Can someone convince me we aren't in for a decade or two of no return?

[SharperDingaan]

Few things to add to this.

 

The more historic the data the less valuable it is for predictive purposes. Simply because todays economy is very different to what it was even 20 years ago, and we are not comparing apples to apples.

 

Agreed central bank currency inflation is highly likely to continue; but asset inflation and 'growth' is a real crap shoot.

Mathematically, the bigger you are the harder it is to get incremental growth; and most would suggest that for the forseeable future - the bulk of global growth will be in Asia, and not in NA or Europe. Most would also expect a run-off of NA/European assets in favour of a build-up of Asian ones. So what? The forecast for NA/Europe is essentially currency inflation +/- (asset inflation+growth); 2-3%+ nominal growth on a good day, or 0-?% after inflation. Charming.

 

Sniff test.

Aging NA boomers are now taking money retirement money OUT of their savings/retirement accounts; their net investments, houses, toys, etc. are now selling down, NOT being built up. So .... if the forecast bias is for ASIAN assets, and NA assets are persistently in a GROWING net sale position, NA asset prices must fall, and deflate. To avoid that deflation, NA central banks must print currency faster, & target higher inflation. Maybe 3% nominal growth, 0% after inflation, and never ending QE?

 

Point?

 

We may well see CYCLICAL equity returns of 12% plus;

but we're compounding year-over-year at maybe 2-3%/yr nominal, and 0-1% real.

 

SD

 

 

 

 

 

 

[DTEJD1997]

Also, I have mentioned this before, I think the next stock market rout may well be caused by political events.

 

I'd expect a pretty sharp sell off if something like this were to go through:

 

https://www.wsj.com/articles/top-democrat-proposes-annual-tax-on-unrealized-capital-gains-11554217383?mod=hp_lista_pos3

 

I was SERIOUSLY considering RADICALLY modifying my investment strategy going forward.  I was considering switching over to income stocks, refraining from investing in long term projects, especially real estate, and generally raising cash.

 

In order for investing to work, you've got to have trust between generations.  You also have to have roughly the same set of rules.

 

I was not so sure that things would look roughly the same 5, 10, 15 years from now.

 

NOW, I am much more optimistic.

 

I think politically, things will start to calm down.

[CorpRaider]

Also, I have mentioned this before, I think the next stock market rout may well be caused by political events.

 

I'd expect a pretty sharp sell off if something like this were to go through:

 

https://www.wsj.com/articles/top-democrat-proposes-annual-tax-on-unrealized-capital-gains-11554217383?mod=hp_lista_pos3

 

Seems like the politicians should (likely will, imop) consider repealing the special rates for capital gains first and reinstate the former "wealth tax", which as Buffett recently noted was just referred to as the estate and gift tax.  Seems it would be so much simpler and easier to sell that than the new "wealth tax" and all these sur taxes on buybacks and junk.  Just roll back the capital gains preference and reinstate the estate tax....use something that has been used just fine before...not even that long ago....derp.

[cameronfen]

Ok I'm clearly in the minority, but let me add, from 1926 to 1946 which I think is at least among the worst performing 20 year period ( I'm on my phone  with no ability to use excel thoroughly) and the total return averaged 7%.  15 years return averaged 4%. People saying the returns for the next 15 to 20 years will be 5-7% nominal are basically saying the markets will perform as bad or worse than they did for the 20 year period covering the great depression. 

[scorpioncapital]

But is it possible to do both at once? If rates are high enough that you want to buy treasuries and sell stocks, wouldn't your stocks be somewhat depressed by that point? catch 22?

[Gregmal]

I also think the concern listed in the thread title is mainly relevant for those that just want to be lazy and index everything. If you own high quality, cash flow generating companies that buyback their own stock, supply and demand by itself will create your returns. If not, you are afforded the opportunity to buy shares at a depressed valuation. win/win. This obviously assumes nothing macro happens that effects said company's ability to generate fcf, or on a fundamental basis that causes the company's prospects to deteriorate. But as always those that do the work should continue to get rewarded.

