Future US Stock Returns – Who is Right?

If you are an avid viewer of CNBC (and I suggest that if you are you immediately stop and seek help) you no likely have become accustomed to rosy predictions of future stock market returns (most based on next years consensus estimates…which are rarely correct) and how the stock market today is at very low valuation levels and is set for a new secular  bull market like that of 1981 – 1999.  While those pundits should not be ignored, it should also be pointed out that there are other points of view – a few of whom we’ve featured here before (Siegel versus Shiller).  This post is meant to show you the less rosy side of the future predictions (with Siegel still kept in the mix for a little balance).

One item I’d like to first point out is that if we use a method of determining stock market valuation made popular by Robert Shiller (CAPE) the market is not undervalued at all, here is a chart:

dshort.com Shiller PE 10 history

While the chart does not show it, this valuation measure hit a low of about 8 in the very early 80’s, the historical average is about 16.  Today that measure is about 21.  This suggests the market is at least fairly valued and in a normal reality over-valued.  While it is entirely possible that a secular bull market could start from the 21 point, we would need for another bubble similar to the one that ended in 2000, which sent the PE 10 on the S & P 500 north of 40.  Of course the damage wrought by such over-valuation is still being felt as the market is essentially where it was 12 years ago.  My point is that betting that valuations will go considerably higher may pay off, but its a high risk bet.  What follows are some links, charts and future estimates of U.S. stock returns from different pundits/gurus.

Stocks’ future return: Just 5.6% annualized

Experts Forecast Returns (from February 2012)

Hussman, Eating the Future

“We estimate that the S&P 500 is likely to achieve a 10-year average annual total (nominal) return of about 4.1% annually”

Cliff Asness, AQR Capital – 4% (utilizes Shiller PE10)

London Business School – 3.5 – 4% above risk free assets, so around 6 – 7%

Rob Arnott (PIMCO All Asset) – 2.5 – 3% over inflation, so 6% if inflation is 3 – 3.5%

Jeremy Siegel (Stocks for the Long Run & Wharton Professor) – 6 – 7% Real or 9 – 10.5% if inflation is 3 – 3.5%

GMO (Grantham Mayo Van Otterloo) – .4% Real on US Large Stocks, so maybe 4%.

GMO August 2012 7 Yr Forecast

Dividend Yield Model – 5.6% total return (actually also Arnott based, see article above and chart below)

Hulbert Digest: Dividend Yield Variant Model History

Most of these predictions are based upon the current valuation of the market, but why does current valuation matter? John Hussman of the Hussman funds gives us some insight:

John Hussman, Eating The Future – 9/24/2012

Every security on Earth works like this. The higher the price you pay for a given set of expected future cash flows, the lower your prospective future rate of return. Higher prices essentially take from future prospective returns and add to past returns. Conversely, lower prices take from past returns and add to future prospective returns.

What returns should you expect from U.S. stocks? My advice is not to expect historical return, but expect historical fluctuation.

Scott Dauenhauer CFP, MSFP, AIF


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