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Re: Retiring In Secular Cycles
Old 02-19-2007, 05:40 PM   #121
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Re: Retiring In Secular Cycles

Quote:
Originally Posted by crestmont
Almost all SWR studies, including FIREcalc, relate to all periods. When the historical universe is separated into halves, or quartiles, or otherwise, the success rate for the higher valuation periods are lower than for all periods. As a result, the user that sets their personal success rate (and related SWR)--in today's environment--has a lower chance of success than they wanted. So for most, that means setting a slightly lower initial SWR than the model indicates.
I believe that this is similar to trying to decide what group constitutes the "base case" in a Bayesian sense. Say we have a 65 year old man and we are trying to predict his life expectancy. Not the most conservative prediction, as one might do for Firecalc, but the most accurate. The class of all 65 year old US males may have an average life expectancy of (say) 18 years. But our guy has diabetes, high blood pressure, high LDL cholesterol and triglycerides and low HDL. Additionally he has a terrible temper, drinks too much and is given to bar fights.

Does he belong in this base group of all US men? Or should be placed in a higher risk grouping, that would suggest though not ordain that a shorter life expectancy might be likely for him?

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Re: Retiring In Secular Cycles
Old 02-19-2007, 05:41 PM   #122
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Re: Retiring In Secular Cycles

"how do you personally determine "the time period over which it is needed" "for today's retiree"?"

I use the IRS life expectancy tables for rminimum distributions.

at age 62 a married couple has a joint life expectancy of 29 years, by age 70 is about 22 years.
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Re: Retiring In Secular Cycles
Old 02-19-2007, 10:52 PM   #123
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Re: Retiring In Secular Cycles

Quote:
Originally Posted by wab
Ed, could you give us more details about the failure sequences at high P/E in your runs? Are they different than the FIREcalc failure sequences at 4% SWR w/100% S&P500?

I ask because it wasn't lower expected returns that caused the failures I'm aware of. Everybody could retire happily with, say, 5% real returns instead of the 7% real average. The failures I've seen were catastrophic: depression and hyperinflation.

We could easily see Something Bad happen again, and I think it's prudent to have both a conservative allocation and a conservative SWR, but not because of lower expected returns due to P/E values.
As far as history goes, all of the past secular bear markets ended with P/Es below 10...in really bad economic conditions. We've not had an extended period of stable, high P/Es to "demonstrate" the impact of 6.5% returns (which would actually provide success as long as there was not a big drop in the early years). The bigger risk is not an extreme period (i.e. either stability or 10 P/Es), rather it would be enough decline to reduce real returns to 3% or 4%. If history is a guide--unless today's historically high profit margin are surprisingly sustained--a modest decline in P/E over the next decade or so could readily cause returns to be muted and success rates to decline.

Remember, this is not about the 90%, 92%, 95% of the time that you die with a gazillion dollars, SWR is all about the small, yet devastating chance that you're still 5 or 10 years away from death and find that you're selling the old homestead and downsizing your wife's (or husband's) lifestyle.

You are absolutely right that the math comes down to real return...and today, the expectation for real returns from stocks is well above (irrationally) the expected return from bonds....when you consider the historical propensity for financial assets to revalue (and the skewed bias from these levels is a downward change in revaluation). I (and others) contend that this reflects unrealistic expectations rather than ongoing market inefficiencies.

Historically, the average is more than 4% (near 5%-6%)...yet with a range that is either well-above or well-below. If valuation matters, then this is likely a circumstance of well-below. Even at 4%, if there is any variability, the constantly growing withdrawal has an adverse effect if cumulative losses occur early in the sequence.

Thanks for the challenging thoughts...
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Re: Retiring In Secular Cycles
Old 02-20-2007, 12:44 AM   #124
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Re: Retiring In Secular Cycles

OK, I'm enlightened now. I think.

Ed has a great matrix on his site that gives real returns for every period in US history:

pdf link

There have been many periods that started with a high P/E that turned out fine in the long run. But there were a couple that both started with a high P/E and ended with a very low P/E.

You can see the failure cases pretty easily. If your retirement period ended in a pink or red square with long-term real returns < 2, you were hosed.

So, starting retirement in a high-P/E environment is sort of a caution flag. All of the failures (really only two clusters out at 30-years) started with this caution. But it took some *very* bad times to drive P/E values to below 10 during those failure sequences.

The risk, as I see it, isn't high P/E values. If E/P implies a 5% earnings yield, that's pretty damn good since it's a *real* yield. The risk is a bad start that includes an economic disaster during retirement.

I think it's important to look at the human component that drove P/E values below 10. These were not ordinary times, and low P/E's are not a natural consequence of high P/E's, IMHO.

The example I like is the Great Depression. The problem with returns wasn't the 1929 crash or monetary policy. The problem was that the government became socialistic to help those in trouble, and investors had a real fear that public companies would be taken over by the state. Who in their right mind would want to invest in stocks if they thought companies would become state-run enterprises?

Anyway, I think the matrix chart is a better illustration than the 79% success rate at P/E > 18.5. Maybe Ed could make a new chart that showed returns after a 4% SWR.
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Re: Retiring In Secular Cycles
Old 02-20-2007, 06:08 AM   #125
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Re: Retiring In Secular Cycles

Fun chart, very interesting!

