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How to Think About Unsustainable Returns

What a difference 9 years makes.

On March 9, 2009, the market capitalization of Apple, Google (now Alphabet), Amazon, and Microsoft stood at $74 billion, $92 billion, $26 billion, and $135 billion. Their combined market cap: $327 billion.

Data Source for all charts/tables herein: YCharts.

9 years later these four companies would grow to become the largest in the world, with a combined market capitalization of over $3.2 trillion.

They are all key components of the Nasdaq 100 Index, which has become a favorite among investors. Glancing at a table of returns, it’s easy to see why. The index is on pace for its 10th consecutive positive year – which would be a new record – surpassing the epic run from 1991-99.

While records are made to be broken, returns like we’ve seen are unsustainable. If the Nasdaq 100 were to repeat its 9-year performance of 23.8% annualized in the next 9 years, large cap tech stocks would own the world.

While that may be possible, it’s not probable. We’re much more likely to see returns come down in the years to come as they did following the 1990’s boom. That doesn’t mean they have to crash in the same dramatic fashion, just that the high rate of growth is unlikely to persist.

So how should investors think about unsustainable returns, in any asset class or strategy?

First and foremost: with high degree of skepticism. One should operate under the assumption that such returns will not continue indefinitely but instead succumb to the law of mean reversion. For an existing investor, that means humbly re-balancing your portfolio to increase diversification and control risk. For a prospective investor, that means setting low expectations and wading in only with a high degree of caution. Since you cannot buy past returns they should have no influence on your decision-making process. Focus instead on the future and you’re best assessment of prospective returns.

This is easier said than done, of course. In the 5 years leading up to the peak in March 2000, the Nasdaq 100 would generate an annualized return of over 60% per year. While it seems absurd in hindsight, many investors at the time were expecting these returns to continue.

What happened next? An 83% decline to its ultimate low in October 2002.

That’s not to suggest a similar fate awaits us. The high returns and valuations in this cycle seem tame in comparison to the 1990’s bubble. But compared to anything else, they seem unsustainable high, and investors would be wise to understand that fact and operate accordingly.

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CHARLIE BILELLO, CMT

Charlie-Bilello

Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Charlie is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Charlie holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and also holds the Certified Public Accountant (CPA) certificate.

In 2017, Charlie was named the StockTwits Person of the Year. He has been named by Business Insider and MarketWatch as one of the top people to follow on Twitter and his work has been featured in Barron’s, Bloomberg, and the Wall Street Journal.

You can follow Charlie on twitter here.

Disclosures:

Pension Partners, LLC is a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. For more information about Pension Partners please visit: https://adviserinfo.sec.gov/ and search for our firm name.

The information herein was obtained from various sources. Pension Partners does not guarantee the accuracy or completeness of such information provided by third parties. The information given is as of the date indicated and believed to be reliable. Pension Partners assumes no obligation to update this information, or to advise on further developments relating to it.

Past performance is not indicative nor a guarantee of future results.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

 

 

 

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