What If U.S. Stocks Stay Expensive For Years?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
User avatar
Simplegift
Posts: 2553
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

What If U.S. Stocks Stay Expensive For Years?

Post by Simplegift » Mon Sep 11, 2017 8:53 am

Reading a recent article at Philosophical Economics this weekend, I ran across the following passage, discussing why expected returns for U.S. stocks could be lower in the future (my bold):
J. Livermore wrote:The mechanism for the lower returns, in my view, is not going to be some kind of sustained mean-reversion to old-school valuations, as the more bearishly inclined would predict. Rather, it’s going to come directly from the market’s expensiveness itself, from the fact that dividend reinvestments, buybacks and acquisitions will all be taking place at much higher prices than they did in the past. On the assumption that current valuations hold, I estimate that long-term future returns will be no more than 4% real.

To get that number, I recalculate the market’s historical prices based on what they would have been if the market had always traded at its current valuation — a CAPE range of 25 to 30. With the dividends reinvested at those higher prices, I then calculate what the historical returns would have been. The answer: 4% real, reflecting the impact of the more expensive reinvestment, which leads to fewer new shares purchased, less compounding, and a lower long-term return.
Without the math skills to reproduce Mr. Livermore’s expected 4% real return at a CAPE range of 25-30, I’ll need to take his word for it. I do share his view that U.S. stock valuations are likely to stay high for years — due to increased investor participation, low-returning alternatives and interest rates, less perceived risk — but this is the first suggestion I’ve seen that the expensiveness of the market itself (and not mean-reversion) could lead to lower future returns.

Does this way of thinking about expected returns make sense? Any math experts that can model this effect?
Cordially, Todd

AlohaJoe
Posts: 2413
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

Re: What If U.S. Stocks Stay Expensive For Years?

Post by AlohaJoe » Mon Sep 11, 2017 10:07 am

I'm not sure exactly how he calculated it but here's a back of the envelope comparison...

If we start with Bogle's model, total return = dividends + earnings growth + P/E expansion....

Mr. Livermore's model seems to get rid of the P/E expansion (since he is assuming that stocks have always traded in the 25-30 CAPE range). As an example of how you might do this...

From Shiller's data we know that in January 1881 (the first year we have CAPE10 data available) that the price was 6.19 and the CAPE10 was 18.47. What price do we need to have a CAPE10 of 25? A price of 8.37.

We get that by calculating a

Code: Select all

"New Real Price": Real Price * 25 / CAPE10
= H129 * 25 / K129
Then we need to deflate the real price back to a nominal price

Code: Select all

"New Nominal Price": New Real Price * "1881 CPI" / "2017 CPI"
= L129 / $E$1755 * E129
Back in January 1, 1881, the (annualised) dividend yield was originally 4.2%. But with our new "adjusted price" the dividend yield has fallen to 3.1%.

Repeating this up to 2017 and taking the average means the average US dividend yield drops from 4.2% to 2.4%. That's a fairly sizeable drop.

So going back to Bogle's model our back-of-the-envelope calculation is something like:

Code: Select all

Total Return = 2.4% + earnings growth + 0% (since there is no P/E expansion or contraction)
In Bogle's paper "Occam's Razor Redux" he says that historical nominal earnings growth has been 4.7%.

All up we have a total return of 7.1%. But that's in nominal terms. Subtract out average inflation, which SBBI tells me has been 2.9%. That's 4.2%.

Back-of-the-envelope seems like Mr. Livermore is probably in the right ballpark.

flyingaway
Posts: 1182
Joined: Fri Jan 17, 2014 10:19 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by flyingaway » Mon Sep 11, 2017 10:36 am

Apart from the exact number (4% real return), I think this line of thinking makes sense, which is what I have in my mind.

OTOH, 4% real is good for me. I was expecting 3% for stocks, and 0% for bonds.

User avatar
Simplegift
Posts: 2553
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Simplegift » Mon Sep 11, 2017 10:40 am

AlohaJoe wrote:
Mon Sep 11, 2017 10:07 am
Back-of-the-envelope seems like Mr. Livermore is probably in the right ballpark.
Thank you, AlohaJoe, that was just the kind of math check on Mr. Livermore’s numbers that I was hoping someone could reproduce. Your math expertise is appreciated!

In the article, Mr. Livermore goes on to suggest that the return-depressing effect of the market’s current expensiveness is likely to be amplified by the fact that more capital recycling is taking place today — more buybacks, more acquisitions, etc.. all at expensive prices — and there’s less growth-producing investment by companies. So he sees 4% as a likely ceiling on returns, not a floor or an average.
Cordially, Todd

columbia
Posts: 485
Joined: Tue Aug 27, 2013 5:30 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by columbia » Mon Sep 11, 2017 11:04 am

More reason to seek better returns elsewhere, it would seem.

alex_686
Posts: 2483
Joined: Mon Feb 09, 2015 2:39 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by alex_686 » Mon Sep 11, 2017 11:05 am

Simplegift wrote:
Mon Sep 11, 2017 10:40 am
AlohaJoe wrote:
Mon Sep 11, 2017 10:07 am
Back-of-the-envelope seems like Mr. Livermore is probably in the right ballpark.
Thank you, AlohaJoe, that was just the kind of math check on Mr. Livermore’s numbers that I was hoping someone could reproduce. Your math expertise is appreciated!

