Dividend Sensei

What You Need To Know About Future Market Returns

Adam Galas

13 postsJune 5, 2021

Let’s start with this…

How 10.5% compound annual growth rate (CAGR) inflation-adjusted annual returns over the last decade are far above the market’s historical norm.

(Source: Ben Carlson)

The market’s real returns are generally stable at 6.5%-7.5% CAGR over time, meaning about 8.5%-9.5% in nominal terms using long-term 2% inflation expectations.

(Source: FAST Graphs, FactSet Research)

The incredible bull market of the last decade is due mainly to multiple expansion. Stocks are now trading at their highest blended price-to-earnings (P/E) ratio in 20 years and their second-highest in history.

(Source: FAST Graphs, FactSet Research)

That bodes rather poorly for short- to medium-term returns.

In fact, analysts expect about 5.9% CAGR real returns from the S&P 500 over the next 30+ years. That’s 16% less than its historical annual post-inflation returns.

Fortunately, there is good and bad news for long-term stock investors, especially the kind that invest primarily in index funds.

(Source: FAST Graphs, FactSet Research)

According to JPMorgan Asset Management, there’s a 50% probability that the market’s future fair value blended P/E will be about 18.5, rather than the 17.3 mid-range we’ve seen over the last 10-20 years.

Ten- to 20-year timeframes are 90%-91% statistically significant. Assuming relatively similar economic, interest rate, and earnings growth fundamentals, the 10- to 20-year average multiple approximates intrinsic value.

The 17.2 average blended P/E of the last decade includes:

Average 2.4% 10-year U.S. Treasury yields (blue-chip economists’ consensus average forecast for the 2020s is 2%-3%)
More aggressive monetary policy from the Fed
Aggressive corporate buybacks.

So why might the future fair value P/E for stocks rise to 18.5? Because, according to Ben Carlson of Ritholtz Wealth Management, the pandemic may have permanently reduced the risk of severe recessions.

The idea is simple. The pandemic lockdowns triggered the worst economic conditions in three-quarters of a century. Unemployment soared to nearly 20%, with -32% GDP growth in Q2.

Yet last year’s actual GDP decline was 3.5%, just 1% worse than the Great Recession. Unprecedented fiscal and monetary stimulus allowed what started out as a depression to become merely a historically mild recession.

(Source: The Balance)

That’s 4x milder than the peak of the Great Depression, when the economy contracted 13% and unemployment almost hit 24%.

Today, the Fed and some in Congress are considering automatic stabilizers, meaning stimulus programs that would kick in based on economic data. Others speculate that Americans will now expect aggressive fiscal and monetary policies to significantly moderate economic downturns.

If so, this means that the age of the severe recession may be over forever.

All asset prices are based on risk/reward.

(Source: Multipl.com)

For example, since 1872, the median and average trailing P/E for the S&P 500 is 14.9 and 15.9, respectively. However, the U.S. is in a very different place than it was in 1872.

Here are all the major fundamental shifts that have caused the market’s modern-era historical fair value to increase to about 17.2:

The U.S. is no longer a developing economy, which means it’s no longer experiencing 10%-30% annual GDP swings like it did in the 1800s.
Modern-day SEC and GAAP standards have led to far lower risks of corporate fraud.
Retirement accounts guarantee that trillions flow into the market each year.
Global investors invest trillions into U.S. stocks as well
Commission-free trading and fractional shares mean that almost anyone can start investing, no matter how much savings they have.

Plus, interest rates have been trending lower, not just in the U.S. but globally, for 800 years.

(Source: Bank of England)

In short, a more globalized world means easier access to capital and a lower cost of money (i.e. interest rates).

Now add in the potential for permanently milder recessions… and the stock market might indeed be permanently less risky, justifying slightly higher multiples.

The Good News and Bad News About Future Market Multiples

With that said, just because investing is potentially going to be less risky over the very long-term doesn’t mean valuations don’t matter.

According to Bank of America (BAC), since 1987, 80% of long-term blue-chip returns are purely explained by valuation. And there’s no other way I can look at it…

Today’s 22x forward earnings, almost 28x blended earnings, and 45x trailing earnings are most certainly representative of a very overvalued market.

