We believe that the prevailing long-term outlook for equities is too pessimistic.
Given the current low-interest-rate environment, it is not unusual to hear investors comment: “In this environment, I would be happy with 4% to 5% return from equities.”
At Janus, we take three different approaches to estimating long-term equity returns, and they all point to meaningfully higher estimates than the 4% to 5% range assumed by many in the marketplace.
Even Bill Gross in his widely read Investment Outlook commented in August 2012:
“Together then, a presumed 2% return for bonds and an historically low percentage nominal return for stocks — call it 4% — when combined in a diversified portfolio produce a nominal return of 3% and an expected inflation-adjusted return near zero. The Siegel constant of 6.6% real appreciation, therefore, is a historical freak, a mutation likely never to be seen again as far as we mortals are concerned.”
The “Siegel constant” represents the annualized long-term inflation-adjusted return for U.S. equities since 1912 as estimated by Jeremy Siegel of the University of Pennsylvania. For the past five years, the S&P 500 index has returned 1.5% per year and for the past 10 years, 7.1%. Given the recent history, the sub-2% real GDP growth for the U.S., and the low-interest-rate environment, many investors believe that the historical 6.6% real return for equities is likely beyond the realm of possibility; in fact, they expect real return for equities to be in the range of 1.6% to 2.6%, nominal return of 4% to 5% minus the market implied inflation rate of 2.4% for the next 10 years.
From a top-down and supply-side perspective, this line of reasoning regarding equity returns appears sensible. However, from bottom-up, historical, and investor demand perspectives, 4% to 5% projected nominal equity return for the foreseeable future seems much too low based on three distinct estimation approaches:
- Corporate revenues and earnings from a bottom-up perspective
- History of equity returns
- Equity returns from an investor demand perspective