Jump to content

Bull Market Turns 7yrs Today


jtvalue
 Share

Recommended Posts

At the end of 2008 the Market capitalization of listed domestic companies (current US$) was 11,590,277,780,000.  The markets have gone up by $17T.

 

That is a 146% gain in 7 years or a CAGR of 13.5%.  Much better than GDP growth. :o

 

Why is the end of 2008 a reference number? Maybe the number was too low at the time because of panic?

 

Quick look at Morningstar shows a 10-year total return CAGR on the SP500 of 4.47% and of 3.03% for 15 years. Not exactly a golden era.

 

Picking start and end points matters a lot.

Link to comment
Share on other sites

At the end of 2008 the Market capitalization of listed domestic companies (current US$) was 11,590,277,780,000.  The markets have gone up by $17T.

 

That is a 146% gain in 7 years or a CAGR of 13.5%.  Much better than GDP growth. :o

 

Why is the end of 2008 a reference number? Maybe the number was too low at the time because of panic?

 

Quick look at Morningstar shows a 10-year total return CAGR on the SP500 of 4.47% and of 3.03% for 15 years. Not exactly a golden era.

 

Picking start and end points matters a lot.

 

That is a good point.  I picked that as a starting point, because it was the beginning of the Central Bank massive intervention.  7 years on, the economy is still on Fed life support, yet the markets have rallied greatly.  There is a definite mismatch.

Link to comment
Share on other sites

What I find interesting is that if profit margins have peaked, and they are sitting around all-time highs, then future market performance will be a function of GDP growth and valuation. If we have nominal GDP growth of 3% and a constant valuation relative to today, do we get more than 3% + 2% dividend yield over the next 10 or 15 years?

 

Genuinely interested in counter-arguments.

Link to comment
Share on other sites

do we get more than 3% + 2% dividend yield over the next 10 or 15 years?

 

Plus net buybacks?

 

What does that actually amount to, net of stock options & restricted stock issued? It's possible that's a bit of a plus factor, but on a net basis I'm not sure that it adds much. If someone has the figures, I'd be interested.

Link to comment
Share on other sites

What I find interesting is that if profit margins have peaked, and they are sitting around all-time highs, then future market performance will be a function of GDP growth and valuation. If we have nominal GDP growth of 3% and a constant valuation relative to today, do we get more than 3% + 2% dividend yield over the next 10 or 15 years?

 

Genuinely interested in counter-arguments.

 

First of all, the link between GDP and the stock market is sketchy at best. This might be interesting reading material: link.

WHEN investors pick the countries they want to back, they tend to be guided by economic growth prospects. The faster an economy grows, they reason, the faster corporate profits will grow in the country concerned, and thus the higher the returns investors will achieve.

 

Alas, this is not the case. Work done by Elroy Dimson, Paul Marsh and Mike Staunton at the London Business School established this back in 2005. Over the 17 countries they studied, going back to 1900, there was actually a negative correlation between investment returns and growth in GDP per capita, the best measure of how rich people are getting.  In a second test, they took the five-year growth rates of the economies and divided them into quintiles. The quintle of countries with the highest growth rate over the previous five years, produced average returns over the following year of 6%; those in the slowest-growing quintile produced returns of 12%. In a third test, they looked at the countries and found no statistical link between one year's GDP growth rate and the next year's investment returns.

 

Why might this be? One likely explanation is that growth countries are like growth stocks; their potential is recognised and the price of their equities is bid up to stratospheric levels. The second is that a stockmarket does not precisely represent a country's economy - it excludes unquoted companies and includes the foreign subsidiaries of domestic businesses. The third factor may be that growth is siphoned off by insiders - executives and the like - at the expense of shareholders.

 

Second, even if that link exists I think you cannot just slap a 2% dividend return on top of it (nor net buybacks). If the economy grows by 3%, the stock market total return should grow by 3%. Dividend is not some magic money coming from nowhere. Whether earnings are reinvested or distributed shouldn't matter for total stock market returns.

 

And last but not least, your estimate for US market returns looks quite reasonable but I think the more interesting question is: can you find individual companies (or other markets) that beat the market? :)

Link to comment
Share on other sites

writser,

 

Your last question we can leave for another discussion - not really worried about that here.

 

As for the other two points.

