Stock Market Expectations
Research has shown that there existed a strong relationship between the cyclically adjusted Shiller-CAPE and long-term equity returns in the past. Our research paper "Predicting Stock Market Returns Using the Shiller-CAPE: An Improvement Towards Traditional Value Indicators? " shows the same relationship for the price-to-book ratio (PB) in 17 countries in the period from 1979-2015.
Based on these findings and the current valuation levels, what returns can equity investors expect over the next 10-15 years? The following table presents the current CAPE and PB valuation of different countries and their corresponding long term performance forecasts:
What returns can investors expect in the long-term ()?
The table shows the valuation ratios and the corresponding performance expectations (local currency, real returns including dividends) over the next 10-15 years for different countries. The underlying methodolgy and data is based on our research paper "Predicting Stock Market Returns Using the Shiller-CAPE: An Improvement Towards Traditional Value Indicators?" . "ø Forecast" represents the average forecast of the CAPE and PB. Source: StarCapital.
Besides forecasting returns using a regression function, from an investor‘s point of view, it is also interesting to take past market phases with comparable valuations to today’s markets and see what their historical returns were. For this purpose, each stock market is assigned a past CAPE or PB interval that is comparable to its current valuation, and the historical distribution of stock returns for the subsequent 15 years is determined using the maximum available data sample (S&P 500 from 1881-2015 and 17 country indexes from 1979-2015):
Which distribution of returns followed on comparable valuations over 15 years?
Based on comparable valuations, the table shows the subsequent real returns over 15 years in local currency and incl. dividends based on current CAPE and PB. The analysis is based on the maximum available data sample (S&P 500 from 1881-2015 and 16 country indexes from 1979-2015). The underlying methodolgy and data is based on our research paper "Predicting Stock Market Returns Using the Shiller-CAPE: An Improvement Towards Traditional Value Indicators?" . Source: StarCapital as of .
The dataset gives an indication of the returns investors can expect over the next 15 years. Even though high valuations indicate a low return potential (and vice versa), the mean reversion process should not be understood to progress linearly. Depending on market conditions, similar valuation levels can be followed by a wide range of returns in the short- to medium-term.
To illustrate the aforementioned range of historical equity returns, the following two examples show the possible paths similarly valued equity markets have taken over the last 140 years. These illustrations serve as an indication of the opportunities and risks long-term equity investors face. Example Germany:
As of December 31th, 2019, the German equity market had a CAPE of 18.9 and a PB of 1.7. In the past 140 years, periods with valuation levels comparable to the current CAPE and PB of the DAX were followed by average long-term annual returns of 6 percent. In the majority of all historical observation periods, real capital gains of 4-9% were achieved. Considering inflation, in 2034, a DAX level of 32,000-60,000 is most likely.
The scenario corridor modeled here also offers insight into medium-term opportunities and risks. Disregarding outliers, the DAX will fall into a range of 14,600 and 21,500 points over a three year horizon (50% probability) and will not drop below 11,800 points (90% probability). Historically, a DAX trend in the area marked light grey corresponds to the most probable development. Hence, the upside-potential is significantly higher compared to its downside-risk.
As of December 31th, 2019, the US equity market had a CAPE of 31.1 and a PB of 3.6. Historically, over the last 140 years, real returns of 2% annually was achieved over the following 15 years which, at a conservatively assumed inflation rate of 2%, would correspond to an S&P 500 level of 6,000 points in 2034 (with a likely range of 5,000 to 7,000 points).
The expensive US market shows great potential for disappointment in the mid-term - if historical experience continues to exist in the future, price declines over 2-6 years and a longer-term stagnation under high volatility are likely.