Watch as Eric D. Nelson, CFA, of Servo Wealth Management demolishes the bubble meme in a new post at his blog this week…
Probably the best method of “bubble detection”, to the extent such a thing is even possible, is to simply observe an investment’s recent past performance history to measure how far in excess of the long-term average it has been. For example, Gold experienced a ten-year run starting in 1971 where it returned almost 32% per year. US small cap stocks earned 27% per year for the decade ending in 1984. And Japanese stocks produced over 28% per year returns in the 1980s. All of these results were well above long-term expectations and unsustainable, as each market eventually “reverted to the mean.” Have we reached this point again?
Table 1 looks at three different investment portfolios: a traditional US total stock index, followed by two more diversified asset class mixes—an all-stock allocation (“Equity”) and a balanced stock and bond combination (“Balanced”).
For the recent ten-year period, investment returns have been healthy despite the debilitating setback in 2008. The US Total Stock Index earned almost 8% per year. But this is far from an alarming rise in prices, as the average over the previous 75 years was 1.7% higher, at +9.6% per year. So far, so good. If lower-than-average returns have created a market bubble, that would certainly be the first time.
Josh here – Stocks are supposed to go up over 10-year periods and they almost always do – 88% of rolling 10-year periods over the last 89 years have shown a positive return for the US market. Looking at the last ten years, even with the inclusion two mega rallies and a massive bear market, we’re just now getting back to historical return averages.
Shall we pause here and reverse or shoot all the way through to a real bubble? That’s the more important question.