After eight years of almost uninterrupted stock market gains, some institutional investors are warning the next few years are unlikely to be as rewarding, at least in the U.S. markets, and that expectations should be tempered.
One such voice is David Swensen, who has led the $27.2 billion Yale endowment to unprecedented heights through timely asset allocation decisions, moving the assets into undervalued asset classes. During his 32-year tenure, the fund has had a 13.5% annual rate of return.
Mr. Swensen warned, in a recent speech, that stock market returns over the next several years are unlikely to be better than 5% per year, on average. That will disappoint many institutional investors, but his warning should be heeded, and should prompt investment committees to review their investment policies, goals and asset allocations. It also should prompt reviews of investment return assumptions.
From Jan. 1, 2009, to Dec. 31, 2016, the U.S. stock market returned 14.9% compounded annually, dividends included. That has more than offset the losses of 2007-2008 for endowments and foundations. But the stock market gains have been countered to a large extent for many pension funds by low interest rates, so that unfunded liabilities increased despite significant contributions.
The current bull market is not yet the longest since World War II. At 104 months and a rise of 263%, it still is short of the October 1990 to March 2000 dot-com bull market that lasted 113 months and rose 417%.
However, it is getting very long in the tooth, both in months and in percentage gain. It is also getting expensive, as the average price/earnings ratio of the S&P 500 as of Nov. 17 was 24.4, compared with the historic average p/e of about 15. This has raised concerns that a market correction is overdue.
A survey by Wells Fargo/Gallup between July 28 and Aug. 6 found that 54% of investors anticipate a market correction in the coming months, and they expect the correction to take back a significant part of the bull-market gains. A majority thought such a correction would hurt their financial situation a moderate amount or a lot. Yet 61% also thought it was a good time to invest in the stock market. To some institutional investors, that is a sign that there is not enough fear in the market, providing the environment for some extraneous event to trigger a long-overdue correction.
The arrival of a market correction cannot be predicted, but an era of lower stock market returns can be anticipated. Fund executives can prepare to maximize these lower returns by shifting the allocations toward the market segments likely to be most rewarding.
Pension fund executives also should adjust their assumed rates of return to the expected new reality, and also reduce fund expenses wherever possible, while endowments and foundations also should review their spending programs.
In the past eight years, the U.S. stock market has been unusually generous to institutional investors. Despite the good earnings being produced by companies, this generosity likely is approaching an end, and investors should prepare for the change.
