Stocks Aren’t for the Long Run

Professor Robert Shiller of “irrational exuberance” fame is back making headlines, this time in an interview with Money magazine. Another of Shiller’s innovations is the Shiller P/E ratio. Instead of using forecasts of next year’s earnings, Shiller suggests using normalized earnings, which he defines as basically an average of the last 10 year’s earnings. That way, you’re dealing with real earnings, not forecast earnings. You’re also not influenced by short-term blips. He believes that’s a much more reliable way to measure the overall stock market valuation and to anticipate forward returns. John Hussman of the Hussman funds uses a similar approach.

Both Shiller and Hussman believe the current P/E ratio forecasts real returns from U.S. stocks over the next 10 years of around 4%.

Shiller says the reliability of his measure could change over time. But he also challenges the argument to own stocks for the long run made by Professor Jeremy Siegel. Shiller thinks the 7% real return delivered by stocks in the past might be an anomaly that isn’t going to be repeated.

My old friend Jeremy Siegel [Wharton professor and author of “Stocks for the Long Run”] makes the strongest claim about this. He has data going back 200 years showing that the market has had a real 7% return over that period.

But there’s no solid reason it should do so well. Things can go for 200 years and then change. I even worry about the 10-year P/E — even that relationship could break down. But I believe I’m on better ground thinking that the P/E forecasts returns than thinking one asset just always outperforms.