I've mentioned that among my mission-critical duties (turn lights on a.m., game improbable market scenarios) is estimating future equity returns. I approached this article warily thinking it might be a variant of the Fed Model which has been accurate for brief periods but in general is worthless and in the current interest-rate environment is worse than useless-plug in the numbers and you get Buzz Lightyear valuations: "To infinity and beyond."
Fortunately my fears were unfounded.
Commentary: Model has enviable record forecasting 10-year returns
Where do you think the stock market will be in a decade’s time?
Investors all too rarely ask this question, probably because they won’t like the answer. In fact, though, a model with an enviable record at predicting 10-year returns is forecasting that the market will grow at barely half its long-term average.I’m referring to a simple variant of the dividend-yield model. Though this model fell into major disfavor during the go-go years of the 1990s, it has redeemed itself in recent years.The lost decade, in fact, can be seen as the revenge of the dividend yield model. Unfortunately, that model foresees only marginally better returns over the next 10 years.The model, at least the variant I will focus on for this column, is breathtakingly simple. It says that the market’s long-term return will be a function of just two things: the current dividend yield and real growth in earnings and dividends.Since this latter growth rate over the last century has averaged about 1.4%, we can forecast what the market will do over the next decade by simply adding the market’s current dividend yield, the assumed real growth rate of 1.4%, and expected inflation.These three components today add up to a nominal return of 5.6% annualized, according to Rob Arnott, founder of Research Affiliates, an investment advisory firm — or 3.4% in real terms....MORE