US equities: zero gains over the last 12 years, how about the next 12 years?


In my misspent youth I worked in international equities sales for Merrill Lynch. That was when I was first introduced to the Capital Asset Pricing Model that still underpins investment analysis today. Aong other things the model suggests that the return on an investment needs to be commensurate with its risk to attract investors.

Through the last century the empirical evidence on equity market investment was that its returns relative to other asset classes was broadly in line with its volatility.

As shown in the chart below, for the last 12 years, since 1998 or 1999 depending on the index, there have been zero gains in US equity markets. It is important to note that this does not account for dividends, which currently yield approximately 2% annually for S&P 500. However there is an important psychological issue in zero gains in the index. And it is clear that dividend yields do not justify the exceptional volatility of equity markets over the last decade or so.

Click on the image for full size
Source: Google Finance

The critical question is whether the nexus is broken, and equity markets will over the long run not offer returns commensurate with risk.

Personally I believe we should remain sanguine about where the stockmarket will go over the long term. However there are definitely plausible scenarios in which equities continue to offer essentially zero returns over the decade ahead.

The heart of the issue is the adaptability and resilience of national and global economic structures through extraordinary social, technological, and industry change. That is where we must focus our efforts.