Some readers argue that Jack Bogle's 7% equity return forecast is too sunny.
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By Christine Benz | 10-30-11 | 06:00 AM | Email Article

In a recent interview at the annual Bogleheads conference, I asked Vanguard founder Jack Bogle to share his outlook for stock and bond returns over the next decade, figures that he arrives at by using a very commonsensical approach.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

Assuming a 2%-plus dividend yield, earnings growth rates of 5% or 6%, and current P/E ratios, Bogle said it's reasonable to expect stock market returns in the range of 7%. Bogle, like many market watchers, is less sanguine about bond-market returns, noting that currently meager Treasury yields predict similarly meager future returns. He noted, however, that investors can reasonably increase their fixed-income returns by taking on slightly more interest-rate and/or credit-quality risk with a component of their bond portfolios.

With that forecast still fresh, I asked users to weigh in on what sort of return forecasts they're using for their own portfolios. Given that many Morningstar.com readers focus on bottom-up security selection more than broad-market forecasting, it wasn't surprising that a healthy contingent responded to my query with a "Who knows?" But other posters weighed in with their views, some aligning with Bogle and others arguing that stock returns will be richer or poorer than the 7% Bogle anticipates. To read the complete thread or share your own market forecast, click here.

'He Has Been Right in the Past'
Several posters put a fair amount of weight on Bogle's forecasts, in part because his track record is pretty darn good. (He correctly anticipated the robust market gains that prevailed in the 1990s as well as the feeble returns of the previous decade.)

LarryGo aligns with Bogle's stock-market predictions, in part because of the indexing guru's past track record and also because they sync up with his views on the economy. "I would trust Mr. Bogle's forecast. He has been right in the past. U.S. stocks are pretty much where they were about 10 years ago, and maybe it's because they had been excessively run up in the '90s. U.S. corporations are today sitting on over a trillion dollars in cash, and are very lean. There will be a drag in the U.S. economy because of the debt burden of the Western economies; however, this will be offset by growth in the global economy. Plus, insiders have been buying U.S. stocks, which is a good indication that stocks are under- or fairly valued."

Counterpoint's estimates for equity-market returns are in the same ballpark as Bogle's, but with the potential for an "upside surprise." "I budget 7% for stocks but I think there is a greater chance of a positive surprise than a negative one. Better to plan reasonably and be pleasantly surprised."

Academic noted that other wise market forecasters are anticipating returns in the same general ballpark as Bogle's. "The latest projections from Jeremy Grantham at GMO for seven-year annualized returns are +5.6% nominal (3.1 % real) returns for U.S. large-cap stocks and +1.3% nominal (-1.2% real) returns for U.S. bonds. This is quite similar to Bogle. John Hussmann comes to similar conclusions. These three are smarter and have thought a lot more about this than me. So I'll be completely unoriginal and project 6% nominal for U.S. stocks, and 2% nominal for U.S. investment-grade bonds over the next 10 years."

DaveD82 looks to a model developed by Richard Grinold and Kenneth Kroner, writing, "I think the Grinold and Kroner model holds some validity for broad market equity return expectations:

Expected Returns = Dividend Yield + Real Earnings Growth + Inflation + Change in shares + Change in P/E Multiple

~ 2% + 3-5% + 2-3% + ? + ?

Without making more broad assumptions than one needs to, you could expect 7%-10% annualized returns."

Nittwit, while noting that the stock and bond market returns don't lend themselves to the mathematical modeling one needs to develop a forecast, wrote, "In this case equity markets are likely to earn more than the bond markets over a long (3 years or longer) time. So I will use Jack Bogle's 7% equity and 2%-3% bond returns. I will not cry if the markets don't yield his predictions; Mr. Bogle has done all investors a great service with his invention of index funds and pushing of low-cost investing."

'Large Lumpy Ups and Downs'
Other posters, meanwhile, varied significantly from Bogle in their outlooks for equity-market returns.

Tricepz3 was a rare poster who's operating with a truly bullish forecast, noting, "I believe after the 'Lost Decade' we have experienced with equity returns well below the historic average, the S&P will return 10%-12% over the next 10 years, with current decent yields and low expectations. The beginning of the next great bull market is somewhere just over the horizon. Most balance sheets are pretty solid, many companies are bursting with cash, costs are leaner and meaner than ever. After the 1987 crash, John Templeton predicted that America's GDP would be 64 times what it was then within forty years. Mr. Templeton was no wild eyed radical."

Yet a larger contingent of posters was less sanguine, with forecasts ranging from cautious to downright bearish.

Capecod wrote, "I estimate that stock indices will likely return an average of 5-7%-- in large lumpy ups and downs."

JohnCo, too, is less optimistic than Bogle, though he agrees that Shiller P/E, which Bogle used to anchor his predictions, is a valid starting point. "The Shiller P/E (on which Bogle was basing his remarks) has quite a good record of predicting the annualized return of the index for the next decade, but not a good record for predicting one or two years' worth of returns. Now, I happen to think Bogle's 7% is a bit optimistic with the Shiller P/E up around 20x now."

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