Bubble Or Not; U.S. Stocks Are Priced To Deliver Dismal Long-Term Returns

Tyler Durden's picture

Submitted by F.F.Wiley of Cyniconomics blog,

If you’ve ever sought advice from a financial advisor, you probably asked the question: “How much of my portfolio should I hold in stocks?”

Somewhere in the answer, you were probably offered long-term return estimates.

These estimates probably placed stock returns at approximately inflation plus 5 or 6%.

But what if standard estimates are too optimistic, as they were in the 1990s when advisors typically predicted double-digit long-term returns? Shouldn’t this change your investment allocations?

We’ll argue that the usual estimates are overoptimistic, and that investment allocations should be based on more realistic expectations.

Worse still, the discrepancy has reached enormous proportions. By projecting earnings forward over the next decade, we’ll show that stocks are now priced to barely outpace inflation at best.

Here’s a chart that demonstrates our approach:


long-term return article chart 1

The black line shows over four decades of S&P 500 (SPY) earnings, expressed in 2013 dollars. The colored lines are exponential trend lines calculated over the last one, two, three, four and five earnings cycles.

To define an earnings cycle, we begin at the exact point in a recovery when earnings busted through their prior peak. Therefore, cycles extend from the first all-time high in a particular earnings recovery to the first all-time high in the next recovery. This approach mitigates the problem of trend lines being sensitive to beginning and ending points. It’s far better to start and end a trend line midway through earnings recoveries than to calculate it from, say, an earnings peak to an earnings trough.

Conveniently, inflation-adjusted earnings likely breached their 2007 peak at the end of 2013, marking Q4 as the beginning of the next cycle and adding the period from 2007 to 2013 as the final cycle in our trend line calculations.

Estimating 10 year returns

As shown in the chart, we extend each trend line forward to estimate earnings in 2023. We can then estimate 10 year returns with suitable assumptions for the price-to-earnings (P/E) multiple.

Specifically, we use median P/Es from the same time periods that we used to estimate trend lines. Even though P/Es in 2023 will surely be higher or lower than historic medians, we have no way of knowing which of these possibilities will play out so far into the future.  Just like the earnings trends above, our approach to estimating P/Es is the most neutral (not cherry picked to produce the “right” conclusions) that we could come up with.

Here are our calculations:

long-term return article table 1

As shown in the right-hand column, all but one of the real return estimates are negative. What’s more, the picture looks even worse with more history. Here’s another chart that adds trend lines covering six, seven, eight, nine and ten earnings cycles, followed by a second set of calculations:

long-term return article chart 2

long-term return article table 2

While the results speak for themselves, we’ll share some thoughts on specific time periods:

  1. Within the period shown in the first table, productivity grew most strongly in the latter half of the 1990s and early 2000s. This is probably the biggest reason for differences between the “last 3 cycles” return estimate (which covers the period from 1988 to 2013) and the other estimates.
  2. Although our future could certainly include another productivity-based profits boom, other factors tell us to be cautious. Consider that earnings were boosted by declining interest rates in each of the last three cycles. Consider also the ratio of corporate profits to GDP, which reached all-time highs in 2013. While these developments are baked into the 1988 to 2013 trend line, they’ll eventually come to an end and even reverse direction. Interest rates can only fall so far, while profit shares can only rise so far.
  3. Households, businesses and the government hold much more debt as a percent of the economy than they did forty years ago. Borrowing in all of these sectors has helped boost earnings in ways that can’t continue forever. In other words, even the worst results from the first table – covering five cycles from 1973 to 2013 – fail to convey the risks of our debt addiction.

Overall, our research couldn’t be further from the financial industry’s conventional thinking. Conventional estimates call for stocks to outpace inflation by 5 or 6%. The results above, on the other hand, show mostly negative real returns over the next decade.

Needless to say, we recommend questioning any advice that’s based on standard estimates.

Better yet, send our charts and tables to your advisor. Request an explanation for how stocks outpace inflation from today’s prices. Will earnings climb even further above established trends? Will P/Es never fall again?

Once you’ve established your advisor’s assumptions, weigh them against history. Challenge him to explain why this time is different.

