‘Investors don’t lack confidence but may lack common sense’

With the number of assets soaring in price seemingly growing and growing, investors could be forgiven for feeling like everyone’s making money except them. However, Nicola Wealth CIO Rob Edel believes this has morphed into unrealistic return expectations.

The sentiment is likely derived from the pace of the market recovery from last March’s crash. Typically, a recession brings lower investment returns, but the S&P 500’s returns one year after the start of the COVID-19 recession are up nearly 30%.  The wealthiest people, due to their larger exposure, are getting richer while those in the travel and service industry, for example, are struggling.

These strong returns have drawn in smaller investors, with retail trading as a share of total US equity volume in Q1 2021 reaching 24% and cumulative daily equity ETF flows reaching record levels, despite it being only early July.

Edel highlighted a recent Natixis Investment Management survey of 750 US individual investors, which revealed that the average after-inflation return they expect to earn this year is 17.3%. This is not unreasonable, he said, given the S&P 500 is up nearly that much so far this year and was up more than that last year.

However, investors participating in the Natixis survey expected an even higher 17.5% return longer term. This is “extraordinarily rich”, Edel added, given that after inflation returns since 1926 have averaged only 7.1% according to Morningstar.  Investors given the same survey in 2019 showed expectations of only 10.9%. Seems they are getting a little greedy.

He said: “Investors don’t lack confidence, but they may lack some common sense and perspective.  According to YouGov, 6% of Americans believe they could beat a grizzly bear in a fight, bare-handed, without any weaponry! It puts the 17.5% long-term investment return projection in perspective.”

“The average investor has no chance against a grizzly and has no chance of attaining a 17.5% real long-term return,” he added. “Taking recent market returns and projecting them into the future long-term is unrealistic.”

The reasons? There are just too many unforecastable variables surrounding the post-pandemic world. The CIO said there are three unknowns for markets that are key: inflation, monetary policy, and the growing influence of fiscal policy. 

He explained: “Low bond yields appear to signal markets are trusting central banks that inflation will be transitory and controllable. The problem with this is that central banks like the Federal Reserve are not static, their members or constituents change, as do their policies. We have no idea how they will deal with inflation in the future. Many believe fiscal policy and the potential to drive economic growth beyond full capacity is what will eventually cause inflationary expectations to rise and inflation not to be transitory.”

In addition, fiscal policy is set to become a headwind to GDP growth in the U.S. – even if the Democrats pass their $4 trillion, 10-year infrastructure and social spending package. Edel believes that because there are a lot of moving parts to analyze when forecasting what happens in Washington, the magnitude and impact of spending is challenging, especially with mid-term elections in 2022.

He said: “Next comes the question of how to pay for it. We will likely see some tax increases but continued support from the Fed in keeping interest rates low and inflation high will be essential. It all comes down to policy decisions, which are very hard to forecast, especially longer-term.”