15 years ago, back on March 10, 2000, the Nasdaq Composite closed at 5,048.62. That has held as the peak until ….. today? If it holds at current levels (~5,065), the Nasdaq will set a new record. One shouldn’t get too excited about such market history as it sets price anchoring, but it does bring up an interesting point and lesson.
When it comes to buy-and-hold investing, our return is driven by a couple of items. The biggest component is the accumulation of earnings and the reinvestment of those earnings into additional earnings. Over time this component has been approximately 6.5%, after inflation, for large US corporations. The longer an investment is held, the closer to this return should be expected — if history holds.
Over shorter periods though the price paid and price sold have a bigger influence on the investor’s return. Most forecasts for long-term capital returns are for at least 10-15 years to help smooth out the fluctuations caused by the initial purchase price and selling price. If you would have purchased the Nasdaq Composite 15 years ago you would have received dividends, which at best offset the price erosion due to inflation leaving little real gains.
While we aren’t in the extreme situation that we were in back in 2000, there is enough data to suggest that returns over the next 10-15 years will not reach the long-term historical average. J.P. Morgan’s 2015 Long-term Capital Market Return Assumptions for U.S. large cap stocks is 4.0%-4.5%, net of inflation. This is 1% point less than the forecast for 2014. Why? Because market valuations continue to climb faster than the underlying fundamentals. When valuations are below the historical average, we expect returns to be better than expected and vice versa. It is expected that the valuation (high or low) will revert to the long-term average over the forecast period.
The mistake that many make is that believe that if we make such observations that we are trying to time the market. That is not the case as the market can go to extremes in both directions, often proving our forecasts blatantly incorrect. However it is important to set expectations and make sure that current investment strategies reflect the investor’s needs. In other words, expecting that near-term returns will reflect the long-term average should not likely be the main expectation (although it could happen.) Rather, we should expect less than average returns over the next several years as earnings are able to catchup with prices. Secondly that those investments in the stock market are truly for long-term investments as short-term results could be even more extreme.