When Can We Make Money In Stocks Again?

verfasst von Rossi, 21.09.2002, 14:35

-->The Sweet Buy and Buy
When Can We Make Money In Stocks Again?
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By John Mauldin

This week we are going to depart from the usual format of surveying
the economic landscape for investment insights, and ask ourselves:

"What type of returns should you expect from the stock market for
the next 5, 10, or 20 years?"

Over the long-term the Ibbotson study, used by stock market
cheerleaders everywhere, says we should expect to make real returns
of 6-7%. This statistic is used by brokers and fund managers who
urge investors to buy and hold. Maybe more to the sales point, it
is used by them to urge investors to buy some more stocks or mutual
fund shares today and hold them as well. If you just keep buying,
the study says you will get your reward, by and by.

This is the sweet buy and buy sales pitch. The Ibbotson study (and
numerous similar studies) is one of the most misused pieces of
market propaganda ever. If I thought for one minute you really could
get 7% compound annualized returns over the next 20 years by simply
buying and holding, I would agree that it would be a smart thing to
do.

Today, with the help of a different and remarkable study by Ed
Easterling of Crestmont Holdings, I am going to help you figure out
what type of returns you should expect in your investment future,
whether you are 20 or 80 years old. We are going to see when you
should be buying, when you should be holding and when you should
simply fold and walk away.

I cannot tell you how many soon-to-be-retired couples I have talked
to, after their retirement savings have been hit 30-40-50% and their
comfortable retirement dreams shattered, who tell me their brokers
or advisors told them if they just hold on the market would come
back. Soon, they are promised. These were the investment
professionals they trusted and they assumed they had done their
homework.

Now they know these guys flunked Stock Market Returns 101, or
possibly skipped class in order to attend lectures by Jack Grubman
on"How To Buy Telecommunications Stocks." Today I give you the
class notes they should have shown you.

Ed Easterling is a colleague of mine in the world of hedge fund
analysis. He is an expert on Texas based hedge funds. (Let's hear it
for specialization.) His client list consists of institutions and
high net worth individuals. He has been trying to develop a graphic
way to show his clients what they should expect from simple stock
market returns over the next decade.

He showed me some of his work. Basically, he has developed an Excel
spreadsheet showing the stock market returns for the last 102 years.
By looking at his tables, you can see what annualized return you
would have earned if you hadbought stocks in any year and held them
for any length of time. Then he began to analyze what affect
inflation, taxes and commissions would have on returns. And finally,
he correlated those returns with Price to Earnings (P/E) ratios.

I looked at those charts for a long time, asked him to modify them
for your use, and have posted them on my publisher's website. In
today's e-letter, I am going to share with you some insights you can
get from looking at these tables. We are going to see that:

*There are clearly times to be in the market, and times when you
should be on the sidelines.
*When you start investing is one of the most critical components for
a successful investor.
*There are clear market cycles, and fighting the trend is a loser's
game.
*Expecting to make 6-7% over the next 20 years is unrealistic in the
current cycle.

I suggest you read this letter, and then go to the tables, should
you find them of interest. (I should also point out that you might
have to be patient, because if all 1,000,000+ recipients of this
letter try to hit the website at the same time, the web site will
be somewhat slow. You will need Adobe Acrobat Reader to view the
tables. More about where to go for these tables later in the
letter.)

First, let me describe the tables. Stick with me, because you are
going to get some very important insights from this study.

#1. The table is a 100 x 100 matrix, starting with 1901. You can
start with any year, move right along the row and find out what
investment return you would have made in any subsequent year. For
instance, if you had bought in 1930 you would have made a average of
2% a year over the next 20 years. If you bought stocks in 1980 and
held, you would have compounded at 16% a year for the next 20 years
assuming no inflation or taxes. For this study, we use the S&P 500
plus dividends.

#2. Each cell which holds a return number is color-coded. If a
return was less than zero, it is colored red. If it was more than
10%, it is dark green, with various colors in between. As you look
at the report, you see periods where there are lots of red, and
periods where there are lots of dark green.

