US Stocks: Set the Bar Low or Look for Value Elsewhere

Gone are the days where investors and savers alike can expect 5-6% real returns on US equities without taking excessive amounts of risk. In fact, many investors might agree that finding value in domestic equity markets has become increasingly difficult. At current valuations, many institutions are lowering their expectations based on the current macroeconomic outlook and it doesn’t look that great for US stocks overall. Below is a chart compiled by Research Affiliates that graphs the next 10-year expected returns on global equities including US equities (in red), emerging markets (in green), and European and far eastern markets (in blue) based on real returns and forward-looking volatility. This chart speaks volumes as to why investors need to rethink their expectations for higher returns over the next 7-10 years and why it may be important to consider searching for value elsewhere going forward.
Although the clear distinction of future expected returns between US equities and emerging markets is quite a revelation unto itself, the chart at first glance is a little noisy. An extra step can be taken in order to understand the relevance of these projections by effectively calculating the risk-adjusted return of all the equities in this graph using the Sharpe ratio. Listed in descending order (see table below), the results are quite eye-opening given that the higher (or lower) the Sharpe ratio, the greater (or lesser) the risk-adjusted return. For those interested in the math, here’s how it is calculated:

This post was published at FinancialSense on 04/03/2017.