To get an idea of what the next decade has in store for the U.S. stock market, think back a decade ago to December 2010. That’s not because the next decade will be like the last one; far from it. The reason to turn the clocks back 10 years is to appreciate just how unexpected the future often turns out to be.
In 2010, the trailing decade had been awful for stocks, and few dared to even fantasize that the subsequent 10 years would be one of the best for equities in U.S. history. But it was. Today the situation is just the opposite, and for that reason we should be prepared for the distinct possibility that the next decade will be as disappointing as the last decade was outstanding.
Ten years ago, investors were still reeling from two bear markets. At the beginning of December 2010, the S&P 500
SPX,
traded just above 1,200, more than 20% lower than where it had stood at the October 2007 bull market high and at basically the same level where it was at the top of the internet bubble in March 2000. In inflation-adjusted terms the picture was even more grim: the S&P 500 in late 2010 was sporting an inflation-adjusted loss of more than 3% annualized over the trailing decade.
Contrast that with where things are today. The S&P 500’s 10-year inflation-adjusted total return is 11.9%, according to data from Yale University’s Robert Shiller. That’s better than 85% of all rolling 10-year periods since 1881.
Here’s why investors should expect below-average returns over the next decade: the historical data exhibit a strong reversal tendency. To show this, I calculated a statistic known as the correlation coefficient, which would be 1.0 if the best trailing decade returns were correlated with the best subsequent decade returns, and so on down the line. The coefficient would have been minus 1.0 if the best trailing returns were correlated with the worst subsequent returns, and so on, while a coefficient of zero would mean there is no detectable relationship between the two.
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The stock market’s return between now and the end of 2030 is not guaranteed to be below average. But the odds are strong that it will be.
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When focusing on all months since 1881 in Shiller’s database, I calculated this coefficient to be minus 0.35, which is strongly significant at the 95% confidence level that statisticians often use when assessing whether a pattern is genuine.
Notice that the coefficient is not minus 1.0, which means that only a minority of the stock market’s subsequent 10-year return is explained by its trailing 10-year return. So the stock market’s return between now and the end of 2030 is not…
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