#3. Easterling does something I have never seen in any tables. He
correlates the annualized return for a given period with P/E ratios.
In the tables, if a number is black, that means that P/E ratios have
been rising since the beginning of that period. If they are white,
that means P/E ratios have been falling.

#4. They are four tables. Tables labeled"nominal" do not adjust for
inflation or deflation. Tables labeled"real" take
inflation/deflation into account. This way you can see what actual
buying power you are getting from your stock market returns.

Tables labeled"individual" assume you are paying 30% taxes. Tables
labeled"retirement" assume your funds have been in a pension or an
IRA, and therefore not subjected to taxes. Easterling assumes 30%
taxes as an average over this period. We are aware that the income
tax did not exist in 1901. This was a tricky number to assumer, as
taxes on stocks are comprised of both long term and short term
gains, and are taxed at different rates for different times. Some of
you pay state taxes.

Why not just assume all long-term gains? If you buy your stocks
through mutual funds, as most individuals do, then you are probably
seeing a lot of turnover in your portfolio. Remember Peter Lynch of
Magellan fame? I am told his average holding period was about 7
months during the 70's. Some of you will pay higher taxes, and some
of you will pay lower, depending upon your investment styles. 30% is
probably fair. You can adjust your expectations accordingly.

#5. There is a thin black diagonal line going from the top right to
the lower left. This line shows you what the returns are 20 years
after an initial investment.

#6. Along the right hand side you can see the average P/E ratio for
any given year, and along the bottom you can see the inflation rate.

Now, what can we learn from these tables?

First, there are very clear periods when returns are better than
others. These relate to secular bull and bear markets. No big
insight there. But what I notice is the correlation with P/E ratios.
In general, when P/E ratios begin to rise, you want to be in the
stock market. When they are falling, total returns over the next
decade will be below par.

With the exception of WWII, when these periods of falling P/E ratios
start, they just keep going until P/E ratios top out. Generally,
this topping period comes prior to a recession.

Can you use the P/E ratios to signal a precise turn from a secular
bull to a secular bear? No, but you can use them to confirm other
signals. And once that turn has begun, the trend continues. You
generally want to exit the stock market, except for trading accounts
and special situations.

Second, this chart shows the high probability that a secular bear is
currently in progress. High and falling P/E ratios, along with
negative returns, are always associated with the beginning of such
markets. When you let your eyes follow along the tables, you can see
those"red" periods when annual gains were negative. Look at the
corresponding P/E ratio. If it is high, it historically has
correlated with the beginning of a secular bear, which always takes
years to work itself out. Fighting this trend is frustrating at
best.

When Can We Make Money In Stocks Again?

When can you profitably begin to be a long term investor, even in a
secular bear market? Look at the tables. You have reasonable to
excellent chances of getting above average returns if you buy when
P/E ratios are below 10-12. You might have to suffer in the short
term, but long term you will probably be OK. A good strategy would
be to start averaging in when the market values drop below a P/E of
10-12. Even in the worst of the Depression, you would have done well
over the next 20 years using this criteria and strategy.

Death and Taxes

If you look at just the nominal returns without thinking about
taxes, some would make the case that trying to time the market is
pointless. Over enough time, the returns tend to be the same. And I
agree, if you have 50 years, time can heal a lot of mistakes.
Investing through full cycles would give you a 10% compound return
after many decades, and 6-7% in inflation adjusted terms.

However, if you take into account inflation and taxes, real returns
tend to be in the 2-3% annual average range. And if you begin to
invest at the beginning of a secular bear, real returns over the
next 20 years are likely to be negative! You lose buying power.

Now this is the major point I want to make that you cannot get from
these tables.

First, these tables include dividends. That greatly increases their
return potential over using simple S&P 500 Index returns

Second, inflation did a great deal to mask the seriousness of the
1970 bear markets. It took 16 years for the index to make new highs
from 1966, but it was another 10 years, or 1992, before investors
saw a rise in their actual buying power in terms of the S&P 500
index.

