Vanguard: Forecasting stock returns: What signals matter, and what do they say now?

Found via The Idea Farm.

Executive summary. Some say the long-run outlook for US stocks is poor (even ‘dead’) given the backdrop of muted economic growth, already-high profit margins, elevated government debt levels, and low interest rates. Others take a rosier view, citing attractive valuations and a wide spread between stock earnings yields and Treasury bond yields as reason to anticipate US stock returns of 8%-10% annually, close to the historical average, over the next decade. Given such disparate views, which factors should investors consider when formulating expectations for stock returns? And today, what do those factors suggest is a reasonable range to expect for stock returns going forward?

We expand on previous Vanguard research in using US stock returns since 1926 to assess the predictive power of more than a dozen metrics that investors would know ahead of time. We find that many commonly cited signals have had very weak and erratic correlations with actual subsequent returns, even at long investment horizons. These poor predictors include trailing values for dividend yields and economic growth, the difference between the stock market’s earnings yield and Treasury bond yields (the so-called Fed Model), profit margins, and past stock returns.