- Lance Roberts warns that stocks are built for a decade of dismal returns.
- Roberts said high valuations and Fed tightening contributed to a poor future outlook.
- The Federal Reserve is raising interest rates aggressively to cool inflation, hurting forward earnings expectations.
However, Roberts, CIO of RIA Advisors, told Insider on Friday that things will remain more fluid for the rest of the year as markets grapple with inflation and tighten monetary policy.
But for Roberts, the outlook for the next decade is bleak, at least compared to the past decade. Roberts, who has worked in financial markets for 26 years, believes the market is at a structural inflection point.
First, there is runaway inflation – 8.3% – not seen in four years. This cuts into corporate profits.
Then came tighter monetary policy that followed. The Fed, the most hawkish in more than 20 years, is now turning to raising rates by 50 basis points. The resulting sluggish economic growth means earnings expectations will have to come down, Roberts said. He also said the market will not benefit from the continued monetary support the market has received over the past decade.
On top of that, even after the sharp sell-off so far this year, stock valuations remain high — the S&P 500 is down as much as 20% in intraday trading since Jan. 3. At valuations as of December 2021, using a cyclically adjusted price-to-earnings ratio, the stock trades at around 40 times earnings.
“The market is not cheap by any means,” Roberts said in recent comments. “If earnings growth fails to meet high expectations, interest rates rise or profit margins shrink due to inflation,
When ‘expectation’ collides with ‘reality’, the thesis collapses. “
For Roberts, these factors are the secret to very low average returns over the next 10 years. Comparing the December valuation with historical valuations, the market is set for a 10-year 0% return, Roberts said. At the height of the dot-com bubble, the S&P 500 had a CAPE ratio of 43, and the index achieved -2% over the next decade.
“Over the past 120 years, valuations have proven to be a strong predictor of future returns, and it’s not uncommon to lose decades,” he said.
He also warned about the power of mean reversion and how disconnected earnings forecasts are from market performance.
“Throughout history, whether it’s valuations, prices, profits, or any other metric, eventually, and always, the bias will revert to the mean,” he said.
Still, Roberts stressed that the low returns he envisions are on an annual basis, and that the stocks could see larger and negative returns in a few years, and he will trade those moves.
Roberts isn’t the only strategist to warn that high valuations could lead to a decade of sluggish returns.
Bank of America Savita Subramanian Last November said market valuations are so high that she expects negative returns for the S&P 500 over the next 10 years, excluding dividends.
Last spring, Subramanian also cited the explanatory power of valuations for long-term returns. Valuations explain 80% of returns over a 10-year period, they said.
permanent bear John HussmanThe president of Hussman Investment Trust has also been warning that with valuations so high, stocks will go through a “long and interesting 10- to 20-year journey with nowhere to go” over the next 12 years.
But as Roberts points out in his remarks, valuations have little impact on near-term returns, as shown in Bank of America’s chart above. Much of Wall Street remains bullish for the remainder of 2022, with top strategists placing their median target price on the S&P 500 at around 4,800. That’s nearly 16% above the current level of around 4,150.
At the beginning of the year, Goldman Sachs Citing stocks’ outperformance at high valuations is one reason why they remain bullish this year. Still, their chief U.S. equity strategist, David Kostin, has cut his S&P 500 target from 5,100 to 4,900, and most recently to 4,700, due to policy tightening and persistent inflation.
With many questions still unanswered, the future of the stock remains uncertain. It is unclear how much inflation will moderate in the coming months and how aggressive the Fed will be after its July meeting. China’s COVID-19 lockdown could also ease, as could Russia’s offensive on Ukraine.
It’s unclear how much demand destruction the Fed has already caused — in the housing market, for example, where mortgage applications are falling sharply, but broader consumer spending remains strong.
But over the longer term, the outlook looks bleak compared to the S&P 500’s 278% appreciation from the beginning of 2011 to the end of 2021.