S&P 500 2026 Consensus Return Potential (17.3 P/E)

(Source: FAST Graphs, FactSet Research)

Currently, analysts expect the S&P 500 to deliver about 5% CAGR returns over the next five years. Adjusted for inflation, that’s about 3% — less than half the market’s historical real returns.

The good news is that, over time, the market will always let us know stocks’ reasonable estimate of intrinsic value. The bad news is that even much lower risk doesn’t justify the kind of multiple expansion that many investors pray will avoid future lost decades.

Consider this: Even with all the improvements in market fundamentals – such as dramatically lower accounting fraud risk and a global investing pool – the market’s historical fair value increased from 15.9 to 17.3.

JPMorgan now thinks that might rise to about 18.5 if future recessions are milder, thereby creating less intense corporate earnings shocks.

Inflation-Adjusted Returns by Decade

(Source: Ben Carlson)

Over the last 200 years, 27% of all decades have seen negative real returns for stocks. As for today’s valuations, they’re not necessarily so high that S&P investors should expect negative returns in the 2020s.

However, even if JPMorgan and Ben Carlson are right and the market’s fair value P/E rises to 18.5… returns aren’t likely to be that impressive.

S&P 500 2026 Consensus Return Potential (18.5 P/E)

(Source: FAST Graphs, FactSet Research)

If JPMorgan is right, then stocks might deliver 6% annual returns over the next five years – about half what investors have enjoyed over the last 10. Adjusted for inflation, that’s about 4%, or 40% lower than historical real return.

But here’s the good news: It’s always a market of stocks, not a stock market.

There are literally dozens of reasonable and even attractively valued companies out there. Something great is always on sale, no matter your goal or focus.

Lowe’s Consensus 2026 Total Return Potential

(Source: FAST Graphs, FactSet Research)

Lowe’s (LOW) is just one example. It’s trading at fair value but among the 1% highest quality companies on earth.

This hyper-growth dividend king is the ultimate Buffett designation of a “wonderful company at a fair price.” And today it’s offering a five-year consensus return potential of 18% CAGR.

The bottom line is that, while it’s certainly possible that stock valuations will be higher in the future… that doesn’t mean that paying insane valuations will ever be reasonable.

ARK Innovation ETF Fundamentals

(Source: Morningstar)

Cathie Woods at ARK has a goal of delivering 15% annual total returns over time. That’s what private equity strives for too, since it represents doubling your money every five years.

But Mrs. Woods is trying to achieve those returns by paying 92x forward earnings for companies that Morningstar estimates will grow at 18% over time.

A P/E to growth (PEG) ratio of 5.1 isn’t just speculative. It’s borderline dangerous.

The most expensive market in history happened to Japan’s Nikkei 225, which hit 60x forward earnings in 1989. That bubble resulted in a 90% crash that was so severe, it still hasn’t come close to hitting new record highs these 30+ years later.

The most expensive U.S. market, meanwhile, was 27.2 forward earnings in 2000. And that led to a lost decade for the S&P 500.

Going back to ARKK for a moment, it has a P/E that’s 50% higher than the worst market bubble in all of human history. That’s not good, to say the extreme least.

But with companies like Lowe’s, you can achieve similar growth to ARKK, only with reasonable valuations, a forward P/E of 18 and a PEG ratio of 1.

That’s multibillionaire fund manager Peter Lynch-like growth at a reasonable price. And that’s just one example among dozens of world-class blue-chips you can safely buy even with the market near all-time highs.

You just need to know where to find them.

Happy Investing

Adam Galas

13 posts

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Adam Galas is a retired Army Medical Services Officer with an economics degree from the University of Minnesota who combines his 23 years of investing experience with a disciplined application of time-tested methods. Adam is holding or has held positions as a professional analyst at The Motley Fool, Seeking Alpha, and Simply Safe Dividends. His work has also appeared on thestreet.com, Forbes and Stocknews.com.

Due to his love of Buffett-style investing in safe, undervalued, dividend growth stocks, Tipranks recently ranked him Americas 43rd best analyst. And he is the second-most followed writer on Seeking Alpha, where as he is also a co-founder of Dividend Kings.

Thanks to a love of Buffett-style investing in safe, undervalued, dividend growth stocks, he was recently ranked the 43rd best analyst in the country by Tipranks and is the second-most followed writer on Seeking Alpha.

