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Welcome to the 4% return market
Old 11-19-2013, 12:02 PM   #1
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Welcome to the 4% return market

Welcome to the 4% return market - The Term Sheet: Fortune's deals blogTerm Sheet

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On average, going back to the 1930s, the market has risen just 4% a year in the following decade when stocks have traded for a similar P/E as they are now, according to Birinyi Associates.

And among a growing group of forecasters, 4% is becoming something of a consensus.

Bridgewater's Ray Dalio last week said that's what he expects from the market for the next decade.

Robert Shiller says his calculations suggest stocks will rise about 2.5% a year for the next decade, plus inflation, which has recently been averaging 1.5%. Cliff Asness, who runs AQR, which manages one of the largest hedge funds in the world, says they will rise 4.5% annually on average.
I generally don't pay a lot of attention to stock market predictions, and ordinarily I would feel the same about this article. But what struck me about this 4% prediction is how close it is to current long term bond yields. Vanguard offers a number of long term bond funds with yields in this range. For example, the long-term bond index fund (VBLTX) has a current yield of 4.49%. Unfortunately, VBLTX also has a duration of 14.1 years, so its yield is not directly comparable to the ten year predictions for stock market returns.

Still, it seems likely that one could put together a mixture of intermediate and long term bond funds that would have an average duration of ten years and average yield of about 4%. Considering that the expected return of such a portfolio would be quite similar to the 4% prediction for stocks, it seems to me this might be a viable option for at least some of one's long term investments.

Note that this is for long term investments only. Over periods shorter than a decade, it's very possible that both stocks and long term bonds might generate negative returns. Over a full ten years, who knows? My guess is that with a properly designed portfolio, bonds would offer more chance of delivering positive returns than stocks, with historically have occasionally fallen over the course of a decade or more.
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Old 11-19-2013, 12:08 PM   #2
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Hey, after a 12% year last year, and a 14.5% YTD, I won't be disappointed in some low growth years. I'm inclined to believe a near term correction is due anyway.
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Old 11-19-2013, 12:12 PM   #3
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If you have followed any of the discussions about PE10 and Dr. Shiller, it seems that people say well, this says nothing about what will happen soon, which is certainly true. However, the unspoken thesis of these investors is that their timing is so good that the 10 year expectation will not dominate my superior shorter time adjustments; or that Shiller is wrong, PE10 is meaningless either for current special reasons, or it just is no good period.

We shall see, in the fullness of time.

Ha
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Old 11-19-2013, 12:20 PM   #4
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Hurry up to wait and I see? This bull just turned the corner and has his eyes on the torero waving the red cloth not even close to the Matador ...plenty of room to run yet.

Go go positive growth, don't let off the gas!
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Old 11-19-2013, 12:34 PM   #5
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4% plus 2% dividend yield = 6%.
That is not too bad given current low inflation rate....
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Old 11-19-2013, 12:40 PM   #6
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Originally Posted by haha View Post
If you have followed any of the discussions about PE10 and Dr. Shiller, it seems that people say well, this says nothing about what will happen soon, which is certainly true. However, the unspoken thesis of these investors is that their timing is so good that the 10 year expectation will not dominate my superior shorter time adjustments; or that Shiller is wrong, PE10 is meaningless either for current special reasons, or it just is no good period.

We shall see, in the fullness of time.

Ha
I don't necessarily agree with your interpretation of the thesis of people who disagree with using PE10 as a market timing tool. I personally have not participated in the PE10 threads because I feel that one can agree with Schiller about reduced stock performance in the future and still think that PE10 is a bad tool for making investment decisions. The underlying problem is that PE10 is currently predicting POSITIVE ten year stock market returns, in fact returns that are modest by historical standards, but that still handily beat inflation.

So if I decide to reduce my stock allocation based on PE10, it means that I either think a stock market correction is imminent, and that I'm smart enough to anticipate it, get out, and then buy back in at lower prices, or that I think I have a better alternative for investing over the next ten years. I don't buy the concept of selling stocks based on PE10 with the expectation of being able to buy back at lower prices some time in the future. Maybe it will happen and I'll look clairvoyant, but maybe I'm wrong and sell too soon and never have a chance to buy back in at the same price.

