Looking ahead to the next 10 years

As we close out 2019, it’s time to look ahead to see what we can expect from the stock market over the next decade.

I want to be crystal clear here: There is no perfect, foolproof stock market indicator. No one knows with any degree of accuracy what the market will do over the following year.

If such an indicator did exist, it would become useless the minute it was discovered. Every trader in the world would start trying to front run it.

But while there is no perfect indicator, there are a few that have a reasonably good track record of predicting stock returns over the next decade.

One of my favorites is the cyclically adjusted price-to-earnings ratio (CAPE) — also called the Shiller P/E ratio after Yale professor Robert Shiller.

An Indicator to Guide You

The CAPE takes an average of the past 10 years of company earnings and compares it to today’s prices. There’s nothing sacred about a 10-year average, and I’ve seen plenty of variants that use other timeframes.

But 10 is a nice round number, and in any given 10-year period we’re likely to have seen a boom, a bust, and everything in between.

Using Shiller’s data, Barclay’s recently ran the numbers back to 1926 to see how the market performed over the following 10 years starting at various CAPE levels.

Not surprisingly, the more expensive the CAPE, the worse the returns were over the following 10 years. Any value investor would tell you the secret to market success is buying low and selling high.

The question is, of course, where are we today?

Where Are We Today?

The S&P 500 is trading at a CAPE of 29.4 at today’s prices, putting it in the most expensive bottom bracket.

If history is any guide — and, admittedly, we have a lot of data points here as the market only got that expensive one other time in the late 1990s — we’re in for a rough decade.

The worst-case scenario has stocks falling 6.1% per year over the next decade, and the best case has stocks rising 5.8%. I think that’s a pretty reasonable range.

If we avoid a deep recession and the Fed somehow manages to pull a rabbit out of its hat and keep pumping money into the financial system without causing inflation, then it’s not unreasonable for us to hit the top end of the range.

But if the wheels come off — if investors lose faith in the Fed and the foundations crumble — the lower end of the range is also very realistic.

As the baseball-player-turned-philosopher-king Yogi Berra said, “It’s tough to make predictions, especially about the future.” Yet we’re going to do it anyway…

What’s to Come in 2020

I think the most likely outcome is something in the ballpark of 2-3% per year.

We’ll get some kind of recession and a maybe a mild bear market or two.

But Fed stimulus, low bond yields, and a dearth of opportunities anywhere else will keep the bottom from completely falling out.

Still, I don’t know about you… 2-3% per year isn’t going to work for me.

I need better returns than that.

I target high-yielding investments with cash payouts of 5-10% and sometimes significantly more than that.

So, even if the stocks and funds I recommend see zero price appreciation (which would be very unlikely), the yield alone would make them attractive.

Photo Credit: Katell Ar Gow via Flickr Creative Commons