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Volume 13, Edition 26 | October 19 - October 25, 2024

Investing Smart Amid Low Expectations

Doug Walters, CFA
Recent forecasts have highlighted the potential for lower returns from US equities in the years ahead, once again bringing home bias and concentration risk to the fore.

Contributed by Doug Walters, David Lemire, Max Berkovich

Investing Smart Amid Low Expectations

A few weeks ago, we wrote about the importance of avoiding home bias in your investing (A Good Time for a Worldly Portfolio). We emphasized the significance of diversification and the pitfalls of concentrating too many of your assets in the comfort of your home market. This week, a pair of research reports made headlines and underlined our home bias point.

Diminishing Returns

The big headlines came from a Goldman Sachs report forecasting 3% returns for the S&P 500 over the next decade. Separately, JP Morgan’s capital market assumptions came out with an expectation of 6.7% returns for US large-cap stocks. Both are well shy of the 13.4% annualized returns the S&P 500 has produced over the past decade. Intuitively, it makes sense. Recent returns have been well above average, so future returns should be below average.

Some Caveats

First and foremost, the great institutions of Goldman Sachs and JP Morgan do not have crystal balls. As evidence-based investors, we are generally fans of analysis like this that leans heavily on the evidence of the past. But it should not be interpreted recklessly. When we look back ten years from now, perhaps returns on average were low, but maybe it was nine good years followed by a big sell-off in year ten. There are two dynamics this highlights:

  • Predicting annualized 3% returns for the next decade is different from saying returns will be 3% every year for a decade. They will not. They will be up and down and, by definition, up more than they are down.
  • Trying to time a sell-off is a dangerous game. A market timing mindset is one of the fastest paths to long-term underperformance.

Combating Low Returns

We have hit on diversification so much in the past few months that we probably don’t need to relitigate that here again. It’s fairly obvious that if US equity returns are expected to be lower than average, it’s a good idea to have exposure to other regions and asset classes. This is not just a good idea now, but always.

So, instead of focusing on the obvious point of diversification, I’ll focus on one of Goldman’s specific drivers of low expectations for the S&P 500: concentration risk within the index itself. Apple, Microsoft, Nvidia, Meta, and Google represent about 30% of the index. These are mega-sized companies, and the S&P 500 is an index built purely on size. The bigger the company, the bigger the size in the index. We prefer indexes that are weighted based on something we care about more than size – evidence-based factors (like Value, Quality, Momentum, and Small Size). These factors have tended to outperform over time.

Looking Ahead

As we navigate this period of (potentially) lower return expectations, we see opportunities for investors: opportunities to diversify, opportunities to not overreact, and opportunities to take advantage of significant market moves should those lower returns concentrate themselves in a short period of time. Our evidence-based approach was built for this.

3.84M

New Home Sales

US home sales fell to a near 14-year low in September as homeowners continue to remain reluctant to give up their low mortgage rates.

Headline of the Week

Housing

Home sales are looking to break the wrong records for the second straight year. The downside to low interest rates continues to reverberate through the real estate market. With years of near zero interest rates, many Americans locked in some of the lowest mortgage rates recorded. Now with rates much higher, mobility (upgrading or downsizing) has been extremely hampered. Home sales have suffered as there is reduced supply due to this low-rate lockup. Demand for housing remains strong and thus prices have continued to march higher. From an economic perspective, the only decent upside is that folks are sitting on substantially higher home equity. Maybe these equity values can unlock a wave of home renovations projects.

The Week Ahead

What a blockbuster week for the markets: biggest week of earnings, Gross Domestic Product (GDP) reports, jobs report, an inflation report, and more.

Trick or Treat

This is the week for earnings, with Visa, McDonalds, Pfizer, Elli Lilly, Merck, Mastercard, Exxon, Chevron, and Berkshire Hathaway all on the docket. However, everyone is tuning in for Alphabet, Microsoft, Meta, Apple, and Amazon.

  • With the sheer volume of reports, it is hard to focus too much on anything, but AI-related commentary from the members of the Magnificent Seven will be something to zero in on.
  • Microsoft’s results should focus on Azure, the cloud unit, and how much revenue AI has generated. Similarly, Amazon’s report will focus on AWS revenue growth.
  • Single-name volatility in response to results, especially from the Big 5, will be for investors the trick or treat, for sure!

The Boo Bucket

Between GDP reports from the US and Eurozone, a Personal Consumption Expenditures inflation report (PCE), jobs report, and a rate decision in Japan, the economics line-up is almost as overloaded as the earnings calendar. Any of these can disappoint and scare investors.

  • The initial GDP reports for both the US and Eurozone will be released during the week. Europe is expected to eke out a slight expansion in the third quarter, while the US is expected to have printed an impressive 3% expansion of the economy.
  • The Bank of Japan is expected to hold its ground and not raise rates at this meeting, but the snap election on Sunday may dominate Japan-related headlines for the week.
  • The United Kingdom budget is highly anticipated. Finance Minister Rachel Reeves is asked to balance the high debt load, hefty public spending, and a pledge not to hike taxes. Uncertainty has been weighing the British markets down.
  • The inflation report, PCE, will be closely watched and is expected to tick down a little bit to 2.6%. This will be the inflation number voters will have on hand when they vote.
  • Current expectations are that 140,000 jobs were created in October, the unemployment rate will remain unchanged at 4.1%, and earnings growth will have slowed slightly.
  • Capacity for further growth in the jobs market will be examined through the JOLTs report on Tuesday.

Happy Halloween!

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