Other Views: Stock market returns are almost destined to be significantly lower in the next era

That is why beating the market remains a loser’s game today, just as it has been over the past 50 years and, for that matter, forever. The title of a popular 1940 book pungently summarized the idea: “Where are the Customers’ Yachts?”

Yet while the market is the same old formidable foe, the returns we can expect from the stock market will change. Returns are apt, indeed almost destined, to be significantly lower in the coming era.

While we are in a new era in the economy, there is no new era in the stock market. The eternal paradigm remains: Hope, greed and fear may drive the speculative enthusiasm of the moment, but it is the fundamentals -earnings and dividends – that will drive the market’s era-long returns.

What else may change, and what else may remain the same? Let’s speculate a bit, starting with what may change.

Today’s overweening focus on the daily sound and fury of the stock market will abate as investors recognize that prices move up and down, and that simply ignoring those fluctuations and eliminating (or trying to eliminate) emotion from the investment equation is the secret of optimizing investment returns.

As investors recognize the futility of trading, today’s extraordinarily high transaction activity in stocks will recede, if not to 1950 levels, at least to annual turnover levels well short of [last] year’s 150%.

Symbolically reaffirming this change, the Nasdaq bulletin board on Times Square – “the largest television screen in the world!”- will move to Wall Street, where it belongs.

Change of focus

As investors realize the heavy toll taken by costs and taxes, they will at long last begin to abandon their short-term focus and do what they should have been doing all along – invest for the long term. Again symbolically, the Weather Channel will replace the business channel as the most popular daylong TV fare.

Economic and financial education will increase sharply, but it will begin to focus on what matters. One symbol of progress, I predict, will be when high school classes abandon their titillating “stock-picking” contests and begin to teach the simple, boring mathematics of long-term compounding.

As investors vote with their feet, the mutual fund industry will recognize it has no monopoly on the affections of investors. We will change as we at last find our way, returning to the principles of stewardship and fiduciary duty, and fulfilling our natural role as “the greatest contributor to financial democracy ever devised.”

What Will Remain The Same

With all this change, however, much will remain the same.

Common stocks will remain the investment choice for America’s families. Despite the fact that the market is all too likely to suffer a few severe bumps during the next few years, most investors will learn to stay the course.

Where else can investors turn other than the ownership of American business to find the extra returns required to assure the financial resources that will sustain their retirement?

Common stocks will continue to provide a long-term risk premium over bonds. However, as both their risks and returns become even better understood, the historic 6% real (inflation-adjusted) premium accorded equities will ease downward, perhaps to as little as 2% to 3%.

Indexing will, as it must, continue to prove itself year after year to all but the “I’m too smart for that” and the “hope springs eternal” crowds.

Of course, statistics being statistics, in some years, indexing won’t look as if it has won, and we’ll be told by the vested interests that the era of the active manager has miraculously returned and “it’s a stock picker’s market again,” ignoring the plain fact that the reality of the mathematics of the market is inescapable.

No matter. The use of indexing strategies will increase steadily and significantly.

Social Security will – and this may surprise you – remain intact. But only because long-overdue adjustments are at last made to increase revenues (some taxability of benefits) and to reduce distributions (a more realistic inflation adjustment; a retirement age that reflects our longer lives).

However, an optional stock-investing plan, overseen by an independent Social Security investment board, will become available for a portion of an employee’s regular contributions. The vehicle? No surprises here: a low-cost, all-market index fund.

Some imponderables

The increasing importance of equity investing in the balance sheets of our citizenry will raise important policy issues.

While “people’s capitalism” will remain the American ethos, I’m not at all sure what the social impact of ownership of stocks by those millions in our population who can afford to invest – and hence de facto corporate control by the public – will have on our political system.

How, for example, can the citizenry be against “big business” when, by owning stocks, “we the people” are big business? In the fullness of time, we shall see.

At the same time, we’ll have to consider the implications of living in a more “market-dependent” economy.

With one half of our families’ assets invested in stocks, and with the financial markets ever subject to extreme waves of optimism and pessimism, will these swings be translated into greater volatility in the economy itself?

Clearly, as risk is increasingly transferred from corporations and financial institutions to individuals, more enlightened and rational attitudes about the stock market will be required.

Even today, we see the Federal Reserve focusing on the level of stock prices as it tries to steer a stable course for the economy.

But in the long run, stocks cannot be propped up at unsustainable levels by encouraging words or easy monetary policy.

I hope that as common stocks inevitably enter the political arena, our governmental authorities will have the wisdom to let the markets take their own course as, finally, they must.

John C. Bogle is the founder and chairman emeritus of the Vanguard Group Inc. in Malvern, Pa. This article was excerpted from an October speech before the Town Hall of Cleveland.