Value Investing

Newfound Research 2016 Market Valuations And Expected Returns [Slides]

Newfound Research 2016 Market Valuations And Expected Returns.

Long-Term Return Forecasts

Equity Valuations

Shiller Cyclically Adjusted Price-to-Earnings Ratio (“CAPE”): Price divided by 10-year average of earnings, adjusted for inflation.

Current ShillerCAPE is in 89th percentile of historical readings, implying that U.S. large-cap stocks are currently expensive.

Market Valuations

Equity Valuation Return Implications

Historically, valuations have been a strong predictor of long-term forward returns.

With a ShillerCAPE reading of 26.03, 10-year annualized real returns are expected to be 4.9%.

Market Valuations

Another Way Of Evaluating Returns

Total Return = Investment Yield + Speculative Re-Pricing

Investment Yield: Dividend Yield + Earnings Growth

Speculative: Price change pressures due to over- or undervaluations; e.g. “reversion to the mean” of P/E ratios

Other Experts On Equity Valuations

Market Valuations

Bond Valuations

10-Year U.S. Treasury rates sit near all-time lows.

Market Valuations

Bond Valuation Return Implications

Starting yields are a great predictor for ending returns in a constant maturity bond index.

At 2.2%, we can expect a 2.2% annualized return over the next decade from a constant maturity 10-year Treasury index. If we assume inflation is 2%, then this is a 0.2% real return.

Market Valuations

60/40 10-Year Real Return Forecast

Market Valuations


Idea #1: Diversify Your Approach

Much like asset classes, different investment strategies will perform well in different market environments.

Diversifying across multiple strategies has historically increased risk-adjusted returns. Chasing the recent performance of the best performing strategies, on the other hand, has proven to be destructive to risk-adjusted returns.

Market Valuations

Idea #2: Actively Manage Risk

10-Year periods with poor returns tend to have a higher frequency and severity of drawdowns. A focus on reducing the impact of these drawdowns can help increase total return.

Market Valuations

Idea #3: Go Global

Valuations are the biggest drag on forward looking returns for U.S. equities.

Many foreign markets are much more fairly priced and offer higher expected returns.

Market Valuations

Idea #4: Pursue Alpha

Equity factor exposures have historically outperformed the broad market and are widely used by institutional investors to increase risk-adjusted returns. Accessing a diversified basket of factors can help smooth out short-term under-performance of a single factor allocation.

Market Valuations

Idea #5: Seek Higher Yields

One way to increase total return is to increase yield.

Market Valuations

See full Slides below.