- The average of S&P 500 for Dec-2019 was 3166; that is 852 (i.e. 27% of 3166) above the Jan-2020 level of the long-term trend line.
- The Shiller Cyclically Adjusted Price to Earnings Ratio (CAPE) is at a relatively high level of 30.1, and the 35-year moving average (MA35) of the CAPE is at 24.2.
- The CAPE-MA35 ratio is 1.25, forecasting a 10-year annualized real return of 5.9%.
- Investing in equities for the long-haul when the CAPE-MA35 ratio is below 1.30 should produce reasonable returns, as this level of the ratio does not indicate an abnormally overvalued market.

This is a follow-up article to Estimating Forward 10-Year Stock Market Returns using the Shiller CAPE Ratio and its 35-Year Moving Average, which is referred to as the “referenced article” further down.

Since March 2009 the S&P 500 with dividends has gained a real 320% to December 2019. So what further gains can we expect, if any?

### Will the bull market continue?

Nobody knows, and the best we can do is to use the historic data (which is from Shiller’s S&P series) to guide us to make estimates for the future. From the real price of the S&P-Composite with dividends re-invested (S&P-real) one finds that the best-fit line from 1871 onward is a straight line when plotted to a semi-log scale. There is no reason to believe that this long-term trend of S&P-real will be interrupted. S&P-real, updated to end of Dec 2019, and the best fit line together with its 95% prediction bands are shown in Figure-1. (See appendix A for the equation.)

The current level of the S&P-real is above the long-term trend line, and a reversal to the mean trend would entail a 27% decline over a short period.

### Forecasting 10-year stock market returns with the CAPE-MA35 Ratio

Also shown in Figure-1 are the CAPE (which is the S&P-real divided by the average of the real earnings over the preceding 10 years) and its 35-year moving average, having end of June values of 30.1 and 24.2, respectively.

As discussed in the referenced article, a superior method to the standard use of the Shiller CAPE-ratio is to predict 10-year real returns using the CAPE-MA35 ratio as a valuation measure, which is simply the value of the Shiller CAPE-ratio divided by the corresponding value of its 35-year moving average (30.1 / 24.2 = 1.25).

Currently, for the 10-year period to Dec-2029, the CAPE-MA35 ratio of 1.25 forecasts an annualized real return of 5.9%. For the S&P-real referenced to the current S&P 500 value this would indicating a Dec-2029 value of 5622, with upper and lower confidence values of 6400 and 4900, respectively, all as shown in Figures-2 and -3.

### Forecasting of returns with the long-term trend

When extending the best fit line and the prediction bands to 2030 (Figure-3) it enables us to estimate the change of S&P-real from the current level of 3166. In Jan-2020 the value of S&P-real as indicated by the best fit line would be at 2314, about 27% lower than where it is now. In Dec-2029, the value of S&P-real should be about 4360, while the highest and lowest values shown by the prediction bands would be 8420 and 2260, respectively.

Thus the historic trend forecasts a probable gain of about 38% for S&P-real to Dec-2029. The worst scenario would be a possible loss of about 35%, and the best outcome could be a 160% gain from the current level.

### Conclusion

The current relatively high CAPE ratio of 30.1 and the elevated level of S&P-real relative to its long-term trend line suggest that the S&P 500 could decline over the shorter term. However, the current CAPE-MA35 ratio of 1.25 still forecasts reasonably good 10-year forward returns for the stock market.

Large drawdowns are always possible during a 10-year look-ahead period. Investments can be protected by following signals from various market-timing models at iMarketSignals. It is also important to know when a recession is looming, because stocks usually do poorly during recession periods. Our Business Cycle Index should provide early warning of an oncoming recession.

### Appendix A

The best fit line and prediction band were calculated from monthly data from Jan-1871 to July-2012. The SP-real values for the period after July-2012 are “out of sample” and were not included in the regression analysis.

The equation of the best fit line is y = 10^{(ax+b)} ^{ }

y = is the dependent variable of the best fit line.

x = are the number of months from January 1871 onwards.

a = 0.0023112648

b = 2.02423522

Excellent! Thank you, sir.