In the article, Mr. Livermore goes on to suggest that the return-depressing effect of the market’s current expensiveness is likely to be amplified by the fact that more capital recycling is taking place today — more buybacks, more acquisitions, etc.. all at expensive prices — and there’s less growth-producing investment by companies. So he sees 4% as a likely ceiling on returns, not a floor or an average.
For some math that is not on the back of the envelope check out "The Shiller CAPE Ratio: A New Look" by Jeremy J. Siegel. Link below. Summary, CAPE 10 does a decent job in predicting future returns. Plus the market does not revert to mean.

http://www.cfapubs.org/doi/pdf/10.2469/faj.v72.n3.1

thangngo
Posts: 302
Joined: Sun Feb 26, 2017 2:08 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by thangngo » Mon Sep 11, 2017 11:08 am

Yes, every book I've read stating that U.S Stocks are expensive and return for the next two decades will be lower than historical rate of return (4% vs. 8%).

I'm doing these 2 things to counter this:
1. Save even more aggressively.
2. Hope for another big crash. The bigger the better (I hope folks in retirement or near retirement have appropriate AA to withstand the fall).

lostdog
Posts: 581
Joined: Thu Feb 04, 2016 2:15 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by lostdog » Mon Sep 11, 2017 11:15 am

Not worried. Total World Stock Index for life.
"Our life is frittered away by detail. Simplify, simplify." -Thoreau | Vanguard Total World Index

alex_686
Posts: 2483
Joined: Mon Feb 09, 2015 2:39 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by alex_686 » Mon Sep 11, 2017 11:18 am

lostdog wrote:
Mon Sep 11, 2017 11:15 am
Not worried. Total World Stock Index for life.
That too is running at high multiples. I can't think of an asset class that is not near its high intrinsic valuation. So save more or chase risky yield.

chevca
Posts: 306
Joined: Wed Jul 26, 2017 11:22 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by chevca » Mon Sep 11, 2017 11:18 am

To me, it makes paying down/off debt sound pretty attractive. Maybe not full steam ahead, but a mix of paying down the mortgage and investing.

Of course, that's very situational and depends on timelines and all.

User avatar
Simplegift
Posts: 2553
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Simplegift » Mon Sep 11, 2017 1:31 pm

One aspect not always recognized is that, though U.S. companies have become more richly-valued in recent decades, they have also become much more profitable (chart below). Whether this justifies their higher valuations is hard to say — but it’s entirely possible that, yes, U.S. stocks are expensive, but not overvalued, given their increased profitability.
This chart shows cash flow return on investment (CFROI), a measure of corporate profitability that is adjusted for inflation. From 1976-1996, the average cash flow return was 5.5% — while from 1997-2016, it almost doubled to 9.1%. All the result of higher operating profit margins for U.S. companies.
Cordially, Todd

lack_ey
Posts: 5616
Joined: Wed Nov 19, 2014 11:55 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by lack_ey » Mon Sep 11, 2017 1:41 pm

Simplegift wrote:
Mon Sep 11, 2017 1:31 pm
One aspect not always recognized is that, though U.S. companies have become more richly-valued in recent decades, they have also become much more profitable (chart below). Whether this justifies their higher valuations is hard to say — but it’s entirely possible that, yes, U.S. stocks are expensive, but not overvalued, given their increased profitability.
This chart shows cash flow return on investment (CFROI), a measure of corporate profitability that is adjusted for inflation. From 1976-1996, the average cash flow return was 5.5% — while from 1997-2016, it almost doubled to 9.1%. All the result of higher operating profit margins for U.S. companies.
The high profit margins are a part of the E already. If profit margins were lower then E would be lower and thus P/E higher (unless price dropped too).


As for the initial question, it has been addressed above, but I recommend checking pages 5-7 of this paper, which goes through the economic and mathematical relations to show why some kind of earnings yield or other multiple (inverse of a P/E or CAPE) might be related to expected return:
Uncloaking Campbell and Shiller's CAPE: A Comprehensive Guide to its Construction and Use

Whakamole
Posts: 458
Joined: Wed Jan 13, 2016 9:59 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Whakamole » Mon Sep 11, 2017 1:58 pm

alex_686 wrote:
Mon Sep 11, 2017 11:18 am
lostdog wrote:
Mon Sep 11, 2017 11:15 am
Not worried. Total World Stock Index for life.
That too is running at high multiples. I can't think of an asset class that is not near its high intrinsic valuation. So save more or chase risky yield.
Cash may be the only undervalued asset. But you can't make any money with cash.

garlandwhizzer
Posts: 1604
Joined: Fri Aug 06, 2010 3:42 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by garlandwhizzer » Mon Sep 11, 2017 2:27 pm

Great post, Todd, and great comment, lack_ey. You can learn a lot on the Forum simply by reading the posts. The forecast for US market returns by Phillips and Ural (6% nominal) is close to what some others suggest (Vanguard, Swedroe, Schwab). Given low inflation, 1.5% - 2.5%, that would offer real returns of 3.5% - 4.5% which isn't great, but on the other hand allows for real portfolio growth over time. The estimates of very dismal return numbers, close to 0 real for US equities, by some (GMO, Research Affiliates) likely don't reflect what seem to me rational adjustments in the CAPE 10 forecast model (Phillips and Ural, Swedroe). A lot of wealth is concentrated in the US investment class and I believe money will continue to flow to solid investments like US equity in spite of generous valuations and lower expected returns than historical averages. Generous valuations and modest positive real returns in US equities may be with us for a long time unless a black swan appears.

