December 15, 2020

Will the Wheels Come Off the Market in 5 Years?

Doubts rise that stock’s boffo performance will keep rolling through 2025, although almighty tech might let it maintain some momentum, savants say.

Reported by Larry Light

Art by James Yang

Stocks have had a great ride the past five years, almost doubling. But what will happen in the next five years? Some believe that the mojo will fade for an unsustainably strong market.

There will be a lot of changes in the stock market, and many observers think equities won’t match what they’ve done since the end of 2015. One area of agreement on Wall Street: Whatever happens, tech will be the central player.

Plenty can change in the economy, the major force that drives shares, between now and 2025. The conventional wisdom for 2021, at least, is for a positive year, although perhaps not as good as this one (the S&P 500 is up 12.9% thus far in 2020).

Current factors—a vaccine that is expected to eradicate the pandemic, pent-up consumer demand, cash-rich companies—should lead to a welcome return to some approximation of normal prosperity, the bullish thinking goes.

That has prompted a number of near-term optimistic calls on Wall Street. Example: Look for the index to hit 4,020 next year, said Sam Stovall, chief investment strategist at CFRA Research. That’s a decent 11.8% advance from Monday’s close. Over the last five full years (2015 through 2019), the benchmark rose an average 12.3%. Can such a string persist?

We asked a number of financial savants to peer five years forward and describe what might happen, given what we know now.

And beneath the entire money apparatus, propelling the economy and the stock market, is one stark reality. “Tech, tech, tech, and more tech” is what drives the market and will continue to, said Vance Howard, CEO of Howard Capital Management.

No doubt, forecasts are a tricky game. As Yogi Berra once said, “I never make predictions, especially about the future.” Or as David Barse, former CEO of Third Avenue Management, framed the issue: “Anything I say is without foundation because it’s through a backward-looking lens. Professionals whose job is to make predictions are wrong 99% of the time.”

Thus, it is with all due humility that we venture into this perilous terrain. Barse, now the head of XOUT Capital, is right that December 2020’s reality can color our view of tomorrow. No one, for instance, can foretell when or if a black swan event may yet again ravage the economy and humanity, like the housing collapse of 2008 or this year’s coronavirus scourge.

That is why we are only peering five years forward, using present trends to craft some picture of what may (emphasize may) come. American Revolutionary War figure Patrick Henry summed up that approach in the face of fickle fortune: “I know of no way of judging the future but by the past.”

That introduces recency bias, the tendency to make judgments based on what you see before you, and thereby miss the larger picture. Science fiction, which traffics in predicting, is really about today. George Orwell’s classic futuristic novel, the chilling 1984, transposed the numbers of the year when he wrote it and extrapolated the trends of the time. In 1948, totalitarian regimes, in particular the Soviet Union and its allies, were ascendant. In the end, circa 1990, the Soviet system failed, although symptoms of its vulnerability were abundant decades before.

We are not going out a full decade, to 2030. Perhaps by then we may be living in caves, or we may have cured cancer, abolished world hunger, and invented interstellar hyper drives. “Going beyond five years is too long to predict,” said Sean Bill, investment program manager at the Valley Transportation Authority (VTA) in California.

With all this in mind, here’s what could lie before us:

The Markets

Few believe that stocks will lose their place as the primary driver of portfolios. As long as the economy grows, or shows signs of resuming growth, companies will create earnings—and stocks will benefit. Wharton Professor Jeremy Siegel wrote in his epic paean to equities, Stocks for the Long Run, that “accumulations in stocks have always outperformed other financial assets for the patient investor.”

One towering companion trend is that traditional fixed income is no longer capable of generating much appreciation. Bonds have run out of fuel, owing to near-zero short-term interest rates. That’s why, over the past five years, the VTA has trimmed its fixed income exposure to 15% of the portfolio from 35%. “We use it as a ballast for risk,” VTA finance chief Bill explained. “As Bill Gross said, ‘It’s the least dirty shirt in the hamper.’”

Among stocks, market leadership has changed over the past five years, but only to a degree. The one thing that is common is that technology remains the dynamo that moves the market and the economy forward, as it has for the past two decades.

The top five companies in the S&P 500, by market value, now are Apple, Microsoft, Amazon, Alphabet, and Facebook, in that order. In 2015, the ranking was Apple, Alphabet, Microsoft, ExxonMobil, and Berkshire Hathaway. Those last two 2015 entries are down the list in 2020, with finance-oriented conglomerate Berkshire at seventh, and suffering oil giant Exxon at 38^th. The difference is that tech is even more prominent, making up 29% of the index, versus 21% five years ago.

