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Caution ahead: Low stock market returns expected

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Global asset manager GMO LLC updated its seven-year forecast for asset returns this week, and the future doesn't look good for investors.

GMO expects large capitalization U.S. stocks to return a negligible 0.4 per cent a year over the next seven years, after taking inflation into account. That, of course, is well below the long-term average return of 6.5 per cent for U.S. equities, again after inflation. Small cap stocks look even worse, with an expected annual return of negative 0.1 per cent.

Meanwhile, U.S. bonds, international bonds and inflation-linked bonds are also expected lose money after inflation.

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To be sure, the latest round of economic stimulus from central banks has not been embraced by most strategists and economists as a big source of hope for the global economy. As Morgan Stanley said in a note on Friday (via FT Alphaville), the stimulus simply cannot counteract the pileup of signs of economic weakness.

"Our stubbornness is quite simple – fundamentals," Morgan Stanley said in its note. "On the other side of QE and OMT are IP, PMI, and GDP, which continue to look worse, not better. As such, the key to our call is very simple: we think poor fundamentals will trump central bank action."

For those of you not up on your acronyms, these refer to central policies of quantitative easing and outright monetary transactions – or bond-buying. The others – industrial production, purchasing managers indexes and gross domestic product – are key economic figures that have been pointing to a stalled recovery. They could have added U.S. initial IJC (initial jobless claims) and NFP (non-farm payrolls), though these don't get expressed as acronyms.

Mark Hulbert, writing in MarketWatch (via Abnormal Returns), shows another way of looking at future returns, but it looks almost as gloomy. He looks at the dividend yield model, which adds the current dividend yield to growth in earning and dividends inflation (which has averaged about 1.4 per cent over the past century) and expected inflation.

The result: 5.6 per cent a year over the next decade. But after inflation, that return shrinks to a likely 3.4 per cent a year.

Does that leave you excited about the future? Probably not. But at least the folks at GMO see better prospects ahead for emerging market equities, which are forecast to rise an average of 6.4 per cent a year over the next seven years.

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