Key Points
- Experts predict that equity returns in the next 10 years will be below the long-run average.
- While the CAPE ratio has been an empirical failure for timing, it can be useful for forecasting.
- Investors and pension funds should adjust their allocations when equities are expected to underperform their historical average.
- When expected returns on everything are low, investors should lower their expectations and adjust their spending habits.
- The equity risk premium may be lower than its historical value in the coming years.
In the latest Equity Risk Premium Forum conversation, investment experts conclude their exploration of the usefulness of the CAPE ratio as a forecasting tool and discuss their expectations for the equity markets and the equity risk premium. The consensus among the experts is that stocks will fail to match their long-term average performance in the next 10 years.
While the CAPE ratio has not been successful for market-timing, it can provide valuable insights into the future returns of equities. Investors and pension funds should adjust their allocations when equities are predicted to underperform their historical average. This adjustment is crucial for maintaining a balanced portfolio and ensuring that returns meet expectations.
When expected returns on all assets are low, investors should lower their expectations and adjust their spending habits accordingly. This is especially important for pension funds, which have fixed liabilities and cannot adjust their spending as easily as individuals. In such situations, pension funds may need to raise additional funds to meet their obligations.
The experts also discussed the equity risk premium, which is the additional return that investors expect to receive for holding stocks compared to risk-free assets. While there is consensus that equity returns will be below the long-run average, there is some disagreement about whether the equity risk premium will be lower or higher in the coming years. Some experts argue that with low bond yields, the equity risk premium may actually be higher than it has been in recent years.
In summary, investors and pension funds should adjust their allocations and expectations when equities are predicted to underperform their historical average. With low expected returns on all assets, it is important to lower expectations and adjust spending habits. The future of the equity risk premium is uncertain, and it may vary depending on the economic and market conditions.
