Antti Ilmanen, a quant from the AQR group (and author of the excellent book Expected Returns), makes the point succinctly in the attached graph. What does the line show? Mr Ilmanen's definition is that
The "60/40 expected real return" is the forward-looking long-run real return of a 60/40 U.S. stock/bond portfolio. Stocks' forward-looking real return is proxied by an average of two measures: (i) smoothed earnings yield, or the inverse of the Shiller P/E and (II) the sum of dividend yield and 1.5% (a proxy for long-run growth rate in earnings per share). Bonds' real yield is the difference of the 10-year Treasury yield and a measure of expected inflation over the next decade. Inflation expectations are proxied by an average of several survey forecasts; before these became available in 1978, statistical estimates are used.
As you can see, the outlook for expected returns is as low as it has been in more than a century, with real US returns likely to be 2.3% a year. Overaggressive pension funds (and endowments) beware!
Two points are crucial. The first is the inverse relationship between starting valuations and likely future returns; when valuations are high, future returns are low and vice versa. The second is a point I have been emphasising for years. While equities can be cheap or dear relative to bonds, the level of bond yields is a useful signalling mechanism for investors. High nominal bond yields are a sign that investors expect the future level of short rates and nominal growth to be high; high real rates give the same message about real growth. Low rates imply low growth expectations. Yes, bond yields have been manipulated downwards by central banks but central banks have indulged in these operations because they fear the growth outlook is weak. That has an implication for profits growth.
Admittedly, there is a very weak relationship between GDP growth and equity returns. But that seems to be because growth expectations are priced into markets; equities in weak economies are underpriced. That brings us back to the starting valuation level, which is still too high in the US (see the Shiller p/e, or indeed the dividend yield.)