Should you be buying shares on the cheap as the market tumbles, or selling out and stashing your funds in cash? Will this market volatility subside – and the peaceful days of gently advancing share prices return?

It hinges on the long-term outlook for the Aussie market and expected returns over the next one to five years.

CompareShares subscribers have been asking us for our views on the 1 to 5 year outlook for the Aussie bourse, so in response to your questions – we approached five leading economists and academics for their valuable insights into what we can expect in the road ahead.

Craig James, chief equities economist, CommSec

CommSec’s chief equities economist, Craig James states that the sharemarkets two main drivers are fear and greed, and at the moment, fear of what could happen if the US goes into recession is impacting returns at home.

But James argues that this fear is unfounded and economists who tip that Australia will follow the US into recession are wrong. He believes that investors will soon return to basing their outlook on solid financial and economic factors as opposed to sentiment, or fear.

According to James, the chief drivers over the next two to five years will be the industrialisation of China and India and a migration-propelled population growth in Australia. He predicts that the local sharemarket will continue to outperform international (MSCI) sharemarket returns because Australia is one of the key beneficiaries of the China’s industrialisation.

The biggest risks on the horizon that could dent forecasts somewhat are further skeletons to emerge from the subprime closet and a downturn in the Chinese economy.

Noting that volatility is starting to decline, James tips that the level of the S&P/ASX 200 will continue to climb; in 12 months to 6350, in two years to 7000 and in five years to 7600.

Professor Fariborz Moshirian, Professor of Finance, Australian School of Business at the UNSW and editor, Journal of Banking and Finance, School of Banking and Finance

Professor Fariborz Moshirian forecasts a moderate increase in the Australian sharemarket over the next few years. He anticipates that the US economy will recover by the second part of 2008. “Through this subprime crisis we have learned from our mistakes and will re-regulate the market in such a way that future crises like these are prevented,” says Moshirian.

According to Moshirian, the chief drivers over the next five years for the local bourse are increasing prosperity in China and India (by 2025 China will represent 40-45% of GDP of the world’s economy each year and Australia will be one of the main beneficiaries), the lifting of the drought and the end of the US credit crunch. Moshirian backs stocks in the resource sector, agriculture, banking and related industries.

The present volatility in the sharemarket is simply a reflection of international events and will remain as long as bad news continues overseas, says Moshirian.

Projecting ahead he expects share prices to move into double digits in the next six to 12 months and is optimistic about continued growth. The biggest risks on the horizon are continued turmoil on the international scene.

Ross Guest, Professor of Economics, Griffith University

Professor of Economics at Griffith University, Ross Guest expects that this time next year the All Ordinaries Index will be back to where it was prior to when the sub-prime crisis hit last November.

Over the next five years he believes the major drivers for the Australian sharemarket will be the growth of China and towards the end of this period, India.

The big factors to impact this rosy outlook are rising oil prices, and a glitch in China’s growth due to inflationary pressures and labour crisis courtesy of its one child policy.

Economically, Guest believes that the re-regulation of the labour market under the Labor Government is a negative stgelopment. “Labour won’t flow as easily and on average wage costs will rise, which will add up to a slow down in the growth in the economy and be reflected in share prices”.

His second concern is that new infrastructure will not keep pace with rising demands, hampering the flow of goods and services to overseas markets.

But Guest anticipates that the local market will outperform international markets. However, he does not see it performing as well as it has over the last few years.

His “best guess” for the next two to five years is “normal sharemarket returns, which is 8% nominally, plus 1% or 2% to account for the continued resources boom”.

Associate Professor Steve Keen, School of Economics & Finance, University of Western Sydney

Steve Keen, Associate Professor at the School of Economics & Finance, University of Western Sydney sees the S&P/ASX 200 on a long-term downward spiral, maintaining that the “gravy days for traders is over”.

He takes his point of reference by comparing asset prices to consumer prices. Dividing the share index by the CPI he explains “you’re effectively getting the real valuation of shares by deflating the index by the CPI”.

In 1987 the All Ordinaries deflated by the CPI reached a peak of 27.1…a few days later it was down to 13.5. At the end of last year we peaked at 43…and we’re currently at 32. (Steve Keen is writing a separate piece for CompareShares on his analysis in next Monday’s newsletter)

“If you do that for the US market you get a truly horrifying view of what is likely to happen to American shares. When you do it for Australia you still get a pretty worrying view,” he says.

Referring to the past ten years or so as the biggest asset bubble in world financial history, Keen says that the implication for the US stockmarket is a 75% fall and for the Australian stockmarket a 50% fall.

The culprit is “the level of leverage we have got caught up in”. According to Keen, debt caused asset prices to reach the levels that they are today and will continue to be the main driver of the stockmarket.

His projection for the level of the S&P/ASX 200 is 5000 in 12 months, 4000 in two years and 3500 in five years.

David Cassidy, Chief Investment Strategist, UBS

David Cassidy, Chief Investment Strategist, UBS is relatively positive on the prospects for the Australian sharemarket. “Valuations look reasonable,” he says. “However I don’t think we’re likely to see the sorts of returns we have experienced over the last three to five years.”

Cassidy’s confidence over the medium to long term is based on fairly conservative valuations for the Aussie bourse; price earnings ratios, dividend yields and valuations relative to long-term bond rates are all looking reasonably attractive.

A question mark, he says, hangs over the sustainability or growth potential of the corporate profit cycle – both globally and domestically.

Cassidy notes that currently we are at an inflexion point cyclically. He predicts a sharp slowdown in global profitability and to some extent domestic profitability over the next six to 12 months.

In the one to five year timeframe he sees “reasonable” prospects for corporate profitability both globally and domestically but nothing to equal the growth over the last three to five years.

He believes that the Australian sharemarket will underperform international sharemarket returns. “Ultimately there is probably more upside potential in global shares”.

“Also, I would expect the trend for the Australian dollar in two to five years is probably down. In addition, when you look at the corporate profitability situation there is probably more juice to be squeezed out of the orange globally than there is domestically.”

Cassidy predicts an above average capital gain on a 12-month basis (a normal return being about 6%). He forecasts a 10% capital gain over the next 12 months. Moving out three to five years, he foresees this normalising back to 6%.