But I'm more amenable to reducing my stock holdings if I have a good alternative that doesn't reduce my long term expected return. The fact that long term bond yields are currently in the same ball park as Schiller's and others' predictions of ten year stock market returns is the first inkling I've had that there might be investment choices available that offer long term returns comparable to stocks.
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Old 11-19-2013, 12:42 PM   #7
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Well, even Bogle already said that we should get used to lower stock gains in the years ahead.

Yes, inflation is another unknown, and if I can get "gain+dividend-inflation = 3.5%WR", I should not complain. There goes my dream of becoming a decamillionaire when I die.

Oh wait! A "nice" inflation can still get me there, in nominal dollars rather than inflation-adjusted dollars like FIRECalc more optimistic lines indicate. There's a silver lining in everything.
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Old 11-19-2013, 12:50 PM   #8
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https://personal.vanguard.com/pdf/s358.pdf

I prefer Vanguard 10 Year outlook. They expect average returns AFTER inflation.
4% plus Dividend is in their most likely range (on a lower side)

They also expect poor returns for bonds.
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Old 11-19-2013, 12:55 PM   #9
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https://personal.vanguard.com/pdf/s358.pdf

I prefer Vanguard 10 Year outlook. They expect average returns AFTER inflation.
4% plus Dividend is in their most likely range (on a lower side)

They also expect poor returns for bonds.
Naturally one has to adjust Vanguard's prediction for stocks downwards by the YTD returns, since the article you cite is dated January, 2013. That' means one has to subtract this year's strong stock market performance from future stock returns, and add some to future bond returns based on the fact that we've already seen very poor bond returns since January.
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Old 11-19-2013, 03:24 PM   #10
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Hey, after a 12% year last year, and a 14.5% YTD, I won't be disappointed in some low growth years. I'm inclined to believe a near term correction is due anyway.
Actually that as of yesterday the Total Stk Mkt index is up 28.6% YTD. Or were those your portfolio returns YTD? Pretty good if so.
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Old 11-19-2013, 03:41 PM   #11
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Actually that as of yesterday the Total Stk Mkt index is up 28.6% YTD. Or were those your portfolio returns YTD? Pretty good if so.
That's my portfolio last year and this year at about 53% equity exposure. Yes, I'm very pleased (knock on wood!!!!).
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Old 11-19-2013, 03:48 PM   #12
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Not an economist, prognosticator, or frequenter of Holiday Inns, but I did read A Random Walk Down Wall Street and Malkiel likens the stock market to the movements of a drunk. In short, I don't think anyone knows. I understand the parameters used by the "experts" to declare lower returns in the near future, I just don't put much salt in these forecasts, even for longer term planning. For example, if you are a practical, stay the course steady eddy investor and the market takes a dive, buying some extra on the really bad day makes good sense. And is this still only going to return 4%??.
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Old 11-19-2013, 03:54 PM   #13
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Originally Posted by karluk View Post
Welcome to the 4% return market - The Term Sheet: Fortune's deals blogTerm Sheet



I generally don't pay a lot of attention to stock market predictions, and ordinarily I would feel the same about this article. But what struck me about this 4% prediction is how close it is to current long term bond yields. Vanguard offers a number of long term bond funds with yields in this range. For example, the long-term bond index fund (VBLTX) has a current yield of 4.49%. Unfortunately, VBLTX also has a duration of 14.1 years, so its yield is not directly comparable to the ten year predictions for stock market returns.

Still, it seems likely that one could put together a mixture of intermediate and long term bond funds that would have an average duration of ten years and average yield of about 4%. Considering that the expected return of such a portfolio would be quite similar to the 4% prediction for stocks, it seems to me this might be a viable option for at least some of one's long term investments.

Note that this is for long term investments only. Over periods shorter than a decade, it's very possible that both stocks and long term bonds might generate negative returns. Over a full ten years, who knows? My guess is that with a properly designed portfolio, bonds would offer more chance of delivering positive returns than stocks, with historically have occasionally fallen over the course of a decade or more.
To be fair, not every country is trading with the US's valuation.

France and Germany are a bit cheaper than the US and aren't total economic basketcases. Actually, most countries are cheaper.