I like the historical events list, too... well, mostly.... "Pluto retires..."


And "Roaring Twenties" looks to have been aptly named... sure could use a ten year span like that to cap off accumulation phase...
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Re: Retiring In Secular Cycles
Old 02-20-2007, 09:16 AM   #126
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Re: Retiring In Secular Cycles

Quote:
Originally Posted by wab
So, starting retirement in a high-P/E environment is sort of a caution flag....
Several key points that I'd like to second:

High starting P/Es are only a caution flag; not a red flag...

Low P/Es are not a natural consequence of high P/Es...high and low P/Es are the consequence of economic conditions (primarily inflation) and to some extent the human component...however, high P/Es rationally present only two scenarios: steady P/Es and lower P/Es--it doesn't provide for the significant increases that drive secular bull markets.

Also:

There's still an 80% success rate for 4% SWR with high starting P/Es...yet that's a lot less than the near 95% that most people expect!

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Re: Retiring In Secular Cycles
Old 02-20-2007, 12:36 PM   #127
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Re: Retiring In Secular Cycles

Quote:
Originally Posted by crestmont
As far as history goes, all of the past secular bear markets ended with P/Es below 10...in really bad economic conditions. We've not had an extended period of stable, high P/Es to "demonstrate" the impact of 6.5% returns (which would actually provide success as long as there was not a big drop in the early years). The bigger risk is not an extreme period (i.e. either stability or 10 P/Es), rather it would be enough decline to reduce real returns to 3% or 4%. If history is a guide--unless today's historically high profit margin are surprisingly sustained--a modest decline in P/E over the next decade or so could readily cause returns to be muted and success rates to decline.
Quote:
Originally Posted by wab
I think it's important to look at the human component that drove P/E values below 10. These were not ordinary times, and low P/E's are not a natural consequence of high P/E's, IMHO.
Quote:
Originally Posted by crestmont
High starting P/Es are only a caution flag; not a red flag...

Low P/Es are not a natural consequence of high P/Es...high and low P/Es are the consequence of economic conditions (primarily inflation) and to some extent the human component...however, high P/Es rationally present only two scenarios: steady P/Es and lower P/Es--it doesn't provide for the significant increases that drive secular bull markets.

There's still an 80% success rate for 4% SWR with high starting P/Es...yet that's a lot less than the near 95% that most people expect!
IMO it took us nine pages to get to:

"This time it's really different. We think."

and

"Be careful out there."

But OTOH I got to read words like "Phillips" and "Bayesian" without the usual "b3aver cheese" or Godwin's Law excursions.

I suspect that even the most blissfully ignorant investors are beginning to hear the word that 10% returns are a thing of the past.

It's been nearly 10 years since Bernstein started writing his "Calculator from Hell" series. I wonder if he'd change any of it today.
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Re: Retiring In Secular Cycles
Old 02-20-2007, 06:29 PM   #128
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Re: Retiring In Secular Cycles

Quote:
Originally Posted by wab
I ask because it wasn't lower expected returns that caused the failures I'm aware of. Everybody could retire happily with, say, 5% real returns instead of the 7% real average. The failures I've seen were catastrophic: depression and hyperinflation.
Lower returns alone are not necessarily enough to sink the ship. Total equity returns from 1966 to 1981 were about 1.7% nominal. 1966 was one of the toughest periods to start retirement. But if you torture the data by keeping the low equity returns but swap out the inflation and interest rate environment with that of another period, 1966 becomes very survivable. It was the combination of low returns AND inflation that kills you.

It's worth repeating that we just survived a similar increase in oil prices to the one that wrecked the economy and helped cause the stagflation of the 70's. It's all well and good to look at historic cycles but the economy we live with today is a lot different (and better) than the one of 100, or even 30, years ago (what's good for GM is no longer relevant for the U.S - and that's true for any single company and most entire industries).

By my guess, we're at about the half-way mark for this particular economic expansion. If you judge by historic standards you'd conclude it should be winding up about now, but you can't judge apples by looking at oranges. And that's true for profit margins too. American workers have never had to directly compete with workers from India and China before - now they do. And labor's share of GDP reflects that pressure. That isn't a transient factor likely to reverse just because corporate profit margins are near highs reached in other cycles when the economy worked differently.

I guess my long winded point is that you can't simply look at historic cycles and say everything is mean reverting. Some changes are structural and have lasting impacts. P/Es are important. But as long as they are within reason, it will be the real economy that drives equity returns and valuation multiples - not the other way around.
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Re: Retiring In Secular Cycles
Old 02-20-2007, 06:47 PM   #129
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Re: Retiring In Secular Cycles

That was one very interesting chart !

The results were after taxes, inflation and fees.

Did the chart indicate what the level of fees were and the tax rate ?? Did these results come from a model with an after-tax account and some level of trading generating capital gains and other taxes along the way. ?

