Estimating Future Stock Returns

seacaitch

Some may be interested in this 10yr S&P 500 expected return forecast:

https://alephblog.com/2019/09/21/estimating-future-stock-returns-june-2019-update/

No great surprises in the model's low (nominal!) return forecast for anyone paying attention over recent years...

Note this paragraph:

Still, it’s a tough call because with forecast returns being so low, many entities will perversely go for the stocks because it gives them some chance of hitting their overly high return targets. If this is the case, there could be some more room to run for now, but with nasty falls after that. The stock market is a weighing machine ultimately, and it is impossible to change the total returns of the economy. Even if an entity takes more risk, the economy as a whole’s risk profile doesn’t change in the long run.

FWIW "If this is the case, there could be some more room to run for now", remains my own central case (partly for the reasons cited, but also some additional factors), and I think it's possible that the "for now" timespan could prove longer than many anticipate.

Main takeaways from this forecast model? Probably: "save more" & "minimise investment costs", but also look to markets beyond the US where other 10yr equity return models are suggesting (much) better outcomes may be available.

talexuser

Trump wants to be re-elected and may blink in the trade wars to keep the market up till the election? My worry is this experiment in central bank low permanent interest support is untested in the long term with a purely fiat money system and cannot go on forever. The reckoning could be worse the longer it is put off.

seacaitch

talexuser wrote: »

Trump wants to be re-elected and may blink in the trade wars to keep the market up till the election? My worry is this experiment in central bank low permanent interest support is untested in the long term with a purely fiat money system and cannot go on forever. The reckoning could be worse the longer it is put off.

I think we're seeing:
(i) something of a monetary policy regime change occurring (where somewhat higher inflation will be tolerated before CBs tighten / a very asymmetric approach); and
(ii) something of "baton pass" from monetary to fiscal policy, with substantial fiscal deficits being tolerated;
...and that this will/is occurring globally.

These are some of the reasons why I suspect the probabilities favour (not guarantee!) more, amd perhaps quite significant, upside over the medium term, ie. another leg up for the secular bull market. NB no guarantees!

itwasntme001

Many so called "experts" were forecasting (over the next year or so) for 10 year treasury rates to rise above 3% a year ago. We are below 2%. Why would anyone be able to forecast with a reasonable degree of confidence what will happen to the stock market? Makes no sense whatsoever.


Stock markets are driven by earnings and yields which are themselves driven by what happens to fundamentals. No one can say with confidence what will happen to the economy over the next year let alone ten years hence why would anyone have a good idea what will happen to stocks?

itwasntme001

I have personally de-risked my portfolio somewhat and hold a decent cash position - having sold some trackers and kept my single shares and managed funds. I think in the current environment it pays to be a stock picker. Of course i sound a bit hypocritical given the above post, but i believe you make your own luck in life so why not take some chances?


I am now wondering what to do with the cash - i just think there are not many great bargains to be found in stocks and i certainly dont want to track an index. Bonds also do not look attractive. So that really leaves property which i think even in London looks like an ok bet given we are closer to a brexit deal.

seacaitch

itwasntme001 wrote: »

Many so called "experts" were forecasting (over the next year or so) for 10 year treasury rates to rise above 3% a year ago. We are below 2%. Why would anyone be able to forecast with a reasonable degree of confidence what will happen to the stock market? Makes no sense whatsoever.


Stock markets are driven by earnings and yields which are themselves driven by what happens to fundamentals. No one can say with confidence what will happen to the economy over the next year let alone ten years hence why would anyone have a good idea what will happen to stocks?

I try to only post high quality stuff that may be useful to others, but if it's not of interest to you that's fine!


The forecast uses this model:

http://www.philosophicaleconomics.com/2013/12/the-single-greatest-predictor-of-future-stock-market-returns/

...the author of which may (should) be familiar to some long-time active investors around here; he also now pens stuff pseudonymously for O'Shaughnessy Asset Management. See: https://osam.com/Commentary/research_partners

MaxiRobriguez

S&P500 CAPE is high by historical standards, the dollar is expensive, global growth is slowing, boomers are going to be liquidating equity positions for the next decade or two. The setup is there for lower the average returns for a number of years.

TINA may play it's part in keeping stock growth going though, with bond yields falling and no obvious change on the horizon for interest rates to increase.

Personally, I've overweighted emerging markets and high dividend yielding stocks - I'm expecting a rotation into these when those who have piled into US assets start to reallocate. I also hold a 10-20% cash reserve (depending on opportunities at the time) in the event of a major pullback and/or interest hike led by inflation.

Thrugelmir

Although it may deviate under or over the mean. The performance ultimately over the longer term will reflect the growth in GDP. With reduced expectations for growth constantly being downgraded. Stock returns overall will remain subdued.

itwasntme001

seacaitch wrote: »

I try to only post high quality stuff that may be useful to others, but if it's not of interest to you that's fine!


The forecast uses this model:

http://www.philosophicaleconomics.com/2013/12/the-single-greatest-predictor-of-future-stock-market-returns/

...the author of which may (should) be familiar to some long-time active investors around here; he also now pens stuff pseudonymously for O'Shaughnessy Asset Management. See: https://osam.com/Commentary/research_partners

Having read the whole post in the first link you sent, i am impressed how the model so accurately forecasts future returns. What it doesn't say however is whether it would be more optimal to hold more cash, bonds or equities as much will depend on inflation and level of interest rates, something the model does not forecast.


So with a 10 year average return forecast of about 3.5% a year, if a lot of vol is to be expected, could we get a sharp drop soon and then a subsequent rally over the next ten years (to get to the forecasted 3.5% return on an annual basis), or vice versa? Something else the model can not forecast.

MarkCarnage

Interesting analysis and comments......back in 2014 or so, when I was gainfully engaged in investment strategy for a major UK pension fund, our team's nominal return forecasts were very much at the lower end of expectations on a forward 5-10 year basis, at 5% p.a. nominal, say 2.5% real for global equities. That conservative estimate quickly became mainstream.

Given performance in the intervening years, and where bond yields now sit, I think that the forecast here of just over 3% nominal is perfectly rational. Indeed there are others who are well below this (GMO Woolley being one).

The issue is that rationality may not prevail in the short to medium term; it will eventually, but when remains to be seen. Therefore the path of returns may be pretty volatile around that boring 3% number.

The number is for the US equity market. Others will vary around it, EM might be the most attractive at current levels. $ will weaken in that timeframe I think, so US returns for a UK investor might be less, though who knows where the Great British Peso is headed....

Fiscal policy will gradually take up the strain - it has to. For Governments, issuing debt at these levels for the RIGHT reasons should be a no brainer.

Keeping a lid on investment costs will be vital in a low nominal return environment.

itwasntme001

MarkCarnage wrote: »

Keeping a lid on investment costs will be vital in a low nominal return environment.

Or conversely it may be worth paying up for someone to pick stocks for you (or spend time doing it yourself).