The Everything Bubble

[Sweet]

23 minutes ago, pricingpower said:

You have to consider tax impact to make a fair comparison, for a high income person that "0 risk" treasury is actually locking yourself into a loss when you consider your marginal post-tax real return in a 3% inflation world

 

treasuries at 4.5% * (100% - 37% ordinary income federal tax - 3.8% investment surtax) = +2.66% gross return - 3% inflation = a -0.34% annual loss in purchasing power

 

your 6.1% steady state return from stocks benefits from a lower cap gains / qualified dividends tax rate (and a real life huge advantage of mostly being tax deferred) and gets hit less hard if inflation goes higher in the future (either taxes/inflation/government spending presumably have to rebalance eventually)

 

stocks at 6.1% * (100% - 20% - 3.8%) = +4.65% gross return - 3% inflation = +1.65% real return expected

 

 

 

 

Great insight.

[frommi]

1.65% real IF there is no rerating to the mean. If you factor that into the equotation you are looking at negative real returns for the index. But most here probably dont invest into the index, so who cares?

[Luke]

47 minutes ago, pricingpower said:

You have to consider tax impact to make a fair comparison, for a high income person that "0 risk" treasury is actually locking yourself into a loss when you consider your marginal post-tax real return in a 3% inflation world

 

treasuries at 4.5% * (100% - 37% ordinary income federal tax - 3.8% investment surtax) = +2.66% gross return - 3% inflation = a -0.34% annual loss in purchasing power

 

your 6.1% steady state return from stocks benefits from a lower cap gains / qualified dividends tax rate (and a real life huge advantage of mostly being tax deferred) and gets hit less hard if inflation goes higher in the future (either taxes/inflation/government spending presumably have to rebalance eventually)

 

stocks at 6.1% * (100% - 20% - 3.8%) = +4.65% gross return - 3% inflation = +1.65% real return expected

 

 

Yeah, considering taxes are different for everyone (i am not US) i didnt include it but your point is well taken! 

 

 

Still, if you are able to find businesses that trade at 27x earnings, grow sales more than 4.1% etc you will likely outperform over time as long as multiples and business stays stable. Not hard!!

[Luke]

Thats why emerging market etfs are so interesting, you pay a very low multiple and get paid a dividend the size of the total US index returns while larger GDP growth! Or emerging markets businesses! 

[Gregmal]

Bottom line is if you’re considering 4-5% on fixed income attractive, you’re better off just putting in more time at the 9-5. 

[Luke]

1 hour ago, Gregmal said:

Bottom line is if you’re considering 4-5% on fixed income attractive, you’re better off just putting in more time at the 9-5. 

Could you elaborate? Not fully understanding what you mean

[Gregmal]

1 hour ago, Luca said:

Could you elaborate? Not fully understanding what you mean

No ones getting to retirement on 5% returns. So if thats the game plan, one needs to really start increasing the amount of money being socked away cuz you sure aint growing the pile very fast at that rate. 

[thepupil]

4 hours ago, pricingpower said:

You have to consider tax impact to make a fair comparison, for a high income person that "0 risk" treasury is actually locking yourself into a loss when you consider your marginal post-tax real return in a 3% inflation world

 

treasuries at 4.5% * (100% - 37% ordinary income federal tax - 3.8% investment surtax) = +2.66% gross return - 3% inflation = a -0.34% annual loss in purchasing power

 

your 6.1% steady state return from stocks benefits from a lower cap gains / qualified dividends tax rate (and a real life huge advantage of mostly being tax deferred) and gets hit less hard if inflation goes higher in the future (either taxes/inflation/government spending presumably have to rebalance eventually)

 

stocks at 6.1% * (100% - 20% - 3.8%) = +4.65% gross return - 3% inflation = +1.65% real return expected

 

 

 

this is why God created IRA's, TIPS, and munis.

[Sweet]

3 hours ago, Gregmal said:

No ones getting to retirement on 5% returns. So if thats the game plan, one needs to really start increasing the amount of money being socked away cuz you sure aint growing the pile very fast at that rate. 

Depends what your goals are and your age.

 

5% is a low return but it is a return and not a loss.

For people on the cusp of retirement it makes sense.

 

For others, and I’d put myself on this category, it’s something to own to tick over until you find something you can swing hard at.

For those thinking they can retire on that - good luck.

 

 

 

Edited May 31 by Sweet

[vinod1]

12 hours ago, Luca said:

Lots of inflows into the US and MAG 7+ because they are perceived as ultra safe and "only go up" (based on last 20 years)...the SP 500 is priced at 27x earnings, the last 10 years these 500 companies grew their sales at 4.1% all together and they pay out 1.3% annually at current valuations. Shares outstanding for all SP 500 companies went 0.7% lower per year over the last 10 years. If you have margins stable you will make-> 4.1% sales growth+1.3% divid. yield+0.7% buybacks= 6,1% annualized the next 10 years. 

