Low returns next decade?

Barron's gives a nice analysis of historical earnings growth and P/E ratios for US equities. The inevitable conclusion? If history is any guide we are in for low returns over the next decade, with the central value for total returns at 6%, rather than the 10% we've become accustomed to. Under these assumptions, the equity risk premium will shrink considerably, and the probability that bonds beat equities becomes significant.

See earlier discussion here and here.

Earnings for the S&P 500 were $58.55 at the end of December 2004. The long-term rate of earnings growth is 6.1%. Compounding that for 10 years gives us an estimate of $105.85 in a decade. For the high and low estimates, we used the standard deviation of earnings growth of plus or minus 2.3 percentage points. Essentially, this means that two-thirds of 10-year periods will experience annual earnings growth ranging from 3.8% to 8.4%. We can then estimate that in 2014, earnings for the S&P 500 are likely to fall in the range of $85.02 to $131.17.

Over the past 55 years, the stock market has sold at an average of 16.4 times earnings, with a standard deviation of plus or minus 7.0 times earnings. This means that a reasonable range for multiples is 9.4 times to 23.4 times earnings. Using this methodology, we can estimate the likely range of values for the S&P 500 in 10 years.

The likely range for the S&P 500 Index in 2014 would be 761.59 to 3069.14. This equates to an average return of minus 1.7% per year to plus 12.2% per year. The base case scenario calls for the S&P 500 Index to be at 1735.94, a yearly 4.1% rate of appreciation. Adding dividend income of 1.9% to the appreciation yields a total return of 6.0% per year -- something between minus 1.7% and plus 12.2% a year.