[TwoCitiesCapital]

If you top ticked the S&P 500 in 2007 and held all the way down then back up to present, you'd have averaged something like 7.5% a year. 

 

I don't think stocks are nearly as expensive now as they were in 2007, so i'll throw my guess in the there and predict that stocks will do about 7 or 8% a year over the next decade. 

 

Also don't see a recession on the horizon at the moment, of course that involves some guess work on the intentions/future actions of the Fed, so take it with a grain of salt.

 

As cameronfed alluded to, multiples should be higher going forward. The standard average 16 P/E Ratio occurred when nominal G.D.P. averaged over 6% in the 20th century.

 

I think N.G.D.P. will be more like 4% going forward, so multiples will likely be higher...and current multiples are justified on a long term basis

 

Isn't this the exact opposite of the logic that determines higher growth companies deserve higher multiples? Why would high growth lead to high multiples at the micro level and low growth lead to them at the macro level?

 

If low GDP is the secret to high multiples, where are they in Germany and Japan 0?

[JimBowerman]

Isn't this the exact opposite of the logic that determines higher growth companies deserve higher multiples? Why would high growth lead to high multiples at the micro level and low growth lead to them at the macro level?

 

If low GDP is the secret to high multiples, where are they in Germany and Japan 0?

 

Buffett answers that question here:

 

[CorpRaider]

As I'm sure we all know, CAPE is at ~30; in 1999 it was at ~45; 10 year was at ~6%. 

 

So we could have room to run without setting any records (and without even needing to talk about Japan). 

 

I wouldn't like to have to place a high-conviction bet either way.

[TwoCitiesCapital]

As I'm sure we all know, CAPE is at ~30; in 1999 it was at ~45; 10 year was at ~6%. 

 

So we could have room to run without setting any records (and without even needing to talk about Japan). 

 

I wouldn't like to have to place a high-conviction bet either way.

 

Right, which is why I wouldn’t be too surprised if we had a final stage of euphoria before this cycle ends.

 

One thing to note though is that corporate profits as a share of GDP have been unusually elevated over the last 10 years or so, and the CAPE ratio (by only looking at earnings over the last 10 years) effectively assumes that this is the “new normal.”  That may be correct, but if it’s not then the market is already just about as expensive as it was in 1999.

 

;) Margins are at a record and appear to be on the cusp of contracting given wage rates rising 3-4% and rising commodity/input costs - much higher than revenue growth/GDP.

 

Then again, markets didn't care in 2015 when earnings contracted for an entire year so maybe we don't care now.

[TwoCitiesCapital]

Isn't this the exact opposite of the logic that determines higher growth companies deserve higher multiples? Why would high growth lead to high multiples at the micro level and low growth lead to them at the macro level?

 

If low GDP is the secret to high multiples, where are they in Germany and Japan 0?

 

Buffett answers that question here:

 

 

1) there's a caveat to what he said which basically is summarized 'if you have the certainty rates will remain low.' Yes, if rates remain at 0%, stocks CAN trade at massive premiums into perpetuity. We don't have that certainty AND it doesn't mean stocks SHOULD trade at massive premiums

 

2) low rates make financing easier and act a sa grease on financial systems. This makes it EASIER to bid up assets which, in turn, causes financing to become even easier. It's a fortuitous cycle, but it says NOTHING of the intrinsic/fair value of the stock. Only that the environment breeds easier financing/speculation/and potentially higher values

 

3) using DCF, the value of a stock is the summation of all cash flows discounted into perpetuity. Basically it's  CF (1+growth)^n/(1+rates)^n

 

People who say that low rates lead higher values/multiples assume it's because your denominator is shrinking. But if those low rates are due to exceptionally low growth/low inflation, then your numerator is ALSO shrinking. Assuming higher multiples is double counting the benefit of low rates.

 

Example scenario. $1 invested at 6% growth for 30 years when discount rates are 5% has a present value of $34.86. A P/E of ~35x. 

 

If you assume the discount rate falls to 4% you get a P/E of 40 and a present value of $40; however, that doesn't consider the impact of the lowered growth. If the 1% drop is primarily due to a 1% drop in inflation or growth, then your numerator also shrinks and your stock's present value is virtually unchanged at $34.91. The same 35x.

