In order to rationally develop an investment plan you need to estimate long-term returns for the asset classes in which to invest – without doing so you cannot determine how much to allocate to risky stocks and how much to safer bonds.
When estimating returns we know that current valuations provide valuable information. As good as any methodology we have is to use the earnings yield derived from the Shiller CAPE 10. The research shows that valuation metrics such as this explain about 40 percent of real (after inflation) 10-year returns. However, it’s also important to note a Vanguard study found that the estimated historical correlations of the various valuation metrics they looked at with the 1-year-ahead return were close to zero. In other words, short-term forecasts aren’t worth anything.
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