With the S&P 500 up almost double digits year-to-date (9.9 percent) after a double-digit total return of +31.2 pct last year, what are the odds we can get another two-digit return in 2021? This might seem like an overly simplistic question, but it is not.
If we do hold our 2020 gains and get another 10+ percent return in 2021, the S&P 500 will be up at least 59 percent in 36 months. In those 3 years we’ve seen a global pandemic/economic crisis and, as a result, US corporate earnings that are (best case) normalizing to right where they were in 2019. Put another way, that would be a 17 percent 3-year compounded growth rate on stocks with a 0 percent increase in profits. Remarkable, if it were to happen…
Here’s a bit of history to consider:
- The S&P has registered two consecutive years or more of annual double-digit total returns 19 times since 1958 (first full year of data).
- In the year after those 19 instances, the S&P was positive a little over half the time (58 pct) and up +3.6 pct on average on a total return basis. The strongest was 33.1 pct in 1997 and the worst was -14.3 pct in 1973.
- The S&P only went on to produce a positive double-digit return for a third year in a row or more during 3 periods:
1963-1965: 1963 (+22.6 pct), 1964 (+16.4 pct), 1965 (+12.4 pct)
1995-1999: 1995 (+37.2 pct), 1996 (+22.7 pct), 1997 (+33.1 pct), 1998 (+28.3 pct), 1999 (+20.9 pct)
2012-2014: 2012 (+15.9 pct), 2013 (+32.1 pct), 2014 (+13.5 pct)
Here are our investment takeaways from the data:
#1: We think the S&P 500 could be up +10% at year-end with finally a vaccine in sight and US elections settled. We are, after all, moving into a part of the year with traditionally good seasonal tailwinds. A rollout of the vaccine in 2021 should also improve investors’ outlooks on 2021 corporate earnings and economic growth. But could US equity markets overshoot in 2020 and “borrow” from 2021?
History shows that a third year of double-digit returns is rare, and typically comes amid easing financial conditions and improving earnings such as during the bull run of the 1990s or after the Financial Crisis. The reason double-digit annual returns seem more common than they actually are is a function of longer economic cycles over the past 3 decades. There’s a link at the end of this note that shows the length of business cycles back to before 1900 from the National Bureau of Economic Research. You’ll see that cycles were much shorter prior to the 1990s thanks to a raft of factors ranging from wars and oil shocks to Federal Reserve policy.
The upshot: 3 or more consecutive years of double-digit returns are more common only recently with longer economic cycles, and it’s important to remember that two straight years of double-digit returns tend to be sporadically sprinkled throughout a cycle.
#2: US equities rallied so strongly last year largely due to Chair Powell’s pivot to lower rates, while this year’s solid returns stemmed from not only an easy central bank but also meaningful fiscal stimulus. Replicating these ingredients for another double-digit performance year will be tough, although not impossible given that the latest recession was so deep. That said, while the S&P mostly delivered positive double-digit annual total returns during the last expansion (2009-2019), there were also a few low performing years on a total return basis: 2011 (+2.1 pct), 2015 (+1.4 pct) and 2018 (-4.2 pct).
#3: Next year’s performance will largely come down to how the market discounts 2022’s economic growth and US corporate earnings. On the plus side, the Fed has signaled it will keep rates low, helping support equity valuations. There’s also still many unemployed workers that can be pulled back into the labor force as the recovery progresses, helping spur marginal consumer spending over the next few years. On the trickier side, corporate margins were already at record highs given the Trump administration’s tax cuts so it will be harder for public companies to show much of a bump in earnings leverage relative to 2019.
Bottom line: as much as positive double digit returns in 2020 would be a welcomed development after a tumultuous year, it would come after an already very strong year for US equity returns. History shows it would not be unprecedented for that to repeat for a third consecutive year, but it’s important to manage expectations as returns are typically more muted after this sequence of events.
Historical data from Aswath Damodaran: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
US business cycle expansions and contractions from the NBER: https://www.nber.org/research/data/us-business-cycle-expansions-and-contractions