 

(1) This is why I held "all else equal" - profit margins and valuation. And for an economy/market like the US, I suspect that the correlation between S&P 500 revenue growth and GDP growth is very high, but I'm willing to be shown contrary data. To argue that my assumption is wrong about GDP growth matching market growth, you'll have to establish either that (a) valuations will rise relative to earnings (b) profit margins will rise © revenue growth in the indexes will be meaningfully higher than GDP growth or (d) that I'm missing a material factor. I see (a) and (b) as possible but not sustainably and am uncertain what would cause ©. I would love to hear about (d) - one possibility that's been raised is buybacks.

 

(2) Regarding dividends, there are two sources of return when you buy an index. The first is the growth in the price of the index, which I would argue is a function of the two sources above -- growth in overall revenue and profit margins on revenue. If buybacks are large enough relative to stock issuance that would be an additional factor. Corporations, in aggregate, must retain earnings to generate that growth. So the 3% sales growth would come from retained earnings, as you mentioned.

 

The second source of return are dividends. I'm not "slapping" a 2% dividend -- that's roughly what it seems corporations are paying out relative to price right now. If dividends grow in line with earnings, and prices grow in line with dividends/earnings, then the dividend yield should be a constant (measured from today's price). Obviously, you can get a higher dividend yield if you are able to buy the index at a lower price.

 

Which leads me back to my original question. How would one get a return meaningfully higher than 5% per annum from today's price if the revenues of American companies in the index grow at 3% and you don't get a tailwind from valuation or profit margins.

 

One possibility is inflation -- but then you'd not be getting any more real return.

Link to comment
Share on other sites

Regarding point 1: I don't think an "all else equal" comparison is useful because market valuations are reflexive. According to the quoted research that is one of the key reasons why the relation between GDP and market returns doesn't hold. In Russia stocks are cheap, in the US they are expensive. But they are so because the expected future is priced in. If you ignore this you are getting into very hypothetical territory. Too hypothetical for my taste.

 

Regarding point 2: I've been thinking a bit about this, it could very well be that I am wrong. Thought experiment: suppose two identical countries exist. In country R all companies reinvest all earnings (0% yield). In country D all companies pay out all earnings (10% yield). GDP of both countries grows by 3% p.a. You are saying stock market total returns in R-land are 3% p.a. and in D-land are 13% p.a. forever?

 

Which leads me back to my original question. How would one get a return meaningfully higher than 5% per annum from today's price if the revenues of American companies in the index grow at 3% and you don't get a tailwind from valuation or profit margins.

Well, if you believe in the EMH and in the GDP - stock market link: you don't. If not, you should look for mispricings. I guess you knew that already, so I'm not quite sure what point you are making / what answer you are looking for.

Link to comment
Share on other sites

do we get more than 3% + 2% dividend yield over the next 10 or 15 years?

 

Plus net buybacks?

 

What does that actually amount to, net of stock options & restricted stock issued? It's possible that's a bit of a plus factor, but on a net basis I'm not sure that it adds much. If someone has the figures, I'd be interested.

 

I don't know but it better be a big plus. According to Yardeni, 63% of operating earnings were spent on buybacks last year..

Link to comment
Share on other sites

What I find interesting is that if profit margins have peaked, and they are sitting around all-time highs, then future market performance will be a function of GDP growth and valuation. If we have nominal GDP growth of 3% and a constant valuation relative to today, do we get more than 3% + 2% dividend yield over the next 10 or 15 years?

 

Genuinely interested in counter-arguments.

 

Growth and yield aren't independent. They are a function of ROE, retention rate, and Price-to-Book.

 

--

This is why there is no correlation between GDP and returns. Imagine that a stock index is growing earnings at 12% with an 10% ROE. The index will need to reinvest 120% of earnings to support that growth. The per share earnings will be diluted by stock issuance, so that stockholders will only earn 10% (assuming P/B = 1).

 

Alternatively, you could have an index that is growing 0% with a 10% ROE. 100% of earnings will be paid as dividends. So stockholders will earn 10% (assuming P/B = 1).

 

Link to comment
Share on other sites

Let's just get this out of the way -- I'm well aware of the disconnect between GDP and returns in certain periods. As I've mentioned, there are two reasons why they diverge: Profit margins and valuations. You could have aggregate market revenues double, but if profit margins are cut in half and valuations are cut in half, the market will not perform very well. And that's what you observe in these studies you're mentioning. GDP does well but the country's businesses are not profitable or there is a very low valuation placed on that profitability. Or vice versa.

