While the flurry of forecasts out and about are focused on the coming year, or coming quarter, Rick Ferri has released his 30-year forecast. And though it does not inspire thoughts of clinking wine glasses, the returns he foresees are respectable.
The ETF advocate and fixture of the advisor lecture circuit foresees an average annual return for large-cap U.S. stocks of 7% nominally — or 5% after an assumed 2% inflation rate.
“Investors should be prepared for lower-than-average returns when asset prices are higher than average,” the RIA and head of Portfolio Solutions in Troy, Michigan, writes on his blog. “It doesn’t matter if the asset is stocks with high PE or bonds with low yield; the outcome is the same. Higher prices today mean lower long-term returns. There is no free lunch on Wall Street.”
While the financial advisor best known for his advocacy of low-cost passive indexing provides a brief table of 30-year projected returns, the most interesting part of his post is his lengthier explanation as to why he is sticking his neck out to make far-out forecasts that are likely to be wrong.
Ferri explains that as an advisor creating long-term asset allocation strategies for his clients, he has to make future risk and return assumptions. His job as an advisor requires him to match current assets to future liabilities, while controlling for risk.
“We must plan,” he puts it simply.
Yet he does so with an appreciation of the limits of human understanding. All that is known is the current asset level, requiring him to plug in estimates for “future deposits and withdrawals, asset class risk and returns, inflation, time horizon, liquidity, taxes, etc.”
Ferri also helpfully adds some key assumptions driving these estimates.
Foremost among them is the mean reversion of asset classes and the outsize influence of artificial forces — such as monetary policy, fiscal policy and other political factors — that direct capital in ways that markets would not were they completely unfettered.
Ferri does make use of government data in building his forecast, including the Federal Open Market Committee’s long-run inflation goal of 2%; and while he asserts that after-inflation real returns are all that really matter, he provides nominal returns as well since most investors are conditioned to evaluating their finances without taking inflation into account.
While current valuations — which are higher than average — are important because of mean reversion, thus implying lower future returns, Ferri also discusses earnings — the flip side of PE valuations (because higher earnings would lower the price-to-earnings ratio).
There, too, the advisor is cautious since, he writes, “corporate earnings for the economy in aggregate are roughly linked to GDP growth,” of which the FOMC has recently lowered expectations to 2% to 2.3% over the longer term.
Highlights of his table — apart from U.S. stocks mentioned above — include international stocks, which mean reversion should carry to 5.4% real, 7.4% nominal, with higher figures for small stocks, small value and higher still for emerging markets.
“Developed markets have underperformed the U.S. equity market for more than 15 years and their valuations are lower. In addition, a strong dollar, quantitative easing in Europe and Japan, and low oil prices have added to the attractiveness,” he writes.
Contrarily, mean reversion should bring down high-flying real estate investment trust values, which Ferri projects as averaging 4.8% real and 6.8% nominal over the next 30 years.
The financial advisor sees 1-month Treasury bills, 10-year Treasury notes and 30-year Treasury inflation-protected securities, respectively, as averaging 0.1% real (2.1% nominal); 1.9% (3.9%); and 2.6% (4.6%).
Ferri’s table also includes standard deviation-based risk estimates.
— Check out Brightman, Ferri Slug It Out Over Smart Beta on ThinkAdvisor.