The Enduring Strength of Stocks: Analyzing Recent Performance and Future Prospects
The stock market, particularly the technology sector, has experienced remarkable growth over the past two years. A closer examination reveals that this impressive performance is largely justified by the significant improvement in corporate profitability. However, the crucial question facing investors now is whether this enhanced profitability is sustainable into 2025 and beyond, or if market expectations have become overly optimistic. A deeper dive into long-term stock returns and earnings data offers valuable insights to address this question.
Analyzing historical data reveals that while the S&P 500 delivered a robust 25% total return in 2024, a longer-term perspective is essential. Over a 10-year period annualized through 2024, stocks returned 13%, exceeding the long-term average of 9.9% since 1928. More importantly, considering real returns (adjusted for inflation) is crucial for assessing true purchasing power growth. The 10-year annualized real return through 2024 was 9.7%, notably higher than the long-term average of 6.7% since 1928. While these robust returns are encouraging, they also raise the possibility of mean reversion, suggesting future returns may moderate.
Earnings, as a fundamental measure of a company’s financial health, play a critical role in shaping long-term stock performance. As Warren Buffett famously stated, the value of a business hinges on its future cash flow. While short-term fluctuations in stock prices can deviate from earnings trends, the two inevitably align over the long run. Notably, the S&P 500 has consistently demonstrated earnings growth that outpaces inflation, highlighting the enduring wealth-generating potential of owning operating companies through stock investments.
Since 1936, S&P 500 nominal earnings have grown at an annualized rate of 6.7%, exceeding inflation by an average of 3% annually. This impressive track record underscores the long-term power of equities. The robust stock returns of the past decade have been accompanied by above-average earnings growth, both in nominal and real terms. This was particularly evident in the post-Covid-19 period, where earnings growth significantly surpassed historical averages despite elevated inflation levels. Projected earnings growth of over 12% in 2025, following 9% growth in 2024, further strengthens the case for continued market strength. The key determinant of future stock performance will be the sustainability of this improved profit profile.
Successful long-term investing requires a patient and disciplined approach, regardless of market valuations or prevailing conditions. Historical data reveals that while stocks have yielded positive returns in 73% of individual calendar years, the probability of positive returns jumps to 94% over a ten-year holding period. Similarly, while 10-year U.S. Treasury Notes have shown positive returns in 79% of calendar years, the likelihood becomes a certainty over a ten-year period. However, the analysis becomes more compelling when considering real, inflation-adjusted returns. Over both one-year and ten-year horizons, stocks significantly outperform bonds in terms of positive real return probability. This highlights the long-term resilience of stocks as a wealth-building asset. It’s important to note, however, that short-term drawdowns in stock prices can be significantly sharper than those of bonds. Therefore, investors with short-term liabilities should prioritize stability and opt for bonds or cash. For long-term investors, however, the data clearly favors stocks.
While recent stock market performance has been impressive, context is crucial. The S&P 500’s 13% annualized total return over the last ten years is still considerably lower than the historical high of 20.1% recorded in 1958. Similarly, the real return over the past decade, at 9.7%, remains below the all-time high of 17.9%, also reached in 1958. As Charlie Munger aptly points out, the worst annual returns for stocks often understate the potential for short-term pain. History is replete with examples of significant market downturns, such as the 49% decline during the technology bubble burst from 2000 to 2002, and the even steeper 57% drop during the global financial crisis from 2007 to 2009. Despite these periodic shocks, stocks have consistently delivered the highest long-term nominal and real returns compared to other asset classes. Furthermore, the average intra-year decline for the S&P 500 over the last 53 years has been 14.6%. The lower-than-average drawdowns observed in the previous two years suggest a potential return to this historical norm. However, it’s worth noting that periods of lower volatility can sometimes persist longer than anticipated. While some market observers express concerns about a potential stock market bubble, citing elevated valuations and optimistic economic assumptions, it’s important to acknowledge the improved profitability of companies, particularly within the technology sector. History has shown that stocks can continue to appreciate even after periods of robust growth, and profitability can remain exceptional. Therefore, predicting a market decline is far from a certainty. Investors should regularly review their risk tolerance, particularly after periods of substantial market gains. As stock valuations rise, so does the overall risk profile of an investment portfolio. Rebalancing stock and bond allocations towards a target risk level remains a prudent strategy. This approach provides the necessary stability to navigate the inevitable market downturns and avoid the "mediocre results" that often befall those who panic during periods of volatility.
