A building block method would be something like dividends + earnings growth + inflation + multiple expansion = expected return. The size of these components and whether they are actually negatives rather than pluses varies from one prognosticator to another.

For valuation, you’ll see things like “At this P/E, the market has averaged X% over the next 10 years.”  Often the presenter will substitute price to book, or sales, or use a trailing P/E, CAPE ratio, or similar.

These forecasts are not useless but they can be misused.  Bad behavior can trump a lot of good thinking.

I write a couple of Q&A columns for consumer media and can say with confidence that there are two common reactions of the general investing public to a return forecast.

The first is to view the forecast as a matter of destiny or as a ceiling.  This is often interpreted as low equity premiums mean one should own less stocks. It is rare that people realize that if the premium is lower, all things being equal, to get the same result, one actually needs more stocks.

The second reaction of the public is to translate an above average valuation into a prediction of an imminent market crash.  Studies of the matter are clear. The better predictors of future returns are P/E related and are most effective predicting the next 10 years. 

However, “better” and “most effective” is misleading.  They really aren’t great predictors even over ten year periods. The range of results for any given valuation level is still quite wide. Certainly not a matter of destiny.

For shorter periods like the next 12 months, there simply is no valuation measure that is a good timing indicator.  CAPE ratios, P/E, GDP growth, dividend payouts, government debt levels, the Fed model and other data points all have little to no predictive value. 

Most real financial planners are not hot on trying to time the market but many are struggling with what to do with the strong consensus that the expected returns and the probable variation around those expectations has made an adverse shift.  

Part of the issue for planners is that it isn’t just a matter of low equity returns. Interest rates are darn low, making future returns from the fixed income portion of a portfolio less productive.