The Long Game – Historical Market Returns & 2022 Expectations

The Long Game - Historical Market Returns and 2022 Expectations

It’s the humbling time of the year to acknowledge the limits of our ability to predict markets. 

For the first time in decades, inflation needs to be properly accounted for when looking at asset class returns but also our plans. 

If you remained invested in Stocks your objectives may be closer than ever. 

Over the past decade, World Equities gained over 320% and returned 12.4% annually.

It’s probably also time to rebalance your portfolio.  Sell some of the winners, buy some losers.

In fact, this is what Vanguard’s model implies (more on that below). While this is great for learning with some small allocation do not forget the rules of the game and try to remain forecast-free. 

While timing any sectorial rotation is tricky, Vanguard’s model can be more helpful in another key aspect – setting the right returns expectations in achieving your financial freedom goals. 

BEST PERFORMERS OF THE PAST DECADE

Asset Classes sorted by performance and 10-year average
  • In 2021, the S&P 500 hit 71x a record high. The most in 26 years. The second most ever after 1995 (77x)
  • The largest peak-to-trough drawdown was only 5.1%. It’s placing 2021 in the Top 10 Best years over a 94-year period
  • World Equities gained 18.9% in USD. From the UK investors’ perspective Vanguard’s FTSE All-World ETF is up 20.3%. European investors recorded 28.5% gains.
  • EUR is down 7% this year while GBP lost 1.5% (both versus the USD)
  • Alphabet, Tesla or Microsoft’s 50-60% rallies drove Tech Stocks but some names started disappointing including Amazon ending the year close to flat
  • This bull run hasn’t been easy for Small and Mid Growth Stocks. 66% of Tech stocks were in Bear Market and at least 35% have lost more than 50% since hitting their records As predicted in 2020, ARK ETFs ended up underperforming (ARKK down 25%)
  • Bitcoin price growth ‘slowed down’ to 65% after rallying 300% last year. Volatility remains very high as BTC plunged over 50% in July before recovering roughly half of the losses
  • Crypto Industry grew to c. $2.3 Trillion Market Cap. Bitcoin is 10% of Gold Market Cap
  • While Inflation is up, the expectation that it will subside (expected to average 2.5% over the next 10 Years in the US) didn’t lift Gold price. Yes, Investing is hard
  • Value Stocks underperformed the S&P 500 by c. 5% while REITs gained 40.5%. 
  • Emerging Markets continued their relative underperformance driven by crackdowns and Real Estate bankruptcies in China 

BEST RISK-ADJUSTED PERFORMERS

Risk and Returns when looking at last 20-Year period

  • US large Caps that represent over 50% of World Stocks, remained the best  risk-adjusted asset class. Most back-testing tools frequently overweight it in portfolios and it’s one of the reasons why some US Investors are reluctant to invest internationally. Optimization for future returns using a rear-view mirror is a tricky game, though.
  • Developed Markets ex-US have a higher dividend yield than US Stocks and if the reversion of Price to Earning ratios materializes as described below, this dividend yield could contribute to higher returns vs. US Stocks.
  • Treasuries exhibited high volatility but hedged well during both GFC and COVID-19 downturns (Standard Deviation doesn’t tell the whole story for Bonds).
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  • Licence to Yield – Which Bond ETFs for your goals? How do price change? Should you hedge currencies?
  • Don’t get fooled by Wall Street – ESG Ratings are not designed to protect the planet. Adjusted for risk, ESG ETFs will also inevitably underperform. So how can you invest Sustainably?
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Beat Most Investors with FREE ETF Master Guides

  • Get Rich, Slowly but Surely – We designed Equity ETF selection frameworks and then picked the best funds in each category, so you don’t have to.
  • Become a Passive Investing Ninja – Have no mercy for Financial Institutions. Cut TERs, Taxes, FX Fees and Invisible Costs.
  • Licence to Yield – Which Bond ETFs for your goals? How do prices change? Should you hedge currencies?
  • Don’t get fooled by Wall Street – ESG Ratings are not designed to protect the planet. Adjusted for risk, ESG ETFs will also inevitably underperform. So how can you invest Sustainably?
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EQUITY MARKETS - MORE RATIONAL THAN YOU THINK

Bogle's Framework for Stocks

In 1991, John Bogle presented a model to estimate long-run stock returns in the United States in the Journal of Portfolio Management.

Bogle noted that you could (reasonably) predict stock market returns with three inputs:

  1. The initial dividend yield on the stock market
  2. The predicted change of Price/Earnings (P/E) ratio
  3. An estimate of earnings growth

Let’s focus on the last two drivers of the Stock Market Equation in 2021.