 

People who say low rates lead to higher multiples are 1) confusing the meaning of CAN and SHOULD and/or 2) ignoring mathematics and/or 3) ignoring real life cases like Europe and Japan where the same relationship HASN'T held true

 

 

[scorpioncapital]

Some argue that Japan and Europe have policies that are anti-growth and deflationary therefore rates can be at 0 or negative and it wouldn't really work. In the end it becomes the policies that unleash the animal spirits and human potential that matter.

[CorpRaider]

As I'm sure we all know, CAPE is at ~30; in 1999 it was at ~45; 10 year was at ~6%. 

 

So we could have room to run without setting any records (and without even needing to talk about Japan). 

 

I wouldn't like to have to place a high-conviction bet either way.

 

Right, which is why I wouldn’t be too surprised if we had a final stage of euphoria before this cycle ends.

 

One thing to note though is that corporate profits as a share of GDP have been unusually elevated over the last 10 years or so, and the CAPE ratio (by only looking at earnings over the last 10 years) effectively assumes that this is the “new normal.”  That may be correct, but if it’s not then the market is already just about as expensive as it was in 1999.

 

I think I failed to follow. How would the share of profits to GDP and/or margins work into measure the dollar of market cap paid share of smoothed net earnings (right?).  So like market cap to GDP is equal to 99? 

 

Many would probably also argue that profits to GDP is higher in 2009 than 1999 because of greater intl trade/share of S&P 500 revenues coming from abroad (e.g., like the FANGS dominating industries across the globe).

 

I personally think margins will mean revert or at least trend that way, but I've (wrongly) thought for a number of years. 

[Cigarbutt]

As I'm sure we all know, CAPE is at ~30; in 1999 it was at ~45; 10 year was at ~6%. 

 

So we could have room to run without setting any records (and without even needing to talk about Japan). 

 

I wouldn't like to have to place a high-conviction bet either way.

 

Right, which is why I wouldn’t be too surprised if we had a final stage of euphoria before this cycle ends.

 

One thing to note though is that corporate profits as a share of GDP have been unusually elevated over the last 10 years or so, and the CAPE ratio (by only looking at earnings over the last 10 years) effectively assumes that this is the “new normal.”  That may be correct, but if it’s not then the market is already just about as expensive as it was in 1999.

 

I think I failed to follow. How would the share of profits to GDP and/or margins work into measure the dollar of market cap paid share of smoothed net earnings (right?).  So like market cap to GDP is equal to 99? 

 

Many would probably also argue that profits to GDP is higher in 2009 than 1999 because of greater intl trade/share of S&P 500 revenues coming from abroad (e.g., like the FANGS dominating industries across the globe).

 

I personally think margins will mean revert or at least trend that way, but I've (wrongly) thought for a number of years.

I don't want to get directly involved in this dicussion but I've read this in the past and thought the discussion fun to read and Mr. Montier talks about the margin effect:

http://lwmconsultants.com/wp-content/uploads/2014/04/JM_CAPECrusader1.pdf

 

 

[wachtwoord]

I don't want to get directly involved in this dicussion but I've read this in the past and thought the discussion fun to read and Mr. Montier talks about the margin effect:

http://lwmconsultants.com/wp-content/uploads/2014/04/JM_CAPECrusader1.pdf

 

Thanks for the report! Now I really want to read an update (post mortem): how did the margins, valuations and metrics evolve over the 5 year period?

 

Can the difference between the prediction (-1.1% p/a) and reality (+9.8% p/a) be explained by variance or is the model invalidated? What are the chances of either? Did they update their model?

 

Edit:

 

For anyone interested they speak about it in their 2018Q4 report: https://www.gmo.com/europe/research-library/and-the-winner-wast-bills/

 

 

[Cigarbutt]

Thanks for the report! Now I really want to read an update (post mortem): how did the margins, valuations and metrics evolve over the 5 year period?

 

Can the difference between the prediction (-1.1% p/a) and reality (+9.8% p/a) be explained by variance or is the model invalidated? What are the chances of either? Did they update their model?