 

Thus bringing me to my point: Unless US companies become more profitable relative to sales or the valuation on them continues to increase, it seems highly likely that we're in for weak returns in aggregate. The only valid issue I see raised is that GDP growth rates and the sales growth rate of the S&P 500 or another index would be very different. But how could it be that the aggregate sales of an index like the S&P 500 would diverge from the growth rate of GDP over a long period?

 

Let's say that GDP is growing at 3% and the revenues of the S&P were growing at 6% per annum. Eventually, the S&P would overtake GDP, wouldn't it? Which is, obviously, impossible. So there must be some relationship between the two.

 

From 1995-2015, the S&P 500's earnings grew at about 5.3% per annum, a period in which profit margins went from from the 6% neighborhood to the 10% neighborhood. That's 2.5% of annual return solely attributable to expansion of earnings, leaving sales growth at around 3%. Also, valuations went from less 13 times earnings to over 19, adding another 1.7% per annum.  Adding those together: 2.5% (margin expansion) + 3% (sales growth) + 2.1% (valuation expansion) = 7.6%. If you look at this chart, you'll see that's almost exactly what the market delivered in that twenty year period plus or minus 10-20bps.

 

https://www.google.com/finance?chdnp=0&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1419627600000&chddm=1990972&chls=IntervalBasedLine&q=INDEXSP:.INX&ntsp=0&ei=Rf_gVqicDpC7e6PLu1A

 

The average dividend yield being paid in that period was less about 1.8%, so total return was just short of 10% per annum.

 

Which that brings me back to me point: If we won't be able to rely on margins expanding or valuations expanding, we're left (at best) with sales growth and dividends to drive aggregate returns. And if valuations and/or profit margins contract, that will make it all the worse.

 

Of course, it's possible that corporations will begin to earn 12% on sales and be valued at 30x earnings, but that's a speculation I can't make and I suspect would not be very sustainable.

 

writser, as for your comment on beating the market, again, not what I'm trying to get at here. I'm trying to figure out what the market has in store for the next 10 or so years from today's price, which has interesting implications. This thread is about the bull market in stocks. Thanks.

Link to comment
Share on other sites

You seem to forget that SP500 operate internationally, so equating their growth with US GDP growth is rather tenuous. Most of their growth could come from EM that could grow 5%+.

 

That said, I won't argue with ~5%'ish return for SP500 for next decade from here.

Link to comment
Share on other sites

You seem to forget that SP500 operate internationally, so equating their growth with US GDP growth is rather tenuous. Most of their growth could come from EM that could grow 5%+.

 

Or that GDP growth could be caused by non-listed firms (startups). Or that insiders siphon off most of the extra profits. Multiple reasons why the relationship used as an assumption doesn't hold at all.

 

I'm curious what you think about my dividend thought experiment. You ignore it - am I mistaken?

Link to comment
Share on other sites

People also forget the change in composition of the SP500 over time. High-margin software and healthcare businesses (for example) weren't as large a part of it before, so it's expected to see margins increase.

 

People compare today's SP500 with the SP500 of the 1970s as if it was actually the same thing, but I'd be curious to see how many companies are the same, and how much even those that remain have changed over time (not saying it's always for the better, but there's certainly a difference).

Link to comment
Share on other sites

Thanks for the responses, but you guys have to produce some data to back this stuff up, and no one has yet answered any of my important questions.

 

(1) GDP includes net exports. If something is produced in the US and sold in Brazil, that's in our GDP. The only thing missing would be things US companies produce and sell abroad. If Apple makes an iPhone in China in sells it in China. That type of sale would, however, be included in Gross National Product -- which takes in foreign sales by US entities. When you look look at the figures, GDP and GNP are pretty nearly identical in for the United States. (The difference is less than 1%.) So this is not alone a large enough factor to make a difference.

 

(2) Liberty, you make a fair point as to why margins have increased, and I think you're at least partially right. But will they go from 10% to 12% or higher? And will margins in software and healthcare be mean-reverting over time? They haven't been yet (as a sector) but I don't consider it impossible at all. This is an unknowable.

 

However, even if I'm wrong and margins stay this high, all I need to establish is that they're not going higher on a sustained basis for my thesis on market returns to be correct.

