You, Too, Can Predict Stock Market Returns

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
User avatar
SimpleGift
Posts: 3098
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

You, Too, Can Predict Stock Market Returns

Post by SimpleGift » Fri Mar 30, 2012 10:02 am

In a recent thread on the equity premium, William Bernstein gently chided us for relying so much on historical data and reminded us of the simple formula for determining long-term expected equity returns — variously called the Gordon equation, the Gordon discounted dividend model or the constant growth dividend model. John Bogle also uses this simplified formula when he periodically opines on expected stock market returns (here with current nominal numbers):

Stock Market Returns (6.5%) = Current Dividend Yield (2%) + HIstorical Growth Rate of Dividends/Earnings (4.5%)

This made me curious if anyone had ever backtested the Gordon Model against long-term equity market returns to see if indeed it had any predictive power. A Google search turned up two interesting papers by Foerster and Sapp, one from 2006 that backtested the model against Shiller's database of dividends and equity returns from 1871 to 2005, and another from 2005 that examined the dividends and returns over 120 years from the Bank of Montreal, the longest dividend paying company in North America.

RESULTS: In both studies, they found that the Gordon discounted dividend model worked well at explaining actual equity prices that occurred 30 years in the future. When interviewed and asked if the model had predictive power, Dr. Foerster said, “On the whole it does,” says Foerster. “The deviations are consistent with times when investors are either overly optimistic or pessimistic.” Any thoughts to share?

Image
Source: Dividends and Stock Valuations
Last edited by SimpleGift on Fri Mar 30, 2012 12:02 pm, edited 3 times in total.
Cordially, Todd

555
Posts: 4955
Joined: Thu Dec 24, 2009 7:21 am

Re: You, Too, Can Predict Stock Market Returns

Post by 555 » Fri Mar 30, 2012 10:07 am

Can you predict the weather?

User avatar
Rick Ferri
Posts: 8464
Joined: Mon Feb 26, 2007 11:40 am
Location: Austin, TX. Twitter: @Rick_Ferri
Contact:

Re: You, Too, Can Predict Stock Market Returns

Post by Rick Ferri » Fri Mar 30, 2012 10:21 am

A couple of clarifications to your formula.

1) Dividends yield should be adjusted upward to about 2.5% for buyback yield. This accounts for companies buy-back and retiring shares it rather than paying cash dividends.
2) Dividend growth is not the same as earnings growth. Earnings have grown faster than cash dividends historically.
3) The growth number should be decomposed into two parts, real earnings growth and inflation. Real earnings growth is roughly GDP per capita growth in the long term, which is about 2.5%. However, it has been higher in the past 20 year due to productivity gains.

Stock market corporate earnings are currently running at about 8% of GDP. That's on the high side historically. The long-term average has been about 6% of GDP. However, this doesn't mean earnings will decelerate. The excess earnings are coming from overseas sales that are not accounted for in GDP. Currently, overseas earnings account for about 23% of overall business earnings in the US and about 45% of US stock market earnings.

Thus, if you tally these items, you get:

2.0% Inflation
2.5% Real earnings growth from US sales
1.0% Real earnings from overseas sales
2.5% Dividend yield including buyback yield

That's an 8.0% sustainable return from equity, and it's 7% if you don't buy my excess overseas earnings adjustment.

There is one more item that has not been mentioned. That is earnings multiple expansion - better known as market P/E. Currently the P/E of S&P 500 is slightly ahead of 14 times trailing 12 month earnings. That's below the historic average of 16 times trailing earnings. Given low very interest rates, it is certainly feasible that stock valuations will go up over the remainder of this decade. I would not be surprised to see a market PE of 18 or 19 by 2020. That would increases annualized returns on stocks by about 3.% percent through the remainder of this decade, and give a total return for the 2010-2019 period of about 10%.

Rick Ferri
The Education of an Index Investor: flounders in darkness, finds enlightenment, overcomplicates strategy, embraces simplicity.

M B
Posts: 198
Joined: Mon Jul 11, 2011 5:58 am

Re: You, Too, Can Predict Stock Market Returns

Post by M B » Fri Mar 30, 2012 10:26 am

Simplegift wrote:Stock Market Returns (6.5%) = Current Dividend Yield (2%) + HIstorical Growth Rate of Dividends/Earnings (4.5%)
Mixing current and historical assumes that the dividend yield is stable over time.

Rodc
Posts: 13601
Joined: Tue Jun 26, 2007 9:46 am

Re: You, Too, Can Predict Stock Market Returns

Post by Rodc » Fri Mar 30, 2012 10:39 am

Simplegift wrote:In a recent thread on the equity premium, William Bernstein gently chided us for relying so much on historical data and reminded us of the simple formula for determining long-term expected equity returns — variously called the Gordon equation, the Gordon discounted dividend model or the constant growth dividend model. John Bogle also uses this simplified formula when he periodically opines on expected stock market returns (with current nominal numbers):

Stock Market Returns (6.5%) = Current Dividend Yield (2%) + HIstorical Growth Rate of Dividends/Earnings (4.5%)

This made me curious if anyone had ever backtested the Gordon Model against long-term equity market returns to see if indeed it had any predictive power. A Google search turned up two interesting papers by Foerster and Sapp, one from 2006 that backtested the model against Shiller's database of dividends and equity returns from 1871 to 2005, and another from 2005 that examined the dividends and returns over 120 years from the Bank of Montreal, the longest dividend paying company in North America.

RESULTS: In both studies, they found that the Gordon discounted dividend model worked well at explaining actual equity prices that occurred 30-years in the future. When interviewed and asked if the model had predictive power, Dr. Foerster said, “On the whole it does,” says Foerster. “The deviations are consistent with times when investors are either overly optimistic or pessimistic.” Any thoughts to share?

Image
Source: Dividends and Stock Valuations
As with using P/E10, Tobin's q, the Gordon equation seems only to be somehow predictive on the 20-year or so time scale. I see in the graph that more often than not the lines separate significantly and for periods on the order of 15 years.

If you lump sum at age 25 and have 40 year to wait, maybe that is useful. Unclear it is actionable information for the rest of us.

