Expect the S&P 500 to Underperform Risk-Free T-Bills Over the Coming 10-12 Years

Guest Post by John P. Hussman

Last week, Treasury bill yields rose to 0.75% following the Federal Reserve’s quarter-point hike in the target Federal Funds rate, placing the yield on even risk-free liquidity above our 0.6% estimate for 12-year prospective S&P 500 annual total returns. This isn’t the first time in history that prospective 12-year stock market returns have fallen below the prevailing T-bill yield, but it’s certainly the lowest return that has prevailed at any of those points.

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We should distinguish those points, in and of themselves, from market peaks. For example, in early-1969, prospective 12-year S&P 500 total returns (based on MarketCap/GVA – chart below) fell below the prevailing T-bill yield of 6.2%. That point wasn’t quite a market top, but it did usher in a long period of equity market underperformance relative to Treasury bills (as it happened, the S&P 500 Index itself would not durably trade above its early-1969 level until late-1982). On a total return basis, the S&P 500 total return averaged 6% over the following 12-year period, while the yield on risk-free Treasury bills averaged 6.8% over the same horizon.

Similarly, by mid-1997, prospective 12-year S&P 500 annual total returns fell below the prevailing T-bill yield. Again, that wasn’t a market top, but over the next 12 years, the actual S&P 500 annual total return averaged just 1.6%, while Treasury bill returns averaged 3.3%.

By 2000, prospective 12-year annual total returns fell to nearly zero. In real-time, using similar methods, I projected negative S&P 500 total returns over the 10-year period ahead. By 2010, the S&P 500 had indeed posted a negative total return over the intervening decade, and even by 2012, the S&P 500 remained lower than its 2000 peak, with a total return, including dividends, of just 1% annually.

Though we know that the extreme valuations of the 2006-2007 period were followed by the deepest market collapse since the Great Depression, we don’t yet know the 12-year outcome for total returns. Given that the market has now ascended to valuations that actually eclipse the 2007 bubble, and roughly match the 2000 extreme, market returns in recent years have exceeded those that we projected back then (as is common at valuation extremes – see A Better Lesson than “This Time is Different” for examples of this overshooting behavior, and how it is typically resolved). As we’ve seen in prior cycles, I have little doubt that the completion of the cycle will similarly resolve the overshooting of valuations in recent years.

Presently, based on the most historically-reliable valuation measures we identify, we expect annual total returns for the S&P 500 averaging just 0.6% over the coming 12-year period; a prospective return that we expect will not only underperform bonds over this horizon, but even the lowly yields available on risk-free T-bills. Like the unwindings that followed the 2000 peak and the 2007 peak, there will be points in the interim where the prospective total return on stocks will likely be elevated (as a result of steep market losses and improved valuations), providing patient, flexible investors substantial opportunities for long-term total returns.

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