Garland Whizzer

User avatar
Simplegift
Posts: 2553
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Simplegift » Mon Sep 11, 2017 2:42 pm

lack_ey wrote:
Mon Sep 11, 2017 1:41 pm
As for the initial question, it has been addressed above, but I recommend checking pages 5-7 of this paper...
Thanks, lack_ey, for the link to the study. A favorite passage from the paper (my bold):
Philips and Ural wrote:A common question that arises when working with CAPE is whether it has a steady state level. In summary, it does not: a steady state level for CAPE is approximately equivalent to a steady-state expected return for equities, and we do not know what the steady state expected return ought to be…(snip)...Investors now have ready access to low cost index funds that did not exist 40 years ago, and much of the decline in fees and expenses should rightly translate into a decline in gross expected return, or equivalently, into a persistent increase in CAPE. For these reasons, we strongly recommend that investors not compare the current level of CAPE to its 135 year average, but instead use CAPE in a regression framework to forecast future equity market returns.
Regarding their returns forecast, about 6% nominal — which, assuming a 2% Fed inflation target, lands right around the 4% real expected return in the OP.
Cordially, Todd

User avatar
celia
Posts: 6926
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: What If U.S. Stocks Stay Expensive For Years?

Post by celia » Mon Sep 11, 2017 2:48 pm

Simplegift wrote:
Mon Sep 11, 2017 8:53 am
I do share his view that U.S. stock valuations are likely to stay high for years — due to increased investor participation, low-returning alternatives and interest rates, less perceived risk — but this is the first suggestion I’ve seen that the expensiveness of the market itself (and not mean-reversion) could lead to lower future returns.
The longer that stock valuations remain high (like for 5-10 years), the more it becomes the "norm". If you re-adjust your thinking over time to the new "norm", I don't think his conclusion will hold. I don't know what will happen, but his premise (stock valuations are likely to stay high for years) wouldn't hold since the those stock valuations would no longer be "high" but "average".

This is allowing your expectations to be modified by "recency bias", just as he is doing now.

User avatar
Toons
Posts: 11912
Joined: Fri Nov 21, 2008 10:20 am
Location: Hills of Tennessee

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Toons » Mon Sep 11, 2017 3:40 pm

What If Stocks Stay Expensive For Years?

Keep investing as much as can as often as you can. :mrgreen:
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

lostdog
Posts: 581
Joined: Thu Feb 04, 2016 2:15 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by lostdog » Tue Sep 12, 2017 7:32 am

alex_686 wrote:
Mon Sep 11, 2017 11:18 am
lostdog wrote:
Mon Sep 11, 2017 11:15 am
Not worried. Total World Stock Index for life.
That too is running at high multiples. I can't think of an asset class that is not near its high intrinsic valuation. So save more or chase risky yield.
Saving more sounds better. :sharebeer
"Our life is frittered away by detail. Simplify, simplify." -Thoreau | Vanguard Total World Index

Grt2bOutdoors
Posts: 16967
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Grt2bOutdoors » Tue Sep 12, 2017 7:41 am

lostdog wrote:
Tue Sep 12, 2017 7:32 am
alex_686 wrote:
Mon Sep 11, 2017 11:18 am
lostdog wrote:
Mon Sep 11, 2017 11:15 am
Not worried. Total World Stock Index for life.
That too is running at high multiples. I can't think of an asset class that is not near its high intrinsic valuation. So save more or chase risky yield.
Saving more sounds better. :sharebeer
When you say "save more", where do you place your savings then? In the high multiple asset classes or somewhere else, like your mattress or bank account?
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

hulburt1
Posts: 232
Joined: Tue Jul 15, 2014 9:17 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by hulburt1 » Tue Sep 12, 2017 8:05 am

I think we already had the correction and didn't know it. This is different times. Be happy it all could change tomorrow. I as a retired person have tripled my IRA in 6 years. And still taking out money to live on.

Neffles
Posts: 11
Joined: Sat Apr 30, 2016 8:47 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Neffles » Tue Sep 12, 2017 8:42 am

)...Investors now have ready access to low cost index funds that did not exist 40 years ago, and much of the decline in fees and expenses should rightly translate into a decline in gross expected return, or equivalently, into a persistent increase in CAPE.
Can someone explain this to me? Is the increase in CAPE a result of more demand->higher prices via easier/cheaper investability?

alex_686
Posts: 2483
Joined: Mon Feb 09, 2015 2:39 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by alex_686 » Tue Sep 12, 2017 9:51 am

Grt2bOutdoors wrote:
Tue Sep 12, 2017 7:41 am
When you say "save more", where do you place your savings then? In the high multiple asset classes or somewhere else, like your mattress or bank account?
If you believe returns are depress across the spectrum then you keep your AA as is.

Valuethinker
Posts: 32899
Joined: Fri May 11, 2007 11:07 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Valuethinker » Tue Sep 12, 2017 10:33 am

Simplegift wrote:
Mon Sep 11, 2017 1:31 pm
One aspect not always recognized is that, though U.S. companies have become more richly-valued in recent decades, they have also become much more profitable (chart below). Whether this justifies their higher valuations is hard to say — but it’s entirely possible that, yes, U.S. stocks are expensive, but not overvalued, given their increased profitability.
This chart shows cash flow return on investment (CFROI), a measure of corporate profitability that is adjusted for inflation. From 1976-1996, the average cash flow return was 5.5% — while from 1997-2016, it almost doubled to 9.1%. All the result of higher operating profit margins for U.S. companies.
I think this is more or less what GMO has concluded.

