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100 plus year chart inflation/earnings and stock worries


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I don't mean to point this out too much but I do so to rationalize what I'm trying to ask...which I am quite interested in discussing.  Others will maybe, or maybe not at all interested.  I guess we will see.  So I'm 68, my parents died very young and I inherited a few stocks, and my small town wealthy brother-in-law put me in an investment club with he and 24 others.  These were the business heads of my community and all those except two including my bro-in-law are now dead.  I found it intersting that several of the men literally owned every stock we ever mentioned in the club to buy.  The club began in 1954 and this is the mid 1970's when I joined and I'm still in business graduate school. 

 

So my perspective today is quite long which is sort of typical of older investors- which seems counter intuitive of course- but it is what it is.  Here's my question:

 

Buffett has said or written of course that inflation is the thief...and so forth.  But I have a wood framed Securities Research 100 plus year chart in my basement, it is about 5 feet wide and has multiple lines on it.  The years on it are 1892 to 1998, and I'm guessing I bought it in 1998 or 1999.  On the chart it is easy to see Dow earnings and beginning in the 1950's S and P earnings.

 

From looking at this chart I will state and it is generalized that other than the Great Depression that the "earnings line" just steps up each and every year.  AND (here's the basis of my question) during the inflationary years of the 70's/80's earnings went up clearly faster.  So my question is this:  Of course it is logical to pay less for stocks if interest rates/inflation (or whatever the combo is) is higher given you can do CD's/bonds etc.....but do we equity investors worry far too much about inflation in the long run?  I am also aware that profit margins averaged 6% or so and have escalated significantly so a second question is: Are inflation, or lack thereof, and profit margins linked and if so to what degree?

 

My premise is that staying invested is the best option and I pretty much got this wild ass view (being a tad facetious or silly) because those in my club 40 years ago always stayed fully invested.  

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Securities are hedges against inflation since most durable companies can increase costs and pass them on to the consumer. 

 

The worst off are the cash holders, fixed income, and minimum wage workers. 

 

The only question I ask during high interest rate periods is 'how much debt do I pay down' vs invest. 

 

I'm of the buy and hold mindset. 

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2 hours ago, ICUMD said:

Securities are hedges against inflation since most durable companies can increase costs and pass them on to the consumer. 

 

The worst off are the cash holders, fixed income, and minimum wage workers. 

 

The only question I ask during high interest rate periods is 'how much debt do I pay down' vs invest. 

 

I'm of the buy and hold mindset. 

 

Pretty certain both treasury bonds and cash/T-bills outperformed equities in the inflationary decade from 1970 - 1980 making it difficult for me to believe these guys are the "worst off". 

 

3 hours ago, dealraker said:

From looking at this chart I will state and it is generalized that other than the Great Depression that the "earnings line" just steps up each and every year.  AND (here's the basis of my question) during the inflationary years of the 70's/80's earnings went up clearly faster.  So my question is this:  Of course it is logical to pay less for stocks if interest rates/inflation (or whatever the combo is) is higher given you can do CD's/bonds etc.....but do we equity investors worry far too much about inflation in the long run?  I am also aware that profit margins averaged 6% or so and have escalated significantly so a second question is: Are inflation, or lack thereof, and profit margins linked and if so to what degree?

 

My premise is that staying invested is the best option and I pretty much got this wild ass view (being a tad facetious or silly) because those in my club 40 years ago always stayed fully invested.  

 

If you have a 20-30 year time horizon, sure. Maybe forget about it and let the earnings/reinvestment average out your result to something less terrible.

 

If you're someone that's retiring soon, it's not enough that the E lines goes up if the P line is falling rapidly. You can't spend the earnings - only the dividends and sales proceeds. 

 

Even if earnings are going up, if it goes up less than inflation it's problematic - particularly if you'd capitalized large increases in expected real earnings into the multiple paid for the stock. 

 

Even in hyperinflationary environments where equity indices go parabolic, you'd have generally been better off owning real assets like real estate, gold, etc.

 

I'll never understand why people think equities are a good inflation hedge and bonds are not. Equities are a significantly longer duration asset than most bonds. They typically do terribly in inflationary environments. And even when nominal equity prices DO rise, they tend to rise quite a bit less than other readily available alternatives. 