 

10 year treasury is at 4.5% with 0 risk. 

 

Lots of value in smallcaps, europe/emerging markets/asia. 

 

Not to nitpick. 

 

There is a subtle unintuitive mistake in this calculation. It would seem obvious that you would use net buybacks to calculate returns, but that is not correct. The stock dilution is already incorporated in the earnings calculation i.e. the earnings are penalized for the stock issued to employees/executives. So you should not be penalizing that again by only calculating net buybacks. You just have to use the total amount of buybacks. 

 

Vinod

[mattee2264]

As Greg says 5% returns do not excite anyone. Especially when you consider how well equities have done over the last 5, 10, 15 years. 

 

Admittedly the equity risk premium is now in the negative territory and therefore investors are banking on future earnings growth for their margin of safety. 

But when confidence is high and there is the belief that the Fed will rescue markets at the first sign of trouble and AI will power fast earnings growth for technology stocks and eventually the rest of the market it isn't difficult to understand why there is still a strong preference for equities in spite of the fact there is now an alternative.

Besides most investors are confident that interest rates will eventually fall and therefore are still using low discount rates. 

[Cigarbutt]

9 hours ago, vinod1 said:

Not to nitpick. 

There is a subtle unintuitive mistake in this calculation. It would seem obvious that you would use net buybacks to calculate returns, but that is not correct. The stock dilution is already incorporated in the earnings calculation i.e. the earnings are penalized for the stock issued to employees/executives. So you should not be penalizing that again by only calculating net buybacks. You just have to use the total amount of buybacks. 

Vinod

Over time, for various holdings, especially when held over longer periods, as part of a retrospective learning experience, when holdings were sold, i have used a simple equation that separates the various components of the return. Reading your post, i'm puzzled by the basic math and wonder if i've been stupid all this time. 

Assumption presently held: The change in shares outstanding reflects the net effect of equity issuance and buybacks over the relevant period.

Please help with the basic math (or with a more 'obvious' explanation).

[EBITDAg]

1 hour ago, Cigarbutt said:

Over time, for various holdings, especially when held over longer periods, as part of a retrospective learning experience, when holdings were sold, i have used a simple equation that separates the various components of the return. Reading your post, i'm puzzled by the basic math and wonder if i've been stupid all this time. 

Assumption presently held: The change in shares outstanding reflects the net effect of equity issuance and buybacks over the relevant period.

Please help with the basic math (or with a more 'obvious' explanation).

I believe you are correct. I’m not following Vinod

Edited June 1 by EBITDAg

[Blake Hampton]

On 5/31/2024 at 6:58 AM, Sweet said:

 

 

Good luck trying to make sense of stocks using a 10% discount rate.  Valuation is largely subjective, and I think it is fairly clear that very very few people are using a 10% discount rate, and haven't been for many years.

 

My own mantra, posted in another thread, is that if you feel the urge to crank numbers into a DCF to check if it is a good investment, its almost certainly not a good investment.  Buffett talks discounted cash flows, Munger said he has never seen him using DCF model even once. 

 

I do believe though there is no sense investing in a company at PE 25 with little to no growth, when you could just buy a treasury yielding 5%.  I do expect valuations to rerate over time especially if GDP growth slows, but I would be surprised at a large crash.

 

 

You know the funny thing to me is that if you go and talk to any financial advisor, they will be very quick to tell you that equites have historically returned about 10%. This can also be “confirmed” with a simple google search. As you probably already assumed, I don’t believe equities will return anything close to that at current prices. Maybe then people are going into this with false assumptions.

[james22]

54 minutes ago, blakehampton said:

I don’t believe equities will return anything close to that at current prices.

 

It's different this time?

[Gregmal]

Perhaps part of the reason volatility has been lower now for years, and multiples higher than normal, is that the market has gotten more efficient as people finally start realizing stocks are by far the most superior long term home for cash.
 

This sort of phenomena happens all the time. I recall in 2012 how everyone insisted the market was overvalued because “it should trade at 14x”. When asked why, answer was always “that’s the historical average”…then you just shake your head and reply “good luck with that”. 

[james22]

58 minutes ago, Gregmal said:

Perhaps part of the reason volatility has been lower now for years, and multiples higher than normal, is that the market has gotten more efficient as people finally start realizing stocks are by far the most superior long term home for cash.

 

The Dow 36,000 argument.

