philosophicaleconomics predicts 4% real equity returns

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getrichslowly
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philosophicaleconomics predicts 4% real equity returns

Post by getrichslowly » Wed Feb 14, 2018 12:10 pm

Future U.S. Equity Returns: A Best-Case Upper Limit
Posted on January 15, 2018 by philosophicalecon@gmail.com
http://www.philosophicaleconomics.com/2 ... per-limit/

I find this article highly fascinating. It confirms a hunch I've had all along that inflated CAPE must imply lower future returns. RIP 4%-SWR.

Tamalak
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Re: philosophicaleconomics predicts 4% real equity returns

Post by Tamalak » Wed Feb 14, 2018 1:16 pm

Average historical has been 6.6% real. 4% real I'll take and say thank you!

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Re: philosophicaleconomics predicts 4% real equity returns

Post by garlandwhizzer » Wed Feb 14, 2018 1:25 pm

Very interesting article, thanks for posting, getrichslowly. Although predicting anything about the market's future is prone to error, I tend to accept the basic premise that, in spite of, and perhaps partially because of, our past exuberant performance, future US equity returns over the next decade or two are unlikely to exceed 4% in inflation adjusted dollars, the only kind that counts. If we do make 4% I'll be happy. I expect higher returns from INTL equity and considerably lower returns, about 0%--1% real, from quality US short and intermediate term bonds. If you haven't been on board during the 2009--2018 bull market, the second strongest in history, you may have to wait a long time until another such equity gravy train pulls into the station.

Garland Whizzer

TheDDC
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Re: philosophicaleconomics predicts 4% real equity returns

Post by TheDDC » Wed Feb 14, 2018 1:41 pm

garlandwhizzer wrote:
Wed Feb 14, 2018 1:25 pm
Very interesting article, thanks for posting, getrichslowly. Although predicting anything about the market's future is prone to error, I tend to accept the basic premise that, in spite of, and perhaps partially because of, our past exuberant performance, future US equity returns over the next decade or two are unlikely to exceed 4% in inflation adjusted dollars, the only kind that counts. If we do make 4% I'll be happy. I expect higher returns from INTL equity and considerably lower returns, about 0%--1% real, from quality US short and intermediate term bonds. If you haven't been on board during the 2009--2018 bull market, the second strongest in history, you may have to wait a long time until another such equity gravy train pulls into the station.

Garland Whizzer
I had a bit in from that period (2007-present), with the bulk of it put in last month. I'm looking forward to the continued performance that we had after after the last recovery. 4% is not much and I don't believe that it would be prudent staying invested if that was it, so we'd be looking at a higher amount to keep this large amount invested over time.

-TheDDC

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whodidntante
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Re: philosophicaleconomics predicts 4% real equity returns

Post by whodidntante » Wed Feb 14, 2018 1:45 pm

I'll take mine as a gut wrenching market crash that then trades sideways for years and years. Then a violently raging bull as I approach retirement. With continuously fantastic career outcomes for me. K thx.

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Re: philosophicaleconomics predicts 4% real equity returns

Post by willthrill81 » Wed Feb 14, 2018 1:48 pm

getrichslowly wrote:
Wed Feb 14, 2018 12:10 pm
Future U.S. Equity Returns: A Best-Case Upper Limit
Posted on January 15, 2018 by philosophicalecon@gmail.com
http://www.philosophicaleconomics.com/2 ... per-limit/

I find this article highly fascinating. It confirms a hunch I've had all along that inflated CAPE must imply lower future returns. RIP 4%-SWR.
Have you seen what those following this line of thinking were predicting regarding future returns ten years ago?

You seem dead set on 'proving' that a 4% WR is no longer safe, looking for anything that will help your case. In this instance, a 4% real return going forward would not necessarily have a negative impact whatsoever on those using a 4% fixed WR. Keep in mind that a 3.33% WR will work for 30 years assuming zero real returns. As long as the sequence of returns isn't more abysmal than the worst periods of the past, only a very small real return is needed to make 4% succeed.

Further, I've already shown you that Michael Kitces published a study a decade ago showing that higher valuations do indeed lead to a lower SWR, but he found that when CAPE was in the highest quintile in the historic record that the SWR was still above 4%. When valuations were lower, the SWR was over 5%.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: philosophicaleconomics predicts 4% real equity returns

Post by MotoTrojan » Wed Feb 14, 2018 1:51 pm

TheDDC wrote:
Wed Feb 14, 2018 1:41 pm

4% is not much and I don't believe that it would be prudent staying invested if that was it, so we'd be looking at a higher amount to keep this large amount invested over time.

-TheDDC
Given that the average is 6-7%, I don't think 4% is anything to scoff at for a period of time. There are many periods with negative annual returns.

If that doesn't sound good to you, perhaps you need to take on more risk. Do keep in mind what "real return" means as well.

