Further to my recent post (see The ABCs of financial planning), I promised that I would write about how to forecast stock prices. First, I want to put together my analytical platform. There is no way to anticipate the price tag on stocks and bonds over another few days or weeks. Nonetheless it is quite possible to foresee the broad span of these prices over longer periods, like the next three to five years.
These findings, which might appear both surprising and contradictory, were analyzed and created by this 12 months’s Laureates, Eugene Fama, Lars Peter Hansen and Robert Shiller. Quite simply, aiming to call the currency markets in the short term is very difficult work, but calling it long-term is relatively easy. However, there’s a right way and an incorrect way to forecast long-run equity market returns. Robert Shiller is well-known for his analysis showing that long-term stock real returns, i.e. after inflation, to be 7%. With CPI at 1.5%, the long-term stock earnings should be 8.5%, right?
There are a number of issues with that approach. First of all, will you live long enough or be patient enough to see those types of returns? The long-term chart below shows periods when the currency markets have been in multi-decade range-bound episodes. If you’re in another of those periods, your comes back may be subpar for an extremely long, very long time.
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