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2 Reasons Why Investor Returns Will Diminish Over the Next Decade

Last Updated September 23, 2020 1:15 PM
Yashu Gola
Last Updated September 23, 2020 1:15 PM

The U.S. stock market in 2019 climbed even though there was plenty for investors to worry about. A mounting trade dispute between the U.S. and China, coupled with a slowing global economy and boiling geopolitical tensions, behaved like a perfect recipe for a financial disaster. A benchmark indicator even cried fears of a recession, building up a scenario for investors to flee from corporate stocks.

But what happened was the opposite. As November began, both the S&P 500 and Nasdaq hit record highs. Even the Dow Jones Industrial Average came half a percent closer to its last historic high, bolstered by a better-than-expected earning session, favorable jobs data, and expectations of a positive outcome from the Sino-U.S. trade talks. Lower interest rates this year also made government bonds less appealing and drove investors to equities.

To some, the growth in equities appears like a trend running ahead of actual investor sentiment. Edward Yardeni, president of Yardeni Research, told CNBC he expects  “nasty corrections” in what appears to be a “too expensive” stock market.

Explaining a similar scenario more broadly, analysts at Morgan Stanley stressed that traditional funds that typically have 60% exposure to equities and 40% to fixed income would face a meltdown in returns over the next ten years. Strategists including Serena Tang and Andrew Sheets noted two main reasons why the stock market would become a less-profitable bet for investors .

Weak Environment for Economic Growth

A downside move in the U.S. economy does not appear imminent, as employment and economic data make it clear time after time. Investors are also confident after the Federal Reserve offered three insurance rate cuts to expand the economy. Despite the U.S. central bank’s reluctance, the market believes it may cut the benchmark lending rate for the fourth time before the year concludes.

At the same time, a weak growth outlook globally is keeping investors on their toes. According to JC O’Hara, the chief market technician at MKM Partners, investors are aware of the ongoing global economic slowdown, which makes them doubt the longevity of the ongoing expansion. But the reason they are moving their capital into stocks anyway is TINA, a backronym for ‘There is No Alternative.’

“In a TINA market, where are they going to put their money?”

Meanwhile, Mr. Sheets sees the ‘growth-for-the-sake-growth’ scenario with skepticism. According to him, Wall Street is overestimating its annual earnings . Their forecasts could fell short in the long run, which would lead to a downside correction in the profitable equities of 2019.

Overall, it undermines investors’ expectations of higher profits.

Lower Sovereign Bond Yields

The other big portion of an average fund belongs to fixed-income securities – loans made to the government or corporation on the promise of returns in the form of regular or fixed interest payments. Lower interest rates have made U.S. sovereign bonds less attractive. Mainly, yields on long-term Treasurys for a dollar-denominated investor are down, with the net debt now touching $13.5 trillion.

For investors, bonds are expensive; they will continue to believe so until the U.S.-China trade war concludes, or possibly until after the next U.S. presidential elections. That makes fixed-income securities less appealing safe-haven assets against potential downturns in the risk-on markets.

morgan stanley, recession, bond yield
Traditional funds could see an annual profit of just 2.8%.| Source: Bloomberg Quint, Morgan Stanley 

Ms. Tang and Mr. Sheets told Bloomberg Quint :

“The return outlook over the next decade is sobering … Investors face a lower and flatter frontier compared with prior decades, and especially compared to the 10 years post-GFC, when risk-asset prices were sustained by extraordinary monetary policies that are in the process of being unwound.”

The strategists estimated that a fund’s earning from both equities (measured by the benchmark S&P 500) and fixed-income securities (driven by long term bond yields) would drop from the current 4.8% to 4.1% per annum over the next decade.