Updated Campbell-Shiller Regressions

Ten- and twenty-year average annual real returns on equities as a function of the ratio of price to a ten-year moving average of earnings:

The price-to-ten-year-moving-average-of-earnings ratio is currently around 18, which suggests very good expected returns relative to a ten-year Treasury bond yield of 3.34% per year.

Comments

[One Eyed Guide:]

Brad,

I'm pretty sure that if you did a forward look assuming that the S&P estimates were accurate (a big assumption) for the next year this chart would show a much more negative picture. If the S&P500 does not go up at all the PE calculated by the Shiller method will expand to 19.49 from today's 18.77 because of the drop in 10 year average earnings.
During most of the period in these charts PE's were expanding which is going to add a positive bias to the data. Going forward the charts will add more periods of declining PE so the negative return points (below the 0 line) in the 10 year charts will increase and average returns will decline. Eventually, the 20 year chart will show some negative points too.
In addition, the points below the 0 represent annual negatives. Over 10 years, a 5% decline means you lose 46% of your investment.
I don't think that comparing a risk free 3.34% to one with a potential negative return this large is appropriate. The fact that declines on the average return shown in this analysis are "baked in the cake" makes this even more inappropriate.
This does show that buy and hold is a poor strategy right now but buying on dips is probably going to be very profitable.

Oct 07 09:28 AM

[Toffe:]

Interesting analysis. To revert to mean, one side of the equation has to correct, either returns on equities increase or yield on bond reduce.

The other way to read the same data it is that the UST yield is too low. This is a consequence of the historical low rates plus massive quantitative easing which are skewing UST markets.

Oct 07 09:53 AM