But, Should We Really Expect Lower Returns Going Forward?

[Fermion]

Not sure I follow. Inflation causes increases in company costs (labor, materials), which reduces EPS. If stock prices were to remain constant OR rise in that scenario, P/E ratios would become even further stretched than they already are. And by all measures - CAPE 10, Buffet ratio and many others, we're sitting at least at 2X+ "normal" at these levels.

Curious to hear more on how inflationary pressures are good for stock valuations, especially compared to historical levels. Maybe I'm just missing something..

Companies pass on the costs to consumers eventually. The dollar buys less, the E in P/E goes up, even if that E can't buy as much as it used to, the P/E number goes down.

And there is obviously demand there, even at the higher prices. Look at lumber...people are willing to pay 300% inflation in just one year....you think they won't still buy toilet paper if it costs 10% to 15% more?

 

[24601NoMore]

Companies pass on the costs to consumers eventually. The dollar buys less, the E in P/E goes up, even if that E can't buy as much as it used to, the P/E number goes down.

And there is obviously demand there, even at the higher prices. Look at lumber...people are willing to pay 300% inflation in just one year....you think they won't still buy toilet paper if it costs 10% to 15% more?

Econ 101, and "Price In-elasticity". At a certain point, consumers will not pay the increased cost. For instance - I was looking to build a new retirement house. NO WAY I'm paying the current ridiculous lumber prices. So we're staying put in our current house.

And companies don't always just pass along their higher costs to consumers - because they have competition seeking to keep THEIR prices lower to win more marketshare. Econ 101 again. Another example - I went to buy mulch the other day. Supplier wanted too much to deliver (a ridiculous amount) because their labor and gas costs increased. I cancelled that order and found a different supplier who wasn't attempting to pass those costs along to me.

And I really don't see how the "E" in P/E goes UP when there's inflation. Someone will need to explain that one to me.

Historically, inflation is an equity price killer that causes - as they say, "asset repricing" (ie: crash).

I'm sitting at < 25% equities, a large part of which is international vs US. Sure, I'll miss out on the party to the upside - but my downside is very limited also. And I DO think the next decade is going to very painful for US equity holders. Guess we will see. (FWIW, I'm actually considering liquidating a big part of my remaining stock portfolio and moving mostly to cash. Sure, I'll "lose" 2-3% this year sitting on the sidelines. But I plan to buy US equities again at a LOT lower price that's more in line with historical average valuations - because equities ALWAYS revert to the mean valuations..eventually. Will that be 2021, 2022 or some other time? Hard to say, but I'm pretty confident it will be in 2021 or early 2022 at the latest for a whole host of reasons, not the least of which is that valuations are artificially super inflated at the moment largely due to Fed pumping and TINA..that's gonna wear off at some point. And when it does, it's not gonna be pretty as people stampede to the exits..).

 

[Fermion]

I guess I don't understand why earnings would not go up.

Say you have XYZ corp who uses energy and copper to make whirlygigs, which they sell for $10 each, making a 10% profit on each sale. This 10% is low enough that nobody else wants to get into the whirlygig business.

Now copper goes up 50% and they raise the price to $12 each, still making 10%...and it is still not worth it for anyone else to get into the same business because they would also have to pay more for copper.

But the company earnings have gone from $1 each whirlygig to $1.20 per whirlygig. Assuming wages stay the same and the demand for whirlygigs stays the same, they have increased earnings 20%.

I mean yeah, it is not this simple and I agree at some point people will stop buying whirlygigs but I don't think we are there yet, especially when you give everyone $5,000 free each year in whirlygig coupons from uncle sam.

 

[Fermion]

Here is a real world example. Boise Cascade has had the E portion of their P/E go way way up due to inflation of wood products. The market has rewarded the stock with a similar increase.

Even Buffett said his companies are going to be passing the costs along to the consumer this year with a 10% or more increase in product costs. You think he is not going to be increasing the E portion?

 

[aja8888]

I guess I don't understand why earnings would not go up.

Say you have XYZ corp who uses energy and copper to make whirlygigs, which they sell for $10 each, making a 10% profit on each sale. This 10% is low enough that nobody else wants to get into the whirlygig business.

Now copper goes up 50% and they raise the price to $12 each, still making 10%...and it is still not worth it for anyone else to get into the same business because they would also have to pay more for copper.

But the company earnings have gone from $1 each whirlygig to $1.20 per whirlygig. Assuming wages stay the same and the demand for whirlygigs stays the same, they have increased earnings 20%.

I mean yeah, it is not this simple and I agree at some point people will stop buying whirlygigs but I don't think we are there yet, especially when you give everyone $5,000 free each year in whirlygig coupons from uncle sam.

Sooner or later, we will have wage inflation. That will raise manufacturer's costs, big time.

