Subject: Re: War, currencies and jurisdictions
You have provided solid reasoning way back in 2011, 2012, 2013 why S&P at 1000 is overvalued. To expect flat returns for the next decade. It turned out to be one of the best ever for stocks for whatever reason.

Simple explanation: My bearish pronouncements have been wrong!

I do try to say at every juncture that **IF** valuation levels in future are like those in the past, **THEN** the returns will necessarily be poor. This is not quite the same as predicting that returns WILL be poor. Valuations have emphatically not gone in the direction of old norms, (no matter how likely I though it seemed) so the "then" part hasn't happened.

Over time I have given up having much of an opinion at all about what the valuation level of the S&P 500 would be at any given time in the future. As it turns out, valuation levels did not go back in the direction of old norms, they just keep going higher and higher. Caution has not been a good stance. I don't think that it was predictable that valuations would climb to this level, and I certainly wouldn't count on that trend of multiple expansion continuing, but who knows?

(quick spot check: in the tech bubble, US market cap to GDP peaked around 138%, and it's currently a nice round 200%)

For a specific example of the if-then thinking, if the market were priced at the same level today that corresponded to its average valuation level since December 1996, the S&P 500 index would be at 4425 instead of 6033, a drop of -27%. And that is a fairly generous choice of time period for the baseline, since it starts the day of Mr Greenspan's "irrational exuberance" speech and covers at least three stretches that were considered bubbles at the time. It's also generous because it's based on cyclically adjusted earnings evaluated during a stretch of historically amazing net profit margins. But that if-then sentence is not saying that the market will now drop to that level...just that the valuations are a lot higher than even the modern era norms, so EITHER valuations will stay higher than those modern era high norms, OR the market will slide. (or be flat for a whole lotta years)

Quite aside from mean reversion, even if valuations remain this high it remains certain that longer run returns will be poor from here, for the simple reason that you're not getting much in the way of (cyclically adjusted) earnings for your investing dollar from the broad US market. Over long periods price will have a strong interest in intrinsic value, and intrinsic value comes from owner earnings. If you pay twice as much for the unchanging sum of all future earnings, you'll end up with half the value in the long run no matter how long you hold...half the owner earnings you would otherwise have purchased.

Looked at another way, ignoring one time changes in valuation, the simplest estimate of your long run return is the (nominal) dividend yield on the day of purchase, plus the (real) rate of future GDP growth. (that works because stock price gains should track their earning power, which will roughly track GDP growth). Fill in your own estimate of whether valuation levels will be higher or lower in future.

In one sense, "it's different this time", in that I am actually predicting weak returns for US equities in the next decade or so. But my warning about poor future returns is not based on the usual, being some unknown degree of mean reversion. This time around, it's because I perceive that there has been a drop in aggregate intrinsic value. I anticipate a materially weaker US economy than previously expected measured in constant currency terms so stocks will be worth less. Perhaps with a mild negative feedback loop between that and weaker valuations (and perhaps currency) because of lower incremental investment flows to the US. That is a much weaker line of reasoning that merely expecting some mean reversion, but that's the end result of my thinking.

I don't have a lot riding on the accuracy of my prediction because a few months ago I sold the vast majority of my US stock positions, bills and cash, so it's just an intellectual exercise. I rather expect my portfolio to do more poorly as a result of eliminating most US securities as possibilities.

There is some hope for the notion that valuation levels matter, though. The usual expectation for an investor in the US stock market has been Siegel's constant, around inflation plus 6.5% including dividends: what you'd have got from the average stock in the average year in the least century or so. For the time horizon I usually look at of 7 years forward with the end date very smoothed, nobody who bought the S&P 500 between October 1996 and March 2008 managed that number.

Jim