stock market future returns

*For reference when I refer to the market or stocks in this article I am referring to the S&P 500 not individual stocks.

I thought this article would be a good follow up on my market valuations article(to see the article click here). At the end of the article I stated that I expected future returns to be about 9.5% per annum, which is the average historic return for stocks.

In truth I expect future stock returns to be less than 9.5% per annum. The market is currently slightly over valued now. I stated that this is reasonable since stocks offer a much more attractive return than bonds due to low interest rates. However, eventually interest rates will get to levels of at least 4%( which is the minimum normal rate on interest rates) and that would justify a P/E closer to 15. I therefore expect the market to return less than 9.5% per year over the coming decade.

Four great minds have recently weighed in on the debate. The Wall Street Journal had an interesting article about Jeremy Siegel and Robert Shiller. Both are best selling authors of great books. Shiller wrote a fantastic book titled Irrational Exuberence, and Seigel wrote Stock For The Long Run. Both are great friends, but have differing views on future stock returns.

Shiller measures market valuations based on the average 10 year P/E. The average P/E since 1881 is 16. That number is currently above 21. According to Shiller’s historical data with a P/E above 20 the market should produce returns that are barely positive over the next ten years. In addition, Robert Shiller is an expert on the housing market and sees some bearish signs in the housing market that might lead to a decline in stocks.

Jeremy Seigel argues with Robert Shiller’s assessment. Seigel believes the numbers are skewed due to the unusually large write off financial firms took in 2008 and 2009. These numbers skews P/E numbers for the entire S&P index. For example, AIG wrote down $80 billion. Seigel believes this will skew S&P P/E ratio for the next ten years.

Excluding one time write off like AIGs’, Seigel argues that the market is undervalued. Taking into account these one time extraordinary write off and charges Seigel believes the market is undervalued. He believes the market can return 10-12% returns for the stock market. In addition, Seigel expects low inflation in the future.

I will bring in two other great minds in part II of this article, and my personal view on future market returns.

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