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Market Wizards: Why Buffett, Shiller Models Are Bearish On Stocks

Calculating the future direction of the stock market is a hazardous business, and even the most eminent experts are frequently wrong. Nonetheless, investors have occasion for some sense of the road ahead, and two notable figures worth heeding are billionaire investment guru Warren Buffett of Berkshire Hathaway and Nobel Laureate economist Robert Shiller of Yale University. Each has a favored carry market valuation method, both of which are followed closely by financial experts who use them to forecast market directions.

The latest forecasts, based on Buffett’s and Shiller’s methods, indicate stock market annual returns will lallygagging drastically–or even decline–over the next 10 years. The forecasts based on these methods were compiled by the respected New York economist and monetary expert, Stephen Jones, in a detailed story in MarketWatch. (See table below.)

What Market Wizards Are Telling Us

  • Buffett Fashion: -2.0% average annual decline in the index
  • Shiller Model: +2.6% average annual real total turn

Source: Economist Stephen Jones per MarketWatch

Significance For Investors

Buffett has said in the past that the ratio of the S&P 500 Ratio to U.S. GDP is “probably the best single measure of where valuations stand,” per MW. He hasn’t made recent public comments on this purport, but there is no evidence that his view has changed. For this ratio to revert to long-term historical averages gradually as surplus the next 10 years, the S&P 500 would fall by 2.0% per year.

Nonetheless, Buffett’s public statements evince he still prefers stocks to bonds right now. “If I had a choice today for a 10-year purchase of a 10-year bond at whatever it is…or purchasing the S&P 500 and holding it for 10 years, I’d buy the S&P 500 in a second,” he told CNBC recently.

Buffett is not the first person to insinuate this metric. A similar one is the Q Ratio, associated with the late James Tobin, also a Nobel laureate. Q Relationship analysis suggests that stocks will fall 0.5% per year over the next decade.

Shiller’s Position

Shiller formulated the cyclically-adjusted price/earnings ratio (CAPE), based on inflation-adjusted average earnings per share (EPS) in excess of the past 10 years. This method is supposed to smooth the passing effects of the business cycle and one-off at any rates on earnings.

While offering no specific predictions, Shiller has noted that valuations have been high dependent on to historic norms, and that low returns going forward are thus likely. Based on CAPE methodology, MW projects that genuine total returns, adjusted for inflation and including dividends, will average 2.6% annually over the next decade.

The flow

Looking Ahead

The projections offered above rest on assumptions about GDP, corporate earnings, and inflation over the next decade that could interchange dramatically–and thus alter the market’s direction.

Regarding Buffett’s favored ratio, rising GDP down the road could bolster further gains in the S&P 500. And in the case of Shiller’s CAPE ratio, if earnings grow, and inflation stays low, that may validate even greater future annual returns than 2.6%.

But the reality of today’s market–driven by slowing GDP growth and slashed profit forecasts–suggests that the frightening forecasts of these two market wizards’ models may be accurate.

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