A piece on John Bogle, founder of Vanguard Group, that discusses his research unveiling three factors that will allow you to predict stock market returns with decent accuracy
Its in the Wall Street Journal, but should be ungated, and is food for thought.
Bogle published his latest research in he Journal of Portfolio Management
- The first is the starting yield, or annual dividends divided by stock price
- Second is earnings growth
- Third is the "speculative return," or any change in the mob psychology of how much investors want to pay for stocks
Looking at where the three are:
- Annual dividends divided by stock price is currently about 2.2%
- Earnings growth historically has averaged about 4.7%
- Speculative return ... the S&P 500 is priced around $23 per $1 of earnings per share (price/earnings ratio of nearly 23) ... If that ratio rose to 25 over the coming decade, that would be roughly a 10% increase - boosting stock returns by about one percentage point annually. On the other hand, if the P/E fell to 20, that decline of more than 10% from today's level would lower the next decade's returns by about one percentage point per year.
That 2.2% dividend yield, plus the 4.7% earnings-growth rate, equals a smidgen under 7%. If market valuations rise one percentage point annually, that would take average returns up to about 8%; if they fall the same amount, total returns would drop to about 6%.
None of these figures count inflation, which the Federal Reserve has targeted at 2% annually. Subtract that to account for loss of purchasing power, and stocks look likely to return an average of about 5% annually over time; bonds, less than 1%.
Note that these are expectations for the coming decade, not the next year - which is notoriously hard to predict.
Bogle's model can be adapted: "If you don't like my numbers [other than dividend yield]," he says, "you can put in your own."