 

(3) If there is meaningful sales growth included in GDP but outside of the indexes, as with startups, then my argument would be even stronger. S&P 500 sales growth would be lagging GDP growth, and returns would be even weaker. But I suspect this is not a large factor: There have been startups outside the indexes forever and yet sales growth has still managed to be in the 3-4% range, in line with I'm outlining for the future.

 

(4) writser, I'm sorry but I don't see the relevance of your dividend experiment here. For the US to be Country R, it's return on equity would have to go to 3% from the double-digits figure that we enjoy today and have throughout our history. If we turn into Japan, that is perhaps possible, but I wouldn't consider it likely. In that case, dividends yield would go to zero and profits would grow at 3% less frictional costs. Again, that'd be a pretty new state of affairs in the US and I wouldn't consider it at all likely to happen.

 

Country D, as you've described it, is essentially impossible. How would GDP grow at 3% per annum with no reinvested earnings? As far as it's been so far in economic history, a country must invest in its productive resources to grow. Very few corporations and no economies can get away with zero reinvestment.

 

Thanks all.

Link to comment
Share on other sites

And will margins in software and healthcare be mean-reverting over time? They haven't been yet (as a sector) but I don't consider it impossible at all. This is an unknowable.

 

I'm not sure what you mean by mean-revert. Do you mean that they would converge to the average margin in the rest of the economy as a whole, or with other sectors?

 

I don't think we'll ever see companies like Visa and Mastercard and Johnson & Johnson and Microsoft and Google have gross and operating margins similar to retailers or miners or carmakers. The industry dynamics are just too different. Some individual companies could lose their way, squander their edge, get their moat breached, or maybe even whole industries could be impaired by government regulation, but I think that's different from saying that there's a secular force pushing the margins in those industries down to the level of other industries. Some businesses are just better than others, that's a fact of life.

Link to comment
Share on other sites

coc,

 

Have you tried to apply your formula to the roughly 10% US equity return in the past 100 years (break it into the little pieces - revenue growth, margin, etc)?

 

Would be curious to see if it holds historically, before we try to kill ourselves by projecting future GDP and profit margins.

 

Link to comment
Share on other sites

The correlation between earnings and prices is very weak, this is wasted time. :)

 

https://caldaro.wordpress.com/2016/03/08/stock-market-myths-and-whats-wrong-with-the-economy/

 

Hmm, make sure you read all the way through the posts. We've acknowledged many times over the correlation between earnings and stock prices. It has to do with valuations. That's why I was proposing to hold "all else equal"  for the sake of discussion. This is not wasted time at all. If we can establish that in order for returns to be stronger than 5% (or thereabouts) that the valuation of the market would have to go up from the 18-19x it's at now, we can think about what to expect. This has implications for pension fund returns, index fund returns, and so on.

 

Calling the correlation between earnings and prices a "myth" is incredibly short-sighted. They are correlated about 100% over a long enough time period. But valuation can move around very unpredictably in given any start and end point.

 

JBTC,

 

I haven't had a chance to do that, but I suspect it comes out close. I'd love to find out though. (I don't have the data.) I get a little skeptical of the 10% number that gets thrown around because it depends highly on starting and ending points. Also, the equivalent of an S&P 500 index or broad-market index didn't exist for the entire period. The best proxy is the DJIA, which, as you all know, is a pretty flawed look at market returns.

Link to comment
Share on other sites

JBTC,

 

I haven't had a chance to do that, but I suspect it comes out close. I'd love to find out though. (I don't have the data.) I get a little skeptical of the 10% number that gets thrown around because it depends highly on starting and ending points. Also, the equivalent of an S&P 500 index or broad-market index didn't exist for the entire period. The best proxy is the DJIA, which, as you all know, is a pretty flawed look at market returns.

 

Precisely because of the problem with starting/ending dates, it makes sense for you to test your formula over a longer period (than just 1995-2015). That should be done before you speculate on future returns.

 

Yes the indexes may be flawed or inconsistent. That does make your exercise difficult.

 

I hope you can see that why it's not easy to draw conclusions based on macro data. Macro data can often be bad data, because it's simply too tough to add up the efforts by hundreds of millions of people and compare them over many decades.

 

In contrast, company specific numbers are infinitely better, even though they can be flawed too.

 

Link to comment
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
 Share

×
×
  • Create New...