Submitted by Nick Colas of DataTrek Research
S&P 6000: Not If or When, But How: The S&P 500 has more than doubled in the past decade, outpacing every other major equity market around the world. In that observation lays the explanation for how it could double again in the next 10 years. History says it will not be Apple or Amazon that gets us there. It will be companies that are not yet public or even not yet created.
Today we’re going to ponder a long term question: “how long will it take for the S&P 500 to double from here and what will cause it to do so?” We got to thinking about this question in the wake of all the commentary around the Lehman bankruptcy a decade ago. Much of it reads like a triumph of buy-and-hold investing, given that US equities are 130% higher since the unofficial start of the Financial Crisis and also sit near all time highs just now.
Fair enough, but it is important to know that the US experience is absolutely unique in this regard. Consider how the rest of the world has done in the last decade or longer:
- The Hong Kong Hang Seng Index is currently 16% below its 2007 all-time peak.
- The Shanghai Composite trades for less than half its October 2007 peak right now.
- The MSCI Emerging Markets Index sits 26% lower than its 2008 highs.
- The UK FTSE 100 is only 10% higher than its 2007 peak and 13% higher than its prior top in 2000 (i.e. you’d have done better in bonds).
- The German DAX Index is 50% higher on a price basis from its 2007 peaks, a 4% CAGR but nowhere near the US experience.
- The French CAC 40 Index saw its all time high in 2000, and the Italian MIB Index is off by more than 50% from its 2007 all time highs.
- The Japanese Nikkei 225 is still some 40% below its all time high from 1989, and currently sits at the same levels as 1996.
- The MSCI EAFE Index is 23% lower than its 2007 highs.
Apologies for that laundry list, but it does a great job highlighting just how differently the US equity market has performed over the last decade and, in some cases, for far longer than that. You’ve likely read a lot recently about how the 2018 divergence of US stock performance (good) and rest-of-world (generally awful) is an unhealthy anomaly. It isn’t. Rather, it is simply the extension of a trend that goes back +10 years.
The point here: US stocks have a unique template to generate long-term performance, and to understand what will drive the next doubling of asset prices means dissecting what caused the last two-bagger. Remember that every country on that list pulled the monetary and fiscal stimulus levers just as hard (and sometimes harder) than American policymakers. That’s not the difference. Rather, it is something in the US economic model.
So what would it take to see S&P 6000 in ten years' time, roughly equivalent to the last decade’s performance? The math here isn’t especially daunting: 7% price appreciation to see that level, and layering on a 2% yield gets you to a 9% total return without reinvestment. That’s below the 50-year average total return (10.1%) and close to the 2008-2017 experience (8.4%).
Here is our 3-part roadmap:
#1. Fresh blood. History shows that the companies that drive outsized future returns are rarely at the top of the capitalization today. The largest US companies in 2008 by market cap were ExxonMobil, GE, Microsoft, AT&T and Proctor & Gamble. Now, that leadership list is Apple, Microsoft, Google, Amazon and Berkshire Hathaway.
Facebook (currently 6th on the US market cap list) is the best example of how new S&P 500 companies help returns. When it was added to the index in December 2012, its market cap was $150 billion. Even with its current troubles, FB’s market cap is now $480 billion. That $330 billion in value creation is about the same as ExxonMobil’s - 2008’s most valuable company - market cap today ($351 billion).
The bottom line: buying the S&P 500 today is not just a bet on what’s in the index right now, but rather the pipeline of new companies that will come public in the next decade. The good news is that pipeline is chock full, given the oceans of VC money funding new ventures just now. The sort-of bad news is those companies come public later, but just remember that Facebook wasn’t in the S&P until it had a $150 billion valuation.
#2. The next 2 recessions/bear markets. The last 20 years have taught us all one thing: bear markets drive long-term performance at least as much as up markets. Total S&P 500 returns from 1997 – 2002 (5 years) and 2007 – 2011 (4 years) were zero. That’s why the current 20-year CAGR for US stocks is just 7.1% versus 17.7% for the two decades ending in the year 2000.
History shows that two catalysts drive basically all pronounced bear markets in US stocks: oil shocks and the bursting of financial bubbles. Given America’s increasing energy independence we are less worried about the former. The latter will always be a risk. The good news is that US financial institution regulation is stricter now, so the chance of a 2008-style meltdown is considerably lower.
The bottom line: we would argue that at current valuations markets discount only garden-variety recessions and manageable bear markets over the next 10 years. There simply is not enough room for error at 16x earnings to believe anything else. Given current bank regulations that enforce large capital buffers, we think the market has it right.
#3. The dollar is less of a concern to us than long-term interest rates. The US currency has appreciated 21% in the last decade, and domestic stocks have performed well. Further appreciation, as long as it is gradual, should not be an issue even if it crimps corporate profits.
Our central worry is interest rates, and that stems from dramatically increasing US sovereign debt issuance. The Congressional Budget Office forecasts +$1 trillion deficits from 2019 onwards, even with the domestic economy in good shape. Any recession will only increase those. Yes, the dollar remains the world’s reserve currency and Treasuries are the go-to safety asset. But everything has a price, and over the long term increasing supply may need to clear at lower prices (and higher yields).
The bottom line: buying the S&P 500 today for the next 10 years implicitly assumes long-term interest rates will remain moderate, or only rise in line with structural corporate earnings growth. So far, this has been a good assumption. But what if 10-year Treasuries pay 6% in 2028? It is hard to see how stocks compound at 7% and double in the next decade with that plugged into a valuation model.
The key takeaway from all this: ultimately, we think the first point about growth and innovation trumps everything else. That is why the S&P 500 has so meaningfully outperformed the rest of the world’s equity markets over the last decade. Recessions are inevitable, and the die is cast with respect to US debt issuance. That leaves technological advancement as the only unknown.
Getting to S&P 6000 won’t be a function of seeing Apple, Amazon or Microsoft at $2 trillion valuations (although it would help). It will be a few still-private companies, possibly not yet even created, that will allow US stocks to compound at their historic rates. As we outline daily in our “Disruption” section, the future is pretty bright here. And that is the best – and perhaps only – reason to be resoundingly bullish about the next 10 years.