Why the stock market could double twice by 2040

Tuesday, January 19, 2021

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Productivity-enhancing tech could juice earnings growth for years to come

While it’s nearly impossible to predict with any precision how the stock market will perform over a short-term period like a year, it does seem to be the case that the odds of a positive return improve as you lengthen your investment time horizon.

In a note to subscribers on Friday, DataTrek Research’s Nicholas Colas observed that historically, 20 years is the shortest period during which the S&P 500 (^GSPC) always produces a positive return. On average the annual returns are 10.7%, with a peak average return of around 17%.

Colas notes that past periods of long-term above average returns were powered by bullish market backdrops, which seem unlikely to repeat.

“We can safely rule out a Volcker era-like period of declining interest rates that juice equity valuations,” he said. “We can also exclude a period of American global economic preeminence like the 1940 – 1950s unless China’s rise grinds to a sudden halt. The same sentiment applies to US population growth, which was 1.7 percent/year in 1961 (first peak S&P 20-year return) but just 0.3 percent now.“

Colas, however, believes that should we get strong stock market returns through 2040, it’ll be thanks to accelerating efficiencies in the corporate.

“Since it will have to be increasing corporate earnings that take us there, and population growth is slack, technology-led productivity growth will have to supply the earnings leverage needed to achieve such returns,” he wrote. “Sitting here in 2021, it’s hard not to think that the pandemic causing a rapid acceleration in tech adoption wouldn’t be part of that answer.”

Indeed, one of the major business themes of the pandemic Morning Brief has written about repeatedly is companies accelerating structural changes to their operations, which has included adopting next-generation tech, reducing office space, and laying off workers. These changes are behind the operating leverage that will amplify earnings growth as revenue growth slowly picks up.

“[W]e’d hazard a guess that the S&P 500 will compound at an average of 7.0 - 9.0% over the next 20 years, essentially doubling twice over the next 2 decades,” Colas said.

This is a relatively optimistic perspective coming in the wake of calls for caution, with some market prognosticators warning that the stock market is doomed to deliver lackluster or even negative returns on average for years.

“Bottom line: in very broad-brush strokes, the next 20 years for US equity returns will come down to how much technology enables widespread productivity growth that translates into earnings leverage across many different industries,” he added. “The last 10 years, which rescued us from an all-time worst 2-decade compounded S&P return, was largely about Tech companies getting first dibs on this trend. Over the next 20 years, that phenomenon will have to spread its wings to cover more of the US economy.”

The stock market has a track record of outperforming expectations. Maybe it’ll happen again.

By Sam Ro, managing editor. Follow him at @SamRo

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