Wednesday, December 19, 2012

Don't Take Our Word For It

"It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" Upton Sinclair

Long-time readers will know that we periodically publish a statistical forecast for U.S. stock market returns over horizons from 5 to 30 years, which we generate from a variety of long-term valuation metrics. We were motivated to conduct this analysis because we observed an enormous amount of misunderstanding and misinformation in estimates quoted in various media sources, which largely serve to protect the interests of equity managers and investment firms whose livelihood relies on equity enthusiasm.

A handful of trustworthy buy-side firms consistently publish similar forecasts based on their own analyses, and there has been a flurry of reports lately, so we thought we would summarize the findings of others who have investigated this topic so that readers don't have to just take our word for it.

Chart 1. below summarizes the forecasts of several firms or independent analysts based on papers published in the last month or so. Since few investors invest purely in stocks, we used large cap stock market forecasts as well as the current yield on the Barclays U.S. Aggregate Bond Index, and the most recent inflation expectations reading from the Cleveland Fed's model to create a real forecast for a U.S. 60/40 balanced portfolio. AQR actually published a balanced fund forecast independent of its stock market forecast, so we used their estimate directly.

Chart 1. Forecast total real returns to a U.S. 60/40 balanced portfolio over the next 7-10 years, annualized

Sorry folks, but good stock picking won't meaningfully alter this conclusion. But don't lose hope - we may have an answer.

The following reports were sources for Chart 1, and we would encourage you to read them all.

GMO forecast

AQR forecast

Hussman forecast

Gray forecast

Pimco forecast

BPG forecast