John Hussman’s excellent Weekly Market Comment for the week beginning September 6 has a superb chart showing the 10-year returns to the S&P500 implied by its present level. The news is sobering. John estimates returns for the coming decade of less than 6% per annum:
Though we use a variety of methods, the consensus estimate is at about 5.6% annually. I’ve detailed our estimation methodology in numerous weekly comments over the years. Below is a chart taking this analysis back to 1928. It would be nice, before quoting alternative valuation models, if Wall Street analysts would at least present similarly broad historical evidence that their methodology actually has a relationship with subsequent market returns. If a valuation opinion doesn’t come with extensive historical evidence, it’s noise.
Worse, the returns above are nominal returns. On an inflation-adjusted basis, John forecasts returns of just 1% per annum:
That said, one thing that does concern me about the foregoing model is that our “real” inflation-adjusted version projects a 10-year real total return for the S&P 500 of just over 1% annually. That suggests that about 4% of the nominal return projection represents implied inflation, which would be consistent with post-war U.S. history, but may or may not be accurate in this instance. My guess is that, in fact, we will observe significant CPI inflation in the latter half of this decade. Still, it is worth noting that our projection for real10-year returns is not compelling in any case. 10-year real returns for the S&P 500 have been predictably negative since 1998, but it is unfortunate that except for a few weeks in early 2009, we have not yet achieved a level of valuation from which we can expect a meaningfully different result.
To the extent that investors wish to compare our 5.6% estimate for 10-year S&P 500 total returns with the 2.7% yield on 10-year Treasuries, it is important to recognize that the higher 10-year expected return in the S&P 500 comes with a several-fold increase in risk, particularly over a shorter horizon. Moreover, the divergence between the two figures tends to expand, not contract, during economic downturns. Stocks are not cheap, and to the extent they may outperform bonds over the next 10 years, it will most likely be with extreme discomfort.