Despite the bleak economic outlook currently being reported in the news media, what is not being communicated is that the market is still high by most historical standards. Thus, we believe returns in the stock market will remain low until the market returns to a more reasonable level relative to the economy. History is the reason for expecting low returns. From 1980 to 2000 the stock market went up 13 times while the economy grew only 3 times. In the long run the stock market can only grow as fast as the economy. Even at the "low" in 2008 the market was up 8 times since 1980 while the economy grew only 4 times during that period.

How low might stocks go? Stocks are, of course, riskier than government bonds. Historically, investors have demanded a dividend yield that is 2.5% higher than the real, after inflation return on government bonds. Based on the September 2009, yield on government inflation protected bonds this implies a dividend yield of 4.5%. The yield on the S&P 500 is currently about 2.4%.

Dividends as a percent of the economy are fairly steady when averaged over the economic cycle so changes in dividend yields are primarily determined by changes in the prices of stocks. When prices go up yields fall. When prices go down yields rise. To achieve dividend yields of 4.5% requires that stock prices drop 47% from current levels, and then stay at that level. While a sustained drop in the market to that level during the next year or so is possible, the most likely scenario is that the decline will occur in the form of 10 or more years like the last 9. Since 2000, the economy and dividends have continued to grow but the Dow has fluctuated in a range between 13,000 and 8,000. This amounts to a real, after inflation loss of one half of the market's value since 2000. Even getting back to the mid point of this range, 10,500, represents a 35% loss.

Since stocks are at a high level of risk right now, an alternative is to devote the majority of ones investment to bonds. Luckily, many bonds are excellent buys at this time. It is important to realize that bonds vary widely in their risk, from ultra safe government inflation protected bonds to normal government bonds to high grade corporate bonds to ultra risky junk bonds that are even riskier than the average stock. The particular types of bonds one should buy depends on your particular situation.

Call (609) 683-8005 today for a no-obligation, complimentary consultation about creating or updating your investment strategy.