Smart money says temper expectations of stock returns

The stock market​ has been generous to investors during the past eight years of almost uninterrupted gains, and some experts are saying it's time to be cautious. Some prominent investors are warning that the next few years are unlikely to be as rewarding as the past eight, at least in U.S. markets, and that expectations should be tempered. One such voice is David Swensen, who has led the Yale Endowment to unprecedented heights through timely asset allocation decisions, moving into undervalued asset classes. During his 32-year tenure, the fund has had a 13.5% annual rate of return. Mr. Swensen warned in a recent speech that stock market returns over the next several years are unlikely to be better than 5% per year, on average. That will disappoint many investors, but his warning should be heeded, and should prompt investment advisers to reach out to clients to temper their long-term return assumptions. From Jan. 1, 2009, to Dec. 31, 2016, the U.S. stock market returned 14.9% compounded annually, dividends included. That more than offsets the losses of 2007-08 for investors who stayed invested. The current bull market, at 104 months, is not yet the longest, even since World War II; and though it has risen 263%, it is still short of the October 1990 to March 2000 dot-com bull market, which lasted 113 months and rose 417%. (More: Bond investors should prepare for string of rate hikes in 2018) However, it is getting very long in the tooth, both in months and in percentage gain. It is also getting expensive, as the average price-earnings ratio of the S&P 500 as of Nov. 17 was 24.4, compared with the historic average P/E of about 15. The market has discounted years of strong future corporate earnings, and this has raised concerns that a correction is overdue.

Not enough fear

A survey by Wells Fargo/Gallup this summer found that 54% of investors anticipate a market correction in the coming months, yet 61% also say it is a good time to invest in the stock market. That suggests there is not enough fear in the market, providing an environment in which some extraneous event could trigger a long-overdue correction. But while the arrival of a market correction cannot be predicted, an era of lower stock market returns can be anticipated, and investment advisers can prepare their clients for a lower rate of growth of their assets and resist any pressure to take an inappropriately high level of risk to earn higher returns. The time to temper client expectations of future stock market returns is now.