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Why I'm Not Selling Stocks Now
Old 03-07-2009, 01:33 PM   #1
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Why I'm Not Selling Stocks Now

As measured by P/E-10 (currently 11.8x), stocks have traded this cheap or cheaper during 10 different periods over the past 100 years. Someone who bought the S&P 500 at the beginning of any of those 10 periods always earned positive returns over the next ten years (with reinvested dividends). Average returns were 11%. The lowest return was 5.8%, earned from October 1931 to September 1941.

So the worst historical 10-year return for stocks bought at current valuations of 5.8% beats money market funds yielding 1%, 10-year treasuries yielding 2.87% and very nearly beats intermediate investment grade corporate bonds yielding 6.11% (for VFICX). Meanwhile median returns for stocks over these 10 periods were close to 10% with the best 10-yr return reaching 18.6%.

SPX returns over the 10 year period immediately following a P/E-10 valuation of 11.8x:

Oct 1946 - Sep 1956 . . . . 18.61%
Sep 1953 - Aug 1963 . . . . 16.04%
Nov 1941 - Oct 1951 . . . . 15.97%
Jul 1974 - Jun 1984 . . . . . 11.97%
Dec 1916 - Nov 1926 . . . . . 9.77%
Apr 1938 - Mar 1948 . . . . . 9.52%
Aug 1934 - Jul 1944 . . . . . . 9.41%
Oct 1907 - Sep 1917 . . . . . 7.54%
Jun 1913 - May 1923 . . . . . 7.17%
Oct 1931 - Sep 1941 . . . . . 5.78%

Many of us have been planning on below average stock returns because of high valuations. Well, those below average returns have already been realized and are now in the rear-view mirror. It's time to start raising your expectations for future returns.
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Old 03-07-2009, 01:36 PM   #2
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Pretty inspiring, though in real returns I suspect that 1974-1984 result would sink like a rock, probably all the way to the bottom.
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Old 03-07-2009, 01:43 PM   #3
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Pretty inspiring, though in real returns I suspect that 1974-1984 result would sink like a rock, probably all the way to the bottom.
Yup. All of the returns would be lower if recast as "real" returns. I'm not going to recalculate them all, but the 74-84 period comes out at a 3.96% "real return" with inflation increasing 7.70% per year on average.

Meanwhile 10-yr bonds were yielding about 7.8% in July 1974. So their "real" return was about 0.1% over the same period.
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Old 03-07-2009, 02:27 PM   #4
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I am thinking that there is an implicit assumption here that a valid and trustworthy prediction can be obtained based on the 100 years of history that we have available. I suspect 100 years is a relatively short time series when we are talking about a handful of 10+ year patterns. I don't think such a prediction is possible with a great degree of confidence, and so I think we need to prepare for very different scenarios which could be reasonably possible, as well.

I'm not selling stocks either, but not because I expect the stock market to rise in the next ten years, necessarily. It might, or it might not. Also, other assets might do well, or they might not. I have tried to spread my risk among different types of assets, because I am concerned about risk. I think a very cautious approach would dictate that moving too much into one category of assets would be a mistake at any time, especially these times when the economy is so flaky.
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Old 03-07-2009, 03:30 PM   #5
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I am thinking that there is an implicit assumption here that a valid and trustworthy prediction can be obtained based on the 100 years of history that we have available. I suspect 100 years is a relatively short time series when we are talking about a handful of 10+ year patterns.
Agreed. What conclusions can we draw from the 100 (or 137 in FireCalc) years with just that handful of patterns? That is like trying to base a daily weather forecast with nothing more than the history of the last 4.5 months. You'd find yourself saying things like "well, it's never rained three days in a row", and there may be entire seasons that you have not experienced.

Geez, that wasn't too cheery, was it?