The question is whether that higher corporate profitability can be sustained. Returns to capital have increased greatly since about 1980 v. returns to labour. It seems to be a function of:

- the "winner take all" nature of the internet w increasing returns to scale across all volumes - i.e. one Google (search engine), one Facebook (social networking portal), one Microsoft (desktop software) etc. Apple as well (ecosystem owner)

- reduced bargaining power of labour force due to: automation; outsourcing & offshoring; decline in trade union membership & power

- increased concentration of corporates in many sectors - think for example of the growth of super retailers like WalMart

Whether with the rise of more populist politics in many western countries (and not only western) this can be sustained is an interesting question.

User avatar
randomizer
Posts: 560
Joined: Sun Jul 06, 2014 3:46 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by randomizer » Tue Sep 12, 2017 10:48 am

Grt2bOutdoors wrote:
Tue Sep 12, 2017 7:41 am
lostdog wrote:
Tue Sep 12, 2017 7:32 am
alex_686 wrote:
Mon Sep 11, 2017 11:18 am
lostdog wrote:
Mon Sep 11, 2017 11:15 am
Not worried. Total World Stock Index for life.
That too is running at high multiples. I can't think of an asset class that is not near its high intrinsic valuation. So save more or chase risky yield.
Saving more sounds better. :sharebeer
When you say "save more", where do you place your savings then? In the high multiple asset classes or somewhere else, like your mattress or bank account?
I think the intention is to put it in "the high multiple asset classes". If you expect a lower return on your investment, save a greater % of your income in that low-returning investment rather than chasing yield and blowing up your risks.

Jeff Albertson
Posts: 384
Joined: Sat Apr 06, 2013 7:11 pm
Location: Springfield

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Jeff Albertson » Tue Sep 12, 2017 10:52 am

Simplegift wrote:
Mon Sep 11, 2017 1:31 pm
Buffett talked about this in Fortune magazine in November 1999 (towards the end of the tech boom).
You know, someone once told me that New York has more lawyers than people. I think that's the same fellow who thinks profits will become larger than GDP. When you begin to expect the growth of a component factor to forever outpace that of the aggregate, you get into certain mathematical problems. In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well. In addition, there's a public-policy point: If corporate investors, in aggregate, are going to eat an ever-growing portion of the American economic pie, some other group will have to settle for a smaller portion. That would justifiably raise political problems--and in my view a major reslicing of the pie just isn't going to happen.
http://www.tilsonfunds.com/MrBuffettStockMarket.pdf

KlangFool
Posts: 6727
Joined: Sat Oct 11, 2008 12:35 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by KlangFool » Tue Sep 12, 2017 11:03 am

OP,

1) Are you saying 4% real return is no good? For me, that is plenty.

2) Are people assuming that the bull market will continue forever? This is unlikely to be true.

3) Are people assuming that we will not hit a recession from now on? This is unlikely to be true either.

So, what is the problem?

The usual cycle is people get overly optimistic and went 100/0. People are overly leveraged. Then, we hit a recession and a lot of folks wiped out. Many folks will sell their assets at a distressed price. Who ever left standing will pick up the bargain. Then, the market slowly recovered.

We went through 2007/2009 recession. History tends to repeat itself.

Only when the tide goes out do you discover who's been swimming naked.
Warren Buffett
Read more at: https://www.brainyquote.com/quotes/quot ... 83933.html

KlangFool

Valuethinker
Posts: 32899
Joined: Fri May 11, 2007 11:07 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Valuethinker » Wed Sep 13, 2017 5:30 am

Jeff Albertson wrote:
Tue Sep 12, 2017 10:52 am
Simplegift wrote:
Mon Sep 11, 2017 1:31 pm
Buffett talked about this in Fortune magazine in November 1999 (towards the end of the tech boom).
You know, someone once told me that New York has more lawyers than people. I think that's the same fellow who thinks profits will become larger than GDP. When you begin to expect the growth of a component factor to forever outpace that of the aggregate, you get into certain mathematical problems. In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well. In addition, there's a public-policy point: If corporate investors, in aggregate, are going to eat an ever-growing portion of the American economic pie, some other group will have to settle for a smaller portion. That would justifiably raise political problems--and in my view a major reslicing of the pie just isn't going to happen.
http://www.tilsonfunds.com/MrBuffettStockMarket.pdf
And of course the old saw with Buffett, Klarman etc. (from Ritholz Wealth Management): "with great investors, watch what they do, rather than what they say". Buffett's whole thrust of investing since then (and before) has been in the purchase of businesses with strong elements of monopoly/ oligopoly-- railways & electric utilities in particular. Corporate concentration has been rising in the USA, and BH has been part of that.

Note WB's bridge playing partner and one of his closest friends is one William H Gates. Who has practiced the monopoly aspect/ network effect of the New Economy to its limit.

User avatar
oldcomputerguy
Posts: 1793
Joined: Sun Nov 22, 2015 6:50 am
Location: In the middle of five acres of woods

Re: What If U.S. Stocks Stay Expensive For Years?

Post by oldcomputerguy » Wed Sep 13, 2017 5:50 am

flyingaway wrote:
Mon Sep 11, 2017 10:36 am
Apart from the exact number (4% real return), I think this line of thinking makes sense, which is what I have in my mind.