Dividend Growth Stock of the Week: The Clorox Company

REIT Mutual Fund	Symbol
Alpine Realty Income and Growth Fund	AIGYX, AIAGX
American Century Real Estate Fund	REAIX, REACX, AREEX, AREWX, ARYCX, AREDX
Real Estate Securities Fund	MRESX
AR Capital Real Estate Income Fund	ARIAX, ARICX, ARIPX
AssetMark Real Estate Securities Fund	AFREX
Aston/Harrison Street Real Estate Fund	AARIX, ARFCX
Baron Real Estate Fund	BREIX, BREFX
BlackRock Real Estate Securities	BIREX, BAREX, BCREX
Brookfield U.S. Listed Real Estate Fund	BRUAX, BRUCX, BRUIX, BRUYX
CGM Realty Fund	CGMRX
West Loop Realty Fund	REIIX, REIAX, REICX
Cohen & Steers Institutional Realty Shares	CSRIX
Cohen & Steers Realty Income Fund	CSEIX, CSDIX, CSBIX, CSCIX
Cohen & Steers Realty Shares	CSRSX
Columbia Real Estate Equity Fund	CREAX, CREIX, CRRVX, CRERX, CREEX, CRRFX, CREWX, CRECX, CREBX
Compass EMP REC Enhanced Volatility Weighted Fund	CWRAX, CWRIX, CWRTX, CWRCX
Davis Real Estate Fund	RPFRX, DREYX, DRECX, DREBX
Delaware Real Estate Investment Trust Portfolio II	DPRTX, DPRBX
Delaware Real Estate Investment Trust Portfolio	DPREX, DPRSX, DPRRX, DPRCX
DFA Real Estate Securities Portfolio	DFREX
Dunham Real Estate Stock Fund	DAREX, DNREX, DCREX
DWS RREEF Real Estate Securities Fund	RRRRX, RRREX, RRRAX, RRRSX, RRRBX, RRRCX
DWS RREEF Real Estate Securities Income Fund	REFAX, REFCX, REFIX, REFSX
Eaton Vance Real Estate Fund	EAREX, EIREX
EII Realty Securities Fund	EIIRX
Fidelity Advisor Real Estate Fund	FHEIX, FHEAX, FHETX, FHECX, FHEBX
Fidelity Advisor Real Estate Income Fund	FRIRX, FRIQX, FRINX, FRIOX
Fidelity Real Estate Income Fund	FRIFX
Fidelity Real Estate Investment Portfolio	FRESX
Fidelity Spartan Real Estate Index Fund	FSRNX, FRXIX, FSRVX
Fidelity Series Real Estate Equity Fund	FREDX, FREFX
Fidelity Series Real Estate Income Fund	FSREX, FSRWX
Forward Real Estate Long/Short Fund	KSRYX, FRLSX, FFSRX, KSRAX, KSRCX, KSRBX
Forward Real Estate Fund	FPREX, FFREX, KREAX, KRECX
Forward Select Income Fund	KIFYX, FSIMX, FFSLX, KIFAX, KIFBX, KIFCX
Franklin Real Estate Securities Fund	FREEX, FRLAX, FRRSX, FSERX
GMO Real Estate Fund	GMORX
Goldman Sachs Real Estate Securities Fund	GREIX, GRETX, GREAX, GRESX, GRERX, GREBX, GRECX
Great-West Real Estate Fund	MXREX
Heitman REIT Fund	OARTX, OBRTX
ING Real Estate Fund	CRARX, IREWX, IDROX, CLARX, CRWRX, CRCRX, CRBCX
INVESCO Real Estate Fund	REINX, IARFX, IARIX, IARYX, IARAX, IARRX, IARCX, AARBX
Ivy Real Estate Securities Fund	IRSAX, IREIX, IRSYX, IRSRX, IREEX, IRSCX, IRSBX
John Hancock Real Estate Securities Fund	JIREX
Johnson Realty Fund	JRLTX
J.P.Morgan Realty Income Fund	URTLX, JRIRX, URTAX, URTBX, URTCX
J.P. Morgan Security Capital U.S. Core Real Estate Securities Fund	CEEAX, CEERX, CEEFX, CEESX, CEECX
J.P. Morgan U.S. Real Estate Fund	SUSIX
Lazard U.S. Realty Equity Portfolio	LREIX, LREOX
Lazard U.S. Realty Income Portfolio	LRIIX, LRIOX
Manning & Napier Real Estate Series	MNRIX, MNREX
Morgan Stanley Institutional U.S. Real Estate Portfolio	MSUSX, MUSDX, MSULX, MURSX
Natixis AEW Real Estate Fund	NRFAX, NRFYX, NRFBX, NRFCX, NRFNX
Neuberger Berman Real Estate Fund	NBRIX, NBRFX, NREAX, NRERX, NRECX, NRREX
Nuveen Real Estate Securities Fund	FREAX, FARCX, FRSSX, FREBX, FRLCX, FREGX
Oppenheimer Real Estate Fund	OREAX, OREIX, OREYX, ORENX, OREBX, ORECX
PHOCAS Real Estate Fund	PHREX
PIMCO RealEstateRealReturn Strategy Fund	PRRSX, PETPX, PETAX, PETDX, PETCX, PETBX
Pioneer Real Estate Shares	PWREX, PYREX, PCREX, PBREX
Principal Real Estate Securities Fund	PIREX, PIRPX, PREPX, PRETX, PREJX, PRRAX, PRERX, PRENX, PRAEX, PRCEX, PRLEX
ProFunds Real Estate UltraSector ProFund	REPIX
Prudential Select Real Estate Fund	SREAX
Prudential U.S. Real Estate Fund	PJEAX, PJEZX, PJECX, PJEBX
REMS Real Estate Income 50/50 Portfolio	RREIX
REMS Real Estate Value-Opportunity Fund	HLRRX, HLPPX
Rydex Real Estate Fund	RYREX, RYHRX, RYCRX
SA Real Estate Securities Fund	SAREX
SEI Institutional Mgd Real Estate Fund	SETAX, SEIRX
Spirit of America Real Estate Income & Growth Fund	SOAAX
SSgA Clarion Real Estate Fund	SSREX
Stratton Real Estate Fund	STMDX
T.Rowe Price Real Estate Fund	TRREX, PAREX
TIAA-CREF Real Estate Securities Fund	TIREX, TRRPX, TRRSX, TCREX
Vanguard REIT Index Fund	VGSNX, VGRSX, VGSLX, VGSIX
Virtus Real Estate Securities Fund	PHRAX, PHRIX, PHRCX, PHRBX

