By |Published On: April 17th, 2013|Categories: Tactical Asset Allocation Research|

We’ve outlined the fundamentals of long-term return projection models in a recent post:
http://alphaarchitect.com/2012/12/projected-15-year-sp-500-returns/

Butler|Philbrick|Gordillo and Associates have a great post that focuses on the “Shiller” or “Hussman” models for return forecasting
http://gestaltu.blogspot.com/2013/04/valuation-based-equity-market-forecasts.html

Empiritrage has a detailed report outlining a more sophisticated way of forecasting long-term returns:

HERE IS A LINK TO THE PIECE

Here is some chart porn:

First, a look at the “Hussman” model for long-term returns. This model assumes a peak-to-peak earnings growth, inputs the current P/E and div yield, and then generates low and high return bounds based on future P/Es.

hussman1


The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Another approach is to model the dynamics of revenue growth, profit margins, and valuations, and then simulate what the economy might look like under certain assumptions. The benefit of this approach is the incorporation of mean-reverting profit margins and valuation ratios directly into the model.basics

Here are some baseline results:

Empiritrage_Forecasts_2013.Q2


The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

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About the Author: Wesley Gray, PhD

Wesley Gray, PhD
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.

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Important Disclosures

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Third party information may become outdated or otherwise superseded without notice.  Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this article.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).

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