Expected Return

Expected return is a function of the point on the value curve at which you buy an equity index. If you buy the S&P 500 index at a PE of 40, you probably shouldn’t expect an exceptional return. We sit now with an estimated forward PE of just above 19. as the Credit Suisse chart below shows, hopes can be high, but one should not expect much.

FWD PE.png

This chart shows data from 1964 and validates the statements above. When you buy stocks at dear levels, you pay the price in low expected returns. The earning yield, of the EP ratio gives us 5.1%. This is not unlike the 10 year annualized returns seen above.  So, you say, that bonds are not cheap either. This is a fair point, and correlations in a downward move could prove high. Alternatives like long/short, market neutral or commodity-linked funds may be worth looking into if you follow this line of thought.

 

Source: WSJ Daily Shot, WSJ, Credit Suisse

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