I have been unconvinced that one can use either P/E10 or q to time markets (e.g. tactical asset allocation) (of course one can time past markets, but the future is another issue entirely), and I am skeptical that one can use the Gordon equation either.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

User avatar
SimpleGift
Posts: 3098
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: You, Too, Can Predict Stock Market Returns

Post by SimpleGift » Fri Mar 30, 2012 10:54 am

Rodc wrote:If you lump sum at age 25 and have 40 year to wait, maybe that is useful. Unclear it is actionable information for the rest of us.
Yes, this is the sense in which I believe Bernstein and Bogle use the model — only for a sense of what the equity markets might return over long holding periods. It has also proven quite valuable in the past as a "sanity check" on market expectations during periods of both irrational exuberance and pessimism. Personally, I feel this is its very best use.

I've never seen anyone suggest it has value for tactical market timing.
Cordially, Todd

Rodc
Posts: 13601
Joined: Tue Jun 26, 2007 9:46 am

Re: You, Too, Can Predict Stock Market Returns

Post by Rodc » Fri Mar 30, 2012 11:08 am

Simplegift wrote:
Rodc wrote:If you lump sum at age 25 and have 40 year to wait, maybe that is useful. Unclear it is actionable information for the rest of us.
Yes, this is the sense in which I believe Bernstein and Bogle use the model — only for a sense of what the equity markets might return over long holding periods. It has also proven quite valuable in the past as a "sanity check" on market expectations during periods of irrational exuberance and pessimism.

I've never seen anyone suggest it has value for tactical market timing.
Fair enough. In part I was triggering on the thread title.

But in times of irrational exuberance and pessimism a nod to history may work as well or better: Just remember or tell the effected person "The long term real return has been ballpark 6% so don't expect this too last for long..." That is likely as powerful as breaking out an equation to predict market returns. Or, "Remember 2001 when everyone felt this way, and what happened after?" or "Remember the Death of Equities issue of Time, and what happened after?"

Of course sad truth is that when people are irrational, they don't generally listen to a rational argument! :)
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

chipmonk
Posts: 625
Joined: Wed Mar 09, 2011 4:32 pm
Location: PDX

Re: You, Too, Can Predict Stock Market Returns

Post by chipmonk » Fri Mar 30, 2012 11:30 am

Rodc wrote:If you lump sum at age 25 and have 40 year to wait, maybe that is useful. Unclear it is actionable information for the rest of us.
I'm 30 and plan to hold most of my equities for 35+ years. Close enough? :D

What does this model say about returns 35 years from now as predicted from today's prices and yield?

User avatar
SimpleGift
Posts: 3098
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: You, Too, Can Predict Stock Market Returns

Post by SimpleGift » Fri Mar 30, 2012 12:24 pm

chipmonk wrote:What does this model say about returns 35 years from now as predicted from today's prices and yield?
The model won't tell you anything about returns 35 years from now — but it does provide an estimate of the average returns you can expect over the coming 35-year period, starting from today.

As you can see above, various experts use the model slightly differently. Bernstein tends to focus on dividend growth and currently expects about a 6.5% return, I believe. Bogle focuses more on earnings growth and talks about a 7% average return going forward. Rick Ferri makes his own adjustments to the model (see upthread) and ends up the 7%-8% range.

Personally, I prefer the simplified "dividend growth only" version used by Dr. Bernstein, as it tends to be a bit more conservative — though I'm intrigued by Rick Ferri's point about adding on a 0.5% buyback yield.

PS. All these assume no long-term changes to the earnings multiple, up or down.
Last edited by SimpleGift on Fri Mar 30, 2012 7:09 pm, edited 1 time in total.
Cordially, Todd

User avatar
nisiprius
Advisory Board
Posts: 36025
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: You, Too, Can Predict Stock Market Returns

Post by nisiprius » Fri Mar 30, 2012 12:40 pm

Simplegift wrote:Stock Market Returns (6.5%) = Current Dividend Yield (2%) + HIstorical Growth Rate of Dividends/Earnings
1) Why would the historical growth rate matter? Isn't the future growth rate what's needed?

2) Why would the current dividend yield matter? Isn't the future dividend yield what's needed?

3) If you accept that the current dividend yield predicts the future dividend yield, and that the historical growth rate predicts the future growth rate, then why not just say that historical stock market returns predict future stock market returns? How does the equation improve on the predictive accuracy of simply assuming historical returns predict future returns?
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

User avatar
SimpleGift
Posts: 3098
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: You, Too, Can Predict Stock Market Returns

Post by SimpleGift » Fri Mar 30, 2012 12:54 pm

nisiprius wrote:
Simplegift wrote:Stock Market Returns (6.5%) = Current Dividend Yield (2%) + HIstorical Growth Rate of Dividends/Earnings
1) Why would the historical growth rate matter? Isn't the future growth rate what's needed?

2) Why would the current dividend yield matter? Isn't the future dividend yield what's needed?

3) If you accept that the current dividend yield predicts the future dividend yield, and that the historical growth rate predicts the future growth rate, then why not just say that historical stock market returns predict future stock market returns? How does the equation improve on the predictive accuracy of simply assuming historical returns predict future returns?
Nisi, an excellent explanation of how the Gordon Model works, plus its theoretical underpinnings, are found in Dr. Bernstein's, The Four Pillars of Investing. He takes a whole chapter ("Measuring the Beast," Chapter 2) to explain it much better than I ever could. Here's a quote from that chapter you might appreciate, though:
William Bernstein wrote: The Gordon Equation is as close to being a physical law, like gravity or planetary motion, as we will ever encounter in finance.
Cordially, Todd

User avatar
SimpleGift
Posts: 3098
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: You, Too, Can Predict Stock Market Returns

Post by SimpleGift » Fri Mar 30, 2012 2:24 pm

nisiprius wrote:1) Why would the historical growth rate matter? Isn't the future growth rate what's needed?
Doing a little more research into this, it appears the historical dividend growth rate is used because, for the U.S. at least, the growth rate has pretty much been a straight line (see chart below) — so the expectation is that the future rate will be the same as the past rate. Backtested over 140 years, it has averaged about 1.5% real and 4.5% nominal per year. Its remarkable steadiness is what gives the model its predictive power, I believe.
nisiprius wrote:2) Why would the current dividend yield matter? Isn't the future dividend yield what's needed?
The model incorporates the current dividends, plus the future growth rate of these current dividends. So, in this way, it does incorporate future dividends, because the growth rate is so predictable. At least this is my amateur understanding. Hope this helps.

Image
Source: Political Calculations
Last edited by SimpleGift on Fri Mar 30, 2012 3:01 pm, edited 1 time in total.
Cordially, Todd

Cubsfan
Posts: 101
Joined: Fri Feb 23, 2007 2:38 pm

Re: You, Too, Can Predict Stock Market Returns

Post by Cubsfan » Fri Mar 30, 2012 2:43 pm

I predict that the Cubs will win the World Series this year. I can probably predict stock market returns with a similar degree of accuracy.