 

[Fermion]

Sooner or later, we will have wage inflation. That will raise manufacturer's costs, big time.

But that will only lead to more price inflation as people have more money to spend.

Short term, I get it, the market won't like a spike in inflation. Long term though Apple will just sell the I-phone for $1400 each instead of $800.

 

[NW-Bound]

In the past, during periods of high inflation the stock market return just could not keep up with inflation. Wages did.

This means that during high inflation, workers earning wages did better than retirees living on fixed income or investments.

The following chart shows that in the period of 1966-1982, the stock return was -59% after inflation. That means after 16 years, you had 41c on the dollar. And that is if you did not withdraw anything!


PS. I don't remember what investment/retirement guru has said this, and I will paraphrase. "Inflation is an efficient method to redistribute wealth from investors to workers".

 

[USGrant1962]

In the past, during periods of high inflation the stock market return just could not keep up with inflation. Wages did.

This means that during high inflation, workers earning wages did better than retirees living on fixed income or investments.

The following chart shows that in the period of 1966-1982, the stock return was -59% after inflation. That means after 16 years, you had 41c on the dollar. And that is if you did not withdraw anything!

Yes, and FWIW this is the case where the 4% rule didn't work by a smidge. ~3.6% did.

 

[Markola]

All I know for sure is that, “going forward”, however one defines such a period, some things are going to zig while others zag, which is why I try to own a little of everything all over the world.

 

[audreyh1]

Equity market PE multiples tend to shrink when interest rates go up.

 

[Montecfo]

...1966-1982, the stock return was -59% after inflation...

Yes. and the reason stocks did poorly? Rising interest rates. Interest rates are the most powerful driver of equity values. S&P 500 earnings grew 7% annully but PEs were cut in half.

A cautionary example.

 

[DrRoy]

Yeah, I plan for lower returns. I just hope they aren’t negative!

+1

 

[DawgMan]

After 20 years in retirement I just take it year by year. Our investment strategy hasn't changed. Our portfolio has really grown. Meanwhile we get older each year......

When our net worth keeps up with inflation, I feel like I've won the lottery!!!!

^This is probably the simplest way to measure a "win" year after year, provided of course, you have not sacrificed your desired spending habits during any given year due to being consumed with seeing your pot grow. If a retiree can 1) spend year after year as planned, and 2) see his pot keep up with inflation (at least over some reasonable period), then I would say he/she has "won the game"!

On another note, I am starting to warm up to your concept of banking any excess annual withdrawal that is not spent as opposed to reinvesting it in the annual portfolio rebalance. Mentally, one more lever to pull in a down market to plug a hole!

 

[Midpack]

So what’s the best course of “action” to maximize returns and avoid losses? I don’t get the need to point out hazards without thoughtful recommendations…

 

[DawgMan]

So what’s the best course of “action” to maximize returns and avoid losses? I don’t get the need to point out hazards without thoughtful recommendations…

Not sure who this is directed to? My initial observation basically made the argument to stay the course, but perhaps arbitrarily handicap your expected returns going forward. Not sure what you mean by "thoughtful recommendations"?

 

[Amethyst]

OMG that is so Pentagon.

I have always liked this story:

... possibly apocryphal but worthwhile anyway: One day well prior to D-day, the army Met (meteorological) office received a request from SHEAF for a weather forecast on a specific day a couple of months in the future. "Impossible," they said and this was relayed up the chain of command. Back down came the order: "A forecast is required for planning purposes."

 

[Fermion]

Looking at NW chart of the 14 year period really makes me want to get some gold lol.

I think gold went from $40 to $400 during that 16 year period when the market returned -59%

Inflation, Interest rates, P/E, gold, bitcoin, Gamestop, Mars

The correct plan of action is to go to Vegas.

 

[Dash man]

Looking at NW chart of the 14 year period really makes me want to get some gold lol.



I think gold went from $40 to $400 during that 16 year period when the market returned -59%



Inflation, Interest rates, P/E, gold, bitcoin, Gamestop, Mars



The correct plan of action is to go to Vegas.

I hear Dogecoin is on sale.

 

[Sniggle]

Reading through this thread is very sobering and concerning. For those that are 15-20 years into retirement, you have had a great run and have had the opportunity to pad their savings. But for those of us who are a few years out and are just hitting our savings target, giving back 30%+ would de devastating, and reduce the number of 'good years' we could enjoy.

I know that 10%+ returns in the market are not sustainable, I know that inflation is well above what the government says it is, and I suspect that the market levels are more of a house of cards than a house built on a firm foundation.

Yet here I sit almost 100% in equities, because there really is no other game in town as far as I can tell. Wondering if I should take my 10% gain this year and go hide......

