Let’s start with this…
How 10.5% compound annual growth rate (CAGR) inflation-adjusted annual returns over the last decade are far above the market’s historical norm.
The market’s real returns are generally stable at 6.5%-7.5% CAGR over time, meaning about 8.5%-9.5% in nominal terms using long-term 2% inflation expectations.
The incredible bull market of the last decade is due mainly to multiple expansion. Stocks are now trading at their highest blended price-to-earnings (P/E) ratio in 20 years and their second-highest in history.
That bodes rather poorly for short- to medium-term returns.
In fact, analysts expect about 5.9% CAGR real returns from the S&P 500 over the next 30+ years. That’s 16% less than its historical annual post-inflation returns.
Fortunately, there is good and bad news for long-term stock investors, especially the kind that invest primarily in index funds.
According to JPMorgan Asset Management, there’s a 50% probability that the market’s future fair value blended P/E will be about 18.5, rather than the 17.3 mid-range we’ve seen over the last 10-20 years.
Ten- to 20-year timeframes are 90%-91% statistically significant. Assuming relatively similar economic, interest rate, and earnings growth fundamentals, the 10- to 20-year average multiple approximates intrinsic value.