Long-Term Stock Returns Are NOT Random

Wednesday, March 4, 2020 |

In these times of high market volatility, it’s important to remember these 2 items:

  1. Cash and Bonds are the insurance in your portfolio to help weather a Bear Market, so be sure you keep enough on hand to do so
  2. Stocks are long-term investments where the longer you hold them, the greater probability you have of earning a positive and more stable return

I want to touch on the second point – why stock returns have a greater probability and become more stable the longer you hold them. The answer is quite simple and not random. Over time stocks tend to follow earnings growth and dividend yield.

Here are the real growth rates since 1900:

  • Real Total Stock Price Return = 6.6% annualized
  • Earnings Growth + Dividend Yield = 6.1% annualized

(Source: Bob Shiller Data, Capital Advisors, Ltd. calculations)

Additionally, the trailing returns over long periods of time (25 years) seem to be fairly correlated:

(Source: Bob Shiller Data, Capital Advisors, Ltd. calculations)

The exception being 2000 and 2008 where a massive decrease in earnings wiped out much of the earnings and dividends gains for the trailing 25 years. However, those earnings losses were quickly recovered as the decline was a temporary shock, which is reflected in the total stock market returns.

Ultimately, the above data shows if you’re bearish on stocks over a long period of time 1 of 3 things need to happen:

  1. Companies stop earning money
  2. Companies stop paying dividends.
  3. The market is extremely overvalued (see Japan in 1990)

I would certainly not bet on 1 or 2 and 3 doesn’t seem to be the case either. Consider staying long in stocks if you have a long-time horizon for those funds invested. Historically it has paid off and I believe it likely will in the future.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment.

Past performance is not indicative of future results.

S&P 500: The index measures the performance of 500 widely held stocks in the US equity market. Standard and Poor's chooses member companies for the index based on market size, liquidity and industry group representation. It is market capitalization-weighted. Investors cannot invest directly in an index.

Price data (average monthly close) per Bob Shiller from 1871 to 1928. Price data (month-end close) after 1928 per Morningstar Direct. CAPE, Dividend (Total Return), and CPI (Real Return) per Bob Shiller and calculated by CAL.

REAL = real rate of return is the annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation

Investing involves risk, including the loss of principal. There are some risks associated with investing in the stock markets: 1) Systematic risk - also known as market risk, this is the potential for the entire market to decline; 2) Unsystematic risk - the risk that any one stock may go down in value, independent of the stock market as a whole. This also incorporates business risk and event risk; and 3) Opportunity risk and liquidity risk.

The bond market is volatile and carries interest rate, inflation, liquidity and call risks. As interest rates rise, bond prices usually fall, and vice versa. Change in credit quality of the issuer may lead to default or lower security prices. Any bond sold or redeemed prior to maturity may be subject to loss.

Standard deviation is a statistical measure of the range of performance in which the total returns of an investment will fall. When an investment has a high standard deviation, the range of performance is very wide, indicating that there is a greater potential for volatility