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The Single Greatest Predictor of Future Stock Market Returns
#1

The Single Greatest Predictor of Future Stock Market Returns

Excellent article :

http://philosophicaleconomics.wordpress....t-returns/

A small part quoted :

Quote:Quote:

There’s a raging debate right now between bulls and bears over whether the U.S. stock market is presently overvalued. The debate rages on because the term is poorly defined. What, precisely, does it mean to say that something is “overvalued”?

When we say that the stock market is “overvalued”, we might mean that it’s currently valued more expensively than it typically has been in the past. Over its history, the U.S. stock market has offered, on average, some expected total return–say 8% to 10%. But now it’s priced for 5% or 6% (using our metric). So it’s “overvalued.”

Fair enough, bulls shouldn’t disagree. There are tons of reasons why the present stock market is unlikely to produce the 8% to 10% returns that it has produced, on average, throughout history. On almost every relevant measure, it’s starting out from a higher-than-average level.

The more important question, however, is this: why should the stock market offer investors the average historical return right now? If, over the next 10 years, bonds are offering investors 2.8%, and cash is offering them less than 1%, why should stocks be priced to offer them 8% to 10%?

How would that even be sustainable? If equities were offering an 8% to 10% return, we would all choose to allocate the bulk of our portfolios into them, rather than languish in the ZIRPY nothingness of bonds and cash. There obviously isn’t enough equity supply for all of us to allocate in that way, and so the price would get pushed up, and the expected return pulled down–very quickly.

Now, it’s a mistake, obviously, to make an assessment of valuation based strictly on a comparison between the yields of stocks and bonds, as the Fed Model suggests we do. The yield of an equity security, again, is not the same as its return. You can buy the market at 33 times earnings–a 3% earnings yield–but your return over the next 10 years isn’t going to be 3%. It will probably be 0% (or less), as the market contracts from the obscene valuation at which you bought it. If you were to try to justify the stock market’s price by comparing its 3% yield to the 10 year bond yield at 1%, touting the healthy risk premium (2%–greater than the historical average), you would obviously be making a huge mistake. The real risk premium on your stock investment would be negative–you would end up with a loss.

But if you properly estimate long-term equity returns using other methods–for example, the method I’ve proposed, which puts the future return for the stock market at 5% to 6%–then it makes perfect sense to assess the “appropriateness” of the current valuation through a process of comparison with the investment alternatives. In the current case, the alternatives of cash and bonds are offering much less than 5% to 6%–so there’s a decent risk premium in place for equities. The market is not “overvalued”–it doesn’t “belong” at a lower valuation. To the contrary, it’s priced where it should be, given the alternatives. Investors have done their jobs properly, leaving no easy arbitrages to exploit.

Now, if bears want to argue that it’s unwise to lock in 5% to 6% equity returns right now (or even 3% or 4%), because the market cycle will eventually produce selloffs in which greater returns are made available, my response would be: who said anything about locking anything in? Let’s time the market–as bears seem to want to do. I’m all for that approach.

But timing the market doesn’t mean boycotting it until it hands you, on a silver platter, the high returns that you’re demanding. After all, there’s an excellent chance that it won’t hand them to you–there’s no reason it has to. General societal progress–particularly in the area of economic policymaking–reduce the odds that it will. Rather, timing the market means monitoring for the types of processes that tend to cause markets to sell off–capturing equity returns except when there are signs of those processes emerging. “Valuation”–at least in the range that we’re currently at–is not one of the processes that cause markets to sell off (or, for that matter, that stop markets from selling off). So stop worrying about it.

Big selloffs usually occur in association with recessions. That’s where market timers make their money–by anticipating turns in the business cycle. A hint to bears: if you’re calling for a recession right now, in this monetary environment, you’re doing it wrong.
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#2

The Single Greatest Predictor of Future Stock Market Returns

Yea our lower interest rate are a historical (manipulated) anomaly. This throw "historical prices" into whack.

WIA- For most of men, our time being masters of our own fate, kings in our own castles is short. Even those of us in the game will eventually succumb to ease of servitude rather than deal with the malaise of solitude
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#3

The Single Greatest Predictor of Future Stock Market Returns

Based upon the excerpt you provided, I didn't read the entire article (because it seemed like nonsense).

All of that mentioning "value" without once mentioning fundamentals.

Here's a novel concept:

1) Calculate the liquidation price of the company per share;
2) Allow a 30% margin of safety (e.g. you think it should be $1.00/share, but you err on the side of caution and say it should be $0.70/share);
3) If the share price is higher than that number, it's overvalued.

Rocket science, I know.

In a way, I'm glad that these clowns either haven't read Graham or have completely ignored him.
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#4

The Single Greatest Predictor of Future Stock Market Returns

Quote: (04-08-2014 07:56 PM)Feisbook Control Wrote:  

Based upon the excerpt you provided, I didn't read the entire article (because it seemed like nonsense).

All of that mentioning "value" without once mentioning fundamentals.

I would recommend you read the entire article, and his follow up article :

http://philosophicaleconomics.wordpress....e-fitting/

"In this piece, I’m going to do four things.

First, I’m going to challenge the entire business of making “valuation vs. future return” charts. These charts are tenuous, unreliable ways of estimating future returns and of attempting to resolve debates about market valuation.

Second, I’m going to explain the conceptual basis for valuation metrics in general, to include a detailed description of the principles on which they operate. These principle are not trivial.

Third, I’m going to discuss the problem with valuation metrics–why it’s so hard to use them to accurately estimate future returns.

Finally, I’m going to delve into the debate on profit margins, which is what the debate on valuations ultimately comes down to."
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