'Money Printing' didn't inflate Equities

  • Ask around you what drove asset prices higher in 2021. Chances are, that similarly to Real Estate, Bitcoin and other assets the answer for Stocks will be that these were directly ‘inflated’ by the Fed. Through P/E multiple expansion. Was that really the case? Well, not quite.

  • P/E Ratios actually compressed. The ratio of Price/Earning for the S&P 500 fell from over 30 to around 25 on a trailing basis. The same trend applies to forward-looking earnings
  • As such, assets were priced at a lower P/E ratio despite ‘Money Printing’ 

S&P 500 Index and Price/Earnings Ratio

Markets rewarded Profitability

  • Company Earnings weren’t really flat in 2021. Quite the contrary, they were off the charts.
  • Wall Street Analysts expect earnings for 2021 to be 50-60% higher than in 2020 
  • By taking into account higher earnings and removing the negative effect of 10-15% compression of the P/E Ratio you can explain most of the S&P 500 performance in 2021
  • That said, government policies inflated earnings growth which won’t be repeated in the near future
  • You can understand why, unsurprisingly, the markets punished a number of growth companies that are unprofitable

S&P 500 Earnings per Share

Can't have a High CAPE and Eat it too

  • Over the course of the pandemic, P/Es expanded 15-20% with another 25-30% coming from earnings growth explaining most of the S&P 500 rally 
  • Despite the recent fall in 1-Year P/E ratios, equity valuations are very high in America, as measured by the cyclically adjusted price-earnings (Cape) ratio, which compares share prices with inflation-adjusted average corporate earnings of the past 10 years
  • The current Cape ratio is 38, a level that was only higher during the peak of the dotcom bubble of 2000
  • In the Stock Market, you either have high valuations or high future returns, not both
  • The CAPE ratio has not been a useful predictor of future price levels but could be an indication that future returns will be much lower
  • Be cautious about comparing countries on that basis, though. Indices e.g. have very different sectorial exposure with America driven by Big Tech

Historic CAPE Ratio by Economy

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We Help You Avoid Costly Investing Mistakes.
Sometimes individual sessions are very helpful to get past your investing concerns. Our readers asked us to create coaching sessions. And we’re proud to say, that some of them even ditched their Financial Advisors, after experiencing the value we provide.

Most coaching participants come from the EU or the UK.

But we have consistent demand from all around the world. We provided coaching sessions to individual investors stretching from Argentina to New Zealand, or Guatemala to Japan.

A significant part of our clients are professionals in the Tech sector, Lawyers or Doctors that want to avoid costly mistakes when investing.

We also coach 25-30 year old young professionals that want to maximise assets for early retirement. We also have a large group of entrepreneurs that e.g. receive large lump sums after selling their company and want to invest it in financial markets. We speak to Crypto millionaires that want to reduce their risks.

Finally, some of our coaching clients are in their 40s or 50s and want to set up customised, income-producing portfolios or create Bond ladders for their retirement.

Most of the coached investors are in the 25–60 year old range.

Yes, some of our coaching clients have shared reviews on Google.

Some considerations are included below. For more details, consult your regulator’s website.

A financial coach is: 

  • Trained but not regulated
  • Skilled at reviewing your overall financial situation and goals
  • Able to help you develop a financial plan to achieve those goals
  • Happy to discuss the pros and cons of various financial products but can’t recommend a specific one for you
  • Comfortable working with anyone, whatever their situation
  • Going to charge for their time

A financial adviser is:

  • Regulated and authorised by the regulator to recommend specific products to clients or is independent and able to offer ‘whole of market’ solutions
  • Often, going to charge an annual management fee, typically 1-2% of their client’s assets with initial fees on top.

We are proud to say that our coaching service has empowered a number of clients to reconsider their financial advisers’ offerings. From our clients’ feedback, in a number of cases, clients were overcharged, and offered unsuitable products, often due to conflicts of interest. However, this is not a rule. The best choice between a financial coach and adviser depends on an individual’s unique circumstances, including their financial literacy, time availability, comfort with managing their finances, and complexity of their financial situation.

We will tailor the sessions and costs to make investing accessible. No financial jargon.

Beginners often ask us: 
 
  • How do I reach my goals – What investments do I need to take into consideration for e.g. Taking a Sabbatical, buying a House or saving for Early Retirement?
  • When should I invest – I fear that investing a lump sum in this market may have a negative impact on my returns. How can timing of buying ETFs affect my performance?
  • How do I Invest – What are the pro and cons of investing with a Bank? Why should I diversify brokers?
  • What should I consider investing in – What are some risks of portfolio diversifiers like Gold or Crypto?
  • Avoiding Extra Costs – I have shortlisted a few ETFs, can you help me to compare them before I decide which one to buy?
  • Benchmarking – What are educated investors doing in a similar situation to mine?

