What to Expect from Stocks & Bonds
"We've long felt that the only value of stock forecasters is to make fortune tellers look good."
- Warren Buffett
There's no harm in idle speculation about the market—it's like talking about the weather or an upcoming sporting event. But if a Wall Street strategist makes a serious-sounding prediction about the near-term direction of the market, and advises some course of action in response, hold onto your wallet. All that's been revealed is this person either (1) doesn't know what they don't know or (2) is willing to lie to you, probably because they want to sell you something.
Fundamentals drive returns in the long run, but short-term market movements are random. They depend on the whims and sentiment of millions of buyers and sellers; no one can predict that.
Still, we can set some baseline expectations about what's possible and what's likely, based on what's happened in the past. The graphic below shows annual total returns for the S&P 500 and Bloomberg US Aggregate Bond Index from 1977 through 2023. The former tracks 500 of the largest U.S. stocks by market cap. The latter is the most referenced bond index; it includes investment-grade government, corporate, and asset-backed bonds, with an average duration of about six years.
Some observations:
• Losses are rare. The S&P 500 only delivered a negative total return (including reinvested dividends) in 9 of the past 47 calendar years. A 15%-plus positive return was far more common, occurring in 25 out of 47 years. The bond index was only down in 5 of the past 47 years.
• Back-to-back negative years are even more unusual. The S&P 500 only had one such stretch during this period: the bursting of the dot-com bubble in 2000–2002. The bond market's only consecutive losses occurred in 2021–2022 as the Federal Reserve aggressively raised interest rates.
• Stocks delivered higher average returns, but with greater volatility. The S&P 500's compound annual total return was 11.4%. The bond benchmark returned 6.4% per year.
• The correlation between stock and bond returns is low at around 0.24 (using monthly returns). This is why diversification across asset classes meaningfully lowers portfolio volatility. In only one year out of the last 47 were the stock and bond indexes both negative: 2022. That year was also noteworthy as the worst year for bonds on record (by a wide margin).
• As I described in Fundamentals Drive Long-Run Stock Returns, future returns are unlikely to match historical averages. That's because P/E ratios are much higher today, and dividend yields much lower. At the beginning of 1977, the S&P 500 was trading for about 10.6x trailing earnings with a 3.9% dividend yield. Today it trades for 25.2x trailing earnings and yields 1.3%. On the bond side, the Bloomberg U.S. Aggregate is yielding about 4.7%, which is a reasonable base-case estimate for future returns.
Here's another perspective on the same data. In this case, I used rolling one-year returns and grouped them into buckets to create a frequency distribution:
Both distributions follow a bell curve. For the S&P 500, the center of the bell is shifted toward the right, reflecting higher average returns for stocks relative to bonds. Stock returns fell between 10%–20% nearly 30% of the time. Bond returns were lower but more consistent, falling between 0%–10% nearly 60% of the time.
The S&P 500 distribution is much flatter because of the greater volatility of returns. Stocks delivered a negative return in about one year out of five. They declined 30% or more in 1.4% of one-year periods. By comparison, the worst one-year return for bonds was a 15.7% decline, and bonds were only negative in about one out of every 7.5 years.
To estimate a 90% confidence interval, we could say that one-year stock returns are typically between negative 15.3% and positive 38.5%. One-year bond returns are typically between negative 2.4% and positive 19.8%.
Keep that in mind the next time you hear some forecaster make a specific prediction about the market's short-term outlook. If they say, "I expect the S&P 500 to be up 10% this year," what they really mean is "I expect the S&P 500’s total return to land somewhere between negative 15% and positive 38%, with 90% confidence." You won't get in Barron's for a prediction like that...
Disclosures
Moatiful is an independent publication of Trajan Wealth, L.L.C., an SEC registered investment advisor. The views expressed are solely those of the author, and may not reflect the views of Trajan Wealth. Nothing in this blog is intended as investment advice, nor is it an offer to buy or sell any security. Posts are for entertainment purposes only and should not be relied on when making investment decisions. Please consult your financial advisor for questions about your personal financial situation. All investments involve risk, including the potential for loss. Historical results may not be indicative of future performance. Data from third-party sources is not guaranteed to be accurate, timely, or complete. Links to external sources are provided for convenience only, and do not constitute an endorsement by Trajan Wealth. Clients and employees of Trajan Wealth may have a position in any of the securities mentioned. Data and opinions are subject to change at any time without notice.