-ERD50
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Old 03-07-2009, 03:31 PM   #6
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I'm not selling my stocks or my house right now just beacuse I just wouldn't get anything for them. Fortunately our basic expenses are covered by my pension. As I told DW if its a good market year we're going to Tahiti, if its a bad year Tijuana.
It lookslike Tijuana.
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Old 03-07-2009, 05:08 PM   #7
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Agreed. What conclusions can we draw from the 100 (or 137 in FireCalc) years with just that handful of patterns? That is like trying to base a daily weather forecast with nothing more than the history of the last 4.5 months. You'd find yourself saying things like "well, it's never rained three days in a row", and there may be entire seasons that you have not experienced.

Geez, that wasn't too cheery, was it?
I'd agree it's not bullet proof, but if you read the history about what was behind the Depression, about the Panics of 1873 and 1893 and 1907, the fact that stocks (and the economy) have always bounced back is stronger evidence to me than a gut feeling that "this time it's different."

In particular, the panics of 1873 and 1907 and to a lesser degree ther Depression had some parallels. This actually has more parallels to the Panics of 1873 and 1907 than the Great Depression, IMO.

They may have felt that "this time it's different" in 1873 and 1893 and 1907 and 1931. And if you lost the recovery from August 1932 to 1936... ouch.

Yes, I'm leaving some powder dry just in case it melts down and I have to rebuild from the ashes. But for the most part, with most of my portfolio, I trust history more than I trust an emotion-addled belief that "this time it's different." Plus, the governments and central banks are flooding debt and new money into the system. That leads to other long-term concerns (inflation), but it doesn't necessarily lead to Armageddon.
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Old 03-07-2009, 05:12 PM   #8
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Id think stock prices will rise with inflation

So why sell and lock in losses, Im in it until Im dead
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Old 03-07-2009, 05:17 PM   #9
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Great post ....Yrs to Go. Thanks for the long term perspective.

Now if we could just hurry up and get to the appreciating side of the curve!

Audrey
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Old 03-07-2009, 05:44 PM   #10
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I'm casting my vote for ...Years to Go.
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Old 03-07-2009, 05:57 PM   #11
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I'm not sure how we can even compute a P/E. Last quarter's earning on the S&P500 was negative. GDP and every other indicator is dropping like a rock. It's a real tough enviroment to forcast even next quarter's earnings. That said. If the P/E is really around 10 then I would be a net buyer. But I need to see stable earning first before I'm jumping in.
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Old 03-07-2009, 08:25 PM   #12
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I'm not sure how we can even compute a P/E. Last quarter's earning on the S&P500 was negative.
That's why smart folks like Robert Shiller average earnings over 10 years.

Negative earnings reflects massive impairment charges which won't likely be repeated. But those same impairment charges also represent a reversal of prior years "earnings" that weren't real. So when we average out the too high prior earnings with the too low current earnings we get back to something closer to reality.
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Old 03-07-2009, 08:39 PM   #13
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I am thinking that there is an implicit assumption here that a valid and trustworthy prediction can be obtained based on the 100 years of history that we have available.
Sure we can retreat into nihilism and assume that nothing can be known. But the relevant question seems to be "are we experiencing something different than we've experienced before?" In other words, is there any reason to think the past isn't a good guide? I'd answer that question "no". After all, we're not talking about nuclear war or a military coup. We have a credit bubble and associated bank failures. Been there done that in the last 100 years. So why is this different? And more specifically, why is this worse?
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Old 03-08-2009, 08:17 AM   #14
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So why is this different?
The beauty of unsustainable behavior is that while you're getting away with it you can live in a la-la land of denial and disbelief. Looking at our society and our planet, are there non-stationary variables you must specifically exclude before you can argue that this 'recession' is just like all of the other 'recessions'? Definitely. Are these exclusions valid? Maybe, maybe not.

My main worry is the capacity of gargantuan central governments to create an illusory prosperity and lull the populace into inaction. When reality finally rears its ugly head - as it inevitably does - the consequences are far worse than if the serious problems had been addressed upfront while they were still relatively small and manageable.

