The “Blood, Sweat & Tears” Era For Investors

16456565_sI’ve often heard the stock market being compared to a roller coaster. It goes up; it goes down. It twists and it turns. It even can make you sick to your stomach sometimes. All of this is true. But my issue with that comparison is that a roller coaster always returns to where it started. No matter how high or low you go during your ride, you know you will always end your trip in the same position that you started.
 
This metaphor supports the popular, yet fallacious, reasoning behind the buy and hold strategy to investing. Performance may drop, but it will come back up. Eventually it will climb back to where it was, and everyone will be enjoying the good times again.
 
In past articles, I have written about the challenges with this logic and the buy and hold strategy as a whole. But there is new evidence slashing the “it gets better” philosophy to shreds. The McKinsey Global Institute (MGI) recently published a report that finds that the future is not bright for the stock market.
 
The future is not even dim.
 
The future is dark.
 
Now, oftentimes predictions about the stock market are not dependable because there is no way of knowing what will happen in the future. However, the authors of the MGI report hedged their bets by estimating returns over the next 20 years in both US and Western European markets under two very different scenarios.
 
In the first, they assumed that today’s slow-growth economic environment would continue. Then they took a different approach, using an entirely different model, featuring faster growth with technological improvements.
 
The results? Both the optimistic and the pessimistic scenarios leave the glass very, very empty.
 
Neither model shows the market matching its performance of the past 30 years. The faster growth model shows US and European stocks still falling 1.5 percentage points behind, while the slower growth model puts us a whopping 4 percent back. According to this report, the future looks even more grim for fixed income, which sits anywhere from three to five points behind the past 30 years.
 
So, the report predicts that even if we see the GDP grow at higher and higher rates in the future, equity and bond returns would still be lower over the next several decades than we’ve experienced.
 
How can this be possible? The report looked at some of the major drivers of equity and fixed-income returns, both in the last 30 years and for the upcoming 20 years. If you look at each of these driving components individually, the expectations and possibilities are telling.
 
Inflation fell in the last 30 years around the globe, from as high as 10 percent to as low as 2 percent since 2008. There isn’t much room to drop further, so whether or not the economy recovers in the next 20 years, we should see inflation rise in either model.
 
Interest rates are on a similar track, as they have hit historic lows. And although it is unlikely we will see them drop further (unless more countries adopt the negative interest policy we have seen start to take hold in some economies), we won’t likely see a quick rise in these rates under either scenario.
 
Lastly, the authors of the MGI report looked at corporate profits. In the last 30 years, corporate profits saw a huge boost from new markets, cheap labor, global supply chains and a lowering of corporate taxes. All of these things that boosted margins in the past are likely to weaken as emerging-market companies and new technology competition cut those profits.
 
So, if that’s the big picture, what does this mean for you, the individual investor, trying to create a successful future for yourself? An MGI illustration of these scenarios predicts that investors will need to save more money earlier, retire later, or have their quality of life suffer in retirement.
 
They argue that a 30-year-old who in the past could have expected a 6.5 percent return from equities and fixed income, can likely expect a 4.5 percent return from the same. This means that, today, they would need to work seven years longer (or almost double their savings) to live as well in retirement.
 
That’s with the “glass half-full” scenario. If we look at the scenario showing slower growth, returns are projected to be just 3.5 percent, in which case, 30-year-olds today would need to extend their career an additional nine years. This doesn’t even take into account the expected increased life expectancy, which would likely mean they would need to work even longer.
 
This struggle, and need for more savings, is only going to cause people to spend less, which means an even heavier anchor on economic growth.
 
Past years have been referred to by some pundits as the “golden age” of the stock market for the buy and hold investor. The next 20 will likely be what I call the “blood, sweat, & tears age.” There has never been a better time in history to prepare and to actively manage downside risk, in the hopes that the upside will take care of itself.
 
How will you prepare?
 
Be vigilant and stay alert, because you deserve more. Have a great week!