This isn't a 1960 world where your choices are the United States, bombed-out Europe and Japan, and the socialist rest of the world. But yes, right now, US equities are looking a tad expensive.
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Old 11-19-2013, 04:11 PM   #14
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I read "Random Walk" many years ago and enjoyed it, particularly the description of mass mania, namely past bubbles.

However, strictly speaking, while the day-to-day variation of the market looks like a mathematical random walk, in the long term we certainly hope it does not. Else, people would not be buying stocks, because a true random walk has a 50/50 chance of gaining/losing, while in the past equities have proven to be worthwhile to buy-and-hold. And in the long term, stocks are driven by a nation's economy, which is in turn affected by political and demographic changes, international competition, and various extraneous factors.

Hence, even a buy-and-hold advocate such as Bogle still talks about lowered expectation for stock returns.

PS. The most common random walk is the outcome of a coin toss. Half the time you win, half the time you lose. There would be no point in betting in such game.
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Old 11-19-2013, 04:24 PM   #15
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Not an economist, prognosticator, or frequenter of Holiday Inns, but I did read A Random Walk Down Wall Street and Malkiel likens the stock market to the movements of a drunk. In short, I don't think anyone knows. I understand the parameters used by the "experts" to declare lower returns in the near future, I just don't put much salt in these forecasts, even for longer term planning. For example, if you are a practical, stay the course steady eddy investor and the market takes a dive, buying some extra on the really bad day makes good sense. And is this still only going to return 4%??.
Well, it's a bit more complicated than the AR 1 model/strict weiner integral described by Malkiel. Lakonishok Schliefer and Vishney published a paper showing that stocks with cheap PEs tend to do better over the long term than more expensive "glamour" stocks; it stands to reason that the same behavioral factors driving their outperformance could result in excess returns for stocks bought at market bottoms.

The only problem is that we only have about 85 years of data in CRSP and if you do a study on 10 year returns, you can only get about 8-9 independent variables out of that. Schiller has data going back to the 1860s, but I don't know how much we want to trust ten railroads and two other stocks to determine S&P 500 returns. Even then, that's only 15 independent data points for a study on 10 year returns, and you really want about 20, more like 30 data points in a regression to say you have statistical significance.

So they are probably right, but we don't have enough evidence to convict, quite yet.
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Old 11-19-2013, 06:16 PM   #16
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That's my portfolio last year and this year at about 53% equity exposure. Yes, I'm very pleased (knock on wood!!!!).
Well that is the last time I feel sorry for you.

BTW, I think we might have similar portfolios.
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Old 11-19-2013, 06:18 PM   #17
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...(snip)...
So they are probably right, but we don't have enough evidence to convict, quite yet.
Good points. We never have enough evidence when it comes to the future and trying to map from the past. Never enough data to apply statistics.
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Old 11-19-2013, 06:30 PM   #18
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A year ago everyone was predicting below-average stock returns going forward. Hmmmm...
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Old 11-19-2013, 06:44 PM   #19
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Good points. We never have enough evidence when it comes to the future and trying to map from the past. Never enough data to apply statistics.
In order to collect past data to get statistics, we must also be sure that the random process is stationary, meaning its characteristics do not change with time.

Suppose we suspect that a coin is not fair, meaning that it is built in such a way that it lands head 55% and tail 45% of the time, instead of the intuitive and natural 50/50 chance. An early problem paused to a student of statistics is that "how many coin toss experiments one would need to prove that that coin is not a fair coin, to a certain level of confidence?". It takes a lot more coin tossing than you would think.

Then next, suppose that while we are conducting the test on the coin to determine its characteristics, a mischievous person keeps swapping different coins on us. Can we ever get anywhere?

The history of the US as a country has not been that long, yet the nature of its economy and that of the entire world has been changing so much in the last 100 years. How do we know things will be like the past, not mentioning that the past was not all that dependable. We had a long string of excellent annual market returns in the decades of 1980-2000. Can we toss a coin and get so many heads in a row? It was not the result of a random walk; it was the peace dividend, plus the advances in computer and other technologies.

Here hoping something will happen to continue that advance, but how do I place bets on something that I have not seen? Is that not called faith?

Not to say that I know how to do better than what I am doing right now, namely 67% equities, 5% bonds, 28% cash...
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Old 11-19-2013, 07:00 PM   #20
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We can depend on human emotions -- greed and fear. No stats needed.
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