 

Equities do well when inflation is low. Just like every other risk asset. 

 

When inflation is medium, even bonds and cash perform better.

 

And when it's hyperinflation, you want commodities and real assets. 

Edited by TwoCitiesCapital
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If you look at the history stocks become a good inflation hedge AFTER PE ratios have adjusted . We are part way through that process. At the same time you are capitalizing peak margins and peak earnings and during the adjustment process margins will take a bit of a hit and earnings are no longer getting the boost from unlimited stimulus and cheap money so again a bit of adjustment to go. 

 

In high inflation environments such as the 70s PE multiples averaged around 10. In low inflation environments such post 2000 PE multiples averaged around 20.

We are probably headed for a moderate inflation environment because there are some secular inflationary forces (e.g. labour shortages, de-globalization, resource scarcity etc) and the Fed cannot be as tough as it wants without threatening financial stability. So I think a 15 multiple is probably about right. 

 

Inflation was pretty high post WW2 but because the starting point was low PE multiples stocks did incredibly well especially as inflation started to moderate. 

Inflation was high in the 70s but because the starting point was high PE multiples stocks did badly and you'd have fared better just rolling over Treasury bills. 

 

As for where we are now inflation is high but is already moderating. PE multiples are high but I do not see them falling as much as they did in the 70s. 

 

My personal take is that at current market levels you will get some kind of real return over the next 10-15 years but it will be well below the historical average of 7%. 

 

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Posted (edited)

To some degree this is also a discussion with myself on the topic, one that I go through not becasuse I'm going to do anything about it because I simply won't.  I've been around long enough to shove down the worries enough that the things dreaded earlier in life - things that do come and go - but you realize they pass fast if you live a while.  For years I did follow Grantham, he was an early counter point to Wall Street and it's media addiction to the pundits of that time and the later rise of  the endless parade of Harry Dent's (euphoric up and down forecasts) and Nouriel Roubini's (total distruction) of the world.   

 

In any event I do know countless people who are well-off, some in their 80's with net worth's of $50 million, most all got there being both diversified and always invested.  Of course I do know those who had one business who have done well.  But most of all I know a bunch of people who endlessly try to time in's and out's, hard assets vs this or that, and those that are certain as to inflation or interest rates, and as of yet don't know one who is well-off unless it was originally inherited wealth.

 

Some of you may find interest in that we do have records of my investment club's performance since 1954.  Thanks to a retired CPA in our club who entertains himself messing around with this sort of thing we have it from day one.  We have had a steadfast value investing approach and we've had short periods where some of our stocks got 20-30 times or more over-valued and we didn't sell at the times when we should.  But we have done well and we've done over time a tad better than Mr. Market.  But given it is a taxable thing for most, but not all of us, we've of course underperformed Mr. Market.  I initially put in $4,300 in the late 1970's and we've never had dues, there are 25 of us.  We've distributed many times, I've gotten a check for $25,000 3 times.  Our portfolio today is $1.1 million, so I have 1/25th of that and we'll probably distribute another $25,000 soon as we have tended to do that when the portfolio reached $1 mil.

 

But as to our club...the one thing, given we are value investors, that has always been the case is that we're less up and down than Mr. Market.  And my guess that's what a lot of those here will experience over time.  Few will beat the market, even those stating "you can't get rich being diversified".....but ups and downs will be significantly less if you stick to being a value investor.  

 

Rambling some, but in recent years my value investing slant has led me to buy nothing but energy stocks and a few mentioned here on this board.  Like Gregmal, while I do own stocks like Google, I fully expected them to fall to the PE's of today at some point.  I added a tad to Google a couple weeks ago.

Edited by dealraker
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32 minutes ago, dealraker said:

To some degree this is also a discussion with myself on the topic, one that I go through not becasuse I'm going to do anything about it because I simply won't.  I've been around long enough to shove down the worries enough that the things dreaded earlier in life - things that do come and go - but you realize they pass fast if you live a while.  For years I did follow Grantham, he was an early counter point to Wall Street and it's media addiction to the pundits of that time and the later rise of  the endless parade of Harry Dent's (euphoric up and down forecasts) and Nouriel Roubini's (total distruction) of the world.   

