As of last week, the S&P 500 was priced to achieve an average annual total return of just 5.83% over the coming decade, based on our standard methodology. Prior to 1995, the lowest implied 10-year total returns priced into the S&P 500 in post-war data were:November 1961: Implied 10-year total return 6.26%.
Actual 10-year subsequent return 6.16%
October 1965: Implied 10-year total return 5.89%.
Actual 10-year subsequent return 3.11%
November 1968: Implied 10-year total return 6.19%.
Actual 10-year subsequent return 2.51%
August 1987: Implied 10-year total return 6.29%.
Actual 10-year subsequent return 13.85%.
Note that in the 1987 case, the unusually strong 10-year return reflects a move to the extreme bubble valuations in the late 1990’s, which have in turn been followed by 13 years of market returns below Treasury bill yields. Once the market becomes overvalued, further gains are ultimately paid for by a period of sorry returns later. To expect normal or above-average long-term returns from current prices is to rely on the market bailing out the rich overvaluation of today with extreme bubble valuations down the road.
While investors can hope that today is similar to August 1987, a moment’s reflection about the market crash that occurred shortly after August 1987 might dampen that hope a bit, particularly because that instance also featured overbought, overbullish and rising-yield conditions.