In previous posts, I have shown how the equity allocation of investors is outstanding at predicting 10 year annualized future stock market returns. While this information cannot be used to time the markets in the short term, it may be useful for long term planning considerations, such as retirement, deciding on a larger downpayment on a home purchase vs. investing the extra money, choosing stock and bond allocations, etc.
We have developed models for market returns based on equity allocation of investors alone, and based on an even more accurate model using both equity allocation of investors and the 10 year Treasury bond “P/E” (the inverse of the yield, called GS10 in the Robert Shiller data listed here). We will use our model of equity allocation plus anchoring to the 10 year Treasury bond P/E for predictions going forward because it appears to be the most accurate.
As of 2024 Q1, the model was predicting a nominal annualized return of -0.1% over the next 10 years. The St. Louis Federal Reserve has just released an updated equity allocation of investors for 2024 Q2. Based on this new data along with the average 10 year Treasury bond P/E over the last year, the model is predicting a return of -0.5% / year over the next 10 years. Figure 1 shows the latest version of this prediction model along with annualized 10 year returns in the market for which we actually have data.
If we adjust for the change in market value from 4/1/2024 to market close on 10/3/2024, the predicted nominal return is -1.3% / year over the next 10 years, which is quite poor when compared to historical returns, so plan accordingly for retirement or otherwise.
Remember also, that this is an overall prediction for the S&P500. Companies and market segments can have different relative valuations, and some can even be a good value when the overall market is richly priced. In the same manner, overvalued stocks or market segments can occur even when the market is undervalued overall. This is why I recommend building a star list of the highest quality companies with durable and sustainable returns on capital. That is, we build a shopping list that we can use to buy any undervalued companies as soon as they go on sale, regardless of what the overall market does. By effectively, over time, building our own index weighted to the highest quality companies purchased at good value, I think we can earn outstanding returns in the very long term regardless of current market conditions.
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