What's in store for stocks

Instead of trying to guess, here's a simple math equation that you can trust.

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By William J. Bernstein, Money Magazine

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William J. Bernstein is co-founder of Efficient Frontier Advisors and author of "The Four Pillars of Investing" and "A Splendid Exchange."
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(Money Magazine) -- The rally that began in March may have marked the start of a powerful new bull market. But precious few strategists called it -- just as few foresaw back in 1999 what a lousy decade this would be for stocks.

Rather than trying to predict the market's short-run moves, your time would be better spent setting realistic long-term expectations. And when it comes to long-run forecasts, there is one prognosticator who gets it generally right most of the time. And I guarantee you've never heard his name: Myron J. Gordon.

Professor Gordon is an economist who, as far as I know, has never ventured a public guess about the direction of equities. He doesn't have to. The simple formula he derived about half a century ago has been helping investors get a feel for the basic trajectory of stocks for years.

Gordon's equation states that annual equity returns should equal dividend yields plus the long-term annual growth rate of those payouts. Over the past 80 years, dividend growth has been a remarkably good proxy for stock-price appreciation, which makes sense since both are tied to earnings growth.

Since the S&P yields 2.2%, and its historic dividend growth rate is 4.3%, stocks are likely to produce a modest 6.5% return going forward.

A word of caution: Gordon's equation doesn't claim to predict moves in the market in the next month or year. This is a long-term indicator -- but one that you'll be far better off relying on than listening to the 24-hour financial news chatter.

In the 20th century, the equation forecast that stocks would return nearly 9% -- just shy of the S&P's 9.7% average annual gains since 1926. In the late '90s, soaring stock prices drove the S&P dividend yield down to 1.1%. While most forecasters assumed this momentum would continue, Gordon's equation predicted meager returns, though it underestimated just how poorly stocks would do.

Still, in a world where investors tend to lose their heads, shifting from irrational exuberance to absolute terror, this equation is the collar that will help you keep yours firmly attached to your neck.

William J. Bernstein is a co-founder of Efficient Frontier Advisors and the author of "The Four Pillars of Investing" and "The Investor's Manifesto."

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