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Investment returns are the reward sought by all investors, not small returns or unpredictable returns, but large and guaranteed ones. Unfortunately, those sorts of returns are imaginary. This is not to say that estimation, a more respectable form of imagination, is not in widespread practice. All investors imagine some sort of plausible future of some kind, with some sort of expected reward. These imaginings are behind every dollar invested in the world today.

“By the end of the next decade, quite a way off, there will be a pandemic, and stock investors will achieve record wealth.” These words, if uttered a decade ago, would have sounded crazy. As it turns out, they would have also been prophetic. What’s more, absolutely nobody spoke them, but that prophecy is what happened.

From the third quarter of 2010 to now, the S&P 500, a measure of large U.S. public companies’ performance, returned a whopping 14.3% on an annualized basis or 270% cumulatively (Chart A, below). U.S. stocks gained $27 trillion in value over the period, rising to $40 trillion today from $13 trillion a decade ago (Chart B, below). Corporations also paid over $8.5 trillion in dividends. How did this happen, especially in the wake of the most significant financial crisis since the Great Depression?

Chart A
S&P 500 Total Return (November 2010 – November 2020)

Chart B
United States Equity Market Capitalization (November 2010 – November 2020)

Simple Arithmetic

We believe that returns are rooted in fundamentals that can be measured. Looking back over the past decade’s performance, we see that the 14.3% return can be traced to three sources:

  1. 5.9% annual growth in profits;
  2. 5.9% annual rise in valuations;
  3. 1.9% annual return from dividends.

Arithmetic proof: We get to 14.3% by multiplying 1.059 * 1.059 * 1.019 and subtracting 1 from the product of those three numbers. Voila! A superior and surprising return!

Deeper Dive

The bulk of the return was generated “fundamentally” through the operations of businesses. The 5.9% profit growth and 1.9% dividend flowed from the operations of individual companies. The remaining 5.9% is tied to “market” or “macro” factors outside the business’s control. Interest rates and market psychology, for example, can influence whether the market carries a high or low valuation. Most of the return came from “fundamental” rather than “market” factors, though.

Profit Growth
(Primary Importance)

The most important fundamental factor is growth. The 5.9% profit growth came about because of three primary forces (Chart C, below).

  1. First, the U.S. economy grew by about 3.4% per year, with about 1.7% coming from “real” growth (higher quantity of sales) and 1.7% coming from price increases (inflation).
  2. Second, business claimed a larger share of the economic pie. In 2010, S&P 500 profits were near $850 billion (5.7% of the economy, measured by gross domestic product, or GDP). Today, S&P 500 profits are over $1.4 trillion, or 6.7% of GDP. This translates into a 1.6% annual growth rate in large public company’s share of economic output and income over the last decade.
  3. Third, and a somewhat technical point, declining shares outstanding has increased the “per share” figures for the S&P 500. The “divisor,” used to adjust billions or trillions of dollar values to index values, is lower today than ten years ago. Most of the reason for the decline relates to share buybacks. The divisor decrease added about 0.7% per year to “per share” profit growth on top of total profit growth.

Chart C
S&P 500 Contributors (%) to Profit Growth (2010-2020)

So the wellspring of return is growth in profits. Apart from rising valuations over the decade, it was by far the largest contributor to return. Even dividend yield paled in comparison, adding only another 1.9% to the return total. Growth, after all, is the main reason why most investors buy stocks at all.

(Secondary Importance)

None of the underpinnings of “fundamental” returns above seem all that unreasonable. Some growth in the economy, a little inflation, dividends, and buybacks seem like reasonable bets. Continuation of a long-running, secular trend toward rising corporate profitability might be an area of controversy. Still, there is little evidence of the trend reversing at the moment. Fundamental drivers of return have been, and continue to appear, well-grounded.

The market multiple, or valuation, paid for a dollar of earnings is less certain (Chart D, below). Today, the S&P 500 trades at 22.2x forward-looking analyst estimates of operating earnings ($163). Ten years ago, this multiple stood at 12.4x. The fall in long-term U.S. Treasury bond rates to 0.9% from 3.5-3.75% contributed to the rise in stock multiples. As Treasury yields fall, investors are more likely to find stock investments more attractive, contributing to an increase in equity valuations.

The rise in market valuations enjoyed for the past decade are not likely to repeat, in our view. If such a tailwind were to repeat, the forward price-earnings multiple for the S&P 500 would need to reach 40x by 2030, a significant stretch. More likely, we envision the multiple to revert to a historically average level near 15x, creating a drag on returns.

Chart D
S&P 500 Valuation
Price / Forward 12-Month Analyst Earnings Estimate

Future Reward?

The last decade has been a rewarding one, although it began in the shadow of the great financial crisis and is ending amid a pandemic. Still, record levels of wealth are being created.

There are imperfect parallels in history. The early-1950s and mid-1980s were both times of prosperity. Stock indices had been on a vigorous upward climb in the prior decade, and returns in the rear-view mirror were ample. Still, stocks continued to generate healthy but lower returns for several more years. From 1950 to 1959, the market returned about 9% a year, on average, and from 1985 to 2000, the stock market returned about 7% annually. There is no reason to believe that a similar result can’t repeat.

In both cases, a strong and growing economy contributed most to the market’s success. The past decade’s large gains occurred as the globe climbed out of the great financial crisis of 2007-2008. Few in 2010 imagined or predicted (we included) everything that actually came to pass. As the world stands at another turning point and seeks a way out of the pandemic, a plausible case for future reward for stock investing still exists.

Investing is not about knowing everything about the future. It is about having a philosophy and discipline that gets one through all the things that can’t possibly be imagined in advance.

Kevin R. Caron, CFA
Senior Portfolio Manager

Chad Morganlander
Senior Portfolio Manager

Matthew Battipaglia
Portfolio Manager

Steve Lerit, CFA
Client Portfolio Manager

Paul Clark, CFA
Senior Portfolio Manager
Municipal Fixed Income

Rick Marrone
Senior Portfolio Manager
Municipal Fixed Income

Daniel Urbanowicz
Senior Portfolio Manager
Municipal Fixed Income

Suzanne Ashley
Internal Relationship Manager

Eric Needham
External Sales and Marketing


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