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Valuations are too high for a long bull market, right? Wrong! The S&P 500 has averaged a 12% total annual return over the last 40 years. It began this four-decade run with prices that averaged, from 1962 through 1963, 18 times expected earnings. That is about where we are today (if you look at earnings before nonrecurring charges). ....................

My point is this: For every period where high-P/E markets fizzled, there are comparable ones, of roughly similar frequency, where they did well. The market's average P/E ratio is a bad market forecaster.

http://www.forbes.com/forbes/2003/0929/116.html

Professor Cliff Asness responding to a similar Fisher piece:

Besides promoting me from hedge fund manager Cliff Asness to "noted University of Chicago Professor Craig Asness" in "Professors and Markets" , Kenneth Fisher disparages an approach I advocate for forecasting long-term stock returns. He's "back-tested" it and found it doesn't get every decade right. Nobody would claim it works all the time. But many noted researchers have shown that when stock prices are higher versus fundamentals, as they are now, future long-term returns are often lower. This common sense helps explain a fair amount of historical decade-by-decade stock returns. So, we're left to choose between a tool that has reasonable (not perfect) power, or Fisher's best guess that the bubble's coming back. I know what Professor Craig Asness--a good-looking fellow, I might add--is betting on.
Clifford S. Asness. PH.D.
Managing Principal,
AQR Capital Management
New York, N.Y.

http://www.forbes.com/forbes/2003/1006/022.html

ataloss wrote: Fisher wrote:Valuations are too high for a long bull market, right? Wrong! The S&P 500 has averaged a 12% total annual return over the last 40 years. It began this four-decade run with prices that averaged, from 1962 through 1963, 18 times expected earnings. That is about where we are today (if you look at earnings before nonrecurring charges).

That period also includes the highest inflation in US history, if I'm not mistaken. I took a look at what the real returns were for the 40 years starting 4/1963 to 4/2003 by using Shiller's inflation adjusted price data and Gummy's annualized gain calculator.

I get an annualized real price gain of 1.9% per year. Looking at the return from dividends: we had a 3.1% dividend yield in 1963. Dividend growth slightly outpaced inflation, but not by much: about .6% annualized.

So we have real returns form April 1963 to April 2003 of 1.9% +3.1% +.6% = 5.6 % real return.

Question: Am I correct in adding in the annualized dividend growth like this? I think so, but am not really sure.

This is pretty darn close to the return predicted by the Gordon Equation: 1 or 2% growth + dividend yield of 3.1% = 4.1-5.1% real predicted return from 4/1963. The actual returns are a bit higher due to a bit of speculative growth in prices and a bit of growth in dividends.

Over that time the PE-10 expanded from 20.2 in 4/1963 to 22.1 in 2/2003. So speculative return was fractionally positive at .2% annualized.

Currently we are at dividend yield of about 1.5% and PE-10 of 25. Gordon Equation yields a prediction of 2.5% -3.5% real return. As discussed here before, dividend yield is a bit below historical averages when compared to earnings yield, so that combined with the newly favorable tax treatment of dividends could mean dividends can be expected to be higher in the near term. Adding more than .5% for this effect would probably be unwise.

It's tough to assume positive speculative return from these levels, but anything is possible. I tend to think mean reversion will be dragging the Gordon predicted return down a bit as speculative return goes negative. Who knows what the speculative return will be on any given date, though! Hence the name.

(edited for spelling)

It began this four-decade run with prices that averaged, from 1962 through 1963, 18 times expected earnings

Our hero needs to be reminded that the market LOST 22% in secular BEAR market from February 1966 through August 1982 (16.5 years!!).

Also noteworthy is that the P/E of the S&P was 7.3 in August 1982.

Put your seat belts on! TRyan

Current valuations will almost certainly drag down long term returns from here. However, with earnings recovering, and the forces keeping valuations high showing no sign of fading, I would guess that the next favorable season for stocks (Nov-May) will likely lead to equity gains. Of course, the danger is very high at these valuations if something goes wrong.

TRyan said

Our hero needs to be reminded that the market LOST 22% in secular BEAR market from February 1966 through August 1982 (16.5 years!!).

My accumulation period was 1960 to 1993 when I retired on marginally adequate assets. I had the good fortune to retire into the bull market of the 1990's, but half my accumulaton period was the secular bear market TRyan mentions. I just didn't want Petey to think that all my luck has been good! Most of my retirement stash, other than the house, accumulated after 1978.

half my accumulaton period was the secular bear market TRyan mentions. I just didn't want Petey to think that all my luck has been good!

I can only dream that the next 14-16 years will be a secular bear. The BEST luck comes when a substantial portion of accumulation takes place during a bear. Of course, only if it's followed by a nice strong bull!

Demographics tell me that the opposite may be true. I will retire in 18 years into a bear unless I can find some nice up and coming Chinese or Indian folks to sell my portfolio to.

WiseNLucky wrote: Demographics tell me that the opposite may be true. I will retire in 18 years into a bear unless I can find some nice up and coming Chinese or Indian folks to sell my portfolio to.

You are talking about the Baby Boom generation retiring, I assume? It does seem to make sense that that period would drive stock prices down.

On the other hand, aren't some boomers already nearing retirement? 1945+60 years = 2005. Some who are ahead of the game are already in FIRE.

Won't quite a lot be paring back stock exposure as they approach retirement? I could see a lot of the damage being done over the next 10 years ...

It's just too dismal to think about that we could be facing PE-10 of 20+ for the next 15 years. I may have to seriously look into buying real estate within my IRA to get some returns. Even if the US stays over-priced I guess there will be pockets of value around the globe at times.

WnL:

I can only dream that the next 14-16 years will be a secular bear.

You are right, of course, that a prolonged bear market could be a good thing for people in their accumulation phases, provided the bull returns eventually. Arguably, a growing economy reflected in a generally rising stock market would be a good thing for you too during your accumulation phase because of its economic and political consequences. My problem was that I chased performance and went broke during the bear market. I got more and more aggressive (options, margin, all that nonsense), going after the big win that would cover all my earlier losses, until there was nothing left. If I serve no other purpose, I can be a bad example.

Hello. My name is Chips. I'm a recovering speculator. I've been dry now for 25 years. I do admit to putting five bucks into a slot machine, usually after a casino here in Sin City gives me a free promotional meal.

Hello. My name is Chips. I'm a recovering speculator. I've been dry now for 25 years. I do admit to putting five bucks into a slot machine, usually after a casino here in Sin City gives me a free promotional meal.

LOL

On the other hand, aren't some boomers already nearing retirement? 1945+60 years = 2005. Some who are ahead of the game are already in FIRE.

Yeah, go ahead and pee on my parade.

I am at the tail end of the baby boom so it could work out either way. If boomers start selling off soon it could lower valuations as I buy up at good prices, only to start a bull after I'm out the door. Maybe a good idea to have 5+ years of cash when I start out (which I intend to do anyway).

Or, the long bear could just be getting going good when I retire. And a long bear leading up to it means I have little in the portfolio to start with. Dog food city.

So, for now, I just keep punching money in as I earn it because the alternative (heavy duty spending) would only ensure a poor outcome.

therealchips wrote: My accumulation period was 1960 to 1993 when I retired on marginally adequate assets. I had the good fortune to retire into the bull market of the 1990's, but half my accumulaton period was the secular bear market TRyan mentions. I just didn't want Petey to think that all my luck has been good! Most of my retirement stash, other than the house, accumulated after 1978.

As if I ever would suggest such a thing!

Future does look good, if your time horizon is over 40 years. Maybe not if it's only 20.