Don’t Get Too Excited

Yesterday’s news of the Pfizer 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.

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:

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.

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:

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!