OTOH, 4% real is good for me. I was expecting 3% for stocks, and 0% for bonds.
Same here. My budget plan in retirement was built using an assumption of 2% nominal.
:beer
Anybody know why there's a 20-pound frozen turkey up in the light grid?

User avatar
unclescrooge
Posts: 1521
Joined: Thu Jun 07, 2012 7:00 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by unclescrooge » Wed Sep 13, 2017 5:57 am

If 4% is the worst case scenario, it sounds pretty good to me.

On the other hand, cheap EM stock index funds are up 30% YTD.

I think global diversification will continue to yield satisfactory results.

alex_686
Posts: 2483
Joined: Mon Feb 09, 2015 2:39 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by alex_686 » Wed Sep 13, 2017 6:46 am

unclescrooge wrote:
Wed Sep 13, 2017 5:57 am
If 4% is the worst case scenario, it sounds pretty good to me.
Many of the above sources are predicting 4% as their baseline over the next 10 years. It could be higher or lower. One can have a 30% up year and still average 4% over 10 years. Sadly I don't think there is a place to hide.

User avatar
unclescrooge
Posts: 1521
Joined: Thu Jun 07, 2012 7:00 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by unclescrooge » Wed Sep 13, 2017 6:54 am

alex_686 wrote:
Wed Sep 13, 2017 6:46 am
unclescrooge wrote:
Wed Sep 13, 2017 5:57 am
If 4% is the worst case scenario, it sounds pretty good to me.
Many of the above sources are predicting 4% as their baseline over the next 10 years. It could be higher or lower. One can have a 30% up year and still average 4% over 10 years. Sadly I don't think there is a place to hide.
Indeed, but it's better than the zero percent real return of bonds!

tibbitts
Posts: 6835
Joined: Tue Feb 27, 2007 6:50 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by tibbitts » Wed Sep 13, 2017 7:52 am

lostdog wrote:
Tue Sep 12, 2017 7:32 am
alex_686 wrote:
Mon Sep 11, 2017 11:18 am
lostdog wrote:
Mon Sep 11, 2017 11:15 am
Not worried. Total World Stock Index for life.
That too is running at high multiples. I can't think of an asset class that is not near its high intrinsic valuation. So save more or chase risky yield.
Saving more sounds better. :sharebeer
It doesn't sound that great if inflation-adjusted income decreases every year.

User avatar
Simplegift
Posts: 2553
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Simplegift » Wed Sep 13, 2017 1:01 pm

KlangFool wrote:
Tue Sep 12, 2017 11:03 am
OP,

1) Are you saying 4% real return is no good? For me, that is plenty.

2) Are people assuming that the bull market will continue forever? This is unlikely to be true.

3) Are people assuming that we will not hit a recession from now on? This is unlikely to be true either.

So, what is the problem?
Sorry not to reply sooner. None of your three questions were at issue when posting Mr. Livermore’s comments in the OP. Of course we will have occasional recessions in the future and many of us will consider ourselves lucky with 4% real stock returns going forward. But that doesn’t mean U.S. stocks can’t also stay expensive for years to come.

The issue is that many return projections these days just assume U.S. stock market valuations will eventually “revert to the mean” — see Research Affiliates, GMO and others — and their expected return forecasts are very low as a result. But what if U.S. stock valuations never mean-revert to a long term average? There’s certainly no reason why they should, or that they have to (see the Philips and Ural paper upthread).

Mr. Livermore’s analysis is the first I’ve seen that looks at expected returns with CAPE ratios continuing in the 25-30 range for the extended future. Yes, U.S. stock returns may be muted around 4% real (due to their own expensiveness, in his view) — but this forecast is not nearly as dire as those who assume mean-reversion will be inevitable in our long-term future.
Cordially, Todd

Slothmeister
Posts: 42
Joined: Sun Sep 10, 2017 11:48 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Slothmeister » Wed Sep 13, 2017 1:22 pm

4% doesn't sound too good to me after expenses, taxes, and inflation.

hightower
Posts: 268
Joined: Mon Dec 12, 2016 2:28 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by hightower » Wed Sep 13, 2017 1:27 pm

chevca wrote:
Mon Sep 11, 2017 11:18 am
To me, it makes paying down/off debt sound pretty attractive. Maybe not full steam ahead, but a mix of paying down the mortgage and investing.

Of course, that's very situational and depends on timelines and all.
This is exactly my approach. I'm maxing out tax advantaged space of course and investing that, but everything else is going to debt pay down. My thoughts are that when the next correction hits, I'll have more cash flow available for buying stocks at a discount.

Da5id
Posts: 1401
Joined: Fri Feb 26, 2016 8:20 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Da5id » Wed Sep 13, 2017 1:32 pm

Slothmeister wrote:
Wed Sep 13, 2017 1:22 pm
4% doesn't sound too good to me after expenses, taxes, and inflation.
It says "4% real", which means above inflation. Expenses should be a small issue (in index funds). Taxes are a real issue except in tax free accounts.