Bonus chart

If you have to choose just one chart to show that current earnings (and especially 2014 forecast earnings) are out of line with established trends, we recommend our last chart below. We calculated trend lines for every combination of three or more consecutive earnings cycles (36 in all). The results leave little doubt about the discrepancy between current earnings and historic precedents.

long-term return article chart 3

More info

Technical notes for this post can be found here.  Also, we discussed the importance of long-term earnings trends in:  “Why Stock Prices Are More Stretched than You Think: A Tale of 3 P/E Multiples” and “P/E Multiples, Deleveraging and the Big Experiment: Sizing Up the Next Bear Market.”

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quintago's picture

If you buy at 5-year high, you will lose a significant amount of money at some point in the next 5 years. If you buy when the market is at a 5-year low, you will make a significant amount of money at some point in the next 5 years.

Hopefully that saves you all some time.

Motorhead's picture

Yeah, like the 12-year high in gold.  That sure ticks off the wankers at KingWorldNews.

Richard Chesler's picture



This time is different.




insanelysane's picture


There are a shit load of boomers and they had all the jobs and those jobs had pensions and 401ks.

Younger generations have jack squat.

Boomers eventually retire and need money so their pension funds and 401k plans start selling.

Who is going to buy?  The social security ponzi is also a pension fund portfolio and 401k portfolio ponzi.

atomp's picture

Isn't this what the ACA is really about?

r3phl0x's picture

Perhaps the Fed will continue expanding the USD as The Toilet Paper That Supports All Other Toilet Paper, keeping equities, bonds, and real estate frothy until the last Boomer leaves this mortal coil. Alternatively, the Elite could chose to fuck all of their Boomer peers, and collapse those other assets a few years into their retirement, leaving non-Elite Boomers as poor and destitute as their thoroughly-fucked offspring. Hard to tell. I'd lean toward the former, but hedge for both scenarios.

Fuh Querada's picture

Yeah, extrapolation is a difficult proposition, especially when it is into the future.
Just do the opposite of what Goddam Sucks recommends to their muppets.

Black Forest's picture

Nice study. Thanks.

Tom_333's picture

Timing is everything .Probably true in the long run. But what is the alternative in the short-medium term. Negative returns year on year with investemnts in bonds and interestbearing instruments. No to speak of cash. Or PM´s.

Black Forest's picture

Don't underestimate PMs in the long run.

Tom_333's picture

No...I don´t. Not in the long or long,long run. But by staying in PM´s as only investment you may loose 10 years of growth , perhaps even more. Time it´s hard to make up for even when trend changes. When the trend changes - change your investment strategy. Barring unforeseen intervention by "big government". They may just resort to outright stealing your assets - and then what investment strategy you are using doesn´t matter.

And - yes PM´s may be outlawed.Maybe one reason why even Park Rangers are being militarized?

jcaz's picture

Best work I've seen to suport that we may have already seen "the bubble" that everyone is panting for this year- nice job.

Gringo Viejo's picture

"Bubble or not?"............Stop it! You're killin' me!

tricklecreek's picture

What does Cramer think?

Winston Churchill's picture

I see what you did there. A trick question.

algol_dog's picture

Tyler can reprint a million articles, but there's only one thing that matters in this game and that is the simple fact that the FED will print and print and print. As long as long as interest rates stay low, which there is no reason why they shouldn't based on the structural for shit economy we have, there will be no other place to put money to work. As Hamilton said "read it, learn it, live it" ....

LooseLee's picture

Another Pinko COMMIE worshipping at the feet of the FED. Grow some balls coward and fight this raping or get out of this country which will eventually be won again by true lovers of FREEDOM!

algol_dog's picture

Really Dude? Pinko Commie ... What the fuck decade are you stuck in? I could give a shit about the FED, democrats, republicans, or any ass-hole political affiliation. I care about making money in the markets, and the reality's that make that happen. I'll let you geniuses fight the next civil war. 

Sufiy's picture

Rick Rule: Money Are coming Into Gold And Silver Now


  Rick Rules discusses the recent bear market in Gold and what is going to happen in the beginning of the new bull phase. Money are coming into the resource sector again. It is the very big money, which are circling this sector now. Who are the investors? You can guess - they are mostly from Asia - China and Korea, new type of long term investors. There are a lot of opportunities in the market now - we have learned from our previous experience and the valuations are very appealing now for the right plays. http://sufiy.blogspot.co.uk/2014/01/rick-rule-money-are-coming-into-gold...

