What Do Past Stock Market Returns Tell Us About the Future?

Reichenstein, William
July 2002
Journal of Financial Planning;Jul2002, Vol. 15 Issue 7, p72
Academic Journal
This article presents a study which examined the reasons of most scholars for believing that long-run real stock returns will be below historic levels and the equity risk premium will be below historic averages and perhaps negative. These return forecasts come from two models. The good news is that the dividends model, which usually produces the most pessimistic forecasts, is faulty. However, the earnings model also predicts that future returns will be below historic levels. The bottom line is that there is theoretical and empirical support for the scholars' consensus view that forward-looking real stock returns and equity risk premium will be below historic levels. Differences in specific predictions usually can be traced to differences in predictions of specific components of the earnings equation. This framework should prove helpful in reducing the range of forecasts at a given financial planning firm. Financial planners should try to adjust investors' return expectations. Most individuals need to save much more to meet a given retirement lifestyle and some retirees must reduce their annual expenditures. Individuals should minimize investment expenses. By reducing expenses, including taxes, investors can reap a larger share of the reduced market returns.


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