Chris Brightman CIO of Research Affiliates explains how his firms uses stock market valuations to project long term future returns. Brightman says the best returns over the next 10 years will most likely come from emerging market equities, places like China, Russia and Brazil, where valuations look much more attractive than US stocks. Brightman utilizes the Shiller P/E, which uses ten years’ worth of earnings as the denominator, in order to predict future returns. Many emerging markets have Shiller P/Es in the 8 to 10 range, while in the US, the Shiller P/E is much higher. He expects real returns for emerging market equities to be around 7-8% per annum, whereas in the US, his firm is projecting 1-2% annual real equity returns and  a zero return for US fixed income over the next 10 years.

Given Brightman’s long term return expectations, he says that today valuations in non-US stocks offer investors a “wonderful opportunity” to increase their international exposure if they are comfortable with the added level of risk inherent in stocks of companies located outside the US.