We are flexible. For example, answering some of these questions could help you avoid very costly mistakes:

  • Challenging My Portfolio – Here is my portfolio – what am I missing? What could derail my strategy?
  • Accelerating My Understanding – What are inflation linked Bonds? How are they different to Nominal Bond ETFs? What makes them outperform? Why do some investors add small cap value stocks to their portfolios? I want to exclude Tobacco companies from my portfolio – what are my options? What is Factor Investing?
  • Simplifying Portfolio Maintenance – How can I diversify my investments? What is historically highly correlated so that I can consider removing it to keep my portfolio simple? How do I perform rebalancing? Does frequency matter?
  • Reducing Risks – I want to understand the risks of investments – what are the different measures and how does it impact me? What are the risks of different types of brokerage accounts?
  • Understanding the Impact of Recent Events – How do recent events impact my portfolio? What can I do to protect my savings from shocks? 
  • Investing Goals – I am investing for a specific goal e.g. Early Retirement, what is the research saying about e.g. the amount I need to have accumulated, how much can I withdraw annually? What are some calculators available and how to run them? What are the assumptions/shortcomings of these models?
  • Comparing Equivalent ETFs – I have certain constraints in my tax-wrapper and can only select certain funds (e.g. I live in France and limited to specific synthetic ETFs). Which ETF characteristics should I pay attention to? 
Learn About Coaching
From Bankeronwheels.com
Get personal help To Set up your portfolio

We Help You Avoid Costly Investing Mistakes.

Sometimes individual sessions are very helpful to get past your investing concerns. Our readers asked us to create coaching sessions. And we’re proud to say, that some of them even ditched their Financial Advisors, after experiencing the value we provide.

Most coaching participants come from the EU or the UK.

But we have consistent demand from all around the world. We provided coaching sessions to individual investors stretching from Argentina to New Zealand, or Guatemala to Japan.

A significant part of our clients are professionals in the Tech sector, Lawyers or Doctors that want to avoid costly mistakes when investing.

We also coach 25-30 year old young professionals that want to maximise assets for early retirement. We also have a large group of entrepreneurs that e.g. receive large lump sums after selling their company and want to invest it in financial markets. We speak to Crypto millionaires that want to reduce their risks.

Finally, some of our coaching clients are in their 40s or 50s and want to set up customised, income-producing portfolios or create Bond ladders for their retirement.

Most of the coached investors are in the 25–60 year old range.

Yes, some of our coaching clients have shared reviews on Google.

Some considerations are included below. For more details, consult your regulator’s website.

A financial coach is: 

  • Trained but not regulated
  • Skilled at reviewing your overall financial situation and goals
  • Able to help you develop a financial plan to achieve those goals
  • Happy to discuss the pros and cons of various financial products but can’t recommend a specific one for you
  • Comfortable working with anyone, whatever their situation
  • Going to charge for their time

A financial adviser is:

  • Regulated and authorised by the regulator to recommend specific products to clients or is independent and able to offer ‘whole of market’ solutions
  • Often, going to charge an annual management fee, typically 1-2% of their client’s assets with initial fees on top.

We are proud to say that our coaching service has empowered a number of clients to reconsider their financial advisers’ offerings. From our clients’ feedback, in a number of cases, clients were overcharged, and offered unsuitable products, often due to conflicts of interest. However, this is not a rule. The best choice between a financial coach and adviser depends on an individual’s unique circumstances, including their financial literacy, time availability, comfort with managing their finances, and complexity of their financial situation.

We will tailor the sessions and costs to make investing accessible. No financial jargon.

Beginners often ask us: 
 
  • How do I reach my goals – What investments do I need to take into consideration for e.g. Taking a Sabbatical, buying a House or saving for Early Retirement?
  • When should I invest – I fear that investing a lump sum in this market may have a negative impact on my returns. How can timing of buying ETFs affect my performance?
  • How do I Invest – What are the pro and cons of investing with a Bank? Why should I diversify brokers?
  • What should I consider investing in – What are some risks of portfolio diversifiers like Gold or Crypto?
  • Avoiding Extra Costs – I have shortlisted a few ETFs, can you help me to compare them before I decide which one to buy?
  • Benchmarking – What are educated investors doing in a similar situation to mine?

