After years of strong stock market returns, many analysts now warn of low public market returns ahead.
This is a tough pill to swallow for investors who have enjoyed years of supersized gains. In a stock market frenzy, everyone wants to get in on the action – but markets are now (still) in a “super bubble” of historically super-high valuations, ready to pop at any moment. That’s according to Jeremy Grantham, the famed investor who predicted Japan’s 1989 market crash, the dot-com bust in 2000, and the 2008 financial crisis.
Criticism against this analysis is in no short supply, but even mainstream investment analysts caution that public market returns will likely be lower in the coming years. In a recent article in the Wall Street Journal, analysts forecasted nominal annual returns of US stocks over the next ten years between 2% and 4% – a sharp contrast to the double-digit gains of recent years.
Valuations Remain Elevated
The concept of “reversion to the mean” is powerful in investing. It says that after periods of outperformance or underperformance, assets will tend to return to the average. This is why Grantham sees big trouble ahead when he looks at today’s market valuations.
All equity bubbles eventually burst and, according to Grantham, we are now in one, largely caused by the Fed’s mass liquidity injected into the economy. This has driven asset prices (including stocks) to artificially high levels.
A pervasive notion that “stocks only go up” has taken hold, as have excessively optimistic views about the future. However, the post-Volcker era is ending, which will have major implications for stock prices. Turning off the tap of easy money may dissolve the notion that stocks only go up, and with it, the super bubble.
The Opportunities Ahead
For long-term investors, market corrections present an opportunity to buy quality assets at a discount. This is easier said than done, of course, but patient and disciplined investors will be rewarded.
In the meantime, there are other opportunities to consider. For example, private markets have been outperforming public markets for decades, which is likely to continue. Private markets have historically outperformed in downturns as well, for several reasons.
For one, private equity firms “buy and build” companies, which they can do at a discount during periods of market duress. Further, these firms tend to be more nimble and adept at dealing with headwinds than public companies. Moreover, they can take a longer-term view without the pressure of quarterly earnings reporting.
Alpha-generating managers provide additional value beyond the liquidity premium and lower correlation with public markets, which should continue to attract a loyal following. So, while public market returns may be lower in the years ahead, investors still have opportunities to generate strong returns in private markets.
However, investing in a diversified portfolio of private market assets can be difficult and expensive. In particular, high-return funds are often access-constrained and have high minimum investment requirements, limits on who can invest, and illiquidity provisions. For these reasons, private markets have largely been off-limits to individual investors – until now.
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