US Stocks Are a Good Bet

04/26/2010 1:00 pm EST

Focus: MARKETS

Knight Kiplinger

Editor-in-Chief, The Kiplinger Letter, Kiplinger's Personal Finance, and Kiplinger.com

Knight Kiplinger, editor-in-chief of The Kiplinger Letter, tells why he thinks much-unloved US stocks should be winners for investors in coming years.

Ready to give up investing in US stocks?

It wouldn’t be surprising, after the dismal returns of the past decade—a miserable 0% on the Standard & Poor’s 500, including dividends.

And given the sharp rebound since the bottom, racking up about an 83% gain, one might think the time to buy has passed.

Don’t. The stock market is still a good bet for long-term investors, for two solid reasons.

Reason one: History tells us so.

Since 1926, big US company stocks have returned an average of about 10% a year to investors, despite the losses sustained in periodic steep plunges, as in 2008-2009.

What’s more, since 1890, in only two ten-year spans—the one ending in the Great Depression and the one ending in what’s being called the Great Recession—has the market lost value. In one-third of the years, returns were in double digits even after inflation.

Reason two: Healthy economic growth ahead.

The outlook for an individual company’s earnings—and therefore its stock value—turns on many factors, including revenue prospects, financial condition, the competitive landscape, likely costs, and the competency of corporate management.

For the market as a whole, however, the calculus is considerably easier: Profits grow about as fast as the economy does. From 1947 through 2009, gross domestic product grew [by] an average of 8% a year; profits, 7.9%. Since 2000, a 4.3% rate for both.

So, how much will the economy grow in coming decades? Our judgment: An average of about 5% a year, with inflation accounting for less than half of the total increase and real economic gains mounting at an average of 2.75% a year.

Add in 2% for dividends—a conservative estimate—for an average 7% return on stocks. That’s high enough to quadruple the original investment in 20 years.

For a somewhat shorter horizon—say, a decade—8%-9% is a pretty safe bet. Why? Because the market is still somewhat undervalued, despite the run-up over the past year.

With the S&P 500 hovering around 1200, and operating earnings in the neighborhood of $78 expected over the coming year, the price-to-earnings ratio is a fairly skimpy 15x or so. The actual average P/E multiple since 1988 has been 19x. Excluding the frothy years of 1998 through 2000, the average still works out to be 18x.

Moreover, the stock market looks good compared with other options. Playing it safe with ten-year Treasuries will yield a mere 3.8% or so. Corporate bonds offer more risks than opportunities, as prices decline when interest rates rise. REIT prices already take into account anticipated commercial real estate improvement.

So, keep US equities in your asset mix, along with foreign stocks and bonds, commodities, and real estate. Diversification, as always, is critical to reducing risk.

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