We are flexible. For example, answering some of these questions could help you avoid very costly mistakes:

  • Challenging My Portfolio – Here is my portfolio – what am I missing? What could derail my strategy?
  • Accelerating My Understanding – What are inflation linked Bonds? How are they different to Nominal Bond ETFs? What makes them outperform? Why do some investors add small cap value stocks to their portfolios? I want to exclude Tobacco companies from my portfolio – what are my options? What is Factor Investing?
  • Simplifying Portfolio Maintenance – How can I diversify my investments? What is historically highly correlated so that I can consider removing it to keep my portfolio simple? How do I perform rebalancing? Does frequency matter?
  • Reducing Risks – I want to understand the risks of investments – what are the different measures and how does it impact me? What are the risks of different types of brokerage accounts?
  • Understanding the Impact of Recent Events – How do recent events impact my portfolio? What can I do to protect my savings from shocks? 
  • Investing Goals – I am investing for a specific goal e.g. Early Retirement, what is the research saying about e.g. the amount I need to have accumulated, how much can I withdraw annually? What are some calculators available and how to run them? What are the assumptions/shortcomings of these models?
  • Comparing Equivalent ETFs – I have certain constraints in my tax-wrapper and can only select certain funds (e.g. I live in France and limited to specific synthetic ETFs). Which ETF characteristics should I pay attention to? 
Learn More About Our Coaching Service

BOND MARKETS - A PRICY HEDGE

Bogle's Observation for Bonds

As John C. Bogle noted, since 1926, the entry yield on the 10-year Treasury explained 92% of the annualized return an investor would have earned over the subsequent decade had he or she held the bond to maturity and reinvested the coupon payments at prevailing rates.

For Europeans this means:

  • If investing for 10 Years, the UK Investor can expect about 1% annual nominal return. After accounting for expected inflation the yield is -3%.
  • Similarly, for the same time horizon, German Investors can expect to lose 0.3% and get a return of -2.1% after inflation. 

Government Bonds' Yields (before Inflation)

Potential upsides

Are further price gains on Bonds possible that can be harvested during a market crash by rebalancing?

There are unlikely but possible. Should there be another exogenous shock it’s not unreasonable to expect rates to go even lower (in which case Bond ETF prices may rally).

It is also a hedge against future deflationary recessions. While this may sound unreasonable in this market, this is the broader trend.

Learn more about how Bond ETFs can lose value or rally using the Bond ETF Calculator.

HOW TO INVEST IN 2022 (AND BEYOND)

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Vanguard Got it Wrong

Overvaluations were driven by 'Investor Psychology'

One of our diligent readers, Roberto pointed out the over-valuation of US Markets.

Vanguard’s Model uses the same Bogle Equation comprising (i) Dividend yield (ii) P/E Ratio aka Valuation Multiple and (iii) Earnings growth to predict future 10-year Market Returns.

According to their simulations Investor behaviour (P/E ratio) is to ‘blame’ for US Equities being largely outside of the expected ranges over the last decade (in the table above the expected range is 25%-75%). 

Vanguard predicted an average c. 9% 10-year return for US Stocks against the current 10-year performance of 16.8%.

Emerging Markets are on the cusp of that range.

Setting The Right Expectations

Vanguard's 10-year Return Projections (before Inflation)

Over the next 10 years, ex-US Equities are expected to outperform the US by c. 3% annually, according to the same model:

  • The strongest assumption is the relative P/E compression (1.5% annually over the next 10 years). 
  • European or Japanese Stocks that are more Value-oriented are expected to maintain a higher dividend yield of 3% (explaining another 1.5% difference in return vs. the US). 

A ‘long-awaited’ growth to value rotation is also implied by Vanguard with US Value Stocks generating 4.1% return while US Growth Stocks are expected to be flat over the next decade.

CONCLUSIONS

While you can’t control market returns you may still think of small adjustments:

  • A more practical take-away from Vanguard’s analysis would be to keep your lazy World ETF and perhaps remove that Nasdaq bet that you may have (and worked so well during the pandemic!)
  • An ex-US cyclist portfolio adjustment could be implemented. But we may also be assisting to a (P/E) regime shift with low interest rates despite higher inflation justifying paying a higher price for long-dated cash flows from Big Tech

In a low return environment controlling what you can is even more important:

Thank you for reading. I wish you a Happy New Year and a great start to 2022,

Raph

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APPENDIX

Equities

  • S&P 500 and NASDAQ need no introduction and are cornerstone of most portfolios
  • Dividend Stocks are favored by some investors but can be less diversified and tilted towards certain sectors / styles (e.g. value)
  • Developed Markets ex-US are important part of the Global Stock Market and include Japan, Europe or Australia
  • Emerging Markets is a volatile asset class but usually held for diversification and optionality should there was a shift of capital in global Economy towards these countries

Bonds

  • Long Term Treasuries provided the best downside protection in recessions
  • Bonds are Aggregate Funds for those seeking low volatility and some income
  • Corporates are high quality US corporate bonds (Investment Grade Rating) that are primarily held for income. LQD ETF was used here and was the #1 ETF bought by the FED in 2020
  • Inflation Linked Bonds are US Government issued Bonds that are adjusted for Inflation
Thank you for reading.
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