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moneysense.ca, 30/10/08
Bogle expects stocks to return 10%
There is nothing like a bear market to boost the expected return from stocks. In The Little Book of Common Sense Investing (review), published last year, John Bogle projected an average annual return of 7 percent over the next ten years: 2 percent from dividends, 5 to 6 percent from earnings growth and a 1 percent loss due to the easing of P/E ratio from 18 to 16.
According to a column on the Fortune website, Mr. Bogle is a lot more optimistic today:
The upside of the painful bear market, of course, is that stocks are much cheaper – as cheap, in fact, as they have been in many, many years. Based on the price/earnings ratio (using earnings from the past 12 months), the U.S. market is as inexpensive today as it has been since 1990. From today’s levels, says Bogle, it’s reasonable to think that the S&P 500’s profits could grow by 7% a year. Throw in the current dividend yield of over 3%, and Bogle believes stocks could return 10% a year for the next decade. “I don’t think that’s a pipe dream,” he says – and this from a man who at the turn of the century was warning of years of subpar returns.
It’s a bit surprising that Mr. Bogle has increased the forecast for earnings growth to 7% from his previous estimate of 5% to 6% but such rates have been observed in the past: 7.4% in the 1990s and 9.9% in the 1940s and 1970s.
moneysense.ca, 30/10/08
I don’t even know why they give ‘predictions’ any print space at all. The only thing analysts are good at is telling you what has just happened.
If dividend rates are unchanged to slightly higher over the next few years and prices keep dropping or staying flat, dividend yields will rise further above 4%. Since dividends have historically accounted for 40% of total stock market returns every year on average, then I would also expect total return at 10%..
Eric: The surprising thing about the stock market is that long-term returns can be forecast with high odds of being correct. Admittedly, the margin of error for 10 year forecasts is wide, say +/- 2 percent because changes in valuation can have a significant effect. For longer periods, forecasting is fairly easy: current dividend yield plus long range growth in earnings. Yields today are around 3%. Long-range earnings growth is 5% to 6%. Over the next 25 years, stocks can be expected to return 8% to 9%.
I don’t know if I agree with that. For one, you can’t possibly know what the odds are with only a 100 of so years of data coupled with the fact that much of that data isn’t relevant considering how different the world market is today than it was. All sorts of long term effects could come in to cause 25 year returns to be flat or negative. I mean if the next 100 years puts 8% return, the tsx will be over 20 million!
I don’t think I see a difference between buying and selling businesses today as it was in the 1950’s. Much like property or selling your car, hasn’t changed much.
Buy a business with good fundamentals and a good price, hold it, and sell it if the market ever quotes you a ridiculously expensive price. With the depressed stock prices today relative to their earnings, it makes sense how you could acheive 10%/year over the next business cycle.
Eric: As long as we remain a capitalist society with corporations acting with a profit motive, I think it is reasonable to assume that earnings will grow in-line with GDP over the long-term. GDP grows by 2%, inflation runs at 2%, so we get 4% earnings growth. It’s true that any number of things could happen — we could have wars or events we can’t foresee today. That’s the risk part — we expect returns to range about 7% but there is a possibility that it won’t be realized.
Eric: Boggle could be right in both his predictions simultaneously. From last year’s level, an investor might get 7% growth. An investor starting today might get 10% growth. No contradiction.
CC: “For longer periods, forecasting is fairly easy” ? I’d say survivorship bias has clouded this analysis. Please forecast 20 year investment returns for these investors: Romans c. 400 A.D.; Germans c. 1930 A.D.; Russians c. 1910 A.D.; French c. 1780 A.D.; Japanese c. 1980 A.D.; …
In 1900 the USA was an emerging market. China and India are in that position today, with 7 times the US’s population. Their rise will certainly have strong effects on our investment returns.
Finally, this guy is a little kooky, but makes some valid points: http://www.chrismartenson.com/crash-course/chapter-1-three-beliefs
Although I also like to value companies based upon their earnings… There is a big difference between trailing earnings and future earnings. A company with a nice low trailing P/E ratio of 8 is actually a P/E of 24 if their earnings get chopped by 2/3 in a major recession or depression. Or if the profits disappear altogether, then the P/E technically shoots up to infinity (divide by 0 error).
While P/Es based on trailing earnings looks pretty nice right now… It may not look very nice when the recession hits us full force as consumer spending drops off a cliff.
