Look For Weak Returns in Stocks & Bonds in 2020
This tidbit from the Wall St. Journal caught my eye this morning.
“Compared with the sharp gains in stock prices, companies in the S&P 500 have reported subpar growth in both earnings and revenue this year. Earnings per share growth will be just 1.4% according to Fact-set data, down from 22% in 2018.”
The Wall St. Journal piece also goes on to say “with low unemployment, low interest rates and strong wage growth, most observers expect the markets to maintain their trajectory.”
TWO things jump out at me from the above.
- EPS (earnings per share) growth of 1.4%.
- “Most Observers expect”
Let’s go over both these shall we?
First, the easiest way to predict stock returns is to follow the John Bogle model:
Total Return (TR) = Earnings Growth Year Over Year (EG) + Dividend Yield (DY)
To simplify: TR= EG + DY
Now, be advised, this equation doesn’t follow any level of yearly correlation, i.e., earnings growth in 2018 of 22% certainly didn’t lead to anywhere near a 22% rate of return for the S&P 500 in 2018. In fact, the S&P 500 was down nearly 5% in 2018.
Just look at the historical numbers, though. EG + DY = TR. It’s almost a science over the long term. Weird, actually.
Anyway, so if earnings blew the roof in 2018 and yet Total Return was negative and then earnings were tepid in 2019 but Total Return was through the roof, what does that mean in 2020?
And that’s why I say 2020 will be subpar, if not downright negative.
Probably my favorite investment piece of all time is this from Vanguard which they update annually. The average annualized return of the US Stock Market was 10.09% in the modern era. Yet, only 6.4% of the time did the returns actually fall BETWEEN 8% and 12%!
That just goes to show you the crazy nature of investing in stocks. You rarely get an average rate of return. Yet, if you were able to discipline yourself to hang in there, you’d have doubled your money every 7 years or so over the last nearly 100 years.
But how do you discipline yourself? Well, it’s to recognize that the markets are finicky. And they don’t follow ANY strategy in the short term.
“Josh, how dare you say markets are correlated with earnings! Just look at what happened in 2018, blowout earnings and negative returns AND 2019, poor earnings and blowout returns!”
Yes, I know it. In any given year, markets don’t follow a formula. I don’t challenge this. But over time you can’t come up with a better correlation with market returns than TR=EG + DY. Trust me, I’ve tried. And this is the best there is, for investors over the longer terms.
As such, can you make a case that earnings growth is a leading indicator, i.e., what happened in 2018 will be reflected in 2019 and what happened in 2019 will be reflected in 2020? Maybe.
I’ve never looked at it specifically. I suppose one could if they wanted to look at the Robert Shiller research. Actually wouldn’t be too difficult. So have at it. But, frankly, I don’t care because I’m not changing my position in the least. I’m all in stocks, with a bit of cash on the side.
The reason I’m all in stocks is because I recognize the market could get crunched and thus I also decide, in advance, whether or not I could take that hit. Say you started 2019 with $100,000. For simplicity we’ll say you’re now up to $130,000 by being in the Vanguard Total Stock Market Index
Could you handle a 30% hit in 2020? That would mean by year end you’re down to $91,000. Thus, over those TWO years time (2019-2020) you would have been down 9% total. At the beginning of 2019, if I said can you afford to be down 9% to $91,000 by year end would you have said yes then?
If so, unless your financial situation has changed in the last year, logic would dictate you can take a 30% hit this year, no? Especially, if you consider that at the beginning of 2019, I would have asked if you could afford your $100,000 to drop to $70,000. If you answered in the affirmative then, I just don’t see why you wouldn’t answer the same way now, after a huge gain last year.
Now, let me close on one other thing. Bonds won’t give you a reprieve from a negative stock return. If there is one lesson I would love for people to learn it would be that bonds are as predictable as the sun rising in the East. You know, for a fact, what your long term return in bonds will be. Thus, when there is short term deviation of the long term return, you know, again, for a fact, that there will be a revision at some point to adjust accordingly.
Above is the chart for the Vanguard Total Bond Index (BND) from Yahoo Finance. Notice the YTD return, I’m assuming it’s for year end of 2019, but it really won’t matter much. That YTD return was 8.93% if you reinvested interest.
Notice though the YIELD? It’s only 2.73%. It’s a mathematical certainty that the YTD returns will drop to be more in-line with the yield at some point. I can not emphasize this loudly enough, you will NOT get nearly 9% returns in bonds going forward. If any year you do, you will have a year with a corresponding loss to account for those returns.
Bond investors can expect a return of whatever that yield is, in this case it’s about 2.73% a year. No more, and maybe a little less if any of the bonds in the portfolio go bankrupt. Please understand this. It’s critical to knowing your investments. And yet, most people don’t. Shoot, I didn’t for the longest time.
Now I’ve done videos and written many times before on why bonds are the Siren Song of the investment world. I won’t rehash all this here. But more to come in 2020 on this topic as it’s one of my favorites to discuss.
I predict markets will have low single digit returns in 2020. And I suggest you prepare accordingly. Could I be wrong? Is Tom Brady the GOAT? Of course he is and of course I could be wrong. I’d highly expect it, actually.
But because I may be wrong doesn’t mean there is no validity in taking the time to set realistic expectations. How will your retirement plan shake out if your portfolio only grew 2% this year? You wouldn’t be doomed, I wouldn’t imagine.
But then ask yourself, how will I shake out if I actually am DOWN 30% on my total portfolio. Will you still be better off than you were a few years back? If so, drive on. However, if your retirement will be negatively affected by a 30% drop, you may want to take some gains off the table to lock them in now.
Oh, I did mention there were TWO things that jumped out at me in that Wall St. Journal piece. The first was the low earnings growth in 2019.
The second was that “most observers expect the markets to maintain their trajectory.” That statement should give you pause. In my experience I’ve found that when most people think one way, the best thing you could do is think opposite. It challenges your critical thinking skills first and foremost.
But also, the crowds are usually wrong and sometimes wildly so. You can profit on the madness of crowds, indeed. If only someone had written a book on this.