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Seventeen years ago, in 1999, Warren Buffett gave a provocative speech that was subsequently published in the midst of the tech stock euphoria that captivated investors.
At the time, some people were quitting jobs to day-trade stocks, and CNBC blared during the daytime in offices around the country. Everyone wanted a piece of the action, since making money in stocks seemed easy. The Nasdaq index skyrocketed 85.6 percent in 1999.
Speaking in front of newly minted IPO multimillionaires, Buffett’s killjoy speech threw cold water on the long-term outlook for investors. The first slide showed the performance of the stock market from 1964-1981. The Dow Jones industrial average started that span at 874.12 and ended at 875.00. Buffett noted that, even though GDP in the United States rose 370 percent over that period, the Dow went nowhere. The key reason stocks flat-lined for 17 years was that interest rates rose dramatically, from 4 percent on long-term government bonds to 15 percent by 1981.
Next, Buffett looked at 1982-1999, the time of his speech. If you had bought stocks at the end of 1981 and reinvested dividends up through year-end 1998, your annual return would have been 19 percent, which he noted beats any return in history over a 17-year stretch. Essentially, the inverse occurred—as long-term interest rates plunged from 15 percent to 5 percent, the market zoomed higher.
Buffett then pondered what investors over the next 17 years, ending in 2016, might encounter. He cited a Gallup survey taken during the market hype, which showed that investors who had invested less than five years were expecting annual returns of 22.6 percent for the next 10 years. Even investors with 20 years of experience were expecting 12.9 percent.
Buffett offered that, if he had to pick the most probable return for stocks from appreciation and dividends combined for the 17 years ending in 2016, it would be 6 percent. And, he added that if 6 percent were wrong, the percentage was just as likely to be lower than higher.
So, here we are today, 17 years after Buffett’s speech and his 6 percent prediction. Drumroll, please: The result is that, from 1999 to present, the stock market with dividends reinvested has given investors a 5.2 percent annualized rate of return, slightly less than Buffett’s forecast. Of note, long-term interest rates dropped from 5 percent to 2.5 percent during this stretch.
Combining the three 17-year periods, a span that encompasses 51 years, the annual stock market return with dividends reinvested is 9.75 percent—higher than the oft-quoted 7 percent historical stock market return.
While there is no particular magic to 17-year periods, Buffett chose them for their instructional value due to their radically different results. So what might be in store for investors looking out to 2033?
Certainly one of the determining factors will be the direction and magnitude of change in interest rates. If interest rates continue to remain low for an extended time, stocks should do fine. If rates were to move considerably higher, expect stocks to encounter turbulence.•
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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. His column appears every other week. Views expressed are his own. He can be reached at 317-818-7827 or ken@aldebarancapital.com.
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