“Tech won’t get any smaller, only bigger,” said Howard Capital’s Howard. He acknowledged that Joe Biden, as president, might hinder the biotech industry, in a bid to control ever-rising drug costs. Still, the outlook is bright for life sciences and the other fruits of science and engineering, he reasoned. “One winner will pay for the losers, and fuel research and development.”

The trailblazing tech titans such as Apple and Alphabet’s Google have spawned companies that, while in other fields, owe their existence and their prominence to technology.

Exhibit A is car service Uber Technologies. The tech-y part of it is that Uber feeds off the smartphone-enabled messaging and tracking that Apple and others made possible. If it belonged to the S&P 500 (which it doesn’t, as the business is unprofitable), the company, at $91 billion in market capitalization, would be around No. 90 on the list. That’s right behind such storied industrial corporations as General Electric and Caterpillar.

Companies with similar tech-supported strategies have had enormous receptions when they’ve gone public. Most recently, DoorDash (food delivery) and Airbnb (lodging) had bang-up initial public offerings (IPOs), catapulting 86% and 113%, respectively, on their first days. Others waiting in the wings include payment processor Affirm, gaming platform Roblox, and stock-trading nexus Robinhood.

Health care has taken many giant steps due to technology. Consider the burgeoning field of telemedicine, which evaluates, diagnoses, and treats patients at a distance using telecommunications technology. Teledoc Health, which went public five years ago, saw its stock more than double this year.

“COVID-19 has sped up conditions that already were in place,” said Jody Jonsson, an equity portfolio manager with Capital Group. She calculated that the telemedicine sphere, which had a $46 billion market cap last year, would reach $176 billion this year.

All that said, the market is priced richly. “It’ll be hard to have the returns that people enjoyed for the last five years,” said Matt Burdett, the portfolio manager at Thornburg Investment Management. The market has increased more than the economy, he observed: The overall market cap is now 158% of gross domestic product (GDP), up from 108% five years ago. If that pattern kept going, it would reach 273% by 2025, he said.

Some good news, to Burdett, is that the industries that the pandemic trashed—airlines, hotels, and cruise lines—should come back well once the virus threat is lifted. While lacking the shine of technology, their recovery will nonetheless be cheered.

The Economy

The course of the US economy next year and for the years following is inextricably tied up with government action, which means politics get involved. The nation still is in a recession, and unemployment is widespread. The partisan complexion of Congress will make a difference. With the Democrats controlling the House of Representatives, all eyes are on two Senate runoff elections next month in Georgia.

A 50-50 Senate split (meaning the two Democrats win) “would be best for the markets,” because chances of a tax hike would dwindle, yet other priorities could march forward, said Ron Temple, co-head of multi-asset and head of US equity at Lazard Asset Management. At the same time, enacting laws on climate change, building out infrastructure, and pandemic relief would be possible then, he added, both next year and in the following ones.

Should the GOP resume control, at 52-48, the odds of more federal economic stimulus would dim, he went on. Temple noted that Republican opposition shrank federal economic relief measures and then produced cuts to government spending early in the Obama administration. “That gave us lethargic economic growth,” he said. On the flip side, it helped spark “an increase in asset values.” That is, a growing stock market.

A big unknown is whether inflation will kick up significantly, and with it interest rates. The fallout from the massive government and Federal Reserve stimulus could hatch that by 2022 or 2023, said Saira Malik, Nuveen’s CIO and head of global equities. Nobody, thankfully, anticipates anywhere near the 1970s double-digit inflation. Odds are that any an inflation increase would be mild, in light of digitization and other deflationary influences.

Of course, the power situation in Washington has less bearing on the international scene, which, given globalization, has an impact on ordinary Americans. Negative GDP this year is the case the world over, but recoveries should be significant. That’s evident for emerging markets (EMs), said Jared Franz, US economist for Capital Group. Next year, the US should grow 3.1%, the eurozone 5.2%, and EMs 6%, he said. That makes some sense since EMs have been held down by lower demand for commodities, which they specialize in, and a better global economy would erase that drawback.

Demographics will exert a mighty influence around the world, not all of that for the better, warned Cameron Brandt, EPFR’s director of research. He pointed to large youth unemployment in Europe, as well as possible further influxes of immigrants, which could cause problems. An aging population bedevils China, which also has an autocratic leader “who wants to be the bully on the block,” he said.

The US harbors its own weaknesses, such as political division. Still, the personal savings rate is high and corporate cash is bounteous. “Americans don’t like cash sitting around too long,” and they’ll spend it, he said. That would be a boon for the domestic economy. “America will do just fine.”

After all, the US remains the crucible of technological innovation, along with its entrepreneurial spirit to harness that strength for economic good. So, to invoke Frank Sinatra, 2025 might turn out to be what we don’t have now—a very good year. On the other hand, Old Blue Eyes’ song was looking back at his frolicking past, with his demise approaching.