Lumpr
Posts: 313
Joined: Tue May 19, 2009 2:23 pm

Re: You, Too, Can Predict Stock Market Returns

Post by Lumpr » Fri Mar 30, 2012 5:19 pm

Rick Ferri wrote:A couple of clarifications to your formula.

1) Dividends yield should be adjusted upward to about 2.5% for buyback yield. This accounts for companies buy-back and retiring shares it rather than paying cash dividends.
2) Dividend growth is not the same as earnings growth. Earnings have grown faster than cash dividends historically.
3) The growth number should be decomposed into two parts, real earnings growth and inflation. Real earnings growth is roughly GDP per capita growth in the long term, which is about 2.5%. However, it has been higher in the past 20 year due to productivity gains.

Stock market corporate earnings are currently running at about 8% of GDP. That's on the high side historically. The long-term average has been about 6% of GDP. However, this doesn't mean earnings will decelerate. The excess earnings are coming from overseas sales that are not accounted for in GDP. Currently, overseas earnings account for about 23% of overall business earnings in the US and about 45% of US stock market earnings.

Thus, if you tally these items, you get:

2.0% Inflation
2.5% Real earnings growth from US sales
1.0% Real earnings from overseas sales
2.5% Dividend yield including buyback yield

That's an 8.0% sustainable return from equity, and it's 7% if you don't buy my excess overseas earnings adjustment.

There is one more item that has not been mentioned. That is earnings multiple expansion - better known as market P/E. Currently the P/E of S&P 500 is slightly ahead of 14 times trailing 12 month earnings. That's below the historic average of 16 times trailing earnings. Given low very interest rates, it is certainly feasible that stock valuations will go up over the remainder of this decade. I would not be surprised to see a market PE of 18 or 19 by 2020. That would increases annualized returns on stocks by about 3.% percent through the remainder of this decade, and give a total return for the 2010-2019 period of about 10%.

Rick Ferri
Rick,

Curious where your are getting your net share buy back information from. Care to share?

lazyday
Posts: 3297
Joined: Wed Mar 14, 2007 10:27 pm

Re: You, Too, Can Predict Stock Market Returns

Post by lazyday » Fri Mar 30, 2012 7:25 pm

Simplegift wrote:
....historical dividend growth rate is used because, for the U.S. at least, the growth rate has pretty much been a straight line (see chart below)....

Image
Source: Political Calculations
I see at least two rates, one or two until 1943, and one since. I guess that's because these aren't real dividends. If there's a graph showing real, would be nice to see.

SheebaElwood
Posts: 55
Joined: Sat Mar 03, 2012 10:17 am

Re: You, Too, Can Predict Stock Market Returns

Post by SheebaElwood » Fri Mar 30, 2012 7:32 pm

Is this even a discussion?
Anyone with half a brain knows that one can time the market with valuation.

If the stock market PE = 40, anyone who says "Stay the course!" is just exhibiting naive willful ignorance.
Even Bogle himself timed the market in 2000. Look it up.

User avatar
Rick Ferri
Posts: 8464
Joined: Mon Feb 26, 2007 11:40 am
Location: Austin, TX. Twitter: @Rick_Ferri
Contact:

Re: You, Too, Can Predict Stock Market Returns

Post by Rick Ferri » Fri Mar 30, 2012 8:03 pm

Lumpr wrote:Rick, Curious where your are getting your net share buy back information from. Care to share?
The latest edition of Jim O'Shaughnessy's book, What Works on Wall Street, McGraw-Hill; 4 edition (October 24, 2011).

Rick Ferri
The Education of an Index Investor: flounders in darkness, finds enlightenment, overcomplicates strategy, embraces simplicity.

User avatar
Taylor Larimore
Advisory Board
Posts: 27100
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

Half a brain vs. a full brain.

Post by Taylor Larimore » Fri Mar 30, 2012 8:32 pm

Anyone with half a brain knows that one can time the market with valuation.
That may be true for those with "half a brain." Investment authorities with a "full brain" say this about market timing:
"The stock market will fluctuate, but you can't pinpoint when it will tumble or shoot up. If you have allocated your assets properly and have sufficient emergency money, you shouldn't need to worry." (AAII Guide to Mutual Funds)

"Endless tinkering is unlikely to improve performance, and chasing last period's stellar achiever is a losing strategy." (Frank Armstrong, author and adviser)

"It must be apparent to intelligent investors--if anyone possessed the ability to do so (market time) he would become a billionaire--quickly--." (David Babson, author, adviser)

"What it really takes to improve your returns and diminish your risks is a willingness to stop focusing exclusively on the movement of the markets." (Baer & Ginsler, The Great Mutual Fund Trap)

"If we haven't said it enough, we'll say it again: Market timing is dangerous." (Barron's Guide to Making Investment Decisions.)

"Only liars manage to always be "out" during bad times and "in' during good times. (Bernard Baruch, famed investor)

"You have to keep reminding yourself. We don't know what's going to happen with anything, ever." (Peter Bernstein)

"There are two kinds of investors, be thay large or small: those who don't know where the market is headed, and those who don't know that they don't know." (Wm Bernstein, author and adviser)

"I've said, 'Stay-the-course' a thousand times, and I meant it every time." (Jack Bogle in Common Sense on Mutual Funds

The Boglehead (forecasting) Contest began in 2001. Of 99 Diehard guesses that year, only 11 even guessed the direction of the stock market.

"If you're determined to succeed at investing, make it your first priority to become a buy-and-hold investor." (Jack Brennan, Straight Talk on Investing)

"I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two." (Warren Buffet)

"Market timing is an ineffective strategy for mutual fund investors." (CDA/Wiesenberger)

"Any investment method that relies on predicting the future is doomed to fail." (Chandan & Sengupta, financial authors)

"A successful investor has a good knowledge base, a well-defined investment plan, and nerves of steel to stick with it." (Andrew Clarke, financial author)

"Most investors are unable to profitably time the market and are left with equity fund returns lower than inflation." (2003 Dalber Study)

"Take my word on it. Buy-and-hold is still your best long-run strategy." (Jonathan Clements, author & journalist)

"Market-timing is bunk." (Pat Dorsey, M* Director of Fund Analysis."

