This decade that is coming to a close has been rewarding for investors. The 2010s were marked by a slow but prolonged economic recovery following the Great Financial Crisis of 2008 and 2009. The U.S. began the decade with an unemployment rate of 10%. Now it is 3.5%. The current U.S. economic expansion is the longest in U.S. history.
Stock and Bond Return Expectations
Against that backdrop, global stock markets as measured by the MSCI All Country World Index in U.S. dollar terms returned 8.9% annualized over the past 10 years. In local currency terms, the 10-year annualized return was 9.9% as a strengthening dollar lowered the dollar-based returns of non-U.S. investments. U.S. stocks did even better, returning 12.9% annualized on a nominal basis as measured by the MSCI U.S. Index.
The U.S. bond market returned 3.6% annualized over the past 10 years as measured by the Bloomberg Barclays Aggregate Bond Index. The math of bond investing is that the best predictor of bond returns over a 7 to 10-year holding period is the starting yield-to-maturity. At the beginning of the decade, U.S. 10-year Treasury bonds were yielding 3.8%. Ten years later, the return of the overall U.S. bond market was very close to that starting to yield.
As we look to the decade ahead, the U.S. bond market has a yield-to-maturity of 2.3%. Based on that, 2.3% annualized on a nominal basis is a reasonable return expectation for U.S. bonds over the ten years.
A reasonable return expectation for global stocks in the next decade is 6.1% annualized on a nominal basis with a range of 0.7% to 9.2%. There is more uncertainty in forecasting returns for stocks than there is for bonds. While bond returns over a decade long holding period are driven primarily by interest income, stock returns are driven by dividends, earnings growth and changes in valuations. More components mean more uncertainty when it comes to predicting stock returns. While dividend yields are generally stable, earnings growth and what investors will pay for those earnings in the future is highly uncertain.
There are four forces that will influence economic growth, stock returns, and interest rates in the decade ahead. These complex forces will interact with each other, leading to feedback loops and uncertain outcomes.
The forces are climate change, money, trust, and technology.
Money. How much will be created? How much will be borrowed and paid back? How will it be spent? How will it be manipulated by central banks? How unequal will be its distribution? Answers to these money-related questions will shape the decade ahead.
Functioning economies, governments, and financial markets depend on trust. Trust in institutions and interpersonal trust is low and declining. One of the biggest risks in the decade ahead is a lack of trust leads to more tribalism and a breakdown in the institutions on which capitalism and democracy depend.
One of the disappointments in the decade coming to a close is how technological advances did not translate into a higher rate of productivity growth. Productivity measures how efficient an economy is with regards to the resources, including people, required to produce goods and services.
Economists remain perplexed as to why economic productivity is not accelerating. They are unsure if it is a measurement problem or businesses are just not as efficient as they could be because they do not make better use of technology.
Without steady productivity increases in the face of slowing population growth, economic growth in the decade ahead could be lower than in the decade coming to a close. That means lower-income growth for households and businesses and lower stock returns for investors .
There are of course other forces and surprises that will impact economic growth and financial market returns in the decade ahead. As investors, we must be adaptable in our portfolio approach so that we can take advantage of the opportunities that present themselves as well as reduce risk if the global economy and financial markets take a turn for the worse.
Please enjoy episode 281 as we take a closer look at these four forces and reflect on how we will change in the decade ahead.
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