TheDDC
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Re: philosophicaleconomics predicts 4% real equity returns

Post by TheDDC » Wed Feb 14, 2018 1:52 pm

willthrill81 wrote:
Wed Feb 14, 2018 1:48 pm
getrichslowly wrote:
Wed Feb 14, 2018 12:10 pm
Future U.S. Equity Returns: A Best-Case Upper Limit
Posted on January 15, 2018 by philosophicalecon@gmail.com
http://www.philosophicaleconomics.com/2 ... per-limit/

I find this article highly fascinating. It confirms a hunch I've had all along that inflated CAPE must imply lower future returns. RIP 4%-SWR.
Have you seen what those following this line of thinking were predicting regarding future returns ten years ago?

You seem dead set on 'proving' that a 4% WR is no longer safe, looking for anything that will help your case. In this instance, a 4% real return going forward would not necessarily have a negative impact whatsoever on those using a 4% fixed WR. Keep in mind that a 3.33% WR will work for 30 years assuming zero real returns. As long as the sequence of returns isn't more abysmal than the worst periods of the past, only a very small real return is needed to make 4% succeed.
Yes. He seems to be talking out of both sides. A 4% ROI from the S&P has to be mostly BS, as most others of us like to point out. 4% long term return from equities isn't any better than keeping cash in the bank from 2004-2007 leading up to the recession. So why are we even here, Mr. Naysayer OP?

-TheDDC

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Re: philosophicaleconomics predicts 4% real equity returns

Post by TheDDC » Wed Feb 14, 2018 1:52 pm

MotoTrojan wrote:
Wed Feb 14, 2018 1:51 pm
TheDDC wrote:
Wed Feb 14, 2018 1:41 pm

4% is not much and I don't believe that it would be prudent staying invested if that was it, so we'd be looking at a higher amount to keep this large amount invested over time.

-TheDDC
Given that the average is 6-7%, I don't think 4% is anything to scoff at for a period of time. There are many periods with negative annual returns.

If that doesn't sound good to you, perhaps you need to take on more risk. Do keep in mind what "real return" means as well.
For how long a period of time, exactly? I'd take mine after 10 years.

-TheDDC

WhyNotUs
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Re: philosophicaleconomics predicts 4% real equity returns

Post by WhyNotUs » Wed Feb 14, 2018 1:53 pm

OMG, another prediction :shock:
I own the next hot stock- VTSAX

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Re: philosophicaleconomics predicts 4% real equity returns

Post by willthrill81 » Wed Feb 14, 2018 1:54 pm

MotoTrojan wrote:
Wed Feb 14, 2018 1:51 pm
TheDDC wrote:
Wed Feb 14, 2018 1:41 pm

4% is not much and I don't believe that it would be prudent staying invested if that was it, so we'd be looking at a higher amount to keep this large amount invested over time.

-TheDDC
Given that the average is 6-7%, I don't think 4% is anything to scoff at for a period of time. There are many periods with negative annual returns.

If that doesn't sound good to you, perhaps you need to take on more risk. Do keep in mind what "real return" means as well.
Almost 30% of the 10 year periods in the historic record have seen U.S. equities earn a 4% real return or less. If it happens, it will be far from anything new and certainly does nothing to cast doubt on the future success of the '4% rule'.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

TheDDC
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Re: philosophicaleconomics predicts 4% real equity returns

Post by TheDDC » Wed Feb 14, 2018 1:58 pm

willthrill81 wrote:
Wed Feb 14, 2018 1:54 pm
MotoTrojan wrote:
Wed Feb 14, 2018 1:51 pm
TheDDC wrote:
Wed Feb 14, 2018 1:41 pm

4% is not much and I don't believe that it would be prudent staying invested if that was it, so we'd be looking at a higher amount to keep this large amount invested over time.

-TheDDC
Given that the average is 6-7%, I don't think 4% is anything to scoff at for a period of time. There are many periods with negative annual returns.

If that doesn't sound good to you, perhaps you need to take on more risk. Do keep in mind what "real return" means as well.
Almost 30% of the 10 year periods in the historic record have seen U.S. equities earn a 4% real return or less. If it happens, it will be far from anything new and certainly does nothing to cast doubt on the future success of the '4% rule'.
OK fair enough. You did the research (heavy lifting) on that. I appreciate the good news and perspective. It's more than just a number.

I was used to seeing 5% interest on checking accounts when saving for a home, when I bought on the way up to the bubble (but not at the very top thankfully). So I have an odd fixation on ROI than some others.

