Why I Remain Sanguine On S&P 500 Returns The Next 3-5 Years

Remaining positive on the stock market today is a good way – like the old saying about pioneers – to get a substantial number of arrows shot into your back.

While the S&P 500 could experience a 10% correction at any time, and we have not seen a 20% correction since 2011, I continue to think that, in terms of experiencing a bear market like the one from 2000 to 2009, with the worst cumulative return on the S&P 500 for a full decade since the 1930’s, the probability of such a bear market remains remote.

Why ?

People forget that prior to the three-year period of consecutive negative returns of 2000, 2001, and 2002, the last time the S&P 500 experienced even two years of negative returns was the 1973, 1974 bear market. Prior to the 1973 – 1974 bear market, the last time the S&P 500 experienced 2 consecutive years of negative returns was 1940 – 1941. (The source of this return data was Morningstar Ibbotson’s “Stocks, Bond, Bills & Inflation” (SBBI) handbook.)

Note the rolling 10-year return relative to the average in Batnick’s article.

The point that these charts should pound home to readers is that given long-term returns and the concept of “reversion to the mean”, the S&P 500 continues to work off the period from 2000 – 2009 and the odds of at least modestly positive returns for the key benchmark remain better-than-average (in my opinion).

But there is another reason I remain pretty sanguine about prospective S&P 500 returns for the next 3 to 5 years:

If you look at the composition of the S&P 500, the bear markets of 2000 – 2002 and then 2008, were entirely sector driven.

Technology reached 33% of the market cap of the S&P 500 in March, 2000, and Financials reached close to 30% of the S&P 500 by mid 2007.

As the reader can quickly see, Technology and Financials are the 35% of the S&P 500 by market cap and nearly 40% by earnings weight, and these are both sectors that have experienced absolutely brutal bear markets in the last 15 years, and from which both sectors are still recovering.

As a reader, do you really think Technology and Financials have potentially 25% downside in front of them, even as Financials have been turned into public utilities and the Old Tech leaders like Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC), Cisco and such are still trading at substantial discounts to their all-time highs and trade today at relatively modest valuations ?

I’m scared to death of the bond markets today, but like the Nasdaq from 1995 to 2000, waiting for an end to the 32-year bull market in Treasuries has been a lesson in frustration.

Client portfolios continue to be tilted towards the S&P 500, and the top half of the S&P 500 in particular, or the S&P 100 and the Nasdaq 100.

Stocks over bonds is the mantra for clients today, and large-cap stocks like the top half of the S&P 500 work best, in terms of risk – reward.

The period from 2000 to 2009 took a LOT of excess out of the US stock market. In fact ,Technology and Financials were the 1980’s and 1990’s bull market sector leaders.

Our two largest sector overweight’s for clients today are Technology and Financials given I just don’t think there is the potential for either of these sectors to get crushed, even if we see a 20 – 25% S&P 500 correction.

Anything can happen in the US stock and bond markets, and when “anything” does, it is usually negative.

Readers can play defense in worrisome markets by shopping in areas that have experienced bear markets, and valuations remain modest.

Written By: Brian Gilmartin