The Lemon Fool

I was thinking about the FTSE 100 and FTSE 250 indexes recently, anyone have any thoughts on estimating returns on these going forward? I mean average over a decade or two, not short term.

Interesting question, the performance of UK markets has been mixed, the FTSE 100 is at a similar level to where it was almost 22 years ago and a total return of around 6.5% annually over the last 10 years, compared to around 11.5% for the FTSE250 and 15.5% for the S&P500.

US markets have been the leaders for the last 10 years and appear expensive, commentators suggest UK markets are cheap.

So we might see a reversal or more of the same, I don’t know but will cover both options with index funds, I personally weight the FTSE100 and 250 equally but hold far more of the US market.

Completely impossible. Nobody has the foggiest. It could be anything. Valuations here are lower than elsewhere, so returns could be better. On the other hand, valuations here are low for good reasons, so perhaps not. The markets could continue to defy gravity. On the other hand, the whole world economy could soon be wiped out. Nobody knows.

Agreed with GeoffF100
if anyone knew they could give up their day job
play the market for a week and retire with a fortune
Where's my crystal ball gone

Being able to make sensible estimates of long-run return doesn't mean that people can "play the market for a week and retire with a fortune".

The numbers I looked at (divis not prices) suggested:
ftse100: ~1%/year growth of divis and a current yield ~4%
ftse250: ~2.8%/year growth of divis and a current yield ~2.7% (or vice versa, can't remember)

If we expect more of the same, and valuations to go up and down but not change drastically, that suggests 5-5.5% / year [total return] in the long run. Obviously anything can happen in the short run.

So is 5%/year a decent estimate of future returns on the ftse 100 / 250, and if so, is that "enough"?

Edit: added "total return"

Hariseldon58 wrote:... I personally weight the FTSE100 and 250 equally but hold far more of the US market.

Equal weight between 100 and 250 seems sensible to me, personally I'm well underweight the US.

SteadyAim wrote:I was thinking about the FTSE 100 and FTSE 250 indexes recently, anyone have any thoughts on estimating returns on these going forward? I mean average over a decade or two, not short term.

Plenty of academic study here (which may be part of the problem!). Working off around 5% real total return wouldn't be far away I would think, and over a decade or two. Of course the difference in compounding at 3% and 7% (compared to each other and 5%) over 20 years is substantial, so even seemingly small errors are meaningful.

dealtn wrote:

SteadyAim wrote:I was thinking about the FTSE 100 and FTSE 250 indexes recently, anyone have any thoughts on estimating returns on these going forward? I mean average over a decade or two, not short term.

Plenty of academic study here (which may be part of the problem!). Working off around 5% real total return wouldn't be far away I would think, and over a decade or two. Of course the difference in compounding at 3% and 7% (compared to each other and 5%) over 20 years is substantial, so even seemingly small errors are meaningful.

There are very much less optimistic forecasts than that:

https://monevator.com/the-60-40-portfolio-problems/

When expected returns are as low as that, random (i.e. unpredictable) factors will dominate even more than they usually do.

GeoffF100 wrote:There are very much less optimistic forecasts than that:

https://monevator.com/the-60-40-portfolio-problems/

When expected returns are as low as that, random (i.e. unpredictable) factors will dominate even more than they usually do.

Yes that's very low, and I don't have much sympathy with an expected 1-2% real earnings growth rate. Specifically that's below expected (and historic) GDP growth. I'd need persuading that equity returns would be below economic growth in the long term (especially when equity is toward the riskier end of the investment options - and higher risk is usually aligned with higher return)*. Furthermore with dividend distributions normally < earnings, there is the additional earnings compounding at the real return rate to take into account too from retained earnings in deriving earnings growth rates.

*To be fair this is addressed in one of the links, albeit it is US based and from 2014.

dealtn wrote:Yes that's very low, and I don't have much sympathy with an expected 1-2% real earnings growth rate. Specifically that's below expected (and historic) GDP growth. I'd need persuading that equity returns would be below economic growth in the long term ...

[ Isn't UK gdp growth about 2%? And maybe declining? 1-2% real doesn't seem that crazy to me?? Obv we'd hope for more from the foreign part of the ftse ... ]

I was a bit surprised that divi growth appeared so low in the FTSE 250. Back in the Fool UK days of 2000 or whatever we learned that we could use (inflation+growth) as a guesstimate for growth. Back then the previous 20/30 years had a whole range of inflation and cheap ETFs were new so it was harder to assess past real growth. Now, we have ~25 years of the MPC controlling inflation [or trying to] so we can just call it 2% and be fairly close without even looking up the numbers*. We can also just look at the record of ISF, MIDD, etc to see what divis they've paid.If we assume 2% growth and 2% inflation that would be 4% growth, and we'd perhaps expect that the 100 would be a bit less than that, and the 250 a bit more. Well growth in ftse 100 divis was lower than the 250, but both were lower than that 4% figure

So it seems the ftse 100/250 (measured by divi payouts) are getting smaller compared to the UK economy? Need to think about what that means. Are divis a poor measure? Are the foreign parts of the companies in the index reducing returns rather than enhancing them? Some other thing(s)?