Earlier this month, John Bogle gave an excellent webinar presentation to the CFA institute. He made some very insightful points about black monday, black swans, the difference between risk and probability, and commentary on present market conditions.
It’s well worth listening to on the weekend.
http://www.cfawebcasts.org/cpe/what.cfm?test_id=822
I read somewhere a research paper ( don’t have the link with me) that showed that if you had created a portfolio of all countries that had functioning stock markets at the beginning of the 20th century and then weighted each country in the portfolio based off its industrial production slice of the total world GDP.. you’d have made about 8% in dollar terms..
Anon: Realized returns can be quite different from expected returns. Forecasting doesn’t mean that something will happen *for sure*, there is always some uncertainty. One example I can provide is 10-year total bond returns. If I buy a 10-year bond today, I can expect with 90% accuracy that the total return over the next 10 years will be the bond’s current yield. But there is that 10% chance that my actual experience could be quite different from what I expect today. Some of those black swans you describe are lurking in that 10% chance of being wrong.
Andrew: Thanks for the Bogle webinar. I’ll be sure to check it out over the weekend.
DGI: The Japanese experience alone is a good reason to construct globally diversified portfolios. Pretty much the same reasoning applies to estimating expected MSCI World returns — current dividend yield (3%) + earnings growth (4% to 5%) = 7% to 8%.
CC: What I’m trying to get at is that 7 to 10% is not a scientifically based forecast, since it is heavily influenced by survivorship bias. It was computed from 10, 20, 30, etc. years of **USA** market returns. But the USA is a survivor!
A scientific computation would start, say, in 1900 A.D.. Then look at all countries with stock markets then in existence. Allocate funds according to market weights (or some other passive strategy) and see what results you get over 10, 25, 45 years, etc.
I bet you wouldn’t get 7 to 10% returns due to all the blow ups that have occurred since then.
In fact, this kind of extrapolation is what got us into the current mess (“house prices have always gone up in the past”; “mortgage default rates have never gone over x%/year”; etc.). ***The Nassim Taleb (Black Swan) books cover these points much better than I can here.***
Solutions/What to do: Assume long run stock returns will be much lower than expected (say, 4 or 5%). **Therefore, save more.** Also, be as diversified as the size of your portfolio allows: stocks, bonds, real estate (eg own small rental properties), gold, different currencies, etc.
If I’m wrong? Yipee, you’ll have a golden retirement and leave some cash to your kids.
Anon: Thanks for your explanation. I don’t feel Bogle’s forecast is inconsistent with your opinion at all. His earlier forecast of 7% in 2007 and 10% now (both nominal, not real returns) could simply be explained by the 30% to 40% in equity values. Also these forecasts are for the next 10 years, not indefinitely into the future and are based on recent stock returns. Because stocks are mean reverting, I think these expectations to be reasonable and logical, not wildly optimistic.
I totally agree with you on blindly extrapolating past experience. To be fair, Bogle’s himself has warned investors of the same dangers in many books and articles. Personally, I’m assuming real returns from stocks in the range of 4% (Link) over my investment horizon (30 to 40 years).
In Triumph of the Optimists: 101 years of Global Investment Returns, the authors look at precisely the data you suggest: stock, bond and bill data from 16 countries starting from 1900 and find that on average stocks have beaten bonds by 4% to 6%. The same book (an updated study in the link below) found that stock returns in two countries — Sweden and Australia — exceeded US returns and in 11 out of 16 nations, real returns were at least 5%. The lowest premium of stocks over bonds over the century was 2% (in Switzerland). Even Germany and Japan experienced positive real returns from stocks (3.3% & 4.5%) over the century.
What I’m getting at is that the superiority of stocks over bonds isn’t just based on the US experience. The real return on world ex-US stocks was 5.3%, shy of the 6.5% real return from US stocks but still impressive.
http://www.london.edu/assets/documents/786_GIRY2008Synopsis.pdf
I couldn’t agree with you more on (1) modest future returns (2) diversification across asset classes (3) diversification across equity markets. I’m guessing you mean 4% to 5% *real* returns from stocks — that’s my assumption as well with the lower end being more probable.
(I haven’t read Black Swan yet but I’ve read Fooled by Randomness…)
I think the increase must reflect his view that inflation will surely creep up. The big question I have isn’t what the average rate of return will be, but what will the average rate of REAL inflation be?
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