My “Choose Your Own Adventure” 2019 Forecast

If you’re something a geek, you may spend may spend just as much time as me reading academic papers and research about markets and valuations.

And you may find one paper about the market and valuations quite valuable.

Win Antoon, the head of asset management at Bank Nagelmackers in Brussels and a member of the Brandes Institute Advisory Board, wrote the paper. The Brandes Institute is a research firm associated with legendary value investor Charles Brandes, and they publish some cutting-edge research on a pretty regular basis.

The paper was titled The CAPE ratio, and Future Returns: A Note on Market Timing, and it covered the use of the 10-year average PE ratio as defined by Nobel Prize-winning Yale Professor Robert Schiller. Professor Schilling uses a definition of earnings that are adjusted for inflation, and this gives us a much clearer view of the markets current valuation.

Not surprisingly, the study found that when the CAPE ratio is low, future stock market returns tend to be higher than average. When the ratio is very high, future stock returns tend to be awful. This has been studied by numerous academics and investment managers who determined it a fairly accurate measure of what we can expect from stock prices over the long term.

The ratio is currently at 29, which is well above the historical average of 16.7. So we can expect that future stock market returns will be lower than the historical average, and Antoon’s study tells us that future returns will be somewhere between bad and abysmal.

But you can’t just assume that a high CAPE ratio means that stock prices will immediately fall. The problem we face as investors are that the path to lower returns is not necessarily straight down, and there are actually many paths to lower returns.  

So let’s take a look at the 3 scenarios that could lead us down

When Elementary Math Can’t Predict the Market, Trust This Supercomputer

We can apply some common sense and elementary math to gain some idea of how much we might earn in the market over the next several years from current levels.

We know that in the past when the 10-year PE ratio of the stock market was below the mean, future returns were pretty high.

We know that when this ratio was above the long-term mean, future returns were very low.

And we know that right now we are way above the mean, and that the future for stock prices is not as good as it has been.

So let’s have a look at a chart and some numbers that prove this (and the supercomputer that could beat it)