Are we standing at the precipice after a strong uphill climb in the world of investing, or does it just seem that way to some market observers?
Interest rates have lingered near all-time lows, meaning that the rate of return on fixed-income bond funds may languish for the foreseeable future. In addition, U.S. stock markets are hitting new all-time highs regularly, leading some experts to suggest we can enjoy this bull run for only so long before we see another market correction. Some in the financial media portray this inevitable correction as a doomsday event that could surpass the Great Recession of 2008-2009.
While this prediction makes for intriguing headlines, the overall plot has a few subtle, yet gaping holes.
Over the past 10 years, the U.S. stock market has been seen as both a monstrous demon and a heaven-sent catalyst for investors. By this time, we’re all too familiar with the 38% drop in the S&P 500 in 2008. But we may not be as familiar with the unwavering tear that the S&P has been on since that time, earning approximately 25%, 15%, 2%, 16%, 32%, and 12% from 2009 to 2014, respectively, according to Morningstar.
Since February 2013, when the S&P reached a new all-time high, we’ve heard the same story again and again from some in the financial media: that a major correction is near. This may be true, but if you heeded that notion by keeping your portfolio mostly or entirely in cash for the past two years, you know by now that you missed out in a very big way.
We reached new all-time highs in the S&P 500 in 2013, 2014 and now 2015. What we’ve seen is that even after some of the most dismal times (2008-2009), the stock market has proven that it has no predictable ceiling.
For long-term investors, and for those who showed strong discipline by staying in the market during the 2008-2009 decline, we’ve seen that it is possible to bounce back from even the worst of times. Assuming that nobody actually owns the coveted “stock market crystal ball,” and knows how and when to time market events, all we can do is remain well-diversified and let time in the market do the rest.
Contrary to the false ceilings, we are experiencing true “floors” in the interest rate environment. Let me stop you and your brain right there, because although I just said we are experiencing true floors, I did not say interest rates are going to rise at warp speed and every fixed-income investment out there is completely worthless. I’m simply pointing out that when the 10-year U.S. Treasury is hovering at or around 2%, there just isn’t much room for it to drop much lower. So what does that mean for investors?
For that, let’s go back to 1948. In that year, one-month T-bills sat at 0.8%. From 1948 to 1981, we saw one-month T-bills rise from 0.8% to over 15%. During that interest rate bull market, long-term corporate bonds saw a return of 2.7% over a 33-year period. Compare that to a return of 10.2% from 1982-2013.
What this means is that for the past three decades, while interest rates were falling, bond investors saw favorable returns. Over the next 30 years, that may not be the case. While interest rates are certainly low, that doesn’t necessarily mean they will begin another climb to 15%. If we study Japan’s economic situation, we see that rates could potentially be flat for quite some time. The truth that we face is that fixed-income investments will be hard-pressed to deliver a return similar to what we saw over the past 30 years.
With these factors in mind, investors should consider what this means for their portfolios. This may include reconsidering the amount of volatility we are willing to accept in exchange for a more favorable, long-term rate of return. This may also include reconsidering what we feel is a fair, realistic, long-term rate of return, especially for balanced portfolios that may consist of 40% bonds. And perhaps while you consider this information, I’ll continue looking for my crystal ball.
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