It seems to be the best of times for stock investors. The S&P 500 Index ($SPX) has smashed record after record, artificial intelligence (AI) euphoria is everywhere, and the “Trump trade” is running wild.
And yet, for all the exuberance, U.S. stocks are actually on track for their second-worst performance over the past 25 years, if you adjust returns for inflation. That’s according to Deutsche Bank’s famous study on market gains over the nine quarter centuries since 1800.
In fact, the yearly advance is so modest, it puts the asset class on track to underperform gold (up nearly tenfold since 2000) for the first time ever. Since the turn of the century, the S&P 500 has seen real annual compounded returns of 4.9%, compared with 6.8% for gold. This is unique among the nine quarter-century periods examined by Deutsche Bank.
The past quarter-century saw the second-weakest stretch of compounded annual returns for stocks out of nine such periods going back to 1800, according to Deutsche Bank. The only interval where stocks fared worse was the 25-year stretch between the dawn of the 20th century and 1924.
This has to be a shock to most investors. After all, the past 25 years have featured Apple’s (AAPL) invention of the iPhone and the dawn of AI. And keep in mind that this century also yielded the debut of three of the so-called “Magnificent Seven” stocks — Alphabet (GOOGL) (GOOG), Tesla (TSLA), and Meta Platforms (META).
Remember the Year 2000?
A big reason why returns have been paltry is the starting point - January 1, 2000 - says Deutsche Bank.
The third millennium is almost 25 years old, making it a sensible landmark for anyone trying to understand financial markets history. That’s exactly what Jim Reid, Deutsche Bank AG’s resident financial historian, did, making for a fascinating study of the century’s financial returns so far.
The century began at the peak of the dot-com euphoria, marking almost the exact top of the biggest stock market bubble in history, with the highest price/earnings (P/E) ratio in the S&P 500 ever.
The fact that the millennium opened with stocks historically so high translated to a not-so-great quarter-century when compared to the past.
And when looking at the traditional asset classes of stocks, bonds, and commodities, Reid found that gold (GCZ24) leads everything else.
When Reid took a look at the history of the ratio of the S&P 500 to the gold price, he found a remarkable trend. The story of the last 25 years has been the steady advance of gold. By this ratio, the only time in history that is comparable is 1980, when the inflation that followed the end of the Bretton Woods gold peg led to an all-time low.
This seems amazing, given how well stocks - led by technology stocks - have performed for the last 15 years.
Why has gold done so well? Look no further than the world’s central banks. Reid looked at an extraordinary amount of data on central bank balance sheets. There are numbers on the Bank of England’s balance sheet dating back to 1697, while the Fed has only been around since 1915. Since 2000 (there’s that year again), central banks' balance sheets have expanded in a manner that would previously have seemed impossible.
The Next 25 Years
And what about the next 25 years? Deutsche Bank thinks stocks will once again reliably beat the performance of U.S. Treasury bonds, especially given the ballooning U.S. fiscal deficits.
“We're unlikely to leave the current policy era behind where the authorities have a bias to reflate when the inevitable crises associated with a levered low-growth system come along,” the strategists wrote. “It's easy to imagine periodic bursts of inflation.”
My advice for long-term investors is to heed the advice of Warren Buffett: “Price is what you pay; value is what you get.”
The key takeaway from the Deutsche Bank study is this: in general, the single most important factor in the long-term performance of an investment is the price at which you bought it. If it was too expensive - as stocks were at the start of the century - you’re much less likely to do well from your investment.
In other words, the higher the valuation of the stock market, the higher the odds are against continued strong performance.
There are two very simple valuation metrics for the S&P 500 — its ratio to sales and its ratio to book value. On the former, the market is very close to the record set in the post-COVID boom in 2021. On the latter, it’s almost taken out the all-time high from the dot-com bubble in 2000.
Let’s also look at the Shiller CAPE (cyclically adjusted price/earnings) multiple, which aims to correct for the market’s moves within the economic cycle by comparing share prices to average inflation-adjusted earnings over the previous decade. Shiller has calculated the ratio back to 1881. He found that only one presidential election has previously taken place with the stock market so expensive. That was back in (you guessed it) 2000, when George W. Bush emerged victorious.
The CAPE is calculated monthly. On November 1, 2000, it was 38.78; on the first of this November, it stood at 38.11. And with the post-election rally, the CAPE is now higher than when Bush took office in 2001, amid the fallout from the dot-com implosion.
This is not a sell signal; just a signal to be cautious. The returns ahead may not be spectacular, which is great for more of a slow and steady investment like gold.
