The Retirement Apocalypse Looms

Sunday, February 25, 2018
By Paul Martin

by John Coumarianos via,
Sun, 02/25/2018

Financial Advisor Larry Swedroe recently wrote an essay called “The Four Horsemen of the Retirement Apocalypse” that should be required reading for anyone embarking on retirement and all advisors helping retirees. Basically, retirees, whether they and their advisors realize it or not, are staring four problems squarely in the face: historically high stock valuations, low bond yields, increased longevity, and increasingly expensive health care.

Low prospective returns, big prospective expenses

First stock valuations are high. The best gauge of the stock market’s valuation is the Shiller PE – current price relative to the past decade’s worth of real, average earnings. This is also called the “CAPE” or cyclically adjusted PE since it relies on a full decade’s, or what should be an economic cycle’s, worth of earnings. Its long-term average is under 17, and it’s currently over 30.

It has admittedly been over 20 for most of the past quarter-century, which means the average may be creeping up. After all, the today’s economy is different from the one in, say, the late 1920’s when electric utilities were the hot technology stocks. But, if there is a new normal, it’s likely not over 20.

A low-30s CAPE means a likely future real return of around 3% or a nominal return of around 5% from U.S. stocks. That’s decidedly subpar, or below, the 10% many advisors quote to their clients. Stocks have returned 10% or so over the last century, but they have endured periods of low returns such as from the mid-1960s to the early 1980s. Given the current valuation, it’s difficult to envision a stellar period for stock returns.

Let’s move from Swedroe to Jack Bogle for a moment. Bogle has another way of looking at stocks. Take the current dividend yield – around 2% — and add historical earnings-per-share growth – 4%-5%. That gets you to 6% or 7%. But then Bogle demands a speculative component to the valuation, which consists of estimating the future P/E ratio. Bogle thinks it’s wiser for investors to assume it will be meaningfully lower than it is today. All of this means stocks will likely produce a 4% real return, according to Bogle – only slightly higher than Swedroe’s 3% estimate.

Any way you look at stocks, it’s difficult to get anywhere near their long-term historical 6%-7% real return or 10% nominal return for the next decade.
Only heroic growth and/or valuation assumptions get you there. Stocks can stay at a Shiller PE of above 30; anything is possible. But nobody should be baking that into their retirement assumptions.

The Rest…HERE

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