What kind of investment returns can we expect on fixed income and stocks as of October 20th, 2020?

by Marc-André Turcot, Corinne Sauvé-Boulé

To be realistic, we should expect over the next few years an annual return of around 1% from fixed income securities and an average annual return of between 4% and 5% from equities with a probable marked drop in their value in the short or medium term.


Suggestions

An Introduction to Our Income Strategy

Are you looking for income? We may have just the solution for you! Introducing the Demos Income Strategy, our newest investment strategy focused on recurrent income generation.

What is financial planning?

Financial planning is used to answer the question “Am I well aligned for my short and long term goals?”. It reduces stress while serving as a guide for portfolio management.

Hello! Here are our conclusions on the returns we can expect from both fixed income and equity investments. Our data was updated as of October 20, 2020.

Fixed-income investments

Here is a graph that shows the evolution of long-term interest rates over the years. Once again, we can see that interest rates have fallen from their historic high of 15.32% in the early 1980s to now stand at 0.68%. This represents a small increase in comparison with 0.59% in September 2020.

Interest rates – Long-term government bonds

Source : http://www.econ.yale.edu/~shiller/data.htm on September 30, 2020

Here are the returns for a 1-10 year laddered provincial bond portfolio. The yield edged down from last month, from 0.90% to 0.88%.

Provincial bonds yield-to-maturity
1 year 0.22% Alberta 1.35% - September 1, 2021
2 years 0.31% Alberta 1.60% - September 1, 2022
3 years 0.57% Ontario 1.50% - September 8, 2023
4 years 0.88% Newfoundland 2.00% - April 17, 2024
5 years 0.92% Saskatchewan 1.80% - May 30, 2025
6 years 0.80% Ontario 0.00% - June 2, 2026
7 years 1.10% Quebec 1.00% - September 21, 2027
8 years 1.18% Quebec 1.40% - June 1,2028
9 years 1.31% Quebec 1.70% - June 1, 2029
10 years 1.48% Manitoba 1.70% - September 5, 2030
Average: 0.88%

Source : Factset as of October 20th, 2020

So, again, we should expect a return of roughly 1% for the next several years from secure fixed income...


Stock market investments

The price paid for publicly traded companies, according to the Shiller ratio, is currently at 30.79 times their profits. There has been a slight decrease since last month, when the ratio stood at 31.60. The market was only as expensive as it was in 1929 and 1999, two periods followed by a sharp correction.

Price paid per one dollar of profit (Shiller PE ratio)

Source : http://www.econ.yale.edu/~shiller/data.htm as of September 30, 2020

We are therefore interested in knowing the return achieved by investors during the 15 years that followed such a high valuation of the stock market in the past.

Shiller PE ratio vs. Average annual return in the following 15 years

Source : Factset as of October 20th, 2020

So here are the results. On the horizontal axis, you can see different levels of Shiller's price-earnings ratio. It should be remembered that the higher the ratio, the more expensive the market is. The vertical axis represents the average annual return for the next 15 years. The blue dots represent all observed data and, finally, the black dotted line is the trendline of the graph. So, it is easy to see that the cheaper the market is considered, the higher the returns of the next 15 years, and vice versa.

If we take the current Shiller ratio which is currently at 30.79, we can see that the worst annual return for the next 15 years was negative and very close to zero, while the best was around 6%. Based on the trendline, at the current ratio, we can expect an average annual return of 4-5% over the next 15 years.

 

The following graph compares the price movement of the S&P 500 index with the earnings per share of the companies that make it up. Normally, it makes sense to observe a positive correlation between profit growth and market price. The more companies' profits increase, the more these companies increase in value and the more investors are willing to pay for them.

Price of S&P 500 index vs. Profits of S&P 500 companies

Source : http://www.econ.yale.edu/~shiller/data.htm as of September 30, 2020

We can observe that in each of the previous major crises, a decrease in profits (orange line) resulted in a decrease in the index price (blue line). During the tech bubble of the 2000s, the profits of the S&P 500 returned to their initial value after four years, while the index price took seven years before returning to the same level. As for the 2008 financial crisis, both profits and the price of the S&P 500 returned to their original values ​​after about four years. In the current situation, we have seen a significant drop in profits since the start of the pandemic and the stock market experienced a marked drop in March in line with this decrease. However, unlike the last two crises, the S&P 500 has regained its value in just a few months and is now priced higher than before the decline! And this time around, this recovery is not accompanied by an equivalent rise in profits, far from it. It is likely that corporate profits will start to rise again, but it is unlikely that this rise will be fast enough to justify the increase in the stock market prices in recent months. Let’s not forget that we have just reached an all-time high in COVID-19 cases worldwide and that several countries are going back to isolation.

The main difference between the current situation and that of the last crises undoubtedly stems from the measures taken by central banks. The massive injection of money into the system, to the tune of 1.4 billion every hour since March1, has contributed greatly to the rise in financial assets without this being justified by fundamental values. However, how far can this disparity between the stock market and prices continue to increase? We believe that this divergence cannot go on forever and that one day or another, profits will have to rise to justify current prices or, conversely, the stock market will have to experience a sharp correction.

1. https://www.businessinsider.com/stock-market-headed-for-challenging-summer-bank-of-america-says-2018-7

Disclaimer

Information in this article is from sources believed to be reliable; however, we cannot represent that it is accurate or complete. It is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell securities. The views are those of the author, Marc-André Turcot, and not necessarily those of Raymond James Investment Counsel Ltd. Investors considering any investment strategy should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decision.


Our Suggestions

An Introduction to Our Income Strategy

Are you looking for income? We may have just the solution for you! Introducing the Demos Income Strategy, our newest investment strategy focused on recurrent income generation.

Learn more

What is financial planning?

Financial planning is used to answer the question “Am I well aligned for my short and long term goals?”. It reduces stress while serving as a guide for portfolio management.

Learn more

Why Should I Start Saving and Investing As Early As Possible?

In order to finance a comfortable retirement, we need to make more strategic consumption choices throughout our lives and start investing as soon as possible. Fewer and fewer companies are offering pension funds to their employees and we should not rely too much on government programs because with the level of government debt that is only increasing and with the aging of the population which will put even more pressure on public finances, we cannot be certain of the amounts of money that will be available in the future.

Learn more

Contact us

We are there to listen, inform and help you.

Call Us

  514-543-6531

Monday to Friday - 9am to 5pm

Email Us

  [email protected]

We'll answer you as soon as possible

Or use the following form to send us a message

 
Demos Family Wealth Management
107-65 St-Paul Street West
Montréal QC H2Y 3S5
Marc-André Turcot, CFA, F.Pl
Portfolio Manager
Raymond James Investment Counsel Ltd.

[email protected]
Phone: 514-543-6531

© Demos - Family Wealth Management