A Foreboding Outlook For The U.S. Stock Market In The Decade Of The 2020s

A Foreboding Outlook For The U.S. Stock Market In The Decade Of The 2020s

Summary

There is a formula for forecasting future stock returns. Its accuracy depends on forecasts of future Price/Earnings ratios.

Crestmont Research provides some guidance on the future range of P/Es.



Unless P/Es remain near their current lofty levels, the outlook for the US stock market is foreboding. We describe what it would take to preserve these high levels.

I have in the past forecast stock market returns using a formula that is, in fact, a tautology – which Webster defines as a statement that is true by virtue of its logical form alone. That formula is shown in the following picture.

Formula forecasts stock returns: Baby Boomer Investing Show

(Source: Target Date Solutions)

My challenge in the past has been estimating “P/E Expansion/Contraction.” I’ve made the mistake of forecasting contraction, reductions in the Price/Earnings ratio. But recent research by Crestmont Research provides justification for forecasting a range of P/Es in this decade.

Likely P/E Ranges

In “Macro View: A Permanent Shift in Valuations?” Lance Roberts reports that Crestmont Research has found that P/E ranges are dictated by economic growth as follows:

Economic Growth P/E Range

Normal 7-25

Slow (Below 2%) 5-17

As shown in the following graph, economic growth has been slow, and we are currently in a COVID-19-induced recession, so a slow-growth P/E range is to be expected.

Return Forecast for US stocks in the current decade

The following tables show the range of future returns for the next 12 months and the decade ahead.

(Source: Target Date Solutions)

P/Es are currently 35, more than twice the historical average of 16. If they remain at 35, the US stock market will earn 8% per year in this decade. I discuss what it would take to maintain P/Es at this level in the next section.

If P/Es contract to within the range identified by Crestmont, the average return in the decade will range between a loss of 1% per year and 7% per year. If the contraction happens quickly, in the next 12 months, the 12-month loss will range between 53% and 69%, in line with forecasters who see a correction worse than 2008 on the horizon.

As shown in the following, the decade of the 2020s is forecast to be like that of the 1930s and 2000s – not the worst, but among the worst.

(Source: Target Date Solutions and Standard & Poor’s)

What could salvage the 2020s?

The US stock market is currently in a bubble, defined as a situation where prices exceed value. In order for the bubble to continue, the following inflators would need to continue for a decade:

  1. Our 92 million millennials will need to keep buying stocks. This group was about 23 years old when the recovery in the 2010s decade began, so they expect stock markets to go up year after year – buying the dips is smart. And they are aggressively trading through services like Robinhood, and they like robo advisors, who are unlikely to bail.
  2. So-called FAANG stocks will need to remain the darlings of the stock market with their mega capitalizations. The FAANG stocks are Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX) and Google (GOOG, GOOGL). Apple recently reached a milestone of $2 trillion in market capitalization, which is the size of the entire Canadian stock market, the sixth largest in the world.
  3. Foreigners will need to continue investing in the US stock market like never before.
  4. The Federal Reserve must continue to inflate US stock and bond markets with new money. Prior to COVID-19, the Fed had injected $5 trillion in Quantitative Easing to buoy up the stock and bond markets. Now it has dropped another $3 trillion in COVID-19 relief and is likely to dump at least another $2 trillion. Be aware that inflated security prices are a money illusion.
  5. Investors need to continue to believe that the pandemic will end quickly and the economy will recover, and maybe even be better.
  6. The upcoming election results will need to be “good” for investors, whatever that means.
  7. 78 million Baby Boomers will have to “stay the course,” which generally means 60/40 stocks/bonds. We strongly recommend against this.

Conclusion

At times like these, the following words of wisdom help clear our thinking. I hope you find them helpful.

(Source: Target Date Solutions)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am co-host of the Baby Boomer Investing Show.


Originally published on Seeking Alpha

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