The Future Ain’t What It Used To Be

We recently completed an analysis of rolling 20-year total returns for the S&P 500, and the results were not what we anticipated. You probably know that the very long average return for US stocks is 11%, and a look at average results from 1928 to 2017 supports that number neatly.

But when you look at rolling 20-year returns, the results are much choppier. At their best, US stocks have actually delivered +15% compounded annual growth rates. Such was the case in the late 1990s (17.7%) and early 1960s (16.7). And at their worst, 20-year rolling CAGRs have been well below 8% (the 1970s and, of course, the mid 1940s since this is a 20 year lookback).

Bigger surprise (at least to us): the 2 decades ending in 2017 are among the worst 20 years for US stocks in the last 90 years with just a 7.1% CAGR.Makes sense once you think about it – 2 bubbles collapsing will ding returns badly. But with US stocks on a tear the last 13 months, it is odd to think that even now equities are still in a rather mangy doghouse.

Still, past returns are no indication… So today we want to think a little outside the box regarding the next 20 years of US equity returns. We’ve shown that the record over the last 2 decades is poor, but longer run averages suggest an organic rate that is substantially better. The big question is, of course, what could either push us back to 11% total annual returns on a sustainable basis or pull us down even further.

Glass half full ideas first – those that could help US equity returns rebound:

• The next 20 years will bring plenty of technologically driven change in business models and society as a whole. And since large tech companies usually know how to generate good return on capital while simultaneously building wide “moats”, that should be good for the sector and the market as whole since the group is the single largest industry in the S&P 500.

• There is still plenty that businesses have to learn about using current technology to make themselves more efficient. The use of electricity in industrial applications from 1900 to 1940 is an interesting historical analog to modern technology. As the US electrified in the early part of the 20th century, industrial facilities simply rewired their steam-powered equipment to electricity. It took 20 years – a generation – for new plants to reformat their layouts more efficiently and take advantage of modular (versus centralized steam) power. The same may happen in the next 20 years with technology.

• The millennial generation is much more adept at using technology efficiently, and as they grow into positions of responsibility inside US companies they will find new ways to use it.

• US companies do not yet fully leverage the global aspects of the Internet, either by dint of regulation (i.e. Google and China) or because other parts of the world are slower adopters (i.e. Amazon is still predominantly a US company in terms of revenue). As they take their business models overseas, they can improve marginal profitability by leveraging their existing infrastructures and competitive advantages.

And the glass half empty stuff:

• US companies may not be the winners, especially in technology, over the next 20 years. We’ve written recently about how Alibaba’s Alipay payment network dominates Chinese mobile payment, and how Didi Chuxing makes Uber look like a yellow NYC medallion cab in terms of urban planning and automation.

• US companies may still lead the world in terms of technological progress over the next 20 years, but they may not be publicly held or in commonly owned indices like the S&P 500. Recall that a company has to make an annual profit before it can be included in the 500. Tesla still isn’t in the S&P 500 for that reason. On top of that, private companies have access to far more capital than at any point in the last 90 years, so they can wait to go public. And while they do, public equity investors only hold the targets of tech disruption rather than some of the winners as well.

• The growth of artificial intelligence and robotics may create a permanent underclass of American workers, especially those with less than a college degree from a competitive school. The resulting social discontent will be hard to contain, resulting either in a “Universal Basic Income” or regulation meant to mitigate the impact of technology. If you think global trade imbalances are a political hot button, just wait until factory automation and AI are good enough to replace workers…

In the end, we find ourselves more “Half full” of hope rather than “half empty” with despair. That’s not our natural bias, as regular readers know. But looking at that 90 year chart is oddly comforting, because it includes a decade long economic depression, wars, presidential impeachments, and investment bubbles. And somehow the country – and its economy and stock market – find a way to make a return. The last 20 years weren’t great. But that says little about the 20 years to come.