-TheDDC

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HomerJ
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Re: philosophicaleconomics predicts 4% real equity returns

Post by HomerJ » Wed Feb 14, 2018 1:58 pm

getrichslowly wrote:
Wed Feb 14, 2018 12:10 pm
Future U.S. Equity Returns: A Best-Case Upper Limit
Posted on January 15, 2018 by philosophicalecon@gmail.com
http://www.philosophicaleconomics.com/2 ... per-limit/

I find this article highly fascinating. It confirms a hunch I've had all along that inflated CAPE must imply lower future returns. RIP 4%-SWR.
That site does have good articles. Interesting to look back in time at previous articles and see how poorly their previous predictions turned out though. They at least acknowledge that.
The problem, of course, is that the people who are voicing concerns about valuation today are essentially the same people who were voicing them several years ago, when equity prices were half their current values. And they’re using the same “mean-reversion” arguments to do it, even though the market has persistently shown that it has no inclination to revert back to the valuation averages of any prior era. They overstated their case then, and so people assume that they’re overstating their case now, even though their underlying warnings may now be worth heeding.
Your conclusion of "RIP 4% SWR" doesn't make any logical sense at all. If expected returns are 4% real, then 4% SWR should still work.

I'm not sure why you are so against the 4% SWR "rule of thumb". Why does it irk you so much?

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Re: philosophicaleconomics predicts 4% real equity returns

Post by saltycaper » Wed Feb 14, 2018 1:59 pm

TheDDC wrote:
Wed Feb 14, 2018 1:52 pm

Yes. He seems to be talking out of both sides. A 4% ROI from the S&P has to be mostly BS, as most others of us like to point out. 4% long term return from equities isn't any better than keeping cash in the bank from 2004-2007 leading up to the recession. So why are we even here, Mr. Naysayer OP?

-TheDDC
It's 4% real, which is not what you earned from keeping cash in the bank from 2004-2007. If you read the article, I don't think you'll find it to be BS.
Quod vitae sectabor iter?

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willthrill81
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Re: philosophicaleconomics predicts 4% real equity returns

Post by willthrill81 » Wed Feb 14, 2018 2:01 pm

This whole idea of real returns being close to half their long-term average is centered around valuations, but U.S. returns over the last 26 years and counting fly in the face of this logic. Since 1992, CAPE has been above its historic average (with only a brief interruption in 2008-2009 lasting a few months), yet the real returns over this period have been slightly above the historic average. Some say that this is an anomaly (if so, it's a pretty long one) or simply due to ever increasing valuations (who says they must ever revert to 16?), but no one really knows.

I think that while valuations matter, they are not actionable.
HomerJ wrote:
Wed Feb 14, 2018 1:58 pm
Your conclusion of "RIP 4% SWR" doesn't make any logical sense at all. If expected returns are 4% real, then 4% SWR should still work.
Like many others, I think the OP mistakenly believes that the 4% WR was built on average returns, not the worst case scenarios it was found to actually support. Even if real returns were zero for the next decade, that alone would not be cause to doubt the success of the '4% rule' over the next 30 years.
HomerJ wrote:
Wed Feb 14, 2018 1:58 pm
I'm not sure why you are so against the 4% SWR "rule of thumb". Why does it irk you so much?
I've asked the same question. Given his other posts, he seems to be on a mission to destroy the '4% rule', but then he doesn't respond to many questions regarding his logic.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: philosophicaleconomics predicts 4% real equity returns

Post by saltycaper » Wed Feb 14, 2018 2:09 pm

willthrill81 wrote:
Wed Feb 14, 2018 2:01 pm
This whole idea of real returns being close to half their long-term average is centered around valuations, but U.S. returns over the last 26 years and counting fly in the face of this logic.
Perhaps you are making a general comment, but the article's 4% number is not centered on mean reversion of valuations.
Quod vitae sectabor iter?

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Re: philosophicaleconomics predicts 4% real equity returns

Post by willthrill81 » Wed Feb 14, 2018 2:14 pm

saltycaper wrote:
Wed Feb 14, 2018 2:09 pm
willthrill81 wrote:
Wed Feb 14, 2018 2:01 pm
This whole idea of real returns being close to half their long-term average is centered around valuations, but U.S. returns over the last 26 years and counting fly in the face of this logic.
Perhaps you are making a general comment, but the article's 4% number is not centered on mean reversion of valuations.
It's not "centered on mean reversion of valuations," but the author is still trying to use valuations to predict future returns. Almost since the inception of this idea back in 1988, valuations haven't been a great predictor of future returns.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: philosophicaleconomics predicts 4% real equity returns

Post by Bwlonge » Wed Feb 14, 2018 2:19 pm

Rental real estate, here I come

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Re: philosophicaleconomics predicts 4% real equity returns

Post by saltycaper » Wed Feb 14, 2018 2:21 pm

willthrill81 wrote:
Wed Feb 14, 2018 2:14 pm

It's not "centered on mean reversion of valuations," but the author is still trying to use valuations to predict future returns. Almost since the inception of this idea back in 1988, valuations haven't been a great predictor of future returns.
Not really. He's trying to be as valuation neutral as you can be. He assumes valuations at the end date of the assumed period are what they are today, and he even drops the years during and after the most recent recession when calculating dividend reinvestment. He's not using valuations to predict returns any more than is necessary, as in, you have to plug something in. You can't ignore valuations entirely because change in valuation is a component of the return. You have to assume a positive, negative, or zero change. He even points out one thing that could make his prediction incorrect is if valuations continue to go up.
Quod vitae sectabor iter?

