The Stock Market Will Go Up By 58% Over The Next 10 Years

The most common way to determine if stock market returns are overpriced or cheap is to use P/E ratios. The two schools of thought include that of permabulls, who argue that the stock market is cheap because of both the trailing 12-month P/E ratio and 2011 earnings estimates; and Permabears, who argue that the stock market is expensive because of a high Shiller’s P/E Ratio. The Yale economics professor who developed this, Robert Shiller, thought that average real earnings during the past decade is a better indicator of long term earnings. He created the cyclically adjusted P/E ratio (CAPE) to predict long term returns in the stock market. The average historical Shiller P/E ratio is around 16, and right now it’s above 20. That means, according to permabears like David Rosenberg, the stock market is overvalued by at least 20% based on this metric.

Insider Monkey thinks long-term interest rates should also be considered. When combined with long term interest rates, cyclically adjusted price earnings ratio could yield better signals. When long-term interest rates are high, stock prices and Shiller’s CAPE could be low. For instance, in March, 1980 Shiller’s P/E ratio was only 8.1 and the S&P 500 index was at 104.70. Ten years later, the S&P 500 index was 338.46, a 3-fold increase. However, in March, 1980 the 10-year interest rate was 12.75% and $104.7 invested in this would have compounded to $347.63 by March 1990. Clearly the stocks were undervalued by 50% according to Shiller’s P/E in 1980, but they didn’t outperform the bonds by a huge margin over the next 10 years.

Today, 10 year bonds yield only 2.4% whereas the cyclically adjusted earnings yield is close to 5%. Historically, when the cyclically adjusted earnings yield is 2-3 percentage points above the 10-year treasury yields, the S&P 500 index returns 58% in real terms during the following 10-year period. When the earnings yield –which is the inverse of the P/E ratio – is above the long-term interest rates, companies can borrow at cheaper rates and invest it in themselves and increase profits. The real yield of 10-year bonds right now is below 1%, so these bonds will return about 10% in the next 10 years. If stocks behave the same way they did in the past, they’ll return 58%, and will beat bonds by nearly 50% over the next 10 years.

blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

10 Top Reasons For Getting Fired

The 3 Best States to Start an LLC

10 Jobs That Allow You to Travel

7 High-Paying Jobs You Can Do From Home

12 Best Cities to Shop in USA

10 Best States To Practice Medicine

The 10 Best States to Have a Business

The 12 Most Expensive Apple (AAPL) Apps in the Market

The 10 Richest Billionaires in the World

10 Biggest Kickstarter Failures

The 10 Best Places to Work At

The Top 10 of Google Inc (GOOGL)’s Most Expensive Acquisitions

13 Best Cities to Visit in South America

10 Most Expensive Works of Art of All Time

The 10 Richest Banks in the World

The 10 Best-Paying Jobs in America (2014)

7 Most Expensive Foods in the World

The World’s Top 10 Earning Authors

Five Wicked and Very Expensive Items (and Other “Stuff”) Sold on eBay

10 Biggest Celebrity Bankruptcies

The Top 10 Highest Paid CEOs in 2014

The 10 Most Expensive Real Estate Cities in America

10 Most Expensive States To Live In America

The 10 Best Airlines in the World

The 10 Best-Selling Cars in 2014

The 10 Best Industries to Invest In

The 10 Most Expensive States to Own a Car In

Top 10 Business Schools in US: 2014 Rankings

Top 20 Female Billionaires in 2014

6 Movies That You Should Watch to Better Understand The Cold War

Top 15 Best Paying Jobs for Women in 2014

Top 6 Things Rich People Do Differently Every Day

5 Retirement Mistakes To Avoid (and Einstein’s Famous Quote)

11 Smartest People in the World

6 Films About the Financial World You Need To Watch (While “The Wolf” is Not Around)

Warren Buffett and Billionaires Are Crazy About These 7 Stocks

The Top 10 States With Fastest Internet Speeds

10 Best Places to Visit in USA in August

Top 10 Cities to Visit Before You Die

Top 10 Genetically Modified Food In the US

15 Highest Grossing Movies Opening Weekend

5 Best Poker Books For Beginners

10 Strategies Hedge Funds Use to Make Huge Returns

Top 10 Fast Food Franchises to Buy

10 Best Places to Visit in Canada

Best Summer Jobs for Teachers

10 Youngest Hedge Fund Billionaires

Top 10 One Hit Wonders of the 90s

Fastest Growing Cities In America

Top 10 U.S. Cities for Freelancers

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!