JBTX
Posts: 1253
Joined: Wed Jul 26, 2017 12:46 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by JBTX » Wed Sep 13, 2017 1:34 pm

The issue of an inflated stock market and perpetually low non mean reverting equities is one Grantham and co have been contemplating for a little while now

https://www.gmo.com/docs/default-source ... f?sfvrsn=2

They have said, or implied, that I believe high prices are here permanently and that I also believe
regression to the mean has ended. This is, of course, inaccurate, as readers of my quarterly letters
know. I have suggested that although mean reversion in margins and price earnings ratios is still
probable, the speed of regression has slowed way down and become sticky. This slowdown is
because nearly all of the factors causing it are themselves unlikely to change fast. These include
Fed policy including moral hazard, lower interest rates, an aging population, slower growth, and
productivity; and increased political and monopoly power for corporations.
Because of this stickiness, I have suggested that regression of P/Es and profit share will take 20 years
as opposed to the 7 years (the basis of GMO’s official 7-year forecast) that is more typical of the
period 1900-1997 and that even then those measures will have only regressed back two-thirds of
the way to the old normals.
What was quite surprising to me in this work, though, was how damaging even this reduced regression
rate would be to the imputed returns of the S&P 500: 2.7% real per year for 20 years, a rate bound to
break the hearts of many corporate and public pension fund officers. (It is also within a half a point
a year of GMO’s standard 7-year forecast methodology when that is extended to 20 years, on the
assumption of normal growth in years 8 to 20.)



On a different but somewhat related note, interest rates can go low and stay low for a long time, post financial crisis

http://ritholtz.com/wp-content/uploads/ ... resent.gif

Rates went below 3% in 1930, and didn't come back up over 3% until 1955, and not over 4% until 1965. You go through a pretty long deleveraging phase (both consumer and govt debt) which works against economic growth, plus with high debt loads there is ample motivation not to increase rates too much or the debt load will become overbearing.

asif408
Posts: 1064
Joined: Sun Mar 02, 2014 8:34 am
Location: Florida

Re: What If U.S. Stocks Stay Expensive For Years?

Post by asif408 » Wed Sep 13, 2017 1:36 pm

Simplegift wrote:
Wed Sep 13, 2017 1:01 pm
The issue is that many return projections these days just assume U.S. stock market valuations will eventually “revert to the mean” — see Research Affiliates, GMO and others — and their expected return forecasts are very low as a result. But what if U.S. stock valuations never mean-revert to a long term average? There’s certainly no reason why they should, or that they have to (see the Philips and Ural paper upthread).

Mr. Livermore’s analysis is the first I’ve seen that looks at expected returns with CAPE ratios continuing in the 25-30 range for the extended future. Yes, U.S. stock returns may be muted around 4% real (due to their own expensiveness, in his view) — but they are not nearly as dire as those who assume mean-reversion as being inevitable.
Hi Todd,

A follow-up question. Assuming US stocks stay expensive for years, do you expect foreign stocks to stay cheap during that time as well? I have no idea what US stocks will return, but it seems that relative to almost any other country US stocks returns have a higher likelihood of being lower (or at least not much different), so the simple solution seems to be to diversify your stock holdings internationally. The last time we saw a divergence like this between US and foreign stocks was the late 90s, and the 2000s ended up being a great time to be diversified internationally. But when I see people discussing CAPE they seem to want to use it to jump from US stocks to bonds when it seems to be more beneficial as a way to shift among stock markets.

I won't get into the discussion if CAPE ratios in the US are permanently higher because of fundamental changes such as accounting standards, etc. in the market. It may be true. But even if that is the case, I haven't seen anyone providing arguments for why the CAPE ratio of other countries are permanently lower due to fundamental changes in accounting standards, etc. as they do for explaining why US CAPE is higher. The main reason I see noted for why foreign stocks CAPE ratios are lower is because of the problems in those countries and their poor 5-10 performance, which could have been said of the US in the early 1930s and late 1970s, after the Great Depression and the out of control inflation of the late 1970s. Of course, these periods of poor performance were followed by bull markets in the US.

frankmorris
Posts: 283
Joined: Tue Apr 25, 2017 4:34 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by frankmorris » Wed Sep 13, 2017 1:43 pm

People who attempt to explain long-term investment returns by math, without explaining some fundamental shift in US or global economics, are a bit over-confident and attempting to break what I've come to learn is rule #1 around here: Don't pretend to know things you don't.

Things move & change - the economy, stock valuations, investor sentiment, etc. The idea that our present economic & investment state would continue indefinitely for decades on end just doesn't make any sense.

I'm also getting somewhat tired of reading about CAPE/mean reversion as some kind of causal agent in our economic engine. No doubt mean reversion occurs, but the idea that CAPE governs the investing world, rather than simply providing one possible means of explanation, is a bit overdone. Personally, I'd put more stock in general market returns for a century than some math formula that states "this time it's different."

Note: I'm not arguing against CAPE or that we might see periods of lower returns, but the idea that a 30+ year investment horizon is firstly knowable, and secondly likely to be vastly different than historical periods, is just such a reach.

JBTX
Posts: 1253
Joined: Wed Jul 26, 2017 12:46 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by JBTX » Wed Sep 13, 2017 1:58 pm

Simplegift wrote:
Wed Sep 13, 2017 1:01 pm
KlangFool wrote:
Tue Sep 12, 2017 11:03 am
OP,

1) Are you saying 4% real return is no good? For me, that is plenty.

2) Are people assuming that the bull market will continue forever? This is unlikely to be true.

3) Are people assuming that we will not hit a recession from now on? This is unlikely to be true either.

So, what is the problem?
Sorry not to reply sooner. None of your three questions were at issue when posting Mr. Livermore’s comments in the OP. Of course we will have occasional recessions in the future and many of us will consider ourselves lucky with 4% real stock returns going forward. But that doesn’t mean U.S. stocks can’t also stay expensive for years to come.

