By Ben Levisohn
March 26, 2021
Traders make trades, while investors are in it for the long haul, or so we’re told. The former is likened to gambling, while the latter is a thoughtful, mature approach. Still, long-term investing is a bet just like any other, a bet that the stock market will be higher than the price we paid for our shares—and hopefully better than that.
But what can investors truly expect from the long haul? The past decade’s returns have been fantastic, with U.S. stocks returning an annualized 11.3% after inflation from 2010 to 2021, according to the Credit Suisse Global Investment Returns Yearbook 2021, despite one massive bear market and a number of near misses. Yet the previous decade’s performance was a disaster, with U.S. equities losing an annualized 2.3% after inflation from 2000 to 2010.
And the worst part is that investors don’t know which kind of decade they are going to get. “Looking in isolation at the returns over the first two decades of the 21st century tells us little about the future expected return premium,” write Elroy Dimson, Paul Marsh, and Mike Staunton, the yearbook authors.
The good news is that the odds of the next decade producing a negative return are low. The S&P 500 index has dropped just 6% of the time over 10-year periods going back to 1929, according to BofA Securities data. The bad news is that with price/earnings valuations where they are—over 20 times—the S&P 500 is expected to gain just 2% annually over the next decade, while dividends could add another 2%, putting the total return at a scant 4%.
But even during previous low-return periods, holding for 10 years instead of one lowered the risk of losing money from over 45% to around 10%. “For US stocks in particular, lengthening one’s time horizon is a recipe for loss avoidance,” Bank of America strategist Savita Subramanian writes.
If limiting losses is the goal, there’s also something to be said for the type of stocks investors own. The past year’s recovery has been led by so-called low-quality stocks, those rated single-B or lower in S&P’s quality rankings, which outperformed high-quality stocks by 48 percentage points.
Yet low-quality stocks now trade at 1.2 times the broad market, while high-quality stocks trade at just 0.9 times. “High-quality stocks remain neglected,” Subramanian explains. “Valuation, positioning, and history lessons suggest that quality may be one of the better investment strategies for the next month, year and decade.”
The simplest way to play high-quality stocks is with an exchange-traded comprised of the companies with the highest-quality scores based on return on equity, financial leverage ratios, and accruals, or one that holds large- and midcap companies with low leverage, high ROEs, and stable earnings growth.
That's a strategy for the long run.
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