( It is funny how as you close in on retirement, the perceived uncertainty seems to increase, and the 30+ years of savings and investment seem to provide little solace when facing a few more years before you reach safe harbors)

 

[Fermion]

I would not be greatly scared of a extended market drop. The current method of dealing with a downturn in the market is to dump money everywhere, which does seem to work pretty well.

10%, 20% drop, yeah, but 50% drop will always be a V with trillions of dollars pouring in during the right side of the V. There can be no other way now without a collapse of US society.

Inflation eating away though is where my concerns are. You can lose 50% of your purchasing power and not even realize you are being boiled.

 

[DawgMan]

Reading through this thread is very sobering and concerning. For those that are 15-20 years into retirement, you have had a great run and have had the opportunity to pad their savings. But for those of us who are a few years out and are just hitting our savings target, giving back 30%+ would de devastating, and reduce the number of 'good years' we could enjoy.

I know that 10%+ returns in the market are not sustainable, I know that inflation is well above what the government says it is, and I suspect that the market levels are more of a house of cards than a house built on a firm foundation.

Yet here I sit almost 100% in equities, because there really is no other game in town as far as I can tell. Wondering if I should take my 10% gain this year and go hide......

( It is funny how as you close in on retirement, the perceived uncertainty seems to increase, and the 30+ years of savings and investment seem to provide little solace when facing a few more years before you reach safe harbors)

Well, if you are 3 years from RE and are counting on your nest egg to fund most of your RE spend (as opposed to SS/pensions/annuities), you probably should start ratcheting down your AA, especially if a 30% drop is going to negatively affect your world.

3-4 years prior to my planned RE, I finally made peace with ratcheting down my AA from 80/20 to 60/40 (where I plan to hang out between 50/50 - 60/40 in RE). It was tough buying bonds, but many of those smarter than me on this site got me comfortable with viewing bonds as a ballast as opposed to a reliable yield or return generator. Despite my continual desire to tinker, I'm in a pretty good place now.

You may want to give your AA some thought now and seriously think about cashing in some of your equity chips for bond-ish alternatives.

 

[GenXguy]

Reading through this thread is very sobering and concerning. For those that are 15-20 years into retirement, you have had a great run and have had the opportunity to pad their savings. But for those of us who are a few years out and are just hitting our savings target, giving back 30%+ would de devastating, and reduce the number of 'good years' we could enjoy.

I know that 10%+ returns in the market are not sustainable, I know that inflation is well above what the government says it is, and I suspect that the market levels are more of a house of cards than a house built on a firm foundation.

Yet here I sit almost 100% in equities, because there really is no other game in town as far as I can tell. Wondering if I should take my 10% gain this year and go hide......

( It is funny how as you close in on retirement, the perceived uncertainty seems to increase, and the 30+ years of savings and investment seem to provide little solace when facing a few more years before you reach safe harbors)

You said it, but with skyrocketing inflation, there's is no place to hide.

 

[24601NoMore]

10%, 20% drop, yeah, but 50% drop will always be a V with trillions of dollars pouring in during the right side of the V. There can be no other way now without a collapse of US society.

I wouldn't be so sure that a 50+% drop will be a "V" or recover quickly.

There are plenty of periods throughout US history where that has not happened. In fact, some of the big downdrafts have taken 10-15+ years to recover from. See upthread for some examples..

 

[Fermion]

I wouldn't be so sure that a 50+% drop will be a "V" or recover quickly.

There are plenty of periods throughout US history where that has not happened. In fact, some of the big downdrafts have taken 10-15+ years to recover from. See upthread for some examples..

The fabric of society is more woven into the market now than in the past so you cannot use the past history as an indicator of what might happen. A 50% drop without a recovery destroys local and state economies and creates a problem for people who need to get elected.

I mean anything *can* happen, I just think anything but a V shaped recovery is unlikely now.

But going forward, I do think we will get lower *real* returns, getting back to the OP. I think we might get 5% to 10% a year in the market but experience 5% to 8% of inflation each year as well.

 

[audreyh1]

^This is probably the simplest way to measure a "win" year after year, provided of course, you have not sacrificed your desired spending habits during any given year due to being consumed with seeing your pot grow. If a retiree can 1) spend year after year as planned, and 2) see his pot keep up with inflation (at least over some reasonable period), then I would say he/she has "won the game"!

On another note, I am starting to warm up to your concept of banking any excess annual withdrawal that is not spent as opposed to reinvesting it in the annual portfolio rebalance. Mentally, one more lever to pull in a down market to plug a hole!

We went through a long period where net worth did not keep with inflation - it took from 2008 through late 2012 to break even inflation adjusted. Much of that time we were down only 10% or less, which is not bad at all. I wouldn’t sweat falling behind 10% for a few years.

Pulling ahead of inflation after spending and taxes just seems incredible!

Banking unspent funds - that goes with my spend it now (in the next few years) rather than later philosophy. It certainly can help weather a rainy day.