I’m taking notice as many experts (and not just Nouriel Roubini) are predicting impending doom and gloom in the equity markets because of the ongoing problems in the EU, the huge and still expanding US debt levels, the hangover from the Great Recession, the effects of entitlement spending, expiration of the Bush tax cuts, Syria, Iran, and whatever else we can throw on the pile.
My concern is not where the markets will be be next month, but instead whether we’re in for another decade or more of flat – or worse – declining share prices. So I thought it could be illustrative to consider equity price levels historically. A wide range of disruptive events have occured in the past (world wars, recessions, high tax rates, low tax rates, dotcom insanity, …), so if there is a lasting/permanent effect of events on the markets, it should become apparent.
I started by looking at the S&P 500 closing prices going back to 1950. I found that it increased at a remarkably steady CAGR of 7%.
Using the historical actuals to extrapolate into the future, the S&P 500 index can be expected to cross the 2,000 price level somewhere in mid 2017, less than 5 years from today (for a healthy 42% gain over current levels).
How sensitive to various events are the equity markets’ long term prospects? While there is a zero chance of accurately predicting where the market will be next month, can we predict where it will be in 5 years with any degree of confidence? To test, I removed large chunks of the market data from the analysis to see what would happen. For example, from 1995-2003 we saw a dramatic bubble/bust cycle. What happens if we remove that time period (in other words the Y2K and dotcom booms, and the subsequent bust, never happened) from the analysis?
Not much, as it turns out. Assuming 1995-2003 never happened, the S&P 500 crosses the 2,000 level only 6-8 months later than in the previous analysis.
I re-ran the analysis with various time periods removed and found pretty much the same thing. Here’s the data assuming the Great Recession that began in 2008 never happened (if only it were that easy):
If Wall Street had not blown up the world in 2008, we could have expected the S&P to hit 2,000 around the beginning of 2014 (thank you, Wall Street, for inventing the synthetic CDO).
Long term, the historical data suggests that the S&P 500 will continue to grow at a 7% CAGR, and will cross the 2,000 mark somewhere around 2017, give or take.
The only scenario I can think of that would invalidate this historical trend is if the equity markets could no longer be viewed as a representative proxy for the economy; for example, if large organizations like Apple and ExxonMobil were to continue to operate, but no longer exist as public corporations. Anything else, like staggering debt, or an incompetent Congress, or funding expensive wars and social programs, or financiers putting their own interests ahead of their clients’, are all things that the markets have seen before and are priced into the historical data.
I have no idea where the market is going short term. But analyzing the long term data helps to drown out the short term noise. I am staying long equities. Unless a private equity firm takes Apple private.