* hmmm, perhaps I should look up the actual inflation numbers! And gdp growth.

The stock market does not necessarily grow at inflation+growth. Share holders do not necessarily receive their share of economic growth, and taxes may increase.

Global stock market valuations are at an unprecedentedly high level. If valuations return to the historical average, prices will fall, even if company earnings grow. An increase in long term interest rates could cause that to happen.

dealtn wrote:
Yes that's very low, and I don't have much sympathy with an expected 1-2% real earnings growth rate. Specifically that's below expected (and historic) GDP growth....

Indeed, but it is trying to factor in the historical trend that following an extended period when returns have exceeded GDP growth (i.e. now), then historically, sooner or later, there is a period where they revert to mean and hence underperform GDP growth. At least, that is how I understood the reasoning.

Edit: what Geoff said.....

NotSure wrote:

dealtn wrote:
Yes that's very low, and I don't have much sympathy with an expected 1-2% real earnings growth rate. Specifically that's below expected (and historic) GDP growth....

Indeed, but it is trying to factor in the historical trend that following an extended period when returns have exceeded GDP growth (i.e. now), then historically, sooner or later, there is a period where they revert to mean and hence underperform GDP growth. At least, that is how I understood the reasoning.

Edit: what Geoff said.....

What extended period of FTSE Total Returns exceeding GDP growth are you referring to please?

dealtn wrote:
What extended period of FTSE Total Returns exceeding GDP growth are you referring to please?

Good point. Well made .

Apologies, I was drawn OT by the more global discussions....

NotSure wrote:

dealtn wrote:
What extended period of FTSE Total Returns exceeding GDP growth are you referring to please?

Good point. Well made .

Apologies, I was drawn OT by the more global discussions....

To be clear I wasn't trying to be clever, just interested on any time frame of relevance as value, and potential mean reversion following a period of over/under performance would be a relevant point for consideration.

Bogle's approach was Future Market Returns = Dividend Yield + Earnings Growth +/- Change in P/E Ratio. https://awealthofcommonsense.com/2016/0 ... n-formula/
It's the Gordon equation if you want to read up more about it.

JohnW wrote:Bogle's approach was Future Market Returns = Dividend Yield + Earnings Growth +/- Change in P/E Ratio. https://awealthofcommonsense.com/2016/0 ... n-formula/
It's the Gordon equation if you want to read up more about it.

Buying back shares also returns capital to shareholders. Earnings growth is known only after the event. If we take all that into account, the equation is telling us that the share price increases by as much as it increases, which is not very helpful.

The UK market is only about 4% of the global market. It does not matter much what it does.

JohnW wrote:Bogle's approach was Future Market Returns = Dividend Yield + Earnings Growth +/- Change in P/E Ratio. https://awealthofcommonsense.com/2016/0 ... n-formula/
It's the Gordon equation if you want to read up more about it.

Yes, I guess earnings growth is more accurate, that would account for changes in divi payout ratio. Will see if I can find data on ftse 100/250 earnings over the last 20 years or so ...
I was assuming no change in p/e ratio, with the idea of adding that as a possible + or - (or neither) at the end of the calc.

GeoffF100 wrote:The UK market is only about 4% of the global market. It does not matter much what it does.

To be clear, my question was specifically about the UK market.

I suggest look at the earnings yield (inverse of P/E ratio) for real annual return in the long term, then add what you think inflation will be to estimate the nominal annual return in the long term.

FTSE 100 currently has a P/E around 16x by my estimates which is an earnings yield around 6.25%.

FTSE 250 has a P/E around 22x giving an earnings yield around 4.5%.

The FTSE 100 tends to be filled with large mature businesses which find it difficult to grow and don't reinvest their profits as effectively as medium or smaller companies.
The FTSE 250 (excluding its numerous investment trusts) tends to be filled with medium sized businesses which are growing and achieving good returns from reinvested profits. Many fallen stars of the FTSE 100 end up in the FTSE 250 while they recover (e.g. Morrisons supermarkets).

I suggest subtracting 1 - 2% real p.a. from the earnings yield of FTSE 100 and adding 1 - 2% real p.a. to the earnings yield of the FTSE 250 to reflect how effective the different company sizes are at reinvesting for growth.

So I would suggest the next 10 - 20 years are likely to see real returns around 4.25 - 5.25% for FTSE 100 and 5.5 - 6.5% for FTSE 250.