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By Jeremy Glaser | 01-03-2014 03:00 PM

Sharpen Your Portfolio Plan for 2014 and Beyond

Roundtable Report: At the outset of 2014, Morningstar strategists dig into the market's current valuation and expected return, seek out high-quality U.S. and foreign stock opportunities, size up the role of cash today, assess the Fed's impact on the market, and reveal the best ways to fight inflation.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

Investors enjoyed a more than 30% return in the stock market in 2013. I'm here today with four Morningstar newsletter editors to see if any major changes are needed to portfolios for the New Year.

I'm joined today by Sam Lee, the editor of Morningstar ETFInvestor; Russ Kinnel, director of mutual fund research and also the editor of Morningstar FundInvestor; Josh Peters, our director of equity-income strategy and editor of Morningstar DividendInvestor; and Matt Coffina, the editor of Morningstar StockInvestor.

Gentlemen, thanks for joining me today.

As we enter 2014, the biggest question all of you were probably asked over the holidays by friends and family is, after this 30% run in the S&P 500, are U.S. equities just incredibly overvalued? Is this a time that people really should be cutting and running?

Matt Coffina: I don't think the market as a whole is all that overvalued. If you look across Morningstar's coverage universe, the median stock is trading at about a 4% premium to our fair value estimate, which actually hasn't changed that much since the beginning of the year. And the S&P as a whole is trading at about 18 times trailing operating earnings, which is high by historical standards if you look over the past 100 years, but it's basically in line with the average of the past 25 years or so, when multiples have been higher relative to the prior 75 years.

That said, I think there certainly aren't the same level of opportunities we saw several years ago. To a certain extent, I think investors have become spoiled by the great valuations that were available in 2008-2009 and even into 2010 through 2012. Right now, we are looking at a much more fairly valued market, which I think over the long run can still deliver total returns after inflation that are somewhere in the neighborhood of 4% to 5.5% a year, which would be a little bit below historical standards. Historically the S&P has returned more like 6.5% a year after inflation. But it's still far better than you are going to do with bonds yielding 3%.

Glaser: Does that range of returns makes sense to all of you, or do you have a different thought?

Sam Lee: I'm on the lower end of the camp. I think 4% is reasonable. That kind of makes me a black sheep at Morningstar, but I'll explain why.

I think, historically, per-share real earnings have generally grown at a rate of about 1.52% per annum over the past 100 years, and right now the S&P 500 yield is about 2%. So if you add in maybe 0.5% for net share buybacks, you're looking at about a 4% real return.

I think a lot of the return that has come over the past 30 years is because interest rates have collapsed, so discount rates have collapsed, and therefore stock price/earnings multiples have collapsed. So lot of the returns that we have experienced over the past 30 years is sort of due to one-off capital gains due to this compressing discount rate, and I don't think investors can rely on that. I think that will actually be a headwind going forward, because when interest rates rise, the market is going to discount future cash flows at a higher rate, therefore making it less valuable today.

Josh Peters: I feel odd being cast here in the role of optimist relative to some, … It's very true. The rise in the P/E multiple of the S&P 500 last year accounted for more than half of the total return. That was a big change. But I don't think we ever got in the post-'08 and '09 environment to the point where those super-low interest rates were really being discounted in the equity market. They certainly we are in the bond market, where everything just trades mechanically off of benchmark yields like the 10-year.

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