The "low estimate" is well-represented by Anthony Brown's "What's Next for the S&P 500?" in the Winter 2000 issue of The Journal of Investing. Brown concludes, "We argue that the S&P 500 is not only unlikely to match its recent 20-year return over the next 20 years, but that it may also very well fall short of the long-term 11% return (since 1926)." What is instructive about Brown's article is the thoughtful and analytical process he uses to reach his conclusion. Decomposing historical return into the components of dividend yield, earnings growth and valuation change, he considers each in detail.

In his evaluation of dividend yield, Brown considers its significant decline vis-a-vis long Treasuries since 1958, the possible reasons for this change and its impact on stock prices. In his evaluation of earnings growth, he acknowledges the possible "catch-up" effect from the dismal performance of the 1970s. He also considers the impact of share repurchase, integrating these influences to quantify an estimate for the future. As for valuation, he utilizes P/E as a valuation proxy and concludes that there is no reason to expect a systematic positive valuation change in the future.

Based on his deconstruction analysis, he concludes (and describes in detail his rationale) that the implied equity risk premium going forward is only 1.7%. Finally, he suggests a reason for Siegel's observation regarding the increasing return on bonds by noting the increasing risk of bonds, particularly since the 1970s, as a result of an inflation risk not being reflected in the long-term data.

What, Me Worry?

Despite this growing consensus by both academics and practitioners that future equity returns may be a tad disappointing, many investors and advisors seem bent on denial.

In Bubble Logic, with specificity and humor, Asness addresses many of the classic denial responses, such as "Equities always win over in the long term," "My estimates of expected stock returns are based on long-term data" and "The long term will be OK, we've entered a period of spectacular growth." One shouldn't forget Paul Samuelson's famous remark that the long-term data for the U.S. stock market is based on a sample of one.

Exhibit 2 from Bubble Logic, demonstrates that by any historical standard, the market today is significantly priced.

Framing this historically unique market valuation from a different perspective, Barr Rosenberg, in a presentation to the AXA Investment Managers Client Conference, noted that the market capitalization of the 500 largest companies in the San Francisco bay area was $3.5 trillion. By comparison, he pointed out that the market capitalization of all of Asia (except Japan), a region of 3.2 billion people, including China and India, was $2.2 trillion.

However one wishes to frame the issue, there is certainly a strong case to be made that equity returns, in the long run, may be lower in the future than the AS currently used by most practitioners.

Don't Forget Bonds

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