"The performance of 185 tactical asset allocation mutual funds was compared with buy-and-hold strategies and equity mutual funds over the years 1985-97. Over this period the S&P 500 Index increased 734%, average equity funds increased 598%, and tactical asset allocation funds increased 384%." (David Dreman, author)

"Market timing is a wicked idea. Don't try it-ever." (Charles Ellis author of The Loser's Game)

"Forget market timing in any form." (Paul Farrell, (CBS Marketwatch.com)

"The best practice for investors is to design a long-term globally diversified asset allocation based on present and future financial needs. Then follow that plan religiously, through all markets good and bad." (Rick Ferri, author and adviser)

"Benjamin Graham spent much of his career trying to devise a goodformula for when to get into--and out of--the stock market. All formulas, he concluded, failed." (Forbes, 12-27-99)

"Buy and hold. Diversify. But your money in index funds. Pay attention to to the one thing you can control--costs." (Fortune Investor's Guide 2003)

"Dont' sell out of fear or buy out of greed. Just keep making investments, and let the market take its course over the long-term." (Norman Fosback, author, researcher)

"The only function of economic forecastng is to make astrology look respectful." (John Kenneth Galbraith, Economist)

"I've learned that market timing can ruin you." (Elaine Garzarelli)

"Staying on course may be just as difficult in bull markets as in bear markets." (Good & Hermansen, Index Your Way to Investment Success)

"For most investors the odds favor a buy-and-hold strategy." (Carol Gould, author & financial columnist)

"If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting that's going to happen to the stock market." (Benjamin Graham)

"From June 1980 through December 1992, 94.5% of 237 market timing investment newsletters had gone of business." (Graham/Campbell Study)

"Your very refusal to be active, and your renunciation of any pretended ability to predict the future, can become your most powerful weapon." (Graham & Zweig, The Intelligent Investor)

"The best advice: buy and hold." (John Haslem, author and researcher)

"Even in a bear market, market-timing and actively managed mutual funds generally hurt investment performance more than they help it." (Mark Hulbert, N.Y.Times columnist)

"After receiving the Nobel Prize, Daniel Kahneman, was asked by a CNBC anchorman what investment tips he had for viewers. His answer: "Buy and hold."

"Timing the market is for losers. Time IN the market will get you to the winner's circele, and you'll sleep better at night." (Michael Leboeuf, author)

"No one is smart enough to time the market's ups and downs." (Arthur Levitt, former SEC chairman)

"It never was my thinking that made the big money for me. It always was my sitting." (Jesse Livermore, author & famed investor)

"Nobody can predict interest rates, the future direction of the economy or the stock market." (Peter Lynch)

"Buying-and-holding a broad-based market index fund is still the only game in town." (Burton Malkiel, Random Walk Down Wall Street)

"At the peak of the bull market in March of 2000 only 0.7% of all recommendations on stocks issued by Wall Street brokerages and investment banks were to "Sell." (Miami Herald, 1-26-03)

"If you can't handle the short term, if the uncertainty is stressful and the headlines are unbearable, then the markets are too hot for you: get out of the kitchen." (Moshe Milevsky, author & researcher)

"We're not keen on market-timing. It just doesn't work." (Morningstar Course 106)

"We've yet to find anyone who can accurately and consistently predict the market's short-term moves." (Motley Fools)

"Odean and Barber tested over 66,400 investors between 1991 and 1997. Their findings: "The most active traders earned 7% less annually than buy-and-hold investors."

"Forget trying to time the market and do something productive instead." (Gerald Perritt, financial author)

"The market timer's Hall of Fame is an empty room." (Jane Bryant Quinn)

"Countless studies have proved that no one is able to time the market effectively." (Mary Roland, author & journalist)

"Trading is based on the rather arrogant belief that the trader knows more than the buyers and sellers with whom he is trading." (Ron Ross, The Unbeatable Market)

"In the long run it doesn't matter much whether your timing is great or lousy. What matters is that you stay invested." (Louis Rukeyser, TV host)

"For the 10 years that ended 12-31-2000, only one newsletter out of the 112 that Timers Digest follows managed to beat the S&P 500 Benchmark." (Jim Schmidt, editor)

"I have learned the hard way that market timing and trying to pick a fund that will out-perform the market are both losing strategies." (Larry Schultheis, author and advisor)

"I'm a strong advocate of buying and holding." (Charles Schwab)

"It turns out that I should have just bought them (securities), and thereafter I should have just sat on them like a fat, stupid peasant. A peasant however, who is rich beyond his limited dreams of avarice." (Fred Schwed Jr., 'Where are the Customers' Yachts?)

"If you are not going to stick to your chosen investment method through thick and thin, there is almost no chance of your succeeding as an investor. (Chandan Sengupta, financial author)

"Investors should look with a jaundiced eye at any market timing system being peddled by its guru-creator." (W. Scott Simon, financial author)

"Buying and holding a few broad market index funds is perhaps the most important move ordinary invests can make to supercharge their portfolios." (Stein & DeMuth, (authors & advisor)

"It's my belief that it's a waste of time to try to time any market decline, or try to pinpoint a market bottom." (James Stewart, Smart Money columnist)

"It's a staple of personal finance advice: Buy-and-hold, because trading the stock market is a sucker's bet." Larry Swedroe, author and adviser.

"People should stop chasing performance and just put together a sensible portfolio regardless of the ups and downs of the market." (David Swensen, Yale Investments)

"Trust in time and forget market timing. Allow time to work its compounding magic for you. Let market timing inflict its miseries on someone else." (Tweddell & Pierce, financial authors)

"Stay invested. Not only does buy-and-hold investing offer better returns, but it's also less work." (Eric Tyson, author, Mutual Funds for Dummies."

"Few if any investors manage to be consistently successful in timing markets." (Wall Street Journal Lifetime Guide to Money)

"If you're considering doing your own market timing, the best advice is this: Don't." (John Waggoner, USA Today financial columnist)

"If you buy, and then hold a total-stock-market index fund, it is mathematically certain that you will outperform the vast majority of all other investors in the long run." (Jason Zweig, author)
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

umfundi
Posts: 3361
Joined: Tue Jun 07, 2011 5:26 pm

Re: You, Too, Can Predict Stock Market Returns

Post by umfundi » Fri Mar 30, 2012 8:40 pm

What does this model say about returns 35 years from now as predicted from today's prices and yield?
Nothing.

In case that is not clear,

NOTHING!!