I've been doing some recreational reading in economics during the past few months, and all I can say so far is that economics is far too important to be left in the hands of economists.
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Old 03-08-2009, 09:38 AM   #15
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I've been doing some recreational reading in economics during the past few months, and all I can say so far is that economics is far too important to be left in the hands of economists.
Or, worse, politicians...
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Old 03-08-2009, 10:39 AM   #16
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That's why smart folks like Robert Shiller average earnings over 10 years.

Negative earnings reflects massive impairment charges which won't likely be repeated. But those same impairment charges also represent a reversal of prior years "earnings" that weren't real. So when we average out the too high prior earnings with the too low current earnings we get back to something closer to reality.
While I agree the market could turn up from here and certainly the market is much more favorably priced than in late 2007, the differences in how people's jobs, governments and personal debt situation have placed a different level on the interaction with stock prices which may not back test as well as the stock history may indicate. Much of this imploding debt is being assumed by the government. This chart causes me to question the ability of the US Government to assume this responsibility with a favorable long-term resolution for shareholders of money-making corporations, who are going to be the main source of income for servicing this debt.

Recall that in 2005 AIG was one of the 7 remaining AAA rated corporations. Even in this chart the sobering reality is increase up in the 1930's is impacted by the fall of GDP in the first 4 years of the great depression, whereas the current increase is really an increase in actual debt in relation to an increasing GDP.

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Old 03-08-2009, 11:32 AM   #17
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A wise man once said, "Be greedy when others are fearful, and fearful when others are greedy". Unless, that is, it really is different this time..............

I don't think it's really different this time, fwiw (nothing).
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Old 03-08-2009, 12:08 PM   #18
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ERD50: That is like trying to base a daily weather forecast with nothing more than the history of the last 4.5 months. You'd find yourself saying things like "well, it's never rained three days in a row", and there may be entire seasons that you have not experienced.

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I'd agree it's not bullet proof, but if you read the history about what was behind the Depression, about the Panics of 1873 and 1893 and 1907, ....
Good point. My oversimplification ends up assuming that the data points are *all* you have to go on. But in the weather example, even if we did not have data going back further, we do have some basic knowledge of the seasons, we could make some educated guesses on seasonal effects based on the latitude of that area, proximity to mountains, large bodies of water, major air currents, etc.

Likewise with the economy, we do have some basic understanding of supply/demand, money supplies, inflation, etc. We can use that in conjunction with the data, but in the end, we probably come up with that old 50-50 forecast for rain tomorrow

So maybe that is what we don't know - is predicting the economy over the next 5-10 years more like predicting it will get hot this summer, or is it more like predicting if it will rain tomorrow?

-ERD50
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Old 03-08-2009, 12:32 PM   #19
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So maybe that is what we don't know - is predicting the economy over the next 5-10 years more like predicting it will get hot this summer, or is it more like predicting if it will rain tomorrow?

-ERD50
Truthfully, there is far too little known to make confident forecasts. But that has always been the case, and few people cared about it before the market started heading down.

What we see and worry about and discuss now has way more to do with the currect market stress than any clever insights we think we are having.

The S&P is cheaper relative to recent history (P/E10) than it has been since the mid eighties. Way cheaper than it was at the bottom in 2002, a bottom that many of us have felt self-congratulatory about catching.

Of course things are different now-but are they clearly more negative than when Nazis were occupying Europe and the Japanese were running amok in the Pacific?

Not to me. The one thing I think I should have considered more carefully was the political feeling leading up to the elections, and the results of the elections.

For may years we have had either business friendly administrations, or at the least split executive/legislative governance. I knew that was changing, but I stayed hopeful instead of looking at reality- we were about to elect the most radical member of the Senate, and a Democratic congress that included Pelosi and Reid in prominant positions.

IMO that is why market quotes can't get a floor.

Ha
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