 

Edit:

 

For anyone interested they speak about it in their 2018Q4 report: https://www.gmo.com/europe/research-library/and-the-winner-wast-bills/

Hi wachtwoord,

I'm not sure this is worth time spent especially in terms of short-term forecasting but if you give importance to where we may be in the cycle, here are some useful tools to answer your questions:

https://www.brandes.com/docs/default-source/brandes-institute/2018/the-cape-ratio-and-future-returns-a-note-on-market-timing.pdf

 

From an academic point of view, models are never wrong and one has to adapt the reality to the model. ::)

People who publicly discuss these valuation models as potential forecasting tools tend to mention that deviations can occur and say that pendulums do swing and underline that they will eventually be proven right but broken clocks can also be right.

 

In reality, as individual investors interested in that line of thinking we have to decide which scenario applies:

-markets can sometimes stay irrational for long periods

-this time is different

 

It's interesting because the opening post referred to an article written by Mr. Buffett in 1999 (I still have the original article with contemporary hand-written notes on it) and, from 1999 to today, his “prediction” about reasonable expectations ended up quite prescient. Maybe that's because of his long-term outlook and because he avoided to think in a binary fashion. I guess then that it would be reasonable to maintain a similar outlook for the next twenty years with a nearer-term path defined by ultra-low interest rates (whatever the implications of that).

 

BTW, I meant to ask you a question about Bitcoin but found out the fundamental explanation behind the price action: the price of avocado. :)

https://www.newsbtc.com/2019/04/03/analyst-bitcoin-btc-likely-to-continue-surging-to-5500-but-significant-pullback-is-imminent/

 

[CorpRaider]

Good stuff guys.  My parting thought back to the original question is that we could be Japan in the early 70s heading toward a CAPE of like 100 (or higher) and like two decades of 20+% CAGRs, so it could be quite risky to make big binary decisions with real money based on predictions around this kind of stuff. 

[DooDiligence]

Thanks for the report! Now I really want to read an update (post mortem): how did the margins, valuations and metrics evolve over the 5 year period?

 

Can the difference between the prediction (-1.1% p/a) and reality (+9.8% p/a) be explained by variance or is the model invalidated? What are the chances of either? Did they update their model?

 

Edit:

 

For anyone interested they speak about it in their 2018Q4 report: https://www.gmo.com/europe/research-library/and-the-winner-wast-bills/

Hi wachtwoord,

I'm not sure this is worth time spent especially in terms of short-term forecasting but if you give importance to where we may be in the cycle, here are some useful tools to answer your questions:

https://www.brandes.com/docs/default-source/brandes-institute/2018/the-cape-ratio-and-future-returns-a-note-on-market-timing.pdf

 

From an academic point of view, models are never wrong and one has to adapt the reality to the model. ::)

People who publicly discuss these valuation models as potential forecasting tools tend to mention that deviations can occur and say that pendulums do swing and underline that they will eventually be proven right but broken clocks can also be right.

 

In reality, as individual investors interested in that line of thinking we have to decide which scenario applies:

-markets can sometimes stay irrational for long periods

-this time is different

 

It's interesting because the opening post referred to an article written by Mr. Buffett in 1999 (I still have the original article with contemporary hand-written notes on it) and, from 1999 to today, his “prediction” about reasonable expectations ended up quite prescient. Maybe that's because of his long-term outlook and because he avoided to think in a binary fashion. I guess then that it would be reasonable to maintain a similar outlook for the next twenty years with a nearer-term path defined by ultra-low interest rates (whatever the implications of that).

 

BTW, I meant to ask you a question about Bitcoin but found out the fundamental explanation behind the price action: the price of avocado. :)

https://www.newsbtc.com/2019/04/03/analyst-bitcoin-btc-likely-to-continue-surging-to-5500-but-significant-pullback-is-imminent/

 

I'd rather eat an avocado but to each his own.

