No. of Recommendations: 6
Bottom line, I conclude that the outlook for the US economy, US profits, and US stocks in the next 10-20 years is poor, and likely to deteriorate further.
Jim
Jim - You are such a honest, generous, extraordinarily intelligent person that I choose to study your posts in detail for quite some time. I have a 200 page document of your posts way going way back 15+ years. I did not find any mentors so I spent years studying Buffett, Graham, Damodaran and a couple of others. I would put you right up there.
In the spirit of speaking honestly to someone who has given so much and who I benefited so much from, I gently suggest that you give the pessimism just a second thought.
I quote you below not to make you look bad, but how pessimism might not be a good idea even when based on what seems very solid reasoning because macro is too tough.
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.
I started with all the inflation-adjusted earnings through history (two different data sources).
...
The average earnings yield is simply the on-trend real earnings for
each date in the past each date in the past divided by the then-current
real market price (index level). This gives an average earnings
yield of around 7.32% since 1940, or a P/E of 13.66x.
...
Obviously the on-trend earnings figure can't be calculated the same way for today,
as we have only half the required data: the past. However, looking
at how earnings varied in the past, one can come up with various
more-or-less likely scenarios for what earnings might do in the next decade.
Earnings never rise for long periods at record breaking high rates, nor
at record-breaking low rates, so something near the middle is most likely.
That gives me a reasonably tight range of the likely on-trend level for today.
As it turns out, the range of possible trajectories of earnings
you choose, varying from optimistic to pessimistic, doesn't change the
estimation for today very much. We already have the past, and we
already have the central value for today, and we know that the figures
don't change extremely rapidly over time, so the range is pretty tight.
I validate that by using some other metrics. I tried quite a large
number of different ways of estimating the on-trend value for each
date in the past based only on the earnings up until that date,
and looked at which estimation methods gave the lowest RMS errors
when tested against the past where we know the right answer.
Then, I applied those methods to today to see what they say now.
...
For example, one popular method is the average earnings in the last 10 years.
The error of this method is minimized if you adjust it to be the
average real earnings times 1.067. That calculation gives you $64.46
for today's on-trend level. A similar method with a lower error
estimate (a better model) is the 12 year WMA of the real earnings,
increased by 1.0492x. That suggests $66.02 right now.
(WMA=weighted moving average=wedge-shaped weighting on the data points,
with the most recent weighted most strongly, weights decreasing
linearly back to the minimal weight on the oldest data point).
A very long run linear fit to the log real earnings suggests a figure of 51.63 right now.
A couple of methods using a constant times the 90th percentile of
earnings in the last 40 years gives a good model; that suggests $64.87.
No method I've looked at gives a figure over $66 at the moment for its estimate
of the October 2011 on-trend earnings level measured in October 2011 dollars.
Throw in an extra pinch of unknown errors and I'd put the absolute
upper limit at maybe around $68, and the lower limit perhaps low 50s.
Hence my serious doubts about folks claiming $90 (or whatever) is the new normal.
...
One side effect is that, since I expect the returns to be very modest
at best in the next several years, since that has what happened in the
past starting from periods of similar overvaluation, I expect that the
market will spend some of the next decade at index levels quite a lot
lower than today's level. So, I have added some long term hedges,
shorting the broad US market. In normal times this would lead to
pleasantly smoother returns but would have an expected cost to overall performance.
However, since I'm pretty darned sure the market will be a lot lower at
some point, I can close my hedges then, giving me both much smoother
returns in the mean time and an ultimate profit on the hedging too.
e.g., a guy could put on a hedge right now, and maybe close 20%
of it each time the S&P hits 1050, 950, 850, 750, and 650.
...
-Jim (Sometime in late 2011)
