In part I, I discussed expected market returns from two great economists Robert Shiller and Jeremy Seigel. Two great other economists had a similar debate recently. John Bogle of Vanguard Group and Bill Gross of Pimco appeared on Wealth Track and argued about what the market will do over the coming years.
Bill Gross expects stocks to return 4-5%, not much more than the current yield on bonds. Gross believes the economy has entered “a new normal” era where GDP growth and corporate earnings growth will be much lower than in the past.
John Bogle on the other hand sees the S&P500 (NYSE:SPY) returning 8% over the coming years. He says that even with weak growth in the economy corporate profits should increase by 6% per year. With a dividend yield of approximately 2% this should yield a return of 8%. He also says it is impossible to predict what the P/E ratio so he assumes it will stay the same.
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I take a major issue with part of Bogle’s argument. Even if the future P/E ratio is impossible to predict, to be conservative an investor must assume it will return to an average level of 16. If that were the case the S&P 500 would have to drop 25% from current levels. This would decrease future returns from 8% per annum to around 5% per annum.
My personal view is that Jeremy Seigel’s views are way too optimistic. He provides no valuation numbers to justify such high returns even excluding onetime financial charges. I am skeptical of Bill Gross because even though he is a great investor he runs an all bond fund and is therefore always biased towards bonds.
I noted the flaw in Bogle’s argument, and therefore argued that using Bogle’s equations stocks should have returns of around 5%. Then we have Shiller who according to his historical calculations predicts returns slightly positive.
I am no prophet but if I had to guess I would think future returns will be somewhere between Bogle and Shiller’s estimates. However, this estimate is only for the S&P 500(NYSE:SPY). Although they are harder to find today, there are still many bargains in equities. There are currently over 1800 domestic stocks trading below book value. That is a good place for value investors to start searching!
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