Keith
Déjà Vu is not a prediction

User avatar
Rick Ferri
Posts: 8464
Joined: Mon Feb 26, 2007 11:40 am
Location: Austin, TX. Twitter: @Rick_Ferri
Contact:

Re: You, Too, Can Predict Stock Market Returns

Post by Rick Ferri » Fri Mar 30, 2012 8:51 pm

I agree that the future cannot be know. That's not what this conversation is about. It's about what people expect as a return for the financial risks they take. Every investor expects something more for taking risk in stocks or no one would take the risk. If you own stocks, what more do you expect and why?

Rick Ferri
The Education of an Index Investor: flounders in darkness, finds enlightenment, overcomplicates strategy, embraces simplicity.

peppers
Posts: 1327
Joined: Tue Oct 25, 2011 7:05 pm

Re: You, Too, Can Predict Stock Market Returns

Post by peppers » Fri Mar 30, 2012 8:53 pm

umfundi wrote:
What does this model say about returns 35 years from now as predicted from today's prices and yield?
Nothing.

In case that is not clear,

NOTHING!!

Keith
So Keith, how do you really feel? :wink:
"..the cavalry ain't comin' kid, you're on your own..."

User avatar
SimpleGift
Posts: 3098
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: You, Too, Can Predict Stock Market Returns

Post by SimpleGift » Fri Mar 30, 2012 8:54 pm

lazyday wrote:I see at least two rates, one or two until 1943, and one since. I guess that's because these aren't real dividends. If there's a graph showing real, would be nice to see.
Image
Source: A Short History of Stock Dividends
Cordially, Todd

User avatar
Rick Ferri
Posts: 8464
Joined: Mon Feb 26, 2007 11:40 am
Location: Austin, TX. Twitter: @Rick_Ferri
Contact:

Re: You, Too, Can Predict Stock Market Returns

Post by Rick Ferri » Fri Mar 30, 2012 9:05 pm

The graph is a little deceptive. Dividend growth kept pace with price growth for about 80 years from 1870 to 1950. It was after 1950 that companies started cutting dividend growth to fuel internal growth, and then when stock option compensation became popular in the 1980s, buy-backs created much faster stock price growth than dividend growth. Now only about 30% of companies pay dividends, and the payout is only about 30% of earnings.

Rick Ferri
The Education of an Index Investor: flounders in darkness, finds enlightenment, overcomplicates strategy, embraces simplicity.

User avatar
nisiprius
Advisory Board
Posts: 36025
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: You, Too, Can Predict Stock Market Returns

Post by nisiprius » Fri Mar 30, 2012 10:14 pm

If it is generally accepted that buybacks are equivalent to dividends except for better tax treatment, then why doesn't the Vanguard Dividend Appreciation Index Fund (VDAIX), and the index it tracks (Mergent Dividend Achievers' index), only include stocks that actually pay dividends? Why don't they include stocks whose companies perform buybacks as well?
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Lumpr
Posts: 313
Joined: Tue May 19, 2009 2:23 pm

Re: You, Too, Can Predict Stock Market Returns

Post by Lumpr » Fri Mar 30, 2012 10:39 pm

nisiprius wrote:If it is generally accepted that buybacks are equivalent to dividends except for better tax treatment, then why doesn't the Vanguard Dividend Appreciation Index Fund (VDAIX), and the index it tracks (Mergent Dividend Achievers' index), only include stocks that actually pay dividends? Why don't they include stocks whose companies perform buybacks as well?
IMHO - It would be practically impossible to construct and index that tracked companies that actually had net buybacks because of the manner in which share repurchase programs are implemented. While share repurchse programs generally set a specific dollar amount, but they are not a mandate. In other words, just because a company implements a program, there is no guarantee that a single share will ever be repurchased. These programs typically have certain thresholds/parameters under which shares will be repurchased (price, volume, etc.). Additionally, these programs have compliance restriants (Rule 10b-18 and Reg. M. in particular). Finally, given a sufficient period of time (a year or longer) these companies can and sometimes do actually issue shares during the same period so you wouldn't know for sure that there will be a net buyback until after the fact. Much more difficult than a group of companies that pay periodic dividends.

FWIW, I believe Modigliani and Miller postualate it as an "optional dividend" (could have been the professor that said that, been a long time). But in essence this is just a continuation of Fisher (i.e. an asset is worth the NPV of its future cash flows, a share repurchase affects those cash flows).

Lumpr
Posts: 313
Joined: Tue May 19, 2009 2:23 pm

Re: You, Too, Can Predict Stock Market Returns

Post by Lumpr » Fri Mar 30, 2012 11:12 pm

Rick Ferri wrote:I agree that the future cannot be know. That's not what this conversation is about. It's about what people expect as a return for the financial risks they take. Every investor expects something more for taking risk in stocks or no one would take the risk. If you own stocks, what more do you expect and why?

Rick Ferri

Stated another way "what discount rate is the market pricing in," correct? IIRC, if EMH holds, then the aggregate equity DR = gordon's ER.

555
Posts: 4955
Joined: Thu Dec 24, 2009 7:21 am

Re: You, Too, Can Predict Stock Market Returns

Post by 555 » Fri Mar 30, 2012 11:22 pm

These are two absurd extremes.
SheebaElwood wrote:Is this even a discussion?
Anyone with half a brain knows that one can time the market with valuation.
umfundi wrote:
What does this model say about returns 35 years from now as predicted from today's prices and yield?
Nothing.
In case that is not clear,
NOTHING!!

umfundi
Posts: 3361
Joined: Tue Jun 07, 2011 5:26 pm

Re: You, Too, Can Predict Stock Market Returns

Post by umfundi » Fri Mar 30, 2012 11:37 pm

555 wrote:These are two absurd extremes.
SheebaElwood wrote:Is this even a discussion?
Anyone with half a brain knows that one can time the market with valuation.
umfundi wrote:
What does this model say about returns 35 years from now as predicted from today's prices and yield?
Nothing.
In case that is not clear,
NOTHING!!
Extreme, yes. "Nothing" must always be an extreme.

Why would you call it "absurd"?

Keith
Déjà Vu is not a prediction

555
Posts: 4955
Joined: Thu Dec 24, 2009 7:21 am

Re: You, Too, Can Predict Stock Market Returns

Post by 555 » Sat Mar 31, 2012 12:10 am

umfundi wrote: Extreme, yes. "Nothing" must always be an extreme.
Why would you call it "absurd"?
Because the model tells you something.

umfundi
Posts: 3361
Joined: Tue Jun 07, 2011 5:26 pm

Re: You, Too, Can Predict Stock Market Returns

Post by umfundi » Sat Mar 31, 2012 12:30 am

555 wrote:
umfundi wrote: Extreme, yes. "Nothing" must always be an extreme.
Why would you call it "absurd"?
Because the model tells you something.
Something about conditions in +35 years from now, March 31 2047? What does the model tell you. Based on today?

