US markets are on track to notch one of their strongest years on record despite a pandemic, the highest inflation in decades and chronic labour market shortages. Australian markets are set for a respectable 10%. For investors, success begets difficult questions: Will the good years come again? What's a reasonable return for equities, bonds or other asset classes? Is a downturn coming and how can I prepare?

In today’s Charts of the week, we analyse the long-term returns for eleven asset classes for clues about the future. Ranging from Australian equities to infrastructure, these tables track market performance going back to 1991.

The data is cause for cautious optimism. First the good news: No asset class had a negative return over a period longer than 3 years and equities tend to grind upwards (given enough time). Now the caution: Returns for most assets soar above long-term averages. Dips can linger for years and some investment losses take more than a decade to breakeven.

Most asset classes are defying gravity

A return to the long-term average would mean lower returns for most asset classes. Those flying closest to the sun fall furthest. International equities notched 18% last year, well above the 30-year average of 8.5%. Australian equities topped the long-run trend by 6%.

Commodities illustrate the year’s idiosyncrasy. The metals, grains and oils that fuel industry and feed society averaged just 1.9% annually over the past twenty years. Last year they clocked 24.6%, as the post-covid boom sparked a scramble for raw materials. It’s unlikely to last. Energy prices are coming off highs, as is iron ore.

Cash and fixed interest are two asset classes where the return to long term average would mean celebration. Leaving money in the bank averaged an almost inconceivable 4% over the last thirty years, while Australian fixed interest a mouth water 6.6%.

Institutional investors think it’s unlikely to happen. Superannuation funds are cutting return targets for cash and fixed interest as expect interest rates to stay low over the longer term. Despite hinting at rate hikes next year to head off inflation, the US Federal Reserve expects rates to remain low in the future thanks to deflationary effect of aging populations, technology and globalisation.

Dip buyers beware

An investor entering the market in 2020 could be forgiven for taking away two lessons: markets crash quickly and rebound just as fast. That experience informs the practice of dip buying—treating downturns as a temporary respite before the climb continues. A look at the biggest drawdowns on record presents two warnings.

First, some dips will go on. Australian markets lost 55% in the worst drawdown on record, but it took 19 months between January 1973 and September 1974 to fully play out. That’s nothing compared to the almost twelve years it took commodities to fall from their June 2008 peak to the April 2020 low.

Second, recoveries are painful. An investor buying international equities in October 2000 would not have broken even until September 2014.

Corrections are common

Longer term data suggests investors should gird themselves for more downturns, perhaps at least one negative quarter a year on average.

Morningstar’s analysts broke the last two decades into 3-month, 1-year and 3-year chunks and measured performance across the periods. They found investors lived through a negative quarter roughly one in three times.

Over longer periods, Australian equities dodged the most downturns, with only one in ten 3-year periods recorded as negative.

The data shows the stability fixed interest gives a portfolio, even in a world where returns are anaemic. Local and international fixed interest had no 3-year periods with negative returns over the sample studied.

As every product disclosure statement declares, past performance is no guarantee of future returns. But long-term averages remain a useful guide for investor expectations because of mean reversion—the idea that performance tends to the long-term average.

“That which has been good will likely fall. That which has been bad will likely rise. If not as immutable as gravity, reversion to the mean is as close to a natural law as exists in investment science ,” says Morningstar’s John Rekenthaler.