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Outlook for U.S. stocks

Capital Economics believes the U.S. stock market may well deliver investors far less over the next 10 years than it has in the “blockbuster” decade since the financial crisis.

Last weekend marked the anniversary of the bottom of the S&P 500 and S&P/TSX Composite Index, which sparked speculation over what comes next.

As John Higgins of Capital Economics sees it, the S&P 500 could generate much lower returns than it has since the low point.

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“The real return from U.S. equities in the coming decade could plausibly be less than a third of what it has been in the last 10 years,” said Mr. Higgins, chief markets economist.

“Since that low on 9 March, 2009, the average annual real return from the index has exceeded 15 per cent, which is very high by past standards,” he added in a report titled “A Blockbuster Decade For U.S. Equities Seems Set To End.”

Mr. Higgins plotted average annual real returns of a previous decade, as of March 9 for each year since 1919.

The average, he found, topped 15 per cent only three other times, including the end of the Roaring Twenties, the late 1950s and the late 1990s.

He also looked at what is known as the cyclically adjusted price/earnings ratio, or CAPE, or the Shiller P/E ratio, named for Yale professor Robert Shiller, which is based on real earnings per share over the course of a decade.

“What do these episodes suggest about the performance of the index in the future?” Mr. Higgins said.

“One thing to note is that its valuation has soared again – the CAPE has risen from about 13 to 30 in the past decade,” he added.

“This has provided the bulk of the return, despite some contribution from growth in cyclically adjusted [earnings per share].”

Mr. Higgins said he doesn’t believe a “big devaluation” is in the cards in the next decade.

“In our view, a secular decline in interest rates has lowered the equilibrium level of the stock market’s earnings yield to 4 to 5 per cent, from the long-run average of closer to 7 per cent.”

There would still be pressure on stocks even if the CAPE ratio “only fell back” to 25 by the end of the next decade.

“Indeed, given conservative assumptions about growth in EPS, the average annual real return in the coming decade might only be 4 to 5 per cent, especially if, as we forecast, the index temporarily slumps again this year,” Mr. Higgins said.

Ah, but …

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“That might still top real returns from many other assets, though,” he added. “It is hard to see, for example, how the real return from Treasuries could average much above zero, given how low their yields are now after inflation.”

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