Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
The Coming Market Environment (long)
Old 07-15-2008, 09:35 PM   #1
Recycles dryer sheets
 
Join Date: May 2005
Posts: 287
The Coming Market Environment (long)

June 2, 2008

John Bogle Speech

"As we look ahead, I must mention my conviction that viewing the future through the prism of
history is nowhere near as useful as the prism that takes into account the sources of stock returns. Of what
use, for example, is history that reflects a dividend yield that averaged 5 percent as in the past
century when the current dividend yield is 2.3 percent, less than half as much? (This point might be even more obvious if we asked the relevance of, say, an historical bond yield of 6 percent when the present yield is 4 ¾ percent.) So I urge those of you who rely on Monte Carlo simulations that rely only on historical stock returns either to exchange them for the kind of source-based analysis we’ve just gone through; or, alternatively, to calculate those Monte Carlo simulations using market returns excluding dividend yields, and then add back today’s far lower dividend yield.

Relying on these unarguable sources of return, let’s now consider what returns we might expect
for stocks in the coming decade, starting from this very day.

We’ll begin with investment return. We know that today’s dividend yield on stocks is about 2.3
percent, less than one-half of the historic norm of 5 percent. What should we add in the way of potential
earnings growth for our publicly-held corporations? For reference, the long-term norm has been about 4.5
percent, though in the past 25 years it’s been more than 6 percent.

So let’s add 5 ½ percent earnings growth rate to the divided yield of 2.3
percent. Result: your rational expectations are for an investment return on stocks of about 7.8 percent,
more or less, in the coming decade.

The P/E that I’ll use for today is 18 times, based on the reported earnings of the S&P 500 over the past
twelve months. (I should note that the P/E would be 16 times if we use projected operating earnings, but
we’ll work with the 18 number.)

If we use a central number of 17 times for the 2018 P/E, speculative return would subtract almost a percentage point from your, 7.8
percent investment return. Result: the clear consensus of you professional financial planners is that stock
returns will likely average about 7.2 percent in the decade ahead.

Indeed my own expectations are for earnings growth of about 6 percent, bringing investment return to
about 8.3 percent. I believe that 16 times is a reasonable expectation for the P/E a decade hence, resulting
in a speculative return of more than -1 percent. Result: total return of 7.1 percent. (Chart 9) So, for the
sake of simplicity, let’s agree on a compromise figure of 7 percent per year as the most likely return on
stocks over the coming decade.

A return of 7 percent per year on U.S. stocks is well below the historical norm of 9.6 percent. But
that shouldn’t be surprising. After all, the current dividend yield of 2.3 percent is more than three full
percentage points less than the long-term norm of 5 percent a dead-weight drag on the future investment
returns that stocks can generate, and the P/E today is well above the long term norm of 15 times. Our
rational, and mutual, expectations simply reflect that change in the simple realities of investing.

So make your own individual forecast: Just add your own earnings growth estimate to today’s 2.3 percent dividend
yield, and calculate the investment return. Then calculate the speculative return by taking a guess at the
prevailing P/E multiple ten years hence. Annualize the change, and then combine the two. But never
forget that it's unwise in the extreme to forecast stock returns based on historical norms rather than on
evaluating the broad forces that have shaped them in the past and will continue to shape them in the
future.

But whatever returns the stock market is generous enough to deliver in the years ahead, please
don't make the mistake of thinking that those pre-inflation, pre-investment-cost figures have anything to
do with reality. In real terms, and after the costs of investing, investors will actually earn returns that are
far lower.

To explain why this is the case, we need only to understand these simple mathematics of
investing:

1. Inflation will almost certainly erode the nominal returns we’ve just calculated. Assuming that
inflation averages 2 ½ percent per year (as expected today), the nominal return on stocks of 7
percent over the coming decade would be reduced to 4 ½ percent. (Chart 10A)

2. All investors as a group must necessarily earn precisely the market’s real return, but only
before the costs of investing are deducted. So if equity funds, on average, incur costs of only
2 percent per year, a conservative figure in the light of combined fund costs fund expense
ratios, sales loads, and turnover costs their average annual net real return would be just 2 ½
percent. (Chart 10B)

3. While equity funds themselves, as a group, are all too likely to deliver that net real return of 2
½ percent, the dollar-weighted returns of fund investors have lagged the time-weighted
returns of the funds themselves typically by at least 2 additional percentage points per year.
(Investors appear to chase past performance, and are penalized both by counterproductive
market timing and adverse fund selection.)