The issue is that many return projections these days just assume U.S. stock market valuations will eventually “revert to the mean” — see Research Affiliates, GMO and others — and their expected return forecasts are very low as a result. But what if U.S. stock valuations never mean-revert to a long term average? There’s certainly no reason why they should, or that they have to (see the Philips and Ural paper upthread).

Mr. Livermore’s analysis is the first I’ve seen that looks at expected returns with CAPE ratios continuing in the 25-30 range for the extended future. Yes, U.S. stock returns may be muted around 4% real (due to their own expensiveness, in his view) — but this forecast is not nearly as dire as those who assume mean-reversion will be inevitable in our long-term future.
On the contrary, the lack of mean reversion may actually be more dire long term, than a mean reversion in the near future and getting back to a more normal long term state.

See attached purgatory vs hell

https://directeconomicdemocracy.files.w ... 4_full.pdf

User avatar
Simplegift
Posts: 2553
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Simplegift » Wed Sep 13, 2017 2:23 pm

asif408 wrote:
Wed Sep 13, 2017 1:36 pm
Simplegift wrote:
Wed Sep 13, 2017 1:01 pm
The issue is that many return projections these days just assume U.S. stock market valuations will eventually “revert to the mean” — see Research Affiliates, GMO and others — and their expected return forecasts are very low as a result. But what if U.S. stock valuations never mean-revert to a long term average? There’s certainly no reason why they should, or that they have to (see the Philips and Ural paper upthread).
A follow-up question. Assuming US stocks stay expensive for years, do you expect foreign stocks to stay cheap during that time as well? I have no idea what US stocks will return, but it seems that relative to almost any other country US stocks returns have a higher likelihood of being lower (or at least not much different), so the simple solution seems to be to diversify your stock holdings internationally.
No doubt U.S. stocks have been the darlings of global investors since the 2008-09 Financial Crisis. Much of this has been justified, in my view, as U.S. corporate profits and earnings have outpaced both developed and emerging market companies by a large margin. Thus if earnings stay strong, valuations can remain high, and expected returns modest (due to the market's own expensiveness, if Mr. Livermore is correct).

Whether international stocks will outperform U.S. stocks in the future is hard to say — but I’m a big believer in broadly diversifying across a wide range of indexed companies globally, in both advanced and emerging markets, since none of us know who the global winners will be in the decades ahead.
Cordially, Todd

User avatar
oldcomputerguy
Posts: 1793
Joined: Sun Nov 22, 2015 6:50 am
Location: In the middle of five acres of woods

Re: What If U.S. Stocks Stay Expensive For Years?

Post by oldcomputerguy » Wed Sep 13, 2017 2:40 pm

unclescrooge wrote:
Wed Sep 13, 2017 5:57 am
If 4% is the worst case scenario, it sounds pretty good to me.

On the other hand, cheap EM stock index funds are up 30% YTD.
Yep. And I just did a bit of poking around, looks like MSCI EAFE Index is up around 17% YTD vs 13% for S&P500.

On the other hand, according to data on the FTSE web site, Russell 2000 Value is up only about 0.14% YTD. Tilt, anyone?
Anybody know why there's a 20-pound frozen turkey up in the light grid?

Grt2bOutdoors
Posts: 16967
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Grt2bOutdoors » Wed Sep 13, 2017 2:55 pm

Valuethinker wrote:
Wed Sep 13, 2017 5:30 am
Jeff Albertson wrote:
Tue Sep 12, 2017 10:52 am
Simplegift wrote:
Mon Sep 11, 2017 1:31 pm
Buffett talked about this in Fortune magazine in November 1999 (towards the end of the tech boom).
You know, someone once told me that New York has more lawyers than people. I think that's the same fellow who thinks profits will become larger than GDP. When you begin to expect the growth of a component factor to forever outpace that of the aggregate, you get into certain mathematical problems. In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well. In addition, there's a public-policy point: If corporate investors, in aggregate, are going to eat an ever-growing portion of the American economic pie, some other group will have to settle for a smaller portion. That would justifiably raise political problems--and in my view a major reslicing of the pie just isn't going to happen.
http://www.tilsonfunds.com/MrBuffettStockMarket.pdf
And of course the old saw with Buffett, Klarman etc. (from Ritholz Wealth Management): "with great investors, watch what they do, rather than what they say". Buffett's whole thrust of investing since then (and before) has been in the purchase of businesses with strong elements of monopoly/ oligopoly-- railways & electric utilities in particular. Corporate concentration has been rising in the USA, and BH has been part of that.

Note WB's bridge playing partner and one of his closest friends is one William H Gates. Who has practiced the monopoly aspect/ network effect of the New Economy to its limit.
I'll go one further, WB is really being "the last mile" between the producers and the consumers. There is alot of money to be made in transmission of product be it energy or products, it's a large scale volume business and it's concentrated in the hands of few to only 1. Nothing better than that, unless of course, regulation goes amuck and really clamps down on permissible ROE. More importantly, notice where geographically he invests - growing or large vast empty stretches of land (grabbed Pacificorp before WA and Utah became in vogue, grabbed Nevada Power more recently - I know, because I owned both of those public utilities, the latter I bought at a deep discount to bv).
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

visualguy
Posts: 313
Joined: Thu Jan 30, 2014 1:32 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by visualguy » Wed Sep 13, 2017 5:08 pm

flyingaway wrote:
Mon Sep 11, 2017 10:36 am
Apart from the exact number (4% real return), I think this line of thinking makes sense, which is what I have in my mind.

