The stock market’s 10-year return potential is better now than it was at the end of 2019 for reasons having nothing to do with the development of a COVID-19 vaccine. The improvement traces to a lowering in the share of household assets invested in stocks.
The stock market’s 10-year return potential is better now than it was at the end of 2019, for reasons having nothing to do with the shape of the economic recovery or the speed with which a COVID-19 vaccine is developed.
Notice that the household equity allocation is the flip side of the coin from household cash — sometimes referred to as sideline cash. Higher cash levels are therefore bullish and, sure enough, household cash allocations have risen markedly as equity allocations have fallen. But backtesting has shown that household equity allocation is the better predictor.
Note that household equity allocation is not a short-term market timing tool. That’s just as well, since the data are updated only quarterly by the Federal Reserve, and with a significant time lag. First-quarter 2020 data, for example, were just recently released. But they show that the allocation at the end of March stood at 49.0%, a drop of 7.3 percentage points from three months previously. That is the biggest quarterly drop since data began being collected in 1951.
Stocks look better than Treasurys — but that’s not saying much To forecast the stock market’s nominal, rather than inflation-adjusted, return, we need to predict what inflation will be. According to a model constructed by the Cleveland Federal Reserve, expected inflation over the next decade is 1.2% annualized. Add in the projected real return of 0.5% annualized from the household equity model, and you arrive at a total return estimate for stocks of 1.7% annualized over the next decade.
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