Fuh Querada's picture

define "circling"

Rick Tool was hawking Pt and Pd a while back, all that pollution in China was supposed to send send the price to the moon. And in spite of the supposed Russian "monopoly" of Pd and the global shortage of Pt, the piss-artists on the Crimex still provide an infinite paper supply of both metals.

Caviar Emptor's picture

I predict that the inflation/ stock appreciation relationship breaks down in 2014. Stocks will lag.

Dollar Akbar's picture

Dollar is Greaaaat!!!!

Bangin7GramRocks's picture

Stocks will go up and up until the Fed stops printing. Keep vigilant waiting for the phone call letting you know its time to sell. I'm sure everyone on Zero Hedge is on the masterlist of insiders who will get enough of a heads up to dump before the market tanks. Fuck all your charts! It will go up until it doesn't and none of your useless anaylsis will clue you into the mind of Janet Yellen.

kwatinhu's picture

So the charts are wonderful, but where are you supposed to nvest?


real estate=nothing


tech=nothing what in the hell is left? cash? It gets smaller every day.

Commodities? Only a fool would go there.

What to do....Punt?!

TheRideNeverEnds's picture

Meanwhile 19 of the past 24 months have been up, and every high / low has been substantially higher than the last.  We are going higher from here; we are not even remotely close to a top.  


The VIX hasn't even bottomed yet, it has another 25-30% more to go on the downside before we hit old lows; and once the VIX bottoms and we see a flattening of the trade with more vol it would be an indication of a top forming.  Come back in 2016 when the S&P is trading over 5000 with P/Es at 20+ and will be a bit extended by then.  


Hell look no further than GS / JPM / BAC saying we are rich up here, they are trying to scare the children into selling them their stocks and or getting short before they take this market sharply higher.   Could we have a small pullback of a few percent soon, sure; that would be super bullish and a screaming buy.  

orangegeek's picture

buy and hold doesn't work - that simple - there is more information for the average investor to do their own investing - funds don't deliver (they just pay themselves) and markets change trend every 4-7 years - anyone's guess


following market indexes is a great place to start



redd_green's picture

It will increase with inflation, which is running over 10%. That is not to say it will be a smooth ride, it will get even more wild. 

Singelguy's picture

As long as the Fed continues with QE and ZIRP, corporations will continue their share buy back programs which skew the EPS upwards. If market rate of interest is less than the dividend rate it is to the corporation's long term advantage to buy back its own stock. There is no historical precedence for the current environment, therefore historical charts are not necessarily an indicator of future expectations.

Decimus Lunius Luvenalis's picture

I'd avise asking your financial advisor what a P/E multiple means.  I'd say for 90% of them, it doesn't matter if they're selling an allocation or a stock or a fucking washing machine.  For your average investor, you're going to speak to somebody just hired, was employed by three different firms in the last five years, sold cars for twenty years and is lookin for something different, or anybody else that sounded "good" in the interview.  There's a reason while financial advisory positions have astronomical turnover.  It's because the only thing that matters is that they sound "good," "confident," or the hiring manager needs to fill a seat.  

wiesenda's picture

The problem is that the unit of account, i.e. cash (not limited to the dollar) has lost meaning when compared to earlier cycles.

Most people get lost when trying to form a mental image of what the stock-index performance is, even in normal times. While usually correcting for interest rates as a discount rate for future earnings (since the discount rate figures in practically all valuation formulae), the importance of interest as a cost factor is usually underestimated as ZH tirelessly points out. On top of that, people frequently get a distorted view 

  • by not realizing that indices in different countries are in different currencies
  • by not accounting for dividends
  • by neglecting changes in the capital structure (share emissions and/or buy-backs)

So even in normal times, there is a bias by looking too much at figures and charts and too little at the units and conventions these figures are based on.

In the current monetary regime, even the units themselves are starting to lose their quality as a frame of reference. Future earnings and stock-market indices completely lose their meaning if anything can happen to the unit of account in terms of value (and it needn't be monetary collapse, a period of sustained inflation will suffice).

How to think of value then? Forget all traditional valuation. All that matters are businesses and assets that survive even in a world in turmoil and continue to consitute a claim on whatever economic output is produced in the future.