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Re: philosophicaleconomics predicts 4% real equity returns

Post by willthrill81 » Wed Feb 14, 2018 2:23 pm

saltycaper wrote:
Wed Feb 14, 2018 2:21 pm
willthrill81 wrote:
Wed Feb 14, 2018 2:14 pm

It's not "centered on mean reversion of valuations," but the author is still trying to use valuations to predict future returns. Almost since the inception of this idea back in 1988, valuations haven't been a great predictor of future returns.
Not really. He's trying to be as valuation neutral as you can be. He assumes valuations at the end date of the assumed period are what they are today, and he even drops the years during and after the most recent recession when calculating dividend reinvestment. He's not using valuations to predict returns any more than is necessary, as in, you have to plug something in. You can't ignore valuations entirely because change in valuation is a component of the return. You have to assume a positive, negative, or zero change.
You don't have to use valuations at all to make a prediction of future market returns. They could be ignored altogether. One could focus on earnings growth instead, for instance, or a number of other factors.

Again, how successful as a predictor of future market returns have valuations been since they were put forward 30 years ago?
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: philosophicaleconomics predicts 4% real equity returns

Post by fennewaldaj » Wed Feb 14, 2018 2:23 pm

Returns still being good over the last 26 years has to do with expanding P/Es over that period right. If P/Es continue to expand on average returns will continue to be good while that happens (but eventually they likely can't expand anymore). If they stay the same returns will be good but below the historical average. Its really only if they mean revert that they get downright bad.

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Re: philosophicaleconomics predicts 4% real equity returns

Post by saltycaper » Wed Feb 14, 2018 2:30 pm

willthrill81 wrote:
Wed Feb 14, 2018 2:23 pm
You don't have to use valuations at all to make a prediction of future market returns. They could be ignored altogether. One could focus on earnings growth instead, for instance, or a number of other factors.
Sorry, but that's just not true. You must include valuations. You can't assume valuations don't exist. You could assume no change in valuation, and that's exactly what the author attempted to do.
willthrill81 wrote:
Wed Feb 14, 2018 2:23 pm

Again, how successful as a predictor of future market returns have valuations been since they were put forward 30 years ago?
I think that's a red herring in the context of the article, since he is not using the reversion argument, and he allows for the fact that valuations could increase. So if you think that valuations will go higher and stay higher, you can assume a higher than 4% real return.
Quod vitae sectabor iter?

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Re: philosophicaleconomics predicts 4% real equity returns

Post by willthrill81 » Wed Feb 14, 2018 2:38 pm

saltycaper wrote:
Wed Feb 14, 2018 2:30 pm
willthrill81 wrote:
Wed Feb 14, 2018 2:23 pm
You don't have to use valuations at all to make a prediction of future market returns. They could be ignored altogether. One could focus on earnings growth instead, for instance, or a number of other factors.
Sorry, but that's just not true. You must include valuations. You can't assume valuations don't exist. You could assume no change in valuation, and that's exactly what the author attempted to do.
By ignoring valuations, you are assuming that they will not change.
saltycaper wrote:
Wed Feb 14, 2018 2:30 pm
willthrill81 wrote:
Wed Feb 14, 2018 2:23 pm
Again, how successful as a predictor of future market returns have valuations been since they were put forward 30 years ago?
I think that's a red herring in the context of the article, since he is not using the reversion argument, and he allows for the fact that valuations could increase. So if you think that valuations will go higher and stay higher, you can assume a higher than 4% real return.
Those using the valuations have not universally said that they would mean revert. But look at Larry Swedroe, for instance, who has been saying for years that high valuations would lead to lower returns going forward, which is the same conclusion as the author here. His prediction may eventually come true, but it hasn't yet.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: philosophicaleconomics predicts 4% real equity returns

Post by saltycaper » Wed Feb 14, 2018 2:45 pm

willthrill81 wrote:
Wed Feb 14, 2018 2:38 pm

Those using the valuations have not universally said that they would mean revert. But look at Larry Swedroe, for instance, who has been saying for years that high valuations would lead to lower returns going forward, which is the same conclusion as the author here. His prediction may eventually come true, but it hasn't yet.
The author may have reached a similar conclusion, but his methods are different from what I've seen from others in the popular and quasi-popular press. (I don't often read scholarly financial journals, so maybe it's not new there.) I think it's a worthwhile read. He tries to form a baseline and say, I'm wrong if such-and-such happens, and then you can decide if you think such-and-such will happen.
Quod vitae sectabor iter?

