Game Planning: Another Lost Decade

Meb Faber Tweeted out portfolio return expectations from various market participants looking out over the next ten years. Vanguard was at the low end looking for 4.5%, the “average investor” was in the middle at 10.2% and hedge funds think they will generate 13.0%. Depending on who you read you can find expectations in the three’s as well.

John Hussman tends to look at this by factoring in current valuations and based on those valuations, figuring what the return probability “should be.” Jeremy Grantham looks at a multitude of inputs to make similar, long-range forecasts. You have no doubt heard/read the concept of borrowing from future returns when getting high current returns. Have the last nine years borrowed or taken in some part, what investors might hope for over the next nine years or some other period. The answer isn’t knowable, but it is an appropriate question.

It is also appropriate to have something in mind if the next ten years return less than half of the previous ten years, at least where the S&P 500 is concerned. Fortunately, we have something of a blueprint in the ten-year period ending February 2010 where Google Finance shows a decline of just over 20% on a price basis (so probably about flat with dividends), obviously far worse than the 4.5% Vanguard is looking for.

In that run, foreign and emerging equities outperformed domestic by a wide margin, as did commodities thanks to a potentially unrepeatable super cycle induced by Chinese demand. Between foreign and domestic equities, one must outperform the other in a given time period and the historical tendency has been for one to outperform the other for many years at a time. Domestic was the leader this decade until last year, foreign outperformed domestic for the previous decade and domestic outperformed for most of the 80’s and 90’s.

Commodities are trickier and while I would want any allocation to be much smaller to them than any sort of equity exposure someone worried that a Vanguard scenario or worse is coming would be well advised to spend time looking for an opportunity in that space.