[Sweet]

1 hour ago, blakehampton said:

You know the funny thing to me is that if you go and talk to any financial advisor, they will be very quick to tell you that equites have historically returned about 10%. This can also be “confirmed” with a simple google search. As you probably already assumed, I don’t believe equities will return anything close to that at current prices. Maybe then people are going into this with false assumptions.

I don’t think owning the broad market at these multiples will return 10% per year either.  However I am relatively sure that the permabears will perform worse, barring a major correction.

 

I do think places will perform significantly better than 10%, I’m thinking areas where new technology will revolutionise.  

[Vish_ram]

There is no law that says market multiples have to be in this range and anything beyond will be subject to a mean reversion.

 

To compare multiples of now vs 5, 10, 15 years of past is absurd. 
1. the expectations of future rates were different in each of past years

2. Relative dominance of platform cos were diff in past

3. Expectations in anti-trust actions were different 

4. market weighted composite ROIC, Growth etc of index are higher now and hence justify higher multiples. 
 

 

[Vish_ram]

The next issue of 10%. 
 

the reason this works are

1. inflation may run at 2-4% LT and cos pass these prices. Nominal stock prices reflect this

2 Index returns reflect pop. Growth of 1-2%, productivity growth of 1-3%. 
3. index returns also reflect more efficient companies that grow faster than GDP (M&A, mgmt incentives etc)

 

add it all up, you easily get 10% or more. 

[Hektor]

13 hours ago, Cigarbutt said:

Assumption presently held: The change in shares outstanding reflects the net effect of equity issuance and buybacks over the relevant period.

Please help with the basic math (or with a more 'obvious' explanation).

Good illustration. @Cigarbutt What is the source for this illustration?

[mattee2264]

Dow 40,000 as I recall is based on the idea that there is no need for an equity risk premium because you get your margin of safety from growth of earnings. 

 

On that basis if bonds yield around 3-4% over the next decade or so then PE multiples of 25-30x are reasonable. 

 

Of course the catch is that historically you got a higher earnings yield to compensate for the risk of investing in equities and essentially got the long term earnings growth for free. And therefore unless long term earnings growth is a lot faster than historically has been the case you aren't going to get 10%. 

 

And it is reasonable to say that in a low interest rate environment (i.e. lower risk free rate) where the perceived risk of investing in equities is a lot lower (because of the Fed put) and where the inflation protection equities offer seems particularly valuable, then you're being greedy insisting on 10% expected returns. Buffett has a great analogy about not wanting to be like a mortician waiting for a flu epidemic that is apt. 

 

Edited June 2 by mattee2264

[Cigarbutt]

11 hours ago, Hektor said:

Good illustration. @Cigarbutt What is the source for this illustration?

The initial thought behind this illustration came a long time ago and a good example (relevant example from a long long time ago for me) with a specific investment can be found in the following, pages 328-333.

The View from Burgundy – A Quarter-century of Investing (Second Edition) (burgundyasset.com)

The illustration can be found in (more theoretical and less practical but the underlying math is well explored):

article_totalshareholderreturns.pdf (morganstanley.com)

[Hektor]

1 hour ago, Cigarbutt said:

The initial thought behind this illustration came a long time ago and a good example (relevant example from a long long time ago for me) with a specific investment can be found in the following, pages 328-333.

The View from Burgundy – A Quarter-century of Investing (Second Edition) (burgundyasset.com)

The illustration can be found in (more theoretical and less practical but the underlying math is well explored):

article_totalshareholderreturns.pdf (morganstanley.com)

Thank you @Cigarbutt

[TwoCitiesCapital]

On 6/2/2024 at 3:44 AM, mattee2264 said:

Dow 40,000 as I recall is based on the idea that there is no need for an equity risk premium because you get your margin of safety from growth of earnings. 

 

On that basis if bonds yield around 3-4% over the next decade or so then PE multiples of 25-30x are reasonable. 

 

Of course the catch is that historically you got a higher earnings yield to compensate for the risk of investing in equities and essentially got the long term earnings growth for free. And therefore unless long term earnings growth is a lot faster than historically has been the case you aren't going to get 10%. 

 

And it is reasonable to say that in a low interest rate environment (i.e. lower risk free rate) where the perceived risk of investing in equities is a lot lower (because of the Fed put) and where the inflation protection equities offer seems particularly valuable, then you're being greedy insisting on 10% expected returns. Buffett has a great analogy about not wanting to be like a mortician waiting for a flu epidemic that is apt. 

 

 

The problem is, you can lock in returns 2x that 3-4% for the next decade today. Even agency mortgages, with a duration of 10-15 years, are currently paying 6-7%.

 

You don't even have to take credit risk!

Edited June 3 by TwoCitiesCapital