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Re: philosophicaleconomics predicts 4% real equity returns

Post by Bastiat » Wed Feb 14, 2018 3:05 pm

getrichslowly wrote:
Wed Feb 14, 2018 12:10 pm
Future U.S. Equity Returns: A Best-Case Upper Limit
Posted on January 15, 2018 by philosophicalecon@gmail.com
http://www.philosophicaleconomics.com/2 ... per-limit/

I find this article highly fascinating. It confirms a hunch I've had all along that inflated CAPE must imply lower future returns. RIP 4%-SWR.
A hypothesis doesn't confirm anything...

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Re: philosophicaleconomics predicts 4% real equity returns

Post by 3funder » Wed Feb 14, 2018 3:21 pm

Tamalak wrote:
Wed Feb 14, 2018 1:16 pm
Average historical has been 6.6% real. 4% real I'll take and say thank you!
At current valuations, me too!

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Re: philosophicaleconomics predicts 4% real equity returns

Post by grayfox » Wed Feb 14, 2018 4:08 pm

I look at this a few years ago. Using a simple model, I have found that I can quite accurately forecast 10-year return of S&P 500. Here is what my simple model forecasts for current valuation:

Code: Select all

                   PE10.2028   
           24.10     32.67    41.24
G.E10.10     
-2.63%     -3.8     -1.1      1.0
-0.50%     -1.7      1.0      3.2
1.63%       0.4      3.2      5.4
3.76%       2.5      5.3      7.6
5.89%       4.6      7.5      9.9
E.g. if P/E10 remains unchanged at current 32.67, and growth in E10 over next ten years G.E10.10 is real 1.63%, the S&P will return about real 3.2% This is close to forecast using 1/PE10 = 1/32.67 = 3.06% real

This is not that hard to figure out. You just have to know what P/E10 will be in Feb-2028 and what the real earnings growth will be over that period.

To get nominal return, we just need to know what CPI-U will be in Feb-2028.

:?: I did my part. Now who can tell us what the inputs PE10, G.E10.10, and CPI-U will be in Feb-2028?

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Re: philosophicaleconomics predicts 4% real equity returns

Post by itstoomuch » Wed Feb 14, 2018 4:17 pm

I hedged into different asset buckets :mrgreen:
YMMV
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

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Re: philosophicaleconomics predicts 4% real equity returns

Post by David Jay » Wed Feb 14, 2018 4:20 pm

whodidntante wrote:
Wed Feb 14, 2018 1:45 pm
Then a violently raging bull as I approach retirement.
Worked for me. I was 80/20 at the start of 2016 and I was 50/50 at the end of 2017, preparing for a 2019 retirement.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Re: philosophicaleconomics predicts 4% real equity returns

Post by bottlecap » Wed Feb 14, 2018 4:25 pm

Bastiat wrote:
Wed Feb 14, 2018 3:05 pm
getrichslowly wrote:
Wed Feb 14, 2018 12:10 pm
Future U.S. Equity Returns: A Best-Case Upper Limit
Posted on January 15, 2018 by philosophicalecon@gmail.com
http://www.philosophicaleconomics.com/2 ... per-limit/

I find this article highly fascinating. It confirms a hunch I've had all along that inflated CAPE must imply lower future returns. RIP 4%-SWR.
A hypothesis doesn't confirm anything...
That’s what I was thinking.

I was also thinking that anyone can have an anonymous webpage.

JT

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Re: philosophicaleconomics predicts 4% real equity returns

Post by WhiteMaxima » Wed Feb 14, 2018 4:31 pm

What if 10 year treasure yield went up to let's say 3.5%. That's would be a disaster.

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Re: philosophicaleconomics predicts 4% real equity returns

Post by saltycaper » Wed Feb 14, 2018 4:45 pm

So far nobody has pointed out any major flaws in the article's methodology, but there have been a number of generally negative comments, which I can only take to mean most people either have not read the article or they have read the article but are uncomfortable with its conclusions.
Quod vitae sectabor iter?

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Re: philosophicaleconomics predicts 4% real equity returns

Post by itstoomuch » Wed Feb 14, 2018 4:59 pm

Bwlonge wrote:
Wed Feb 14, 2018 2:19 pm
Rental real estate, here I come
We are settling for 3-4% ROI; Hoping to gain on depreciation for tax purposes for another 1%. A longterm hold.
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

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Re: philosophicaleconomics predicts 4% real equity returns

Post by JoeRetire » Wed Feb 14, 2018 4:59 pm

getrichslowly wrote:
Wed Feb 14, 2018 12:10 pm
I find this article highly fascinating. It confirms a hunch I've had all along that inflated CAPE must imply lower future returns. RIP 4%-SWR.
Of course you find it fascinating. Many folks seem to enjoy hunting down articles until they find one that confirms what they suspected all along.
And so it goes...