OTOH, 4% real is good for me. I was expecting 3% for stocks, and 0% for bonds.
Right, but this means that the overall after-tax real return on, say, a 60/40 portfolio will be minuscule. This is what I expect, but I hope for something better miraculously. Also, this is a good reason for investing in rental properties where you can easily do better than this, although it does require some work.

Stormbringer
Posts: 309
Joined: Sun Jun 14, 2015 7:07 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Stormbringer » Wed Sep 13, 2017 5:29 pm

Define "expensive" in an environment where the US 10-year is stuck at 2% and the German 10-year is under .5%.

ttjt_99
Posts: 11
Joined: Sun May 21, 2017 7:49 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by ttjt_99 » Wed Sep 13, 2017 9:35 pm

One word: Dollar cost averaging.

There are three types of people in this world, those who can count, and those who can't.

itstoomuch
Posts: 4547
Joined: Mon Dec 15, 2014 12:17 pm
Location: midValley OR

Re: What If U.S. Stocks Stay Expensive For Years?

Post by itstoomuch » Wed Sep 13, 2017 11:40 pm

"Re: What If U.S. Stocks Stay Expensive For Years?"
A backtest performed in the future will show that stocks of earlier years were cheaper. :oops:

Reverse the statement, " What If US Stocks Stay Cheap For Years." The backtest performed in the future will show that stocks of earlier years were more expensive. :annoyed

Einstein's General Theory of Relativistic Velocity of Money :mrgreen: :idea:
Which is why I generally ignore backtesting. :beer
Rev90517; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax 25%. Early SS. FundRatio (FR) >1.1 67/70yo

Ari
Posts: 439
Joined: Sat May 23, 2015 6:59 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Ari » Thu Sep 14, 2017 12:24 am

Seems pretty straight-forward to me, really. Higher P/E means lower earnings per invested dollar. Of course returns are going to be low. I don't think the predictive power of CAPE when it comes to future earnings has much if anything to do with mean reversion. You simply have to pay more for the same amount of return.
All in, all the time.

User avatar
HomerJ
Posts: 10253
Joined: Fri Jun 06, 2008 12:50 pm

Re: What If U.S. Stocks Stay Expensive For Years?

Post by HomerJ » Thu Sep 14, 2017 1:07 am

Simplegift wrote:
Mon Sep 11, 2017 10:40 am
So he sees 4% as a likely ceiling on returns, not a floor or an average.
If I had a dollar for every time some PhD thought that economics was an actual science and wrote an article predicting something....

I'd have a lot of dollars.

I'm not saying he's wrong, but there's no way to prove he's right. Just one example, plenty of PhDs used "math" to write articles predicting 4% real going forward in 2010.

Instead, we've gotten 12% real since then. That's not just a little bit off. Most human beings might consider that their model must be missing a variable or two to be so far off. But many of these PhDs just keep on writing articles instead with lots of math and new predictions.

So how long is his prediction for anyway? Is 4% the ceiling forever? Or just the next 10 years? (which may be followed by 10 good years, so it all averages out anyway).

Sooner or later we will have muted returns for a while (or another crash.. or both!). That's normal and expected.

I guess if they keep writing articles, sooner or later they will be right, and then they can make the talk-show circuit, with proof that they "called it".

Valuethinker
Posts: 32899
Joined: Fri May 11, 2007 11:07 am

Re: What If U.S. Stocks Stay Expensive For Years?

Post by Valuethinker » Thu Sep 14, 2017 7:43 am

Grt2bOutdoors wrote:
Wed Sep 13, 2017 2:55 pm
I'll go one further, WB is really being "the last mile" between the producers and the consumers. There is alot of money to be made in transmission of product be it energy or products, it's a large scale volume business and it's concentrated in the hands of few to only 1. Nothing better than that, unless of course, regulation goes amuck and really clamps down on permissible ROE. More importantly, notice where geographically he invests - growing or large vast empty stretches of land (grabbed Pacificorp before WA and Utah became in vogue, grabbed Nevada Power more recently - I know, because I owned both of those public utilities, the latter I bought at a deep discount to bv).
Good analysis.

"Last Mile" in electricity is surely (am I the only one who hears "stop calling me Shirley"? ;-)) the only safe to be in an industry changing this fast (towards distributed power generation, towards free electricity at a wholesale level when the sun is shining, etc.).

I agree the generation assets, if renewable, need lots of land-- although it's perfectly possible to farm between the rows of solar panels, or beneath tall wind turbines.

He makes a big effort to ensure good relationships with regulators re ROC, ROE-- by emphasizing service quality, reliability, community participation by his utilities.

I think it tends to be the northeastern utilities that have bad reputations for customer service and deep antagonism with Public Utility regulators. In the South, I think there are a couple of big players (TVA + Southern + Duke?) and they are vertically integrated. Also prices to consumers are low, and that matters simply because it gives the utility less room to manoeuvre, even if its costs are lower.

On "Last mile" as per Amazon, it seems to me that whilst that might be a competitive advantage for amazon against other e-formats, it is actually a pretty competitive, pretty low return business. Here (UK) they rely on independent contractors, basically a way of getting employees off your payroll (the Uber model) and working them very hard. Or did you mean product as in natural gas?

Post Reply