Covid Vaccine? Don’t Get Too Excited

Proceed with caution

Yesterday’s news of the Pfizer Covid vaccine may well be the emotional highlight of 2020. It certainly put a big smile on my face, notwithstanding an otherwise challenging day at work.

A triumph of good over evil. Of human ingenuity over a nasty, deadly illness. Of progress over yet another temporary setback.

The markets reacted accordingly. I watched in astonishment as the FTSE 100 shot up nearly 5% in seconds, and the S&P futures went up by nearly that amount.

FTSE 100 1 Day

As expected, the more “traditional” industries received the biggest shot in the arm. Airlines, industrials, hospitality, and even the good old banks all got a massive boost.

Technology didn’t fare nearly as well. Still up by a percent here and there. The benefits of accelerated digitalization are here to stay. No one ever rolls back progress.

However, you can sense some wind coming out of the sails of big tech companies.

During the darkest times, it wasn’t a stretch of the imagination to believe we will end up living in a Matrix of sorts.

Stuck in our home offices. Rolling lockdowns every few weeks or months. Resigned to virtual communication becoming a pervasive part of our lives. All enabled by the FAANGs of the world.

Thankfully, a vaccine will help us live the (better parts of) pre-Covid lifestyle again.

The Only Way Is Up

At the time of this writing, the S&P 500 is hovering just north of 3,600:

S&P 500 YTD

Up about 62% off the March lows. An increase of about 10.5% YTD. Add a ~1.8% dividend yield and you’ll get to a very respectable 12.3% total return.

Not too shabby for a year with the worst pandemic on record in a century, is it?

And certainly a worthy continuation of the incredible bull run of the past decade, which delivered an annualized return of 14% to patient shareholders.

Recent S&P 500 performance

The reality is that if you are looking to build serious wealth over long periods of time, you’ll struggle to find a better ally than the stock market.

And yet, it’s worth keeping in mind what it can – and cannot do.

What the stock market can do is deliver a return that’s roughly equal to the sum of dividend yield and real earnings growth.

Over the past 100 years or so, the combination of those two factors delivered a c.6.5% return on US equities.

On a nominal basis, the stock market also serves as a pretty good hedge for inflation. Add another 3-4% to account for it, and you end up at a c.10.5% long-term nominal return.

This is exactly the return you would have realized if you had faithfully continued buying equities over the past hundred-odd years:

Annual investment in the S&P 500

However, that’s also where the long-term return potential caps out.

In fact, in today’s low-growth, low-inflation environment, it’s tough to see our way to stock market returns of the past.  Somewhere between 7% and 8% is probably a more sensible assumption.

Pushing The Limits

The fact pattern doesn’t lie. 14% over the past decade. Another 12% this year.

Unless you can find a reason why long-term returns should exceed what we’ve experienced historically (I’m all ears!), we are all but set for a period of below-average returns.

I have no idea when it will happen – and how things will play out.

A withdrawal of the stimulus, perhaps, with a painful readjustment as Mr. Market weans itself off the addiction to easy money.

A period of above-average tax rates, to plug the massive deficits incurred as a result of Covid. Nothing like some extra taxation to put a damper on economic growth.

Or yet another of a myriad of other reasons why we may end up with something like the lost decade of the noughties, when even the most seasoned investors were driven to despair by lack of returns.

Of course, there’s no reason to despair. Just like there was no reason to sell in the face of bad news back in March, there’s no reason to buy (more than you normally would) today.

Pick your asset allocation. Stick to it, no matter what happens.

Slow and steady wins the race.

Happy investing!

About Banker On FIRE

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Banker On FIRE is a London-based M&A (mergers and acquisitions) investment banker.  I am passionate about capital markets, behavioural economics, financial independence and living the best life possible.

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4 Comments

  1. Thanks for another excellent article, BoF – I’m sure your skill of writing up all the polished IMs does help. :). Agree that “slow and steady wins the race” – I just set my regular monthly amount and watch. It’s nice to stand on the sideline, watching storms come and go.

    • Cheers AoF.

      Thankfully I’ve got others doing the heavy lifting on IMs so far though I do have to provide a dose of inspiration once in a while 🙂

  2. Hi BoF, I have a few ideas about why the stock market can continue melting up indefinitely. Central banks have ceded control over the money supply to politicians, and indeed in the UK we have seen the government doesn’t even need to use the central bank to create money i.e. by guaranteeing bounce back loans and pressuring commercial banks to offer them. We have adopted MMT in all but name. What politician can resist the lure of unlimited spending? We’ll need UBI as technology wipes out jobs.

    Additionally, the only way to clear our national debt burdens is financial repression. We cannot repeat the rapid technology and demographically fueled post-war boom this time. What I mean by financial repression, is interest rates lower than inflation for a sustained period of time. This is the only politically acceptable way to clear this debt. Central banks have already intimated they will not necessarily raise rates if inflation increases. I expect negative real rates for decades. Interest rates have been on a downward trend for thousands of years anyway. The stock market and the cash flow it offers (plus real estate) will be the only place with a positive yield. Microsoft/Apple/Google are the new bonds.

    In summary, the stock market is the only place for the wall of newly created money to find a yield. There’s also the Greenspan put idea.

    • I agree with that. When you get 5% on cash/bonds, the 8% yield on the stock market doesn’t look great, especially with all the volatility.

      When holding cash/bonds decimates your net worth day in and out, all of a sudden that alternative looks far more attractive!

      You can agree or disagree on the approach, but if the rules of the game have been set this way, staying on the sidelines isn’t an attractive option.

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