Keith
Déjà Vu is not a prediction

User avatar
SimpleGift
Posts: 3098
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: You, Too, Can Predict Stock Market Returns

Post by SimpleGift » Sat Mar 31, 2012 12:44 am

John Hussman has an interesting commentary from 2005 on the effect of share repurchases upon the Gordon Model. In his view, if one uses per-share dividend growth of the S&P 500 Index, no adjustments to the model are needed for share repurchases, as they are already factored in:
John Hussman wrote:It is extremely important that the dividend discount model is valid, even with share repurchases, provided that you use growth in per-share dividends.

This is big news, which easily escapes attention unless you go through the tedium of actually deriving it mathematically. It's big news because it turns out that the calculation of the S&P 500 index does result in a dividend figure that grows on a per-share basis. In other words, if you use index dividends and their associated growth rate, you don't NEED to factor in repurchases, because the index does it for you.

The easiest way to see this is to recognize that the divisor for the S&P 500 index is reduced in response to share repurchases, so the same aggregate level of dividends will, after a repurchase, result in a proportionally higher index dividend. To demonstrate it mathematically, notice that if the companies in the index were to repurchase 10% of their shares, the recalculated index divisor would be reduced by exactly 10%, so the same level of aggregate dividends from the component companies would be associated with an 11.11% increase in the dividend reported for the S&P 500 index. Of course, that's exactly how much per-share dividends have increased as a result of the repurchase.

In short, the index dividend for S&P 500 (and its associated growth rate) already captures the impact of net share repurchases. Further adjustments to the dividend discount model represent double-counting.
Cordially, Todd

555
Posts: 4955
Joined: Thu Dec 24, 2009 7:21 am

Re: You, Too, Can Predict Stock Market Returns

Post by 555 » Sat Mar 31, 2012 12:53 am

umfundi wrote:
555 wrote:
umfundi wrote: Extreme, yes. "Nothing" must always be an extreme.
Why would you call it "absurd"?
Because the model tells you something.
Something about conditions in +35 years from now, March 31 2047? What does the model tell you. Based on today?
It contains non-vacuous information about a statistical ensemble of possible sequences of events over the next 35 years, of course.

SheebaElwood
Posts: 55
Joined: Sat Mar 03, 2012 10:17 am

Re: Half a brain vs. a full brain.

Post by SheebaElwood » Sat Mar 31, 2012 1:02 am

Taylor Larimore wrote:
Anyone with half a brain knows that one can time the market with valuation.
That may be true for those with "half a brain." Investment authorities with a "full brain" say this about market timing:

"I've said, 'Stay-the-course' a thousand times, and I meant it every time." (Jack Bogle in Common Sense on Mutual Funds
Here's an excerpt from a book from John Bogle. You may have heard of him. He's the founder of Vanguard.

p.105: That the dividend yield as 2000 began was at an all-time low of just 1% and the PE at a near record high of 32 times earnings together explain why the average return on stocks in the current decade is at present running at an annual rate of less than 1%.

p. 237: "But, in late 1999, concerned about the (obviously) speculative level of stock prices, I reduced my equities to about 35% of assets, thereby increasing my bond position to about 65%."


"You can't time the market" really should be read as "It can be done, and done quite EASILY, however, odds are, YOU'RE not going to understand things like PE ratios, so don't bother. It's buy and hold for people like you."

For people with basic grasp of the stock market, timing is the way to go.

You Should Have Timed the Market
http://online.wsj.com/article/SB1000142 ... nalfinance

cjking
Posts: 1793
Joined: Mon Jun 30, 2008 4:30 am

Re: You, Too, Can Predict Stock Market Returns

Post by cjking » Sat Mar 31, 2012 3:32 am

Rodc wrote:If you lump sum at age 25 and have 40 year to wait, maybe that is useful.
I think strategy is as important as long holding periods if you want any prediction method to look good. Compared to someone who sells all equities on hist 65th birthday regardless of PE-multiple at the time, someone who spread equity sales evenly over 30 years will experience far less variable outcomes. Someone who sells opportunistically has an even better chance of getting what they expect.

FinanceFun
Posts: 722
Joined: Mon Nov 28, 2011 9:29 am

Re: You, Too, Can Predict Stock Market Returns

Post by FinanceFun » Sat Mar 31, 2012 5:15 am

Rick Ferri wrote:A couple of clarifications to your formula.

1) Dividends yield should be adjusted upward to about 2.5% for buyback yield. This accounts for companies buy-back and retiring shares it rather than paying cash dividends.
2) Dividend growth is not the same as earnings growth. Earnings have grown faster than cash dividends historically.
3) The growth number should be decomposed into two parts, real earnings growth and inflation. Real earnings growth is roughly GDP per capita growth in the long term, which is about 2.5%. However, it has been higher in the past 20 year due to productivity gains.

Stock market corporate earnings are currently running at about 8% of GDP. That's on the high side historically. The long-term average has been about 6% of GDP. However, this doesn't mean earnings will decelerate. The excess earnings are coming from overseas sales that are not accounted for in GDP. Currently, overseas earnings account for about 23% of overall business earnings in the US and about 45% of US stock market earnings.

Thus, if you tally these items, you get:

2.0% Inflation
2.5% Real earnings growth from US sales
1.0% Real earnings from overseas sales
2.5% Dividend yield including buyback yield

That's an 8.0% sustainable return from equity, and it's 7% if you don't buy my excess overseas earnings adjustment.

There is one more item that has not been mentioned. That is earnings multiple expansion - better known as market P/E. Currently the P/E of S&P 500 is slightly ahead of 14 times trailing 12 month earnings. That's below the historic average of 16 times trailing earnings. Given low very interest rates, it is certainly feasible that stock valuations will go up over the remainder of this decade. I would not be surprised to see a market PE of 18 or 19 by 2020. That would increases annualized returns on stocks by about 3.% percent through the remainder of this decade, and give a total return for the 2010-2019 period of about 10%.

Rick Ferri
Excellent explanation. Thank you.

