The Case for Modest Future Market Returns

By on October 17, 2010

Paul Lim, writing for the N.Y. Times, investigates the prospects for the market over the next 10 years. There has been some recent commentary speculating on decent returns going forward based on the fact that the last 10 years have been so lousy. However, a look back at the last 20 years would give a statistically-minded investor a vastly different perspective:

Sam Stovall, chief investment strategist at Standard & Poor’s, points out that over 20-year periods since 1919, the average annual price gain for stocks has been 6.8 percent. And even with the market’s losses from 2000 to this year, the S.& P. 500-stock index has still appreciated 7.8 percent a year, on average, in the most recent 20-year stretch. When you factor in dividends, the market has performed even better: up around 10 percent a year, on average.

“On a 20-year basis, we’re only now getting back to the mean,” Mr. Stovall said. This would imply that the market, despite the so-called lost decade of the 2000s, isn’t necessarily coiled like a spring, ready to explode higher.

Lim’s article includes commentary from Jeffrey N. Kleintop, chief market strategist at LPL Financial in Boston; John S. Osterweis, president of Osterweis Capital Management in San Francisco; Elroy Dimson, a finance professor at the London Business School; and Robert D. Arnott, chairman of the investment management firm Research Affiliates in Newport Beach, California who provides this nugget of information:

Mr. Arnott uses 10-year averaged earnings to calculate the market’s P/E, a conservative method that smoothes out extreme swings in corporate profits. The method is favored by Robert J. Shiller, the Yale economist.

Despite the market’s recent troubles, its P/E ratio, based on this method, currently stands at 21. That’s significantly higher than the long-term average of 16 for domestic stocks.

Until that changes, stocks are likely to be in store for below-average returns, Mr. Arnott argues. In fact, since 1900, whenever P/E ratios have ranged from 16 to 24, stocks have gained about 7 percent, annualized, on a nominal basis — or 4 percent after inflation — in the following 10-year stretch.

For his part, Mr. Arnott says he thinks that stocks are likely to produce total returns of about 6 percent a year. He comes to that figure by taking the current 2 percent dividend yield for the S.& P. 500 and adding it to the long-term earnings growth rate of around 4 percent.

Source: N.Y. Times
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