 

https://diegorod.github.io/WillMcAfeeEatHisOwnDick/

 

:D

[scorpioncapital]

Good stuff guys.  My parting thought back to the original question is that we could be Japan in the early 70s heading toward a CAPE of like 100 (or higher) and like two decades of 20+% CAGRs, so it could be quite risky to make big binary decisions with real money based on predictions around this kind of stuff.

 

If this comes to pass it pays to be reckless, 2x margin, hold for a while longer.

If it doesn't and stays flattish, also might be worth to be semi-reckless.

If there is some crashes ahead, pays to be prudent.

 

So take an average...but if you have a margin account an argument for 'fully invested' 100% can be made under the above uncertainties. If there is a crash you dip into your borrowing power (at lower rates).

If there is a melt-up boom you can always sell on the way up.

If there is just chiseling away at carrying cost , you can just collect dividends and have some prudent ratio of stocks to cash.

[james22]

Or go "anti-fragile" (BRK, BAM/OAK, etc.).

[Spekulatius]

Or go "anti-fragile" (BRK, BAM/OAK, etc.).

 

With the largest  BAM  sub (BIP/BPR) at 12x debt/EBITDA, I wouldn’t call BAM antifragile. It is essentially a bet on having low interests for a long time to come, IMO.

[scorpioncapital]

Bam went to $8.49 in 2008. Anti-fragile it is not. It is also a lesson in debt with a cost (as opposed to say float with no cost if done well). Even Berkshire can drop 50% even though it has a war chest in the subsequent recovery to pounce. Well, it's not a straight line to riches. You can go down 30% and up 300% several years after that. I am not as extreme as buffett with debt since he was always rich, even when he started , or could at least get a million bucks from friends. But I think anything above max 1.5x leverage is very very risky.

[Spekulatius]

Bam went to $8.49 in 2008. Anti-fragile it is not. It is also a lesson in debt with a cost (as opposed to say float with no cost if done well). Even Berkshire can drop 50% even though it has a war chest in the subsequent recovery to pounce. Well, it's not a straight line to riches. You can go down 30% and up 300% several years after that. I am not as extreme as buffett with debt since he was always rich, even when he started , or could at least get a million bucks from friends. But I think anything above max 1.5x leverage is very very risky.

 

The max “safe” leverage depends on the predictability of the cash. Pipeline companies typically have 10 year contracts spore or less guaranteeing stable or slowly growing cash flows during that time, so a 4-5x EBITDA coverage is considered “safe”, E&P’s have very volatile cashflows, so everything higher than 2.5x EBITDA can be dangerous (depend on asset life of course ), high quality real estate can be leveraged 6x or even a bit higher and is considered safe.

 

12x leverage is very high and in my opinion unsafe, no matter the underlying asset, imo.

[Cigarbutt]

^This is morphing into a BAM topic but the point is how a company can thrive whatever environment in the next decade or two.

BAM is highly levered but a lot of the debt is structured at the asset level (real assets) and maturities are quite long. But the high leverage makes it an inadequate candidate for the tight definition of anti-fragility.

 

If the 2008-9 episode is considered a test for fragility, at the height of the crisis, AUM did decline by 5% but, in the end, BAM was able to raise $1.2B in 2008 and $14B in 2009. And to thrive, it was able.

 

In 2008-9, the crisis was unusually deep but the recovery was unusually steep (at least for the assets relevant to BAM) so how BAM deals and comes out of the next one may be different.

 

Since then, AUM has pretty much tripled and as of now, BAM has $35B of deployable capital (year-end) and a committed $35B.

 

https://archive.nytimes.com/www.nytimes.com/imagepages/2010/12/19/business/19brook-gfc.html?action=click&contentCollection=Business%2520Day&module=RelatedCoverage&pgtype=article&region=EndOfArticle

 

Unless the future test is unusually deflationary and unless capital in general disappears for a prolonged period, I think BAM meets the relaxed definition of anti-fragility.

 

-----)Back to expectations of market returns for the next decade or two.

 

[james22]

I don't doubt that BRK and BAM/OAK will fall with the expected larger correction. But believing they'll come out of it strenghened allows me to be more fully invested at a time of overvaluation than I otherwise would be.

 

They hedge against the possibility of there being no correction too, of course.