I always used GDP + Dividend = total return. Very rough, didnt account for inflation etc. I think I will adopt this model

FinanceFun
Posts: 722
Joined: Mon Nov 28, 2011 9:29 am

Re: You, Too, Can Predict Stock Market Returns

Post by FinanceFun » Sat Mar 31, 2012 5:23 am

Simplegift wrote:
lazyday wrote:I see at least two rates, one or two until 1943, and one since. I guess that's because these aren't real dividends. If there's a graph showing real, would be nice to see.
Image
Source: A Short History of Stock Dividends
Is there any data available to add buy backs to dividends and recalculate slope over this period?

FinanceFun
Posts: 722
Joined: Mon Nov 28, 2011 9:29 am

Re: Half a brain vs. a full brain.

Post by FinanceFun » Sat Mar 31, 2012 5:33 am

SheebaElwood wrote:
Taylor Larimore wrote:
Anyone with half a brain knows that one can time the market with valuation.
That may be true for those with "half a brain." Investment authorities with a "full brain" say this about market timing:

"I've said, 'Stay-the-course' a thousand times, and I meant it every time." (Jack Bogle in Common Sense on Mutual Funds
Here's an excerpt from a book from John Bogle. You may have heard of him. He's the founder of Vanguard.

p.105: That the dividend yield as 2000 began was at an all-time low of just 1% and the PE at a near record high of 32 times earnings together explain why the average return on stocks in the current decade is at present running at an annual rate of less than 1%.

p. 237: "But, in late 1999, concerned about the (obviously) speculative level of stock prices, I reduced my equities to about 35% of assets, thereby increasing my bond position to about 65%."


"You can't time the market" really should be read as "It can be done, and done quite EASILY, however, odds are, YOU'RE not going to understand things like PE ratios, so don't bother. It's buy and hold for people like you."

For people with basic grasp of the stock market, timing is the way to go.

You Should Have Timed the Market
http://online.wsj.com/article/SB1000142 ... nalfinance
This is a foolish interpretation of what was said. To argue that reversion to the mean is more likely to have a larger impact the further from the mean you stray, is accurate and logical. To then extrapolate that and claim you can time the market - is absurd. In your example, why wouldn't you have gotten out of equities at 25 PE? 30? How much gain would you have left on the table if you sold at 25PE? And if you waited to the peak at 40 PE, how did you predict the continued multiple expansion?

It's easy to pretend to be smart in hindsight. But the simple fact is that you cannot tell me where equities will be 1 week, 1 year, or 1 decade from now. Nor can you tell me what the earnings multiple will be. How then can you claim to be able to time the market.... ???

Back to your example, the strategy of rebalancing should have been providing exit points all along the multiple expansion timeline. At 30 or 40... Or frankly anything north of 20, COULD be seen as a good time to trim your AA of stocks on a reversion to the mean basis. No one here would lambaste you for taking 10-15% stocks and move into bonds based on the principles of reversion to the mean. It's not ivory tower purist, but certainly viable.

My favorite quote on financial markets "the market can stay irrational, longer then I can stay solvent"

If you do have the ability to time the market, or talk to the dead, walk on water, fly... Then I expect you will shortly be a billionaire, and you can report back to us when that happens.

User avatar
docneil88
Posts: 927
Joined: Mon Apr 30, 2007 3:39 pm
Location: Taxable

Re: You, Too, Can Predict Stock Market Returns

Post by docneil88 » Sat Mar 31, 2012 6:05 am

Simplegift wrote:In a recent thread on the equity premium, William Bernstein gently chided us for relying so much on historical data and reminded us of the simple formula for determining long-term expected equity returns — variously called the Gordon equation, the Gordon discounted dividend model or the constant growth dividend model. John Bogle also uses this simplified formula when he periodically opines on expected stock market returns (here with current nominal numbers):

Stock Market Returns (6.5%) = Current Dividend Yield (2%) + HIstorical Growth Rate of Dividends/Earnings (4.5%)
Which is it, dividends or earnings? I don't understand why Bernstein would chide us for using so much historical data, then promote the Gordon equation, which has a huge historical component. And I don't see much reason to assume that the HIstorical Growth Rate of "Dividends/Earnings" will continue. Even if stock buybacks are counted as dividends, payout ratios could change in a major way, thus affecting the future growth rate up or down. For one, changes in various tax laws could inspire such changes. Best, Neil

afan
Posts: 3566
Joined: Sun Jul 25, 2010 4:01 pm

Re: You, Too, Can Predict Stock Market Returns

Post by afan » Sat Mar 31, 2012 9:06 am

There is a difference between making forecasts about long term market returns and market timing.The forecast does not imply changing asset allocation. Market timing, by definition, means changing allocation in response to changes in forecast. Cochrane makes a strong case that long term returns can be be forecast. However, it is not at all clear that this means one should make changes in allocation on this basis. The forecasts have error, naturally, and they are long term. Thus, they do not tell one to increase or decrease stock allocation month to month or even year to year based on changing expectations about 5, 10, or more year returns.

At most, one might use long term forecasts, along with risk tolerance, to establish a base asset allocation. One might look at it now and then to see whether forecast returns have changed so drastically that, allowing for error, a major change in allocation is indicated. Then one would have to decide whether even such a big change in forecast returns was reliable.

Market timing needs precise and accurate short term forecasts, which I have never seen anyone show they can produce.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

User avatar
SimpleGift
Posts: 3098
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: You, Too, Can Predict Stock Market Returns

Post by SimpleGift » Sat Mar 31, 2012 10:13 am

docneil88 wrote:Which is it, dividends or earnings? I don't understand why Bernstein would chide us for using so much historical data, then promote the Gordon equation, which has a huge historical component.
Neil, most experts (including Bernstein) use the dividend growth rate, but John Bogle uses the earnings growth rate, I believe, which is why I mentioned it in the OP. In practice, over long time horizons, it doesn't make a huge difference for the Gordon Model (see chart below) — though earnings have historically grown slightly faster than dividends and have been much more volatile.

Because the growth rate of dividends has been so remarkably consistent over long periods, the historical average, for all intents and purposes, is the same as the future average. This is why the Gordon Model has had such reliable predictive power for over a century. Things may change in the future, of course, but I'd be very cautious about abandoning the model without very good cause, as it has served so reliably for so long.

Image
Source: Efficient Frontier
Cordially, Todd

VennData
Posts: 575
Joined: Mon Feb 26, 2007 5:52 pm

Re: Half a brain vs. a full brain.

Post by VennData » Sat Mar 31, 2012 10:23 am

SheebaElwood wrote:You Should Have Timed the Market
http://online.wsj.com/article/SB1000142 ... nalfinance
Your example does not support your argument. Individuals failed to do what you say is possible in this example.