 

In any event I do know countless people who are well-off, some in their 80's with net worth's of $50 million, most all got there being both diversified and always invested.  Of course I do know those who had one business who have done well.  But most of all I know a bunch of people who endlessly try to time in's and out's, hard assets vs this or that, and those that are certain as to inflation or interest rates, and as of yet don't know one who is well-off unless it was originally inherited wealth.

 

Some of you may find interest in that we do have records of my investment club's performance since 1954.  Thanks to a retired CPA in our club who entertains himself messing around with this sort of thing we have it from day one.  We have had a steadfast value investing approach and we've had short periods where some of our stocks got 20-30 times or more over-valued and we didn't sell at the times when we should.  But we have done well and we've done over time a tad better than Mr. Market.  But given it is a taxable thing for most, but not all of us, we've of course underperformed Mr. Market.  I initially put in $2,300 in the late 1970's and we've never had dues, there are 25 of us.  We've distributed many times, I've gotten a check for $25,000 at least 3 times and smaller checks before that.  Our portfolio today is $1.1 million, so I have 1/25th of that and we'll probably distribute another $25,000 soon as we have tended to do that when the portfolio reached $1 mil.

 

But as to our club...the one thing, given we are value investors, that has always been the case is that we're less up and down than Mr. Market.  And my guess that's what a lot of those here will experience over time.  Few will beat the market, even those stating "you can't get rich being diversified".....but ups and downs will be significantly less if you stick to being a value investor.  

 

Rambling some, but in recent years my value investing slant has led me to buy nothing but energy stocks.  Like Gregmal, while I do own stocks like Google, I fully expected them to fall to the PE's of today at some point.  I added a tad to Google a couple weeks ago.

Spot on. “The system” incentivizes buying and selling. Doesn’t matter what it is. Its engrained. It’s why everyday you see trade inspiring headlines and without ever even giving second thought, people succumb to things like “how to prepare” or “the coming …..”.
 

Bottom line is owning assets beats not owning them. Yes I’m sure there’s exception to the rule as there is with everything, but generally speaking, you want to be an owner of good assets in life. Ignore the “well there was this one time” crowd.

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1 hour ago, dealraker said:

But given it is a taxable thing for most, but not all of us, we've of course underperformed Mr. Market. 

 

Thanks @dealraker for sharing your experience here.  Really appreciate it.  

 

In hindsight, and to go along with the rest of your theme, because of the taxes, would it have been better to buy things for forever that you would never have to sell, e.g. S&P 500 ETF, or companies with durable longevity of FCFs and opportunities to grow without much capital investment for decades?

Edited by LearningMachine
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5 hours ago, Gregmal said:

Bottom line is owning assets beats not owning them.

 

So true! I just reviewed a portfolio that I manage and marvelled at the tax free (some oddity of german tax law) WRB ten bagger, and that is without counting regular or special dividends.

Edited by maxthetrade
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8 minutes ago, maxthetrade said:

 

So true! I just reviewed a portfolio that I manage and marvelled at the tax free (some oddity of german tax law) WRB ten bagger, and that is without counting regular or special dividends.

That’s actually something I’ve had the unique experience of seeing first hand as well. Doing the manage money for others thing, especially earlier in my life, I’d see and review portfolios all the time. And yup, it’s amazing when you look at the stuff longer term and see just how much the system works if you let it. Meanwhile people are itching to buy or sell the next 10% move on tomorrows jobs report or next weeks CPI. It’s kind of incredible actually when you think about how easy it is, again, assuming you buy quality stuff.

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Yeah did even ok, relatively speaking, in weimar (until Kaput) and Zimbabwe.  But probably not starting at everything is glorious, highest valuations in history (first we likely have to run down to CAPE 8).  

 

Are you the guy who posted about insurance brokers (I keep trying to find that post).  From what I can tell three are in VIG's portfolio (high quality cash gushing dividend growers).  I am wondering if any are like family/insider controlled (less likely to be operated for the benefit of the hired hands).

Edited by CorpRaider
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