REVERSION TO MEAN MEANS MEANER RETURNS; WARNING: STOCK GAINS COULD SLIP TO 7% A YEAR

Long-term stock returns could slow to 7% a year over the next two decades, some experts are warning. What a shock to investors used to the 17.3% over the past 10 years, and 11.2% over the past 73.

If actual returns fall below the assumed rate of return of 8%, as calculated by Watson Wyatt Worldwide, pension funds are in trouble.

Funding levels would decline, and plan sponsors would have to make up the investment return shortfall by increasing employer contributions. Also, pension plans would need to assume higher levels of risk for better returns.

Jeremy J. Siegel, a finance professor at Wharton School of the University of Pennsylvania in Philadelphia and author of “Stocks For The Long Run,” and David Brief, principal at Chicago-based Ennis Knupp & Associates, both predict that over the next 20 years, U.S. stock returns will fall below the 73-year average.

Mr. Siegel predicts an inflation-adjusted return of 5% to 7% for the stock market over the next 20 to 30 years. He predicts 30-year Treasuries will return 3%.

Mr. Brief predicts a drop in the spread between stocks and bonds and in the equity risk premium. He forecasts the same stock returns, and nominal bond returns, as measured by the Lehman Intermediate Aggregate bond index, of 5% to 6%. The indexes returned 23.4% and 7.9%, respectively, for 1998.

Meanwhile, Wilshire Associates Inc. in Santa Monica, Calif., has lowered its expectations for Standard & Poor’s 500 stock index returns to an annualized 8.75% over the next 10 years, down from 11%.

“The historical gap that has existed in the last 50 to 75 years between stocks and bonds is closing,” Mr. Siegel says.

In the long run, he believes, returns on stocks will continue to be more stable than returns on bonds. . Allocations to international stocks may help boost long-term gain, even though they carry higher risk, he says.

“I think every day is a new ball game, that’s why we think we need to look at the clues in the market today” rather than past returns, Mr. Brief says.

Mr. Brief’s strategy involves adding his predictions for overall economic growth (3%), dividend yield (2%) and inflation (2%) to come up with a 7% return for stocks. A test of his formula against historical market returns showed that it works, he says.

Stocks still a lock

Roger Ibbotson, president of Ibbotson Associates in Chicago and professor in the practice of finance at Yale School of Management, doesn’t see the gap between stocks and bonds (the 30-year Treasury has returned 5.3% on average over 73 years) narrowing soon. He’s not lowering expectations for stocks.

“I’m reluctant to say the markets are overpriced right now,” he says.

The 10 percentage-point equity premium over bonds in the past 10 years has paid off, Mr. Brief says. Those days are over, and the spread has shrunk to 1% and 2%.

Jay Kloepfer, director of capital market research at Callan Associates, says the San Francisco research and consulting firm has lowered its expectations for large-cap stocks in the next five years. “There’s no earnings out there,” he says.

Mr. Kloepfer advocates increasing international stock and decreasing domestic bonds for investors with high assumptions but who want to decrease the risk in their portfolio.

Investors will need to be more aware of the need to rebalance because of the bull market. Those with 80% stocks and 20% bonds may want to get back to a 70-30 asset mix, taking mainly from large-cap equity portfolios, Mr. Kloepfer says.

Not everyone is listening to what their consultants are saying, though.

hold the junk, thank you

The $430 million pension fund of the Board of Public Utilities in Kansas City, Kan., has rejected consultant DeMarche Associates’ recommendations to add emerging markets and junk bonds, says pension administrator George Dalton.

The fund had a good year in 1998, he says, gaining $20 million, and trustees don’t think the fund needs to assume more risk. The fund’s current asset allocation is 60% stocks, 20% bonds, 5% cash, 10% international equities and 5% real estate.

Mr. Dalton remains optimistic but does acknowledge that sooner or later the gap between stock and bond performance will narrow.

Michael Bostler, senior investment consultant at Alpha Investment Consulting in Milwaukee, says he doesn’t expect asset allocation changes, nor does he expect stocks to plummet as long as cash flows and liquidity continue.

“The more money you put into stocks, the more you will have 20 years from now,” he says. “That’s not 18.2%, but anyone that tells you 18.2% is just guessing anyway.”

Crain News Service