REIT ETF	Symbol
Flex Shares	ASET
Wisdom Tree Global Ex-US	DRW
S&P 500 Equal Weight	EWRE
iShares FTSE Industrial/Office	FNIO
MSCI Real Estate Index	FREL
S&P REIT Index	FRI
First Trust S&P REIT	FRI
iShares Real Estate 50	FTY
Flexshares Global	GQRE
iShares Cohen & Streers	ICF
iShares International Developed RE	IFGL
iShares US RE	IYR
Premium Yield Equity REIT	KBWY
ETRACS Monthly Pay 2x Leverage	MORL
Market Vector Mortgage	MORT
iShares Global REIT	REET
iShares FTSE Mortgage	REM
iShares Residential	REZ
IQ US Real Estate Small Cap	ROOF
iShares FTSE NAREIT Retail	RTL
DOW Jones Global RE	RWO
SPDR Dow Jones	RWR
Schwab US REIT	SCHH
Super Dividend REIT	SRET
ProShares Ultra RE	URE
Vanguard REIT	VNQ
Vanguard Global ex-US	VNQI
iShares International Developed	WPS
Wilshire US REIT	WREI
Pacer Benchmark Data & Infrastructure RE	SRVR
Pacer Benchmark Industrial RE	INDS
Pacer Benchmark Retail RE	RTL
Hoya Capital Housing	HOMZ
NetLease Corporate RE	NETL

REIT Name	Ticker	Annual Increases/yr
Federal Realty	FRT	51
Universal Health Realty	UHT	33
National Retail Properties	NNN	29
Realty Income	O	27
Tanger Outlets	SKT	26
Urstadt Biddle	UBA	25
Essex Property Trust	ESS	25
W.P.Carey	WPC	22
National Health Investors	NHI	17
Equity Lifestyle	ELS	15
Digital Realty	DLR	15

What You Need To Know About Future Market Returns

Adam Galas

13 postsJune 5, 2021

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