Why Are People Depressed About the Medium-Term Prospects for Equity Investments? Something I Do Not Understand: Friday Focus: April 25 2014

Consider Henry Blodget, who appears to expect rapid and full mean-reversion to the very long run average ratio of prices to earnings, in spite of secularly low interest rates…

Henry Blodget: Stock Market And Investing Outlook: “Everyone’s getting cautiously bullish again…

…except me. I still think stocks are poised to have a decade or more of lousy returns…. Stocks are very expensive. Corporate profit margins are at record highs. The Fed is now tightening…. Unless ‘it’s different this time’ — the four most expensive words in the English language — stocks are priced to return only about 2.5% per year for the next decade, a far cry from the 10%-per-year long-term average…. I own lots of stocks, though, and I’m not selling them…. No other asset classes are attractively priced, either. Unfortunately, it looks as though we’re set up to have one of the worst decades in history in terms of the performance of financial assets….

The chart below is from Yale professor Robert Shiller. It shows the cyclically adjusted price-earnings ratio of the S&P 500 for the last 130 years. As you can see, today’s P/E ratio of 25X is miles above the long-term average of 15X…

Stock Market And Investing Outlook Business Insider

I don’t see this: I see that stocks are likely to return:

  • 6%/year in real (inflation adjusted) terms,
  • plus or minus whatever changes we see in valuation ratios.

That means that if we expect to see P/E10 fall over the next decade from 25X to 19X then we can expect to see returns of 3%/year real–that is, 5%/year nominal. That means that if we expect to see P/E10 fall all the way back to 15X over the next decade, then we can expect to see returns of 1%/year real–that is 3%/year nominal. But that is unlikely to happen. And if P/E10 remains at its current valuation ratios, we have 6%/year real returns–8%/year nominal.

Equities still look very attractive to me…


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