Stock market returns are going to be weak — for the next 5 years, Jim Paulsen says

Key Points
  • High levels of consumer confidence and low unemployment historically have suggested good times on Main Street but a tough investing environment.
  • Jim Paulsen, the Leuthold Group's chief investment strategist, said his "Main Street Meter" has been a useful gauge of market conditions five years or so out.
  • Current indicators point to a less favorable environment for some of the assets that have pushed the market higher and a better time for small- and mid-cap stocks along with commodities, inflation-indexed bonds and momentum stocks.

Get used to it: Stock market returns are setting up for a tough five years ahead as economic benefits shift from Wall Street to Main Street.

That's the conclusion of a model constructed by Jim Paulsen, chief investment strategist at the Leuthold Group, who said the sharp rise in consumer confidence compared to the generational low in unemployment has happened before and almost always signified a lull or worse in the market.

"Because confidence is high today and unemployment is low (i.e., the capacity of this recovery is near a peak), the risk-return profile of the stock market has worsened considerably, and investors should prepare for far less satisfying results in the next five years," Paulsen said in a note to clients.

The timing of the analysis seems apt, as multiple economic signs point to above-trend growth ahead while stock prices have languished.

However, Paulsen said his "Main Street Meter" isn't met to be a market timing device but rather a look over the longer term on what can be expected from stocks now that the economy may have turned a corner. Rising values in the MSM almost always — the early 1970s was an exception — coincide with lower equity values, and vice versa.

The indicator reached its lowest reading since 1960 as the current bull market began. It now sits at its third-highest level, as measured by the University of Michigan's consumer confidence survey compared to the Labor Department's core measure of unemployment.

"When this ratio is high, Main Street has probably been good for a while," Paulsen said.

"The MSM is not a useful short-term timing tool and offers little insight into how this year may yet play out," he added. "However, sometimes it is a good practice to step away from your inclination to figure out what is likely to happen next week, next month, or even next year, and consider how you are positioned to succeed during the next several years."

Amid the current backdrop, investors may want to reconsider their choices.

Where large-cap stocks and the value/growth play have led the bull market since it began in 2009, Paulsen said the future points to small- and mid-cap companies and momentum stocks.

He also sees opportunity in commodities, inflation-indexed bonds and international equities vs. the U.S.

"While the change in the recovery’s character has near-term implications for the financial markets, it speaks volumes about the potential character of your investment portfolio during the coming five years," Paulsen wrote. "Conditions currently evident on Main suggest a tougher road for the financial markets in the next several years, but perhaps improvement in the real asset markets."