The high returns in the late 1990s did not reflect reality. The fundamentals–corporate free cash flows, earnings, and book values–were not keeping pace with market prices and investors were merely “pulling forward” into the late 1990s the returns they could expect to earn in the 2000s. And, the S&P 500 Index fared much better than the NASDAQ composite after the bubble burst. The NASDAQ needs to rise another 24% to match the 5,132.50 it reached at its peak in March 2000; broader indexes have frequently passed old highs over the last twelve months.

It was a remarkable year for the U.S. stock market in 2013, as the S&P 500 delivered an overall cialis drug return of 32.39%. You can buy this medicine by following this link.

After 2002, Greenspan’s rescue took effect and the stock and housing market experienced a brief period of asset inflation, but the bottom eventually fell out in 2008 when the S&P 500 delivered a -37% total return, which was followