Do stocks face a bleak future? Photo by RubberBall Productions/Getty Images
Headlines questioning stocks’ long-term growth potential abound lately, and many reach the same conclusion: Investors should expect subpar returns for decades. The last 30 or so years were an aberration, they say, and the party is over. Here’s a word of advice: Beware all long-term forecasts, good or bad, as they are merely fallacies masquerading as research. Moreover, they are meaningless for markets, which don’t look more than 30-ish months ahead. As our boss, Ken Fisher, wrote in his 2015 book, Beat the Crowd, “Anything further out is sheer guesswork—possibilities, not probabilities, and markets move on probabilities.”
One recent study by the McKinsey Global Institute typifies the error, claiming “exceptional economic and business conditions” in the US and Europe over the last 30 years drove stock and bond returns above their hundred-year averages, and we’re about to go back to “normal”—lower—for the next two decades. It’s full of models and math, lending an air of precision. But it isn’t airtight. Nothing looking that far ahead can be. It’s impossible to say what the world will look like 20 years from now. For evidence, look to an array of other attempts to divine the distant economic future: fears of peak oil; the Congressional Budget Office’s projections; the famous “Dow 35000” call—we could go on. All had “data” supporting them; all seemed plausible given the zeitgeist of the day. None were right. Not all are this off-base, but these examples show long-term forecasting’s pitfalls.
Stocks move on supply and demand. In the short run, supply is relatively fixed, as activities that raise or lower it—like IPOs, buybacks, mergers and acquisitions—are complicated and time-consuming. Thus demand is the swing factor. The factors influencing demand—economics, politics, sentiment—are identifiable, and it’s entirely possible to assign probabilities to how these drivers will develop over the next year or two. We know when elections are scheduled, and recessions usually carry plenty of advance warning if you know where to look. But in the long run, supply determines pricing. Hence forecasting long-term returns requires forecasting stock supply years and years in advance.[i]
No one has successfully forecasted stock supply years in advance, and we aren’t aware of any way to do so. It would require knowing how the market would evolve, how regulations would treat IPOs and mergers, how zealous investment bankers are feeling, how enthusiasm in any sector or country would drive firms to market, how trouble might force firms to consolidate and so much more. In the long run, stock supply can expand or contract hugely based on these factors. Demand’s short-run effects are secondary.
Most long-term forecasts don’t even try to predict future stock supply. Instead, they use modeling, which usually entails a mean reversion argument based on past performance. This presumes long-term averages are a gravitational force that stocks must always come back to. The McKinsey report argues stocks’ average yearly return from 1915 to 2014 is “normal,” and since the last 30 years were above this longer-term average, the next couple decades must therefore be worse to restore balance. But this argument rests on a fundamental fallacy: presuming past performance predicts future returns. There is nothing predictive about past performance, whether last year’s or the last 100 years. Averages don’t determine stock prices—they simply result from stocks’ often extreme annual returns. Calculating them helps us all make sense of and find the larger direction in stocks’ sharp short-term variation, and nothing more.
Long-term forecasts usually blend modeling with purported fundamental analysis, linking stocks’ projected malaise to factors like economic growth, productivity and corporate profits. Yet here, too, they err in basing projections of these variables on the recent past and long-term averages. Most use straight-line math, ignoring near-certain cyclical swings. Then they presume these economic trends have a set market impact. Yet in reality, stock returns and economic data aren’t joined at the hip. China has one of the world’s fastest growing economies, but Chinese stocks are basically flat over the last seven years. Meanwhile, the countries in the MSCI World Index grew much more slowly, but the index has roughly doubled over the same span. Political and sentiment factors matter, too, and long-term forecasts don’t account for these. Nor can they—the far future is simply too foggy to see clearly.
There is also a philosophical flaw at the heart of most dreary long-term forecasts. By presuming the 1980s and 1990s tech revolution was a one-off, they woefully underestimate humanity’s creativity and potential. It is a virtual certainty that few if any investors in the 1950s foresaw the Internet or even personal computers. Back then, integrated circuits were ginormous and “computers” took up entire rooms. Who knows how medical technology, communications, energy efficiency, computing power, big data, artificial intelligence and other frontiers will collide over the next 10, 20, 30 or more years to revolutionize daily life and power the world economy forward? Assume the future resembles the recent past at your peril.
All that said, these skeptical reports do have some usefulness: They show sentiment’s continued weakness—likely a function of the flattish point-to-point returns of the last year. Over the foreseeable future, this skepticism supports the bull market, as reality should surpass low expectations. As for what the future holds, even if McKinsey’s prognosis of diminished returns proves correct, equities would still be preferable for those looking to grow their assets. If your goals and needs require owning stocks, this study’s conclusions don’t warrant a change.
[i] The same logic applies to bonds, but we’ll focus on stocks in this article for simplicity.