This morning we got a sad note from a famous former hedge fund manager (a friend of the firm who shall remain nameless):
What if the [stock] returns are never positive again? Just a question from a deeply scarred former investor.
Indeed, everywhere one looks there are calls that the stock market and the bond market will have low expected returns.
Logic would suggest that such commentary is “correct;” after all, if prices go up–expected returns go down–and if prices goes down–expected returns go up.
But low expected returns, doesn’t necessarily mean realized low returns, hence the use of the word, “expected.”
Can the stock market double from here?
What if we and all the scared/scarred hedge fund managers (i.e., the so-called pros) are all wrong? What if something “crazy” is on the horizon? Dare we say it — what if this time is “different?”
Consider the world we live in today:
- 10-year bond yields are really low and some are even negative.
- Stock dividend yields are really low (e.g. ~2% on the S&P).
- Financial repression is in play and hyperinflation bets are likely sucker bets — see this piece we originally wrote in 2011.
- Most finance professional feel like stocks and bonds are “overvalued” and sentiment is generally “blah.”
- Much of the investable capital is held by the retiring baby boom generation in search of “yield.”
Now imagine the world in 5 years:
- 10-year bond yields are flat or negative across the globe. (i.e., not exciting–at all!)
- Putting money in a bank account has a non-trivial cost of carry (i.e., not a great “feel good” option)
- Financial repression is in play and banks and insurance companies are structurally non-profitable enterprises.
- Retiring baby boomers are begging for yield.
What happens in this scenario?
Let’s assume that stock dividend yields seem increasingly attractive to investors and hit 1%.
Did you notice what just happened?
The stock market yield went from 2% to 1% and the stock market just doubled…
…and now it might be time to consider investments in gold (without serial numbers), guns, and family compounds.
Note: we have 0% faith in our ability to predict macroeconomic events, but we also recognize that pontificating on these subjects is immensely more entertaining and fulfilling than simply focusing on “all-weather” long-term concepts of value, momentum, and trend-following.
About the Author: Wesley Gray, PhD
—
Important Disclosures
For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Third party information may become outdated or otherwise superseded without notice. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this article.
The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).
Join thousands of other readers and subscribe to our blog.