On the table, you see that compound returns over the 26 years from
1966 to 1992 was 9% without inflation and 3% taking into account
inflation. The actual index was flat. That means the bulk of
earnings on this table over that period came from dividends. The
compounding effect of dividends upon returns was huge.

The 9% returns an investor apparently got from 1966 through 1992
depended largely upon inflation. The 3% real returns are entirely
due to dividends. During much of that period, dividends were in the
4-5% range.

Today, dividends on the S&P are around 1.5%, instead of the 4-5% of
the 70's. Further, we are not in a period of high inflation.

Go to the retirement account real returns table, and look at the
1966 through 1992 period. The after inflation return numbers for the
majority of that decade are negative for a long time, until you
begin to get to periods of low P/E ratios.

Today, inflation is well under 2%, and will probably be in that
range for many years. To get a picture of what nominal returns could
look like for the next decade, add 2% to the inflation adjusted real
returns for the 70's. Further, since dividends today are about 3%
less than they were in that period, you might want to subtract a few
points. The two numbers would just about wash each other out.

A secular bear market in which inflation and dividends are low would
look like the 1970's on the table titled"retirement real." I am
suggesting that returns for the next decade will probably look like
the returns of the 70's on this chart.

Now, look forward in time from any year in the 70's when P/E ratios
were above 10. Figure out when you want to be able to use your
investments for retirement. See if there is enough growth and time
to get you to where you want to be.

If you expect to retire in 10 years, it is very unsafe to assume a
5-6% return on stocks from where we are today. The table suggests it
might even be unsafe to assume 2%!

How can I even think that stocks might not compound at 2% a year
over the next ten years? It is because there has never been a time
when investors have made a 2% return over ten years when P/E ratios
are over 21, which is easily where they are today. I would not want
to bet my retirement plans on something which has never happened in
history.

If you are using a standard retirement planning software program,
and it asks you to assume how much you are going to get from stocks,
you had better not be using 10% or even 5% if you are planning on
retiring in 10 or 20 years. Yes, that means the when General Motors
assumes they will get 10% on their pension portfolios, they are
smoking funny smelling cigarettes. If 50% or so of their portfolio
is in bonds, and we know how low those returns are, that means they
assume that stocks will be returning 15% or more over the next 10
years.

Now, don't jump off that ledge yet. This doesn't mean you can't make
8% on your portfolio. It just means you have to look at alternatives
to traditional buy and hold mutual funds. Value will rule. Think
dividends. Absolute returns from bonds and specialized funds will be
critical to the growth of your portfolio.

One last and major point: these numbers are all averages. That means
50% of investors will do worse than the numbers suggested on these
tables. Just food for thought.

You can look at the tables by going to www.2000wave.com. Look below
the stock index returns on the upper right to the link marked"Get
the Stock Market Return Graphs Here." The original tables were done
in an 11 x 17 format. You might have to increase the"zoom"
percentage in order to see any details. If you want to print them
out and only have an 8.5" x11" color printer, we have split the
table in two. You can print both tables and put them together to
get the full affect. If you don't have Adobe Acrobat Reader, we
provide a link for you to download it for free.

I will be speaking in New York on October 10-11 at the annual 2002
Fund of Hedge Funds Forum; in Los Angeles on November 4-5 at the
Endowments and Foundations Symposium; in New Orleans on November 7-9
at the always outstanding New Orleans Investment Conference
(www.neworleansconference.com) and in San Francisco on November 11
at the Public Pension Funds conference. I still have some openings
in my schedule to speak with clients and potential clients at these
events.

But this weekend I am with my family, and I can tell you that tops
my list, although I do not get quite the same reception from my
speaking when I lecture the kids. But they love me anyway, and
that's what counts. Make sure you spend some time this week with
family and friends, because I can guarantee you the dividends will
be better than 1.5%.


John Mauldin
www.2000wave.com

Stock Market Return Graphs

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• When Can We Make Money In Stocks Again? - Rossi, 21.09.2002, 14:35