I think most investment professionals are generally aware of how well the S&P 500 has done relative to virtually every other asset class since the end of the global financial crisis (GFC). A bit more precisely, the S&P 500 is up 352 percent from March 2009 through October 2018 while international developed stocks, emerging markets stocks and bonds are up 140, 142 and 39 percent, respectively. What you might be surprised to know though (I certainly was) is that it’s almost impossible to simulate another same-length period where the S&P 500 had better risk-adjusted returns. In other words, saying the S&P 500 has done well during this period is a gargantuan understatement. As we will see, it’s done so well that it’s reasonable to ask whether anyone alive will ever experience a better performance period for U.S. large-cap stocks.
The last sentence may sound extreme, but I think returns data for the S&P 500 illustrates just how mind-blowingly astounding the post-GFC returns experience has been. Using a technique called bootstrapping (also referred to as re-sampling), you can take the entire historical returns history for any asset class and build out an extremely large number of alternate histories of any length. For example, you can use the entire monthly returns history of U.S. small-cap stocks to build out 100,000 unique, 10-year-length histories to get a sense of what’s theoretically possible, performance-wise, over a 10-year period.
As you might guess, bootstrapping is very similar to Monte Carlo simulation with the key difference being that bootstrapping directly utilizes historical data as opposed to simulating returns according to a particular distribution (e.g., the normal distribution). Bootstrapping is widely used in a variety of other fields outside of finance (and was recently used in a paper by professors Gene Fama and Ken French), and there are a multitude of online resources that you can check out if you want to more deeply understand the procedure. For most, though, all that you need to know is that it’s a great way to get a sense of the possible range of outcomes that you can then utilize to compare to specific, actual historical periods of returns data, as I’ll do here.
From a financial market point of view, it’s been about 116 months since the official end of the GFC. This period covers March 2009 through October 2018. In years this is just shy of a decade of time. Over this period, the S&P 500’s excess return, i.e., the return in excess of the Treasury bill return, has been 16.5 percent per year (or 1.35 percent per month)! In terms of the growth of a dollar, $1 invested in the S&P 500 had grown to $4.52 by the end of October. Most impressively, however, the S&P 500’s excess return achieved a Sharpe Ratio of almost 1.30. While Sharpe Ratios are generally a bit harder to interpret than the growth of $1 or annualized returns, this Sharpe Ratio is about three times higher than its long-run historical value. In other words, not only have raw returns been astounding in the post-GFC period, but the risk-adjusted returns (i.e., Sharpe Ratio) have been otherworldly.
Using bootstrapping, I create 100,000 other 116-month returns histories for the S&P 500’s excess return and analyze them below. The excess returns history I utilize for this bootstrapping procedure encompasses the complete history of January 1926 through October 2018. Let’s first look at a histogram of the average monthly excess return across each of these histories.
Notably, the graphic shows that a wide range of outcomes are possible over a decade, a good lesson in and of itself. We see a significant number of 116-month periods where the average monthly excess return was zero percent or less. The average 116-month period achieved an average monthly excess return of 0.67 percent. It also shows, however, that an average monthly return of 1.35 percent — what the S&P 500 actually achieved from March 2009 and October 2018 — is an outlier outcome. Less than 10 percent of the 100,000 samples achieved monthly returns higher than what the S&P 500 has recently achieved. You might say this is noteworthy but not overly impressive and I’d mostly agree. It’s been a great run for returns but there are at least a significant percentage of bootstrapped histories that exceed the March 2009–October 2018 result.
The picture changes when we look at risk-adjusted returns. Figure 2 is a histogram of the Sharpe Ratios across all 100,000 samples.
As it turns out a Sharpe Ratio of 1.30 or higher was achieved in less than 1 percent of the 100,000 samples! The actual percentage of samples with a Sharpe Ratio higher than what the S&P 500 achieved was 0.57 percent. In other words, the risk-adjusted returns the S&P 500 actually achieved from March 2009 through October 2018 are almost outside the range of the possible.
The practical lesson here is that the returns the S&P 500 has achieved relative to the volatility investors experienced is virtually unparalleled and may not repeat for many, many decades to come. This result also lends strong support to expectations for very modest returns going forward. It’s hard to imagine how the S&P 500’s excess returns, or certainly risk-adjusted returns, could be anywhere near as high over the next decade as they have been recently. This, of course, isn’t a prediction that the market will crash, but it is a prediction that it’s highly unlikely this amazingly strong (approximately) decade of performance will repeat over the next decade. Wise investors should maintain a globally diversified approach and appreciate that at least some portion of their portfolio benefited from a historically great run for the S&P 500.
This commentary originally appeared November 19 on MultifactorWorld.com
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