Could stock prices begin going up soon and then continue going up for a good bit of time?
Yes, that could happen.
The Stock-Return Predictor tells us that the most likely annualized 10-year return today is 1.8 percent real (the numbers that apply when this blog entry appears may not be precisely the same as those that applied when it was written). That’s not so hot. It becomes especially unexciting when you take into consideration how high the odds are that we may see a price crash in the not-too-distant future. If I am going to take those sorts of chances with my retirement money, I want to see a likely return of a good bit more than 1.8 percent.
But “most likely” is not the same thing as “definite.” If those going with high stock allocations today are lucky, they could see returns a good bit higher than 1.8 percent real. How does an annualized 10-year return of 4.8 real sound? There’s a 20 percent chance that we’ll see a return that high or higher.
Should you take a chance on stocks then? At least stocks give you a chance of earning a real return of 4.8 percent real. You don’t stand any chance whatsoever of earning a return that high today in TIPS or IBonds or CDs. Stocks have more potential.
I think you should take a chance on stocks. With a small portion of your portfolio.
Where I take issue with the conventional advice is that I say that you should not take as much of a chance with stocks as you would at a time when prices were at reasonable levels.
Stocks do indeed possess the potential to provide a nice return over the next 10 years. In that sense they are more appealing than TIPS or IBonds or CDs. Stocks also possess the potential to provide an absolutely horrible return over the next 10 years. There’s also a 20 percent chance that the annualized 10-year return will be a negative 1.20 percent real or something worse than that. The super-safe asset classes are providing low returns today but they aren’t providing negative returns.
Everyone agrees that stocks are the more volatile asset class. Everyone agrees that the distance between the potential up for stocks in 10 years and the potential down for stocks in 10 years is considerable. On those two points my thinking and the conventional thinking are in line.
The problem with the conventional advice is that it does not point out the extent to which the potential ups and downs of stocks change with changes in the valuation level. The conventional view is that stocks always offer a better deal than the super-safe asset classes and that you thus don’t need to pay much attention to the effect of valuations.
The historical data does not back up that claim. The historical data shows us that there are times when stocks offer a deal so much more compelling than the super-safe asset classes that it is hard to make a reasoned argument for not going primarily with stocks and there are other times when it is a close call and there are yet other times when the super-safe asset classes offer the better deal. My take is that the super-safe asset classes generally offer the better deal today.
If you believe that stock returns are going to be on the lucky side of the spectrum of possibilities, you should invest accordingly. We are not able to see into the future to the extent needed to know with precision what return stocks will provide over the next 10 years. My goal in encouraging use of the Return Predictor is to educate you about the odds. If you know what the historical data says about the odds of the various outcomes, you are investing in an informed way.
Combine that with a little bit of luck and you’re on your way!
Today’s Passion: Find out what they said at the Vanguard Diehards board about the Predictor by checking out the article entitled Community Comments on Predicting Stock Returns.
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