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Re: philosophicaleconomics predicts 4% real equity returns

Post by garlandwhizzer » Wed Feb 14, 2018 5:01 pm

It's not just philosophicaleconomics that makes such predictions. Bogle, Vanguard, Swedroe, Bernstein, Arnott, Grantham and others who are experienced students of the market and sound number crunchers are making similar or even worse projections of future returns of US stocks and bonds. Those who disagree argue that long or short term backtesting US markets sounds a happy tune and that valuations have been out of line for a long time even as the market keeps going ever higher. The problem is that past performance is not reliably predictive of the future as we learned in 1929, 1982, 2007, etc.. Secular shifts in the rate of return do occur from time to time, usually totally unforeseen by market participants and experts alike. I hope the optimistic group turns out in the fullness of time to be right, but I'm not optimistic that we'll see historical rates of US long term real returns in the next decade or two. Time will tell. Likely it is best to be prepared for both outcomes since neither is a sure thing IMO.

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Re: philosophicaleconomics predicts 4% real equity returns

Post by Bwlonge » Wed Feb 14, 2018 5:26 pm

itstoomuch wrote:
Wed Feb 14, 2018 4:59 pm
Bwlonge wrote:
Wed Feb 14, 2018 2:19 pm
Rental real estate, here I come
We are settling for 3-4% ROI; Hoping to gain on depreciation for tax purposes for another 1%. A longterm hold.
Jeez, depending on how that's being calculated, that sounds like its time to sell! Where is that?

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Re: philosophicaleconomics predicts 4% real equity returns

Post by minimalistmarc » Wed Feb 14, 2018 5:29 pm

I’m okay with 4% but would prefer the long drawn out crash then eventual recovery to get there

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Re: philosophicaleconomics predicts 4% real equity returns

Post by Bwlonge » Wed Feb 14, 2018 5:47 pm

Does return even really matter that much?

Saving $500/mo at 7% for 40 years= $1,327439
Saving $500/mo at 4% for 40 years= $593,911

Saving $1000/mo at 4% for 40 years= $1,187,822

:(

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Re: philosophicaleconomics predicts 4% real equity returns

Post by White Coat Investor » Wed Feb 14, 2018 5:51 pm

getrichslowly wrote:
Wed Feb 14, 2018 12:10 pm
Future U.S. Equity Returns: A Best-Case Upper Limit
Posted on January 15, 2018 by philosophicalecon@gmail.com
http://www.philosophicaleconomics.com/2 ... per-limit/

I find this article highly fascinating. It confirms a hunch I've had all along that inflated CAPE must imply lower future returns. RIP 4%-SWR.
People said that 5 years ago. Yet the 5 year annualized return for TSM is 15.51%. How do you explain that?

I explain it like this: Nobody has a working crystal ball, including Philosophical Economics.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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Re: philosophicaleconomics predicts 4% real equity returns

Post by willthrill81 » Wed Feb 14, 2018 5:51 pm

garlandwhizzer wrote:
Wed Feb 14, 2018 5:01 pm
It's not just philosophicaleconomics that makes such predictions. Bogle, Vanguard, Swedroe, Bernstein, Arnott, Grantham and others who are experienced students of the market and sound number crunchers are making similar or even worse projections of future returns of US stocks and bonds. Those who disagree argue that long or short term backtesting US markets sounds a happy tune and that valuations have been out of line for a long time even as the market keeps going ever higher. The problem is that past performance is not reliably predictive of the future as we learned in 1929, 1982, 2007, etc.. Secular shifts in the rate of return do occur from time to time, usually totally unforeseen by market participants and experts alike. I hope the optimistic group turns out in the fullness of time to be right, but I'm not optimistic that we'll see historical rates of US long term real returns in the next decade or two. Time will tell. Likely it is best to be prepared for both outcomes since neither is a sure thing IMO.

Garland Whizzer
But isn't the past performance of valuations as a predictor of future market returns what every single one of these authors is relying on to varying extents? They may be proven right eventually, but this is a classic illustration of the boy who cried wolf.

The whole "past performance doesn't equal future performance" argument, if taken too far, will result in you throwing up your hands altogether. Maybe that's the optimal outcome.

