(FROM THE WALL STREET JOURNAL 5/26/15)
By E.S. Browning
If David Kostin's calculations are right, the fizz is out of the
stock market's Champagne.
Mr. Kostin, Goldman Sachs Group Inc.'s chief U.S. stock
strategist, last week forecast no price gain at all for the S&P
500 over the next 12 months, with the index's only return coming
from dividends. For the coming 10 years he projected just 5% yearly
total returns, with nearly half from dividends. That means the
index value would rise only about 2.7% a year for a decade.
Many money managers say he is a little on the pessimistic side,
but they widely agree that future U.S. stock gains probably will be
limited, simply because stocks have gotten so expensive.
"We, too, think that investors should temper their enthusiasm
for stock returns. They will be mid-to-high single digits and not
the double digits we have all enjoyed historically," said Lori
Heinel, chief portfolio strategist at State Street Global Advisors,
which oversees $2.4 trillion in Boston.
Analysts and money managers are devising ways to deal with the
problem. Many, including Ms. Heinel, are shipping money into
foreign stocks in hopes that European and Asian gains will outstrip
those in the U.S. Mr. Kostin and Nicholas Bohnsack, head of
quantitative research at Strategas Research Partners, suggest that
with dividends making up a growing share of market returns, clients
put money in stocks that can sustain high dividend yields. The
yield is the dividend payout as a percentage of the stock's
price.
"Companies that have a higher yield are outperforming recently
and also would outperform in a pullback," Mr. Bohnsack said,
although he added that Strategas isn't predicting a stock
decline.
The short term is complicated by the expected Federal Reserve
rate increase, which Goldman forecasts for September. Mr. Kostin
projects a small stock gain before rates rise, followed by a choppy
period that would leave the S&P 500 a year from now virtually
unchanged from Friday's 2126.06 close. He bases that partly on
stock behavior the last three times the Fed started raising rates,
back to the early 1990s.
For the longer term, Mr. Kostin uses a method popularized by
Nobel Prize-winning Yale economist Robert Shiller: Mr. Kostin
measures the S&P's value against its companies' average annual
per-share earnings over the previous 10 years and then looks at how
stocks have performed when that indicator was at this level in the
past.
The method isn't a strong predictor of short-term stock moves,
but it has been a good forecaster of 10-year returns, Mr. Kostin
said.
Using a modified version of Mr. Shiller's system, Mr. Kostin
calculates that the S&P 500 today stands at 23.4 times average
earnings for the past 10 years. That is well above its historical
average of about 17 times. When it has been this high in the past,
his work indicates, the average annual return from stocks has been
5% over the next 10 years. That is well below the historical
average of 9% a year, including dividends, Mr. Kostin said.
"It is a lower return than we have historically generated,
predicated on the fact we are starting at a very high initial
valuation," he said.
Based on future dividend levels projected by indicators
including the swaps market, Mr. Kostin calculates that dividends
will contribute 46% of that return. Over the past 10 years
dividends have contributed just 35% of stock returns, and since the
2009 low, less than 20%, he said. Over the past 25 years, however,
dividends have contributed 45% of returns, and Mr. Kostin forecasts
a return to that level.
If he is right, that leaves just 54% to come from S&P 500
price gains, meaning those will represent only about 2.7% a
year.
No one, of course, expects the S&P 500 simply to plod ahead
at 2.7% a year; it has never done that. What has happened
historically is that stocks keep rising until their high cost
combined with adverse economic events cause a sharp decline, after
which they recover. Mr. Kostin isn't predicting a big decline,
although he acknowledges that his average 5% annual gain could be
achieved that way.
Whatever happens in the next few years, few on Wall Street
expect a return to the performance of the past two. The S&P 500
rose 32% in 2013 and 14% in 2014, counting dividends.
Experts disagree on where best to put money in a period of weak
stock gains.
Ms. Heinel of State Street is skeptical of high-dividend stocks
because they historically do less well when rates are rising. That
is because rising bond yields make bonds more attractive compared
with dividends. She expects U.S. economic growth to improve now and
is looking for stocks that will benefit from that, notably
industrials, raw-materials producers, financials and energy stocks.
She also likes Europe and Japan.
Mr. Kostin is skeptical of foreign stocks because of the cost of
hedging against currency declines. He prefers U.S. companies "that
are returning cash to shareholders, and the Nasdaq 100 index looks
better to us than the S&P 500," he said.
He recommends a basket of 50 stocks that, as a group, have a
higher overall dividend yield than the S&P 500, a
price/earnings ratio that is lower than average and dividends that
are expected to rise faster than the index. It includes Cisco
Systems Inc., Microsoft Corp., Ford Motor Co., International
Business Machines Corp., Verizon Communications Inc., Pfizer Inc.,
International Paper Co., Valero Energy Corp., Lockheed Martin Corp.
and Regions Financial Corp.
Mr. Bohnsack of Strategas said it is important to find companies
that can generate enough revenue gains to permit them to keep both
growing and boosting dividends. His list includes CME Group,
General Mills Inc., Lockheed Martin, People's United Financial
Inc., Pfizer and Western Union Co.
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