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By Christine Benz | 03-04-2011 09:56 AM

Hussman: Stocks Poised to Achieve Modest Long-Term Returns

Looking at historical growth rates, John Hussman expects the S&P 500 to return 3.5% annually during the next decade.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. I'm here at the Morningstar Ibbotson Conference and today I had the opportunity to sit down with John Hussman he runs very wide ranging portfolios and we got his opinions on a broad swath of different asset classes.

So let's talk about your long range forecast for stock returns.

John Hussman: Sure, well one of the things that we do and we have a lot of this on the Hussman Funds website in terms of the actual quantitative methods that we use and showing their historical records and so forth, is to take a look at the 10 year perspective return for the S&P 500.

If you look at S&P 500 earnings, even though there is a lot of volatility you can chart those back to the depression and you'll see that historically the peaks from cycle-to-cycle have been pretty well bounded by a 6.3% annual growth rate and that hasn't changed even during the inflation period of 70s, during World War II and during some of the smaller wars. So we've got a pretty good idea of S&P 500 earnings over the long run that they pretty well track nominal GDP, because nominal GDP has been about the same growth rate. What we can do with that is we can form these longer term projections for the S&P they are best for about seven to 10 years. And back in 2009, early 2009 stocks were priced briefly to return a little bit more than 10% annually over the decade ahead.

Benz: So if you've been a buyer then, that was a good thing.

Hussman: In hindsight that was a good thing. In the depression 10%, 12% wouldn't have worked out too well. Once stocks had dropped to the point where they were priced to deliver 10% or 12% they actually went on to lose two-thirds of their value. So even though the 7 to 10 year might have been okay, the shorter term pressures were terrible in the depression. 

There are certainly sometimes where stocks have been priced to deliver significantly beyond that. If you look at '74 and 1982, both of those points stocks were priced to achieve total returns annually about 20% compounded. So there are clearly periods where stocks have been priced to deliver enormously good returns there are periods where prices have been expected to essentially gain nothing over a decade. If you look at 2000, we had a negative 2% expected return using these same models and again these fit pretty tightly over history. And where they don't, in other words where stocks have outperformed what you would have expected, you typically find that subsequently they dramatically underperform like we saw after the 2000 peak. When stocks have underperformed what you would have expected which was the case in the decade leading up to 1974 you find that stocks have been great values and perform much better.

Right now, given the advance that we've had our expectation is that stocks are priced, the S&P broadly, is priced to achieve total returns averaging about 3.5% annually. Not a great return, but it's actually still better than it was at the 2007 peak and certainly better than it was at the 2000 bubble peak. So for long-term investors that's a consideration. The problem with valuations is that again 7 to 10 years is really the horizon over which valuations exert their effect and they don't have a lot to do with shorter term returns.

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