I didn't notice it as the chart was very busy.
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Re: Retiring In Secular Cycles
Old 02-20-2007, 07:26 PM   #130
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Re: Retiring In Secular Cycles

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Originally Posted by MasterBlaster
Did the chart indicate what the level of fees were and the tax rate ?? Did these results come from a model with an after-tax account and some level of trading generating capital gains and other taxes along the way. ?
Yes, the expense and tax drag assumptions are pretty high, but I picked that chart figuring it would reflect some of the selling costs and capital consumption of a retiree.

Here are the assumptions:

pdf link

And he has other charts without some of these drags as well:

link

Lots of intersting stuff on his site. It'd be nice to get some tax modeling incorporated into FIREcalc since there is an effect on returns.
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Re: Retiring In Secular Cycles
Old 02-20-2007, 08:39 PM   #131
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Re: Retiring In Secular Cycles

with so many comments made, perhaps i've missed it ... p/e cannot be evaluated without context ... the 10yr treasury is today earning 4.68% ... a "p/e" > 21!!
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Re: Retiring In Secular Cycles
Old 02-20-2007, 09:03 PM   #132
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Re: Retiring In Secular Cycles

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Originally Posted by d
with so many comments made, perhaps i've missed it ... p/e cannot be evaluated without context ... the 10yr treasury is today earning 4.68% ... a "p/e" > 21!!
Warren Buffet cautions against sliding your discount rate too far down no matter what prevailing interest rates are.

People often underestimate the influence of the discount rate chosen on the present value of a series of cash flows.

I think the "Fed Model" or similar is very helpful if you are in the business of selling securities to others, because it sounds plausible. As a buyer for one's own account I (and Warren) find it less useful.

Ha
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Re: Retiring In Secular Cycles
Old 02-21-2007, 07:07 AM   #133
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Re: Retiring In Secular Cycles

Why not just buy decent shares with decent dividends and a good record of raising them? A starting 4% should be pretty easy. Then just live off the dividends, which more or less rise with inflation. Buy a truckload of index linked bonds for minor withdrawals to supplement the dividends if they don't rise.

Never need to sell any equity. No need to care about secular cycles.
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Re: Retiring In Secular Cycles
Old 02-21-2007, 11:34 AM   #134
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Re: Retiring In Secular Cycles

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Why not just buy decent shares with decent dividends and a good record of raising them?
Dividends are paid out of earnings. Earnings growth is cyclic. Right now, we're pretty high in the earnings cycle. Relative to historical cycles, we're at a high peak.

So, which high-yield stocks/sectors have a record of paying out increasing dividends in bear markets? I'd bet the financial sector isn't one of them, for example, but I really don't know.
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Re: Retiring In Secular Cycles
Old 02-21-2007, 12:00 PM   #135
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Re: Retiring In Secular Cycles

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Earnings growth is cyclic. Right now, we're pretty high in the earnings cycle. Relative to historical cycles, we're at a high peak
... 'tis true, and worrisome ... though a peak can only be seen in hindsight

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Re: Retiring In Secular Cycles
Old 02-21-2007, 12:19 PM   #136
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Re: Retiring In Secular Cycles

Quote:
Originally Posted by wab
So, which high-yield stocks/sectors have a record of paying out increasing dividends in bear markets? I'd bet the financial sector isn't one of them, for example, but I really don't know.
Actually most of the big money-center banks and S&L's grew their dividends faster than inflation during the 2000-2003 bear market.
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Re: Retiring In Secular Cycles
Old 02-21-2007, 12:23 PM   #137
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Re: Retiring In Secular Cycles

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Originally Posted by FIRE'd@51
Actually most of the big money-center banks and S&L's grew their dividends faster than inflation during the 2000-2003 bear market.
Good point. In an economic bear, short-term rates are likely to go down, which is good for banks.
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Re: Retiring In Secular Cycles
Old 02-21-2007, 08:37 PM   #138
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Re: Retiring In Secular Cycles

Quote:
Originally Posted by d
... 'tis true, and worrisome ... though a peak can only be seen in hindsight
I'm not sure how to get the chart to reproduce, but it's missing important information that needs to be put into perspective. If you start the chart (EPS/GDP) in the late 1940s (as the prior quote/post does), then it relfects what could be 'normal' high levels that are similar to today. Yet if you go back another twenty years, you'll see that the severe trough of the 1930s was probably being rebalanced by the above-average period of the late 1940s--the average ratio for the 1920-1950 period (with its extremes) is virtually the same as the post-1950 period. A number of historical economic relationships are much more consistent than most non-economists appreciate. The current level of EPS/GDP is 50% over the historical average...either this time is different and we've entered a new era, or earnings growth can be expected to be well-below GDP growth for quite a while to restore a century-long relationship. Just food for thought based upon observations of history and recognized economic principles, this is not a prediction.
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Re: Retiring In Secular Cycles
Old 02-21-2007, 11:38 PM   #139
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Re: Retiring In Secular Cycles

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Originally Posted by crestmont
Just food for thought based upon observations of history and recognized economic principles, this is not a prediction.
Ed, I just found this article written by you with a bit more detail on the earnings cycle.

link

Edit: oops, looks like this is just a reprint of an article on your site: pdf link
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