From the December 2011 newsletter:
As mentioned last year, valuation ratios such as P/E are not very useful in making one year market predictions. This is disappointing, since they do a fair job of predicting longer-term returns of at least 5-10 years. As a result, you will not see a market forecast from us for 2012 or any other single year, unless we can support it with a high standard of evidence.
The next best thing is to evaluate the markets today using those valuation ratios and consider how that affects future returns in the 5-10 year time frame. It’s not as exciting, but it’s far more responsible and reliable based on historical market data.
The following table shows valuation ratios for US stocks and US real estate as of 12/23/2011, with P/E ratios using 10 years of earnings. Estimates for future returns assume that valuations revert to fair levels 10 years from now, and that asset classes otherwise perform in line with their historical averages.
|Asset Class||Valuation Ratio||Market Valuation||Future 10y Returns
vs Historical Average
|US Stocks||Q||33% overvalued||3% per year lower|
|US Stocks||P/E||30% overvalued||Almost 3% per year lower|
|US Real Estate
|P/E||46% overvalued||Almost 4% per year lower|
The two valuation ratios for stocks (Q and P/E) are calculated using separate sets of data, yet produce essentially the same results, indicating that our methods are at least consistent.
Both stocks and real estate are currently overvalued by a significant amount, so we can expect lower than average returns for both assets classes over the next 10 years. However, tactical bets should be measured, since 10 year returns are still expected to be positive and the margin of error in these predictions is meaningful.