305pelusa wrote: ↑
Wed Oct 09, 2019 3:19 pm
ukbogler wrote: ↑
Wed Oct 09, 2019 2:02 pm
willthrill81 wrote: ↑
Wed Oct 09, 2019 1:57 pm
Bogle had a record of consistently underestimating stock returns. If you'll pardon the metaphor, even a broken clock is right twice a day. This no disrespect for the gentleman that Bogle was.
If you don't rate his abilities, why are you on a Bogle forum?
Anyhoo, you don't have to agree or disagree with Bogle. All you have to do to invalidate the idea is point out why the formula is wrong. Or why the inputs into it need tweaking. Which would involve explaining why you think earnings will grow more rapidly, or why multiples will expand past the currently high level.
He already did. The P/E implies a 4.6% return rn. Since earnings grow at least at the rate of inflation, that represent 4.6% real return. The CAPE imples 3.5% real.
The 1% comes because the author assumed a reversion of the mean P/E (valuations get better). This is a speculative return which has nothing to do with fundamentals.
I agree the derivation by which the dividend discount model is rearranged to give E[r]=1/PE is fundamental only. It neglects any speculative return from PE changing. Therefore a common reason estimates of expected return to be lower than 1/PE is the assumptions PE's (or CAPE) will revert from currently high values more to historical mean. Although, that's not the only assumption one might make to get a lower/higher estimate. Self plagiarizing from a previous post that explains where the idea E[r]=1/PE=E/S comes from:
"The price of a stock S=Div/(r-g) S the stock price, r the return, and g the dividend growth rate, or IOW r=S/Div+g, the return the perpetual payout of the dividend plus dividend growth. .. we take these terms to be real (ie inflation adjusted)
But dividend growth comes from earnings growth comes from return. Assume in equilibrium the real expected return on the stock is the return on capital of the company.
So restate the first equation as S= p*E/(r-(1-p)*r), where p is the payout ratio, ie Div=p*E, div growth rate is (1-p)*r
Simplify and you get r=E/S"
The quasi-sleight of hand 'we take these terms to be real' actually has some complications as to the effect of real v nominal debt, inventory, depreciation etc. The simple assumption is that that all washes out, some academic papers have looked at whether it really does.
But another related assumption there is that the depreciation charge is the actual cost to maintain zero earnings growth. Historically that hasn't been true: companies needed to reinvest some 'earnings' for future real earnings growth not to be negative (as opposed to the theoretical assumption that 'earnings' is the free and clear profit that could be entirely distributed each year and the company maintain its real earnings constant indefinitely, I think most observers intuitively realize that's optimistic). Also note that derivation doesn't end up caring what the dividend or payout ratio is, those drop out, so buybacks aren't directly relevant to it either.
Anyway I agree negative expected speculative return is likely a component in an estimate of overall US stock expected return that's only 1% real. Various prognosticators are upfront about that, it's the assumption of Research Affiliates' expected return estimates where US large cap is estimated 0.5% real, DM non US 5.4% EM 7.4%. Which *are* predictions, as I'd see it.
A straight earnings yield is not a 'prediction' as I'd see it. It's a benchmark of expected return under particular assumptions. For my planning purposes I assume expected return of US stocks is 1/CAPE, so around 3.5% real as you say. On the somewhat separate topic of US v foreign I believe it's better to diversify globally at this point even if one has benefited by not doing so up to now, not necessarily to literally believe projections like RA's that foreign will have several % point higher returns.
I would also say though that some people seem to want to have it both ways on the speculative return. Positive speculative return, namely tendency to valuation *increase* particularly in US in recent decades is the main reason the supposed 'prediction' of the CAPE has been 'wrong', or anyway why the correlation of CAPE to subsequent realized return is not super high. But then one can't IMO say a negative expected long term speculative return is an absolutely invalid assumption about the future. Is it really equally likely the CAPE will rise more than fall? That's the rough assumption of no speculative return. Again I use just 1/CAPE but I think people dismissing that as significantly too low are whistling past the graveyard.
https://interactive.researchaffiliates. ... e=Equities