Stock (Russell 2000 Index) +4.3% +62.0%
Non-US Stock (MSCI EAFE Index) +5.2% +32.4%

Kay_Kramer_0001-2It’s been a year of change for many of you as it has for us at Birchwood. As I noted in a previous letter, Ellen Johnson retired from Birchwood earlier this year. And this summer, our founder, leader, visionary, and, by all accounts, “the heart of Birchwood” stepped into retirement. This short note of thanks to Kay Kramer can’t possibly do justice to the enduring impact she has had on all our lives and so many of yours. The culture at Birchwood is unlike any other company that I have been part of. It has been remarked many times over the years by people outside and inside of Birchwood that this is a truly wonderful place to work. Our values influence our priorities, doing right by you, our clients, being principal among them. Kay made it clear in her words and actions what was important and that integrity toward the relationships we have with all of you has been ever present in every decision made. That includes her vision in building a strong, like-minded team of individuals to continue her legacy. While Kay has retired from her work as an exceptional financial planner, she remains a good friend to all of us.

Photo Jun 22, 2 52 10 PM (1)

We all take great pride in being part of the Birchwood team and can’t thank Kay enough for the opportunity and purpose she has given us. Our best way of thanking her will be to continue what she started with the same responsibility and integrity upon which Birchwood was founded over thirty years ago.

Gratefully yours,

Steve Dixon, CFA® CSRICTM
Investment Manager

Dana Brewer, CFP®, Bridget Handke, CFP®, Damian Winther, CFP® CSRICTM, Rachel Infante, CFP® CSRICTM, Kimmie Moehring, CFP®


1 Source: “Capital Market Assumptions - Institutional.” BlackRock, BlackRock Investment Institute, Aug. 2021, www.blackrock.com/institutions/en-us/insights/charts/capital-market-assumptions.

2 Source: Bilton, John, et al. “Long-Term Capital Market Assumptions.” Executive Summary | J.P. Morgan Asset Management, 9 Nov. 2020, am.jpmorgan.com/us/en/asset-management/institutional/insights/portfolio-insights/ltcma/executive-summary/.

3 Source: Nastou, CFA, Benjamin R., et al. “MFS Long Term Capital Market Expectations.” Capital Markets | US Edition, July 2021, www.mfs.com/content/dam/mfs-enterprise/mfscom/insights/2021/july/mfse_fly_679695/mfse_fly_679695.pdf.

4 Source: Morningstar Direct.
S&P 500® Index average annualized return for rolling 10-year periods between December 1, 1935 and July 31, 2021 has been +11.30%.

5 Source: Morningstar Direct.
IA SBBI US Long-Term Corporate Index average annualized return for rolling 10-year periods between March 1, 1946 and July 31, 2021 has been +6.01%.
IA SBBI US Intermediate-Term Government Index average annualized return for rolling 10-year periods between December 1, 1935 and July 31, 2021 has been +5.13%.

6 Source: Morningstar Direct.
Morningstar US Fund Allocation- - 50% to 70% Equity Category annualized return for the rolling 10-year period between March 1, 1999 and February 28, 2009 was -0.10%. All other rolling 10-year periods between July 1, 1939 and July 31, 2021 have been positive.

Table 1 Source: Morningstar. Market indexes are unmanaged, and investors cannot invest directly in indexes. However, these indexes are accurate reflections of the performance of the individual asset classes shown. All returns reflect past performance and should not be considered indicative of future results. Representative indexes used are: S&P 500® Index (U.S. Large Company Stocks); S&P MidCap 400® Index (U.S. Mid Company Stocks); S&P SmallCap 600® Index (U.S. Small Company Stocks); MSCI EAFE Large Cap Index (Non-U.S. Large Company Stocks); S&P Developed ex-U.S. SmallCap Index (Non-U.S. Small Company Stocks); MSCI Emerging Markets Investable Market Index (Emerging Markets Stocks); Wilshire US Real Estate Investment Trust IndexSM (Real Estate Stocks); Bloomberg Barclays US Aggregate Bond Index (U.S. Investment Grade Bonds); Bloomberg Barclays Intermediate US High Yield Index (U.S. High Yield Bonds).

Table 2 Source: Morningstar. Market indexes are unmanaged, and investors cannot invest directly in indexes. However, these indexes are accurate reflections of the performance of the individual asset classes shown. All returns reflect past performance and should not be considered indicative of future results.

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