## The Next Decade Will Likely Foil Most Financial Plans

The charts below show the 10 and 20-year rolling REAL, inflation-adjusted, returns for the market as compared to trailing valuations.

(Click on image to enlarge)

(Important note: Many advisers/analysts often pen that the market has never had a 10 or 20-year negative return. That is only on a nominal basis. Inflation must be included in the debate.)

(Click on image to enlarge)

As we pointed out in “Do You Feel Lucky,” virtually all measures of valuation currently suggest that forward returns over the next decade, or longer, will be low.

There are two important points to take away from the data. First, there are several periods throughout history where market returns were not only low but negative. Secondly, the periods of low returns follow periods of excessive market valuations.

### This Time Is Not Different.

As David Leonhardt noted previously:

“The classic 1934 textbook ‘Security Analysis’ – by Benjamin Graham, a mentor to Warren Buffett, and David Dodd – urged investors to compare stock prices to earnings over ‘not less than five years, preferably seven or ten years.’ Ten years is enough time for the economy to go in and out of recession. It’s enough time for faddish theories about new paradigms to come and go.

History shows that valuations above 23x earnings have tended to denote secular bull market peaks. Conversely, valuations at 7x earnings, or less, have tended to denote secular bull market starting points.

This point can be proven not only by looking at the distribution of returns in the chart below but mathematically as well.

Capital gains from markets are primarily a function of market capitalization, nominal economic growth plus the dividend yield. Using John Hussman’s formula we can mathematically calculate returns over the next 10-year period as follows:

(1+nominal GDP growth)*(normal market cap to GDP ratio / actual market cap to GDP ratio)^(1/10)-1

Therefore, IF we assume that GDP could maintain 2% annualized growth in the future, with no recessions, AND IF current market cap/GDP stays flat at 1.25, AND IF the dividend yield remains at roughly 2%, we get forward returns of:

(1.02)*(1.2/1.5)^(1/10)-1+.02 = 1.75%

But there is a “whole lotta ifs” in that assumption. More importantly, if we assume that inflation remains stagnant at 2%, as the Fed hopes, this would mean a real rate of return of -0.25%.

In either case, these numbers are well below the majority of financial plan projections which will leave retirees well short of their expected retirement goals.

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