The S&P 500 Has the Hiccups: How Investors Should Think About Long-Term Returns
Investors in the S&P 500 Index might be experiencing a slight dip in performance, but let’s not confuse this with a crisis of confidence. Despite being down slightly year-to-date, the S&P 500 has tripled investor returns over the past decade, signaling a resilient market. However, there are underlying anxieties that cannot be ignored.
Distinct shifts within the market are becoming evident. The S&P 500 Equal Weight Index has been outperforming the traditional index, which is heavily weighted by technology giants—a possible indicator of a change in market leadership. Additionally, defensive sectors such as healthcare, once a lagger in performance, are now leading the charge in 2023. Recent statistics from Bank of America Securities indicate that value stocks exceeded growth stocks by 3.9 percentage points in February, ranking as one of the top five months for such relative value returns since 1979.
Global Perspectives: The S&P 500 vs. International Markets
Interestingly, shares in Europe and China have outperformed their U.S. counterparts this year, leaving index investors pondering whether to adjust their fund allocations to reflect these global market dynamics.
To shed light on how investors might conceptualize long-term returns, we can turn to a recent report from three U.K. professors: Paul Marsh and Mike Staunton from the London Business School and Elroy Dimson from Cambridge University. Their findings are derived from a comprehensive analysis of stocks, bonds, bills, currencies, and consumer prices spanning countries and time periods often overlooked by traditional financial narratives.
Through their work—including the influential book Triumph of the Optimists: 101 Years of Global Investment Returns—they have demonstrated the vast changes in stock market performance over more than a century. One revealing observation is the evolving dominance of the U.S. stock market. In the year 2000, the U.S. represented 14% of the world market; fast forward to last year, and that figure expanded to an astonishing 64%, accounting for 73% of the developed markets globally.
Declining Dominance: The U.K. and Japan’s Market Challenges
The evolution hasn’t been uniformly positive for all markets. The U.K. stock market has seen a steep decline, dropping to just 3% of global stock markets, a stark contrast to its commanding 24% at the turn of the 20th century. Japan, once a contender during the late 1980s, has faltered from 40% to below 6% today—highlighting that even the strongest markets can face drastic downturns.
The Case for International Diversification
Historically, international diversification has been shown to benefit investors, leading to reduced risks. However, U.S. investors may find themselves in a peculiar position. Although theoretical frameworks support international investments, practical evidence has not consistently validated the concept for American portfolios. “Even for a U.S. investor, it makes sense to diversify internationally,” said Marsh. “But it isn’t guaranteed.”
The Place of Bonds in Investment Portfolios
When it comes to bonds, the news isn’t particularly rosy. The average real return on government bonds since 1900 has merely reached 0.9% per year. While bonds typically experience lower volatility compared to stocks, they can also face protracted periods before investors can break even, particularly during times of economic downturn.
This brings to light the importance of including bonds in investment portfolios. While they may not project long-term success, their role as a stabilizing force during stock market turmoil cannot be understated.
The Power of Stocks: Quality Over Quantity
For investors inclined towards stocks, the U.S. has yielded an impressive 9.7% annualized return over the past 125 years, or 6.6% when factoring inflation. Stocks remain a better-performing asset class across countries with continuous investment histories spanning 125 years; however, a significant number of individual stocks underperform, making diversification essential. A 2018 study highlighted that 57% of U.S. stocks produced returns less than those of Treasury bills, showcasing that the bulk of market gains is driven by a mere 4% of stocks.
The Implications of Market Concentration
The current stock market looks increasingly concentrated, with three companies constituting approximately 19% of the S&P 500. This concentration level has reached heights not seen in 92 years. However, markets have thrived before, even during periods of high concentration—as evidenced by the historical prominence of railroads in the early 1900s.
Future Returns: Outlook for New Generations
Looking towards the future, predictions for real annual returns have become milder. Generation Z, for instance, can anticipate a real return of approximately 3.9% per year on a balanced portfolio of stocks and bonds—a rate that is lower than that of previous generations but not entirely bleak for prospective investors.
In conclusion, while the S&P 500 may currently exhibit signs of instability, the long-term outlook for diversified investment still remains promising. Investors need to navigate with awareness of market fluctuations, historical context, and fundamental principles in order to secure sustained returns in an ever-evolving investment landscape.