If this pattern continues and I see no reason that it will not continue the average equity fund investor could earn a net real return of as little as ½ percent per year over the coming decade. (Chart 10C)

Of course, our expectations for stock returns may be too low. On the other hand, I have ignored
the impact of excess taxes forced on taxable fund investors by our hyperactive fund managers. While we
have no ability to control the level of returns our businesses and our stock markets are generous
enough to generate in the years ahead, we ought to be thinking about controlling what we can control,
including investor costs and investment risks. (These same cautions, of course, apply to thinking about
future bond returns. Since decade-long bond returns are established largely by today’s interest rates, we
can forecast the nominal return on a portfolio of intermediate-term U.S. government and corporate bondsat about 4 ¾ percent, or about 2 ¼ percent after inflation but before all-in bond fund costs of 1½ to 2percent.)"
__________________

__________________
boont is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 07-15-2008, 09:54 PM   #2
Thinks s/he gets paid by the post
Htown Harry's Avatar
 
Join Date: May 2007
Posts: 1,516
Classic Bogle (and I mean this in a positive way)...title the speech as a variation on "how you can make money in the years ahead" to get the audience interested, then use every opportunity to stick it to all of the advisors, traders, salesmen, etc. who conspire to get their hands in the investor's pockets.

Thanks for the post.
__________________

__________________
Htown Harry is offline   Reply With Quote
Old 07-15-2008, 10:19 PM   #3
Moderator Emeritus
 
Join Date: May 2007
Posts: 11,043
If he is right, then locking in an individual longer term municipal bond paying 5% right now would be a better investment than stocks over the next 10 years. You still have to worry about the inflation, but they have no load, no ER, no turnover costs, no taxes, no performance chasing. That would leave a net real return of 2.5% per year.
__________________
FIREd is online now   Reply With Quote
Old 07-15-2008, 10:25 PM   #4
Full time employment: Posting here.
 
Join Date: Jan 2008
Posts: 798
Quote:
Originally Posted by FIREdreamer View Post
If he is right, then locking in an individual longer term municipal bond paying 5% right now would be a better investment than stocks over the next 10 years. You still have to worry about the inflation, but they have no load, no ER, no turnover costs, no taxes, no performance chasing. That would leave a net real return of 2.5% per year.
Great point
__________________
RockOn is offline   Reply With Quote
Old 07-15-2008, 10:36 PM   #5
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
NW-Bound's Avatar
 
Join Date: Jul 2008
Posts: 19,405
I saw a clip of an interview with Bogle yesterday morning on CNBC. He said this was the 10th bear market in his career, and this one is "a bit worrisome" (his words). Just a short clip which might have been taken out of context, so I do not know what to make of it. If anyone knows of the full interview on youtube, please share it.


P.S. I have not been able to find the video clip, but this blogger saw the same clip I did.

http://stockmarketadvantage.blogspot.com/2008/07/john-bogle-on-cnbc.html
__________________
NW-Bound is offline   Reply With Quote
Old 07-16-2008, 08:34 AM   #6
Recycles dryer sheets
 
Join Date: Apr 2008
Posts: 191
Quote:
Originally Posted by FIREdreamer View Post
If he is right, then locking in an individual longer term municipal bond paying 5% right now would be a better investment than stocks over the next 10 years. You still have to worry about the inflation, but they have no load, no ER, no turnover costs, no taxes, no performance chasing. That would leave a net real return of 2.5% per year.
By your statement, I am assuming that long-term municipal bond funds wouldn't produce similar returns compared to purchasing the individual bonds. Why is that?
__________________
statsman is offline   Reply With Quote
Old 07-16-2008, 09:02 AM   #7
Moderator Emeritus
 
Join Date: May 2007
Posts: 11,043
Quote:
Originally Posted by statsman View Post
By your statement, I am assuming that long-term municipal bond funds wouldn't produce similar returns compared to purchasing the individual bonds. Why is that?
According to the OP:

Quote:
These same cautions, of course, apply to thinking about
future bond returns. Since decade-long bond returns are established largely by today’s interest rates, we
can forecast the nominal return on a portfolio of intermediate-term U.S. government and corporate bondsat about 4 ¾ percent, or about 2 ¼ percent after inflation but before all-in bond fund costs of 1½ to 2percent."
So a bond fund would cost an additional 1.5 to 2% a year to investors compared to individual bonds according to Mr. Bogle. Those costs include expense ratio + load + turnover costs. By picking your bond fund carefully you can reduce those expenses (choose a cheap, no load fund for starters), but an individual bond should have lower expenses than a bond fund. And when you are talking about returns as low as those anticipated by the Mr. Bogle, it can make a big difference!
__________________
FIREd is online now   Reply With Quote
Old 07-16-2008, 09:21 AM   #8
Recycles dryer sheets
Pete's Avatar
 
Join Date: May 2008
Posts: 350
As the housing market continues it's slide and tax receipts dry up, putting heavy pressure on municipalities, would that affect long term muni bonds? Has there been any history to guide us? Do rates go down as municipalities report being bankrupt or do they go up as they try and attract new monies?
__________________
Pete is offline   Reply With Quote
Old 07-16-2008, 09:23 AM   #9
Thinks s/he gets paid by the post
 
Join Date: Jun 2005
Posts: 1,543
did Bogle give any advice? last interview i saw with him he said he hasn't made any portfolio changes in years
__________________
al_bundy is offline   Reply With Quote
Old 07-16-2008, 09:33 AM   #10
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
NW-Bound's Avatar
 
Join Date: Jul 2008
Posts: 19,405
Quote:
Originally Posted by al_bundy View Post
did Bogle give any advice? last interview i saw with him he said he hasn't made any portfolio changes in years
Not that I've seen nor heard. I think he's mainly telling us to lower our expectations. Darn, how do I live on less than 4% SWR? Can you? I would cut out on the cognac, but it wouldn't help much. No, I'll need my shots more than ever. I am sure my wife has some indulgences that she can do without.
__________________
NW-Bound is offline   Reply With Quote
Old 07-16-2008, 09:34 AM   #11
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
FinanceDude's Avatar
 
Join Date: Aug 2006
Posts: 12,484
Quote:
Originally Posted by FIREdreamer View Post
According to the OP:
So a bond fund would cost an additional 1.5 to 2% a year to investors compared to individual bonds according to Mr. Bogle. Those costs include expense ratio + load + turnover costs. By picking your bond fund carefully you can reduce those expenses (choose a cheap, no load fund for starters), but an individual bond should have lower expenses than a bond fund. And when you are talking about returns as low as those anticipated by the Mr. Bogle, it can make a big difference!
Did he say HOW many bonds, what duration, and which companies? It's not as easy as that...........
__________________
Consult with your own advisor or representative. My thoughts should not be construed as investment advice. Past performance is no guarantee of future results (love that one).......:)


This Thread is USELESS without pics.........:)
FinanceDude is offline   Reply With Quote
Old 07-16-2008, 09:44 AM   #12
Moderator Emeritus
 
Join Date: May 2007
Posts: 11,043
Quote:
Originally Posted by FinanceDude View Post
Did he say HOW many bonds, what duration, and which companies? It's not as easy as that...........
You will have to ask that question to Bogle himself because I don't know how he came up with the numbers (you can read the OP as well as I do and he is not going into too many details). But I would assume he is talking about an average bond fund (average ER. average load, average turnover costs) containing intermediate term US government and corporate bonds.
__________________
FIREd is online now   Reply With Quote
Old 07-16-2008, 11:05 AM   #13
Thinks s/he gets paid by the post
 
Join Date: Sep 2006
Posts: 1,690
Well 7 percent over the coming decade will be a 100 percent improvement over the 3.5 percent the Vanguard Total Stock Market has had over the past decade or the 3.8 percent Berkshire Hathaway earned in the last decade. So things are actually looking up 100 percent from here.

With continued contributions hopefully the declines happen early in the decade and the gains late in the decade and not vice versa.
__________________

__________________
Running_Man is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
Toxic Environment: How Do You Identify? BunsGettingFirm Young Dreamers 28 05-28-2008 02:02 PM
Subprime - How Long Before the Real Estate Market Normailizes chinaco FIRE and Money 26 12-17-2007 01:30 PM
Office Environment wildcat Young Dreamers 64 09-04-2007 12:37 PM
Top 7 Ways to Tell a Bear Market is Coming........ FinanceDude FIRE and Money 25 10-02-2006 02:17 PM
Market direction for this coming week ? frayne Other topics 28 07-19-2006 11:04 AM

 

 
All times are GMT -6. The time now is 01:32 PM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.