I'm not saying that valuations don't matter, but the historic record is clear that returns can stray very far from what is predicted on the basis of valuations, so far and for so long as to not make them a very actionable metric for anything.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: philosophicaleconomics predicts 4% real equity returns

Post by Grt2bOutdoors » Wed Feb 14, 2018 5:56 pm

4% real? I’ll take that and say thank you very much!
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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Re: philosophicaleconomics predicts 4% real equity returns

Post by triceratop » Wed Feb 14, 2018 5:59 pm

White Coat Investor wrote:
Wed Feb 14, 2018 5:51 pm
getrichslowly wrote:
Wed Feb 14, 2018 12:10 pm
Future U.S. Equity Returns: A Best-Case Upper Limit
Posted on January 15, 2018 by philosophicalecon@gmail.com
http://www.philosophicaleconomics.com/2 ... per-limit/

I find this article highly fascinating. It confirms a hunch I've had all along that inflated CAPE must imply lower future returns. RIP 4%-SWR.
People said that 5 years ago. Yet the 5 year annualized return for TSM is 15.51%. How do you explain that?

I explain it like this: Nobody has a working crystal ball, including Philosophical Economics.
The blog assumes no valuation changes. S&P500 PE1 on Jan '13: 17, on Feb '18: 25.21. Source: http://www.multpl.com/table

Many of the 'problems' raised in this thread are addressed at length in the blogpost, which is well written and thoughtful. This includes the one you raise, WCI. It's worth mentioning Philosophical Economics also does not claim to have a crystal ball.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: philosophicaleconomics predicts 4% real equity returns

Post by Grt2bOutdoors » Wed Feb 14, 2018 6:02 pm

White Coat Investor wrote:
Wed Feb 14, 2018 5:51 pm
getrichslowly wrote:
Wed Feb 14, 2018 12:10 pm
Future U.S. Equity Returns: A Best-Case Upper Limit
Posted on January 15, 2018 by philosophicalecon@gmail.com
http://www.philosophicaleconomics.com/2 ... per-limit/

I find this article highly fascinating. It confirms a hunch I've had all along that inflated CAPE must imply lower future returns. RIP 4%-SWR.
People said that 5 years ago. Yet the 5 year annualized return for TSM is 15.51%. How do you explain that?
5 years is not the long run, it’s 5 years. Second, returns over last 5 years come from a backdrop of significant declines in market, the magnitude of which had only been surpassed in the 1929 and 1931 bloodbaths. Sure, there were subsequent bear markets but the severity was much lower. The decline in 2008/2009 was an overshoot to downside, subsequent rise in market was overshoot to upside helped by easy money - “Bernake put” or “Yellen put”.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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Re: philosophicaleconomics predicts 4% real equity returns

Post by willthrill81 » Wed Feb 14, 2018 6:10 pm

triceratop wrote:
Wed Feb 14, 2018 5:59 pm
White Coat Investor wrote:
Wed Feb 14, 2018 5:51 pm
getrichslowly wrote:
Wed Feb 14, 2018 12:10 pm
Future U.S. Equity Returns: A Best-Case Upper Limit
Posted on January 15, 2018 by philosophicalecon@gmail.com
http://www.philosophicaleconomics.com/2 ... per-limit/

I find this article highly fascinating. It confirms a hunch I've had all along that inflated CAPE must imply lower future returns. RIP 4%-SWR.
People said that 5 years ago. Yet the 5 year annualized return for TSM is 15.51%. How do you explain that?

I explain it like this: Nobody has a working crystal ball, including Philosophical Economics.
The blog assumes no valuation changes. S&P500 PE1 on Jan '13: 17, on Feb '18: 25.21. Source: http://www.multpl.com/table

Many of the 'problems' raised in this thread are addressed at length in the blogpost, which is well written and thoughtful. This includes the one you raise, WCI. It's worth mentioning Philosophical Economics also does not claim to have a crystal ball.
I've skimmed the post, and he's using a very similar methodology to that used by most of the 'experts' and coming to the same conclusion: high valuations will lead to lower returns going forward.

Image

That chart clearly indicates that higher valuations have tended to lead to lower returns. That is indisputable by anyone. But look at the range of returns. When CAPE was above 20, the subsequent ten year nominal returns ranged between -1.38% and +12.07%. What are we supposed to do with that? I'd argue we can't really do anything with that.

Should we be counting on 7% real returns going forward? I'd argue that that's unwise but not on the basis of valuations. There was one 10 year period where CAPE started below 10 but nominal returns were just 2.91%. We never know what forces will lead the market to produce any given return. I think that on the basis of historic returns over long-term periods, planning on real returns of 4-5% in equities is prudent and not excessively conservative.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: philosophicaleconomics predicts 4% real equity returns

Post by itstoomuch » Wed Feb 14, 2018 6:17 pm

Bwlonge wrote:
Wed Feb 14, 2018 5:26 pm
itstoomuch wrote:
Wed Feb 14, 2018 4:59 pm
Bwlonge wrote:
Wed Feb 14, 2018 2:19 pm
Rental real estate, here I come
We are settling for 3-4% ROI; Hoping to gain on depreciation for tax purposes for another 1%. A longterm hold.
Jeez, depending on how that's being calculated, that sounds like its time to sell! Where is that?
Seattle. :oops: :P
the ROI and cap rate is relatively low against the common thumb rule, but the dollar figure return is not too shabby :wink: :greedy
at least for our needs. :D
I see it as a bond that will give greater returns in inflationary times. Lag time of 12 months or less (between lease contracts) :wink:
YMMV
Last edited by itstoomuch on Wed Feb 14, 2018 6:27 pm, edited 2 times in total.
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Re: philosophicaleconomics predicts 4% real equity returns

Post by triceratop » Wed Feb 14, 2018 6:21 pm

It's possible skimming is not the best way to obtain a clear, complete idea of what an author is attempting to convey. But I'll oblige, this is the central question:
Rather than assume that they will revert back to some past average, let’s start by granting the very bullish assumption that they will remain exactly where they are today forever.

<snip>

This is what we’re trying to figure out: if the S&P stays at its current valuation indefinitely into the future, what return will it likely deliver?
There is no discussion of mean reversion, as many people are ascribing to the post. willthrill81, your post is not about what is being discussed, because that chart includes changes in valuations, which is explicitly assumed not to occur in this model.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: philosophicaleconomics predicts 4% real equity returns

Post by HomerJ » Wed Feb 14, 2018 6:29 pm

saltycaper wrote:
Wed Feb 14, 2018 4:45 pm
So far nobody has pointed out any major flaws in the article's methodology, but there have been a number of generally negative comments, which I can only take to mean most people either have not read the article or they have read the article but are uncomfortable with its conclusions.
I read the article. He makes a decent case.

But no one knows enough to predict anything. He assumes valuations will remain constant, and plays around with the numbers. But valuations won't remain constant. So it's just a mental exercise.

Even though I find it quite plausible that the next 10 years we will get lower than normal returns and valuations will drop, I also find it plausible that a new bull market will start up again after that, and over the long-term, we'll likely end up with near historical average returns. But maybe not. Nobody knows.

I found this very interesting in the article above, since so many people here are against dividends.
This crudely calculated result is consistent with the academic finding that corporations who favor real investment over the return of capital have historically generated lower returns for shareholders. The finding appears to extend to the macroeconomic level as well–shareholders in the larger economy got a much bigger bang for their buck when cash was returned to them as dividends than when it was deployed into capital expenditure.
But that's a whole other topic.

By the way, here's another article from the same site from 2014, debunking valuations as a prediction tool.

http://www.philosophicaleconomics.com/2 ... ixpercent/
In this piece, I’m going to present and explain a simple, easy-to-understand method of forecasting stock market returns on the basis of valuation. I’m then going to insert the popular Shiller CAPE into the method to assess how well the historical predictions fit with the actual historical results. As you can see in the chart below, they fit almost perfectly, across 133 years of available data (no arbitrary exclusions). The correlation coefficient is a fantastic 0.92.

After presenting the chart, I’m going to demonstrate that its tight correlation is an illusion. I’m going to carefully flesh out its subtle trick, a trick that is ultimately hidden in every chart that purports to use valuation to accurately predict returns in historical data.

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Re: philosophicaleconomics predicts 4% real equity returns

Post by willthrill81 » Wed Feb 14, 2018 6:33 pm

triceratop wrote:
Wed Feb 14, 2018 6:21 pm
willthrill81, your post is not about what is being discussed, because that chart includes changes in valuations, which is explicitly assumed not to occur in this model.
What many people fail to initially realize is that if valuations remain where they are today, the contribution from the third component, reinvested dividend payouts, will end up being significantly depressed relative to the past.
The future contribution from the second component, per share growth in fundamentals, will also potentially be depressed if valuations remain elevated.
How is he not assuming that high valuations will lead to lower returns going forward? He seems to be using valuations to compute expected returns, albeit in a different way than most. Maybe I'm blind or something.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: philosophicaleconomics predicts 4% real equity returns

Post by itstoomuch » Wed Feb 14, 2018 6:43 pm

Personally, I think he has it in reverse.
The egg and the chicken or is it, The chicken and the egg? Which came first?
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Re: philosophicaleconomics predicts 4% real equity returns

Post by JBTX » Wed Feb 14, 2018 7:28 pm

I find the article hard to argue against. His 4% real return assume no decrease in valuation. Citing what has happened over the last 25 years as evidence against it is nonsensical. Valuations have increased and earnings yields have increased. If you to assume both will increase further even beyond their historic highs then more power to you. Sure It could happen but not something I would want to bank on.

For somebody not approaching retirement, best case scenario is the market mean reverts sooner vs later and returns to historic trends after that. For those approaching or in retirement there is no good news here.

This is similar to GMO arguments regarding hell vs purgatory.

I’m sure a 4% withdrawal rate will work with 4% real return but the chances of success are lower.

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