Lower Returns For Longer?
By Roger Nusbaum, AdvisorShares ETF Strategist
Doug Ramsay from The Leuthold Group was interviewed in Barron’s over the weekend. There was one especially interesting point noting that since 1880, a 60/40 portfolio has had an average annual return of 8% but that about half of that (4.1%) has come from dividends and interest. For almost ten years the fixed income portion of this equation has not carried its weight in terms of yield with a good chance that it will continue to yield far below “normal” for an extended period. He says that today a 60/40 mix yields 2.1% (I assume he is talking about indexed exposure but the article doesn’t clarify). He thinks it will be difficult for a 60/40 portfolio to have a total return 3-4% annualized over the next ten years.
Nassim Taleb published an article at medium.com that covered a lot of ground related to risk taking saying that it is impossible to get the market return because eventually you must reduce your exposure as a function of life circumstances. Not surprisingly the article was long winded but life circumstances can have a big influence over portfolio outcomes as does the sequence of returns around those life circumstances.
We’ve looked previously at examples of what can happen when the transition to taking/needing portfolio income happens right before a bear market versus early in a bull market or smack in the middle of one. This is probably the most common example of changing life circumstances related to Taleb’s point (if you’re lucky enough to have an investment portfolio you’re probably going draw from it at some point) and it very well could change some aspect of how your portfolio is managed and how successful the retirement ends up being, financially.
After eight and half years of bull market someone who plans to start taking portfolio income in the next six months might want to think about this. The idea is not predicting, as Ramsay tries to do in Barron’s, that a bear market will start late this year or early next year or whatever, but understanding probabilities and what risks you’re exposed to; a 30% drop in equities in the next year could really jack up my retirement plan and while the market can go down at any time for any reason (or no reason at all) there is a greater probability of doing so after an eight-year bull run than after a two year bull run.
Ramsay’s comment about expecting 3-4% returns over the next ten years reminds me of John Hussman’s process which simplistically put says that based on prevailing valuations the next X number of years should produce X% in annual returns. Hussman’s conclusions have not been correct during the bull run, he’s thought the markets have been overvalued all the way up such that return prospects were dim and even if he’s been right about valuation the market has of course skyrocketed.
It seems as though any time I’ve read anything about Ramsay, he’s leaned bearish so hopefully he will be wrong about 3-4% for the next ten years but what if he’s not wrong? In the 2000’s, domestic equity markets had a bumpy ride to nowhere, alpha was added by having foreign equity exposure (in the four years ended April 18, 2008 the S&P 500 was up 22%, one of the large developed market ETFs was up 57% and one of the larger emerging market ETFs was up 142%). If we ever a long period of low equity market returns again, whether it is on Ramsay’s timetable or not, investors and their advisers will need to figure out how to overcome the problem.
There is a pendulum effect to these sorts of things. Domestic equities were very much in favor in the 1980’s and 90’s to the point of people not thinking they needed foreign exposure but foreign was exactly what they needed in the 2000’s. Similarly, passive has worked so well this decade that people think they will never need active again and that pendulum will swing the other way. There haven’t been too many ten year rolling periods where the S&P 500 declines but the 2000’s was one of them. Depending on the timing of the next one in relation to your life circumstances you either have a problem or a challenge to overcome actively.
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