555
Posts: 4955
Joined: Thu Dec 24, 2009 7:21 am

Re: You, Too, Can Predict Stock Market Returns

Post by 555 » Sat Mar 31, 2012 10:51 am

Simplegift wrote: Source: Efficient Frontier
This article,
The Returns Fairy. . . Explained
William J. Bernstein
is excellent, and fun to read, as always with this author.
Now everyone, go read it.

umfundi
Posts: 3361
Joined: Tue Jun 07, 2011 5:26 pm

Re: You, Too, Can Predict Stock Market Returns

Post by umfundi » Sat Mar 31, 2012 11:08 am

555 wrote:
Simplegift wrote: Source: Efficient Frontier
This article,
The Returns Fairy. . . Explained
William J. Bernstein
is excellent, and fun to read, as always with this author.
Now everyone, go read it.
I read it. Towards the end, he says:
The sharp-eyed among you may detect that the slope of all three plots is slightly higher during the second half of the period. Alas, it is entirely due to inflation; in real terms, the growth rate of corporate dividends and earnings did not increase during the twentieth century.
Is he saying that if you accounted for inflation, the lines on his semi-log chart would be approximately straight?

Thank you,

Keith
Déjà Vu is not a prediction

User avatar
SimpleGift
Posts: 3098
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: You, Too, Can Predict Stock Market Returns

Post by SimpleGift » Sat Mar 31, 2012 11:23 am

umfundi wrote:I read it. Towards the end, he says:
The sharp-eyed among you may detect that the slope of all three plots is slightly higher during the second half of the period. Alas, it is entirely due to inflation; in real terms, the growth rate of corporate dividends and earnings did not increase during the twentieth century.
Is he saying that if you accounted for inflation, the lines on his semi-log chart would be approximately straight?
Exactly. See the chart of real dividend growth (inflation-adjusted) upthread. It has a much more constant slope.
Cordially, Todd

User avatar
docneil88
Posts: 927
Joined: Mon Apr 30, 2007 3:39 pm
Location: Taxable

Re: The Gordon Equation

Post by docneil88 » Sat Mar 31, 2012 3:20 pm

Re. the Gordon Equation, I just want to mention that large changes in the taxation of corporate earnings could greatly affect the future earnings growth rate and thus the future dividend growth rate, e.g. if the corporate tax were removed as some advocate. Environmental limitations on population size could also greatly affect the future earnings growth rate and thus the future dividend growth rate. In addition, changes in the taxation of dividends and capital gains could also influence corporate decisions re. future payout ratios, which would impact future dividend growth rates. E.g. if the current tax rates on dividends expire as they are set to do:
The special tax rates on long-term gains and qualified dividends will expire on December 31, 2012. Starting 2013, the tax rate on long-term gains will be 20% (or 10% if a taxpayer is in the fifteen percent tax bracket). [From: http://taxes.about.com/od/capitalgains/ ... sTax_4.htm .]

umfundi
Posts: 3361
Joined: Tue Jun 07, 2011 5:26 pm

Re: You, Too, Can Predict Stock Market Returns

Post by umfundi » Sat Mar 31, 2012 5:33 pm

So,

Is there a contradiction?

A) There is an expected return, perhaps calculated by the Gordon equation. The longer your future horizon, the more likely the expected return is to be attained. The funnel narrows?

B) The longer your investment horizon, the more your risk rises. That is because the dispersion of possible results grows over time. The funnel widens?

If this is a stupid question, please excuse me.

Thank you,

Keith
Déjà Vu is not a prediction

User avatar
SimpleGift
Posts: 3098
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: You, Too, Can Predict Stock Market Returns

Post by SimpleGift » Sat Mar 31, 2012 6:48 pm

Keith, all the Gordon Equation can tell you is the "fundamental return," as John Bogle would call it, that you can expect from your stocks over the coming 30 years — which is based on the discounted value of the future stream of dividends. But It can't tell you anything about the additional element of "speculative return" (positive or negative) expected over the next 30 years — which will be determined by the changes in the earnings multiple, up or down.

So the fundamental return says what the final value of your stocks "should" be after 30 years — and it has shown some good predictive power. But it's the additional speculative return (positive or negative) that will determine what the final value of your stocks will actually be. Because this speculative return is unknown and volatile, your resultant final wealth is subject to a large degree of luck and dispersion. Hope this helps!
Cordially, Todd

umfundi
Posts: 3361
Joined: Tue Jun 07, 2011 5:26 pm

Re: You, Too, Can Predict Stock Market Returns

Post by umfundi » Sat Mar 31, 2012 7:11 pm

Todd,

I am fine with that.

I'm just trying to reconcile what, at times, seem to be competing arguments.

For example, Zvi Bodie, who seems to advocate taking a much lower risk in favor of a more deterministic or predictable outcome.

Don't invest in the expected 30-year market return. It's too risky. Invest in a T-bond instead. Much lower (than the expected) return, but it's a sure thing.

(Am I going off-topic?)

Thank you,

Keith
Déjà Vu is not a prediction

Rodc
Posts: 13601
Joined: Tue Jun 26, 2007 9:46 am

Re: You, Too, Can Predict Stock Market Returns

Post by Rodc » Sat Mar 31, 2012 7:19 pm

Stock Market Returns (6.5%) = Current Dividend Yield (2%) + HIstorical Growth Rate of Dividends/Earnings (4.5%)
One thing to note is that the last term is fixed. In this case at 4.5%. That means this is no more and no less than:

Long term returns going forward are "predicted" by current dividend yield. If we are in a recession or coming out of one, and companies cut dividends, well that is the way it will always be.

Does that really make sense?
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

User avatar
docneil88
Posts: 927
Joined: Mon Apr 30, 2007 3:39 pm
Location: Taxable

Re: You, Too, Can Predict Stock Market Returns

Post by docneil88 » Sat Mar 31, 2012 8:03 pm

Rodc wrote:
Stock Market Returns (6.5%) = Current Dividend Yield (2%) + HIstorical Growth Rate of Dividends/Earnings (4.5%)
One thing to note is that the last term is fixed. In this case at 4.5%. That means this is no more and no less than:

Long term returns going forward are "predicted" by current dividend yield. If we are in a recession or coming out of one, and companies cut dividends, well that is the way it will always be.

Does that really make sense?
Interesting points Rodc, though the historical growth rate could change a modest amount over time as new data points are added to the history.

Post Reply