Predicted 10-Year returns from the Shiller P/E

Predicted 10-Year returns from the Shiller P/E

November 16, 2012 Research Insights
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(Last Updated On: March 14, 2017)

A quick update on the Shiller P/E predictions–been a slew of articles/research on this recently:

We’ve written fairly extensively on the topic of predicting future returns:

Here is an article we wrote up describing Hussman’s model:

John Hussman has an interesting piece on predicting long-term market returns

The article is a bit dated (2005), but still fascinating.

In the short piece Hussman suggests that the projected annual total return on the S&P 500 over T years can be represented with the following equation:

  • Long term total return = (1+g)(future PE / current PE)^(1/T) – 1 + dividend yield(current PE / future PE + 1) / 2

He makes the following assumptions and plugs them into the equation above:

  1. Peak to Peak earnings growth, g=6%
  2. T=10 years
  3. future PE (E=Peak Earnings over cycle) range between 20 (major bull) and 7 (major bear)

Here are the results of our analysis of this model:

143
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Low-end prediction is -0.84% 10-Year CAGR; high-end prediction is 7.61% 10-Year CAGR

We also have a piece that is related to predicting 10-year returns with a simple regression model:

http://blog.alphaarchitect.com/2011/10/the-shiller-pe-ratio/

144
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

The model is predicting a 3.31% 10-Year CAGR.

Summary

Expect 10-year returns to fall in the -.84% to 7.61% range over the next 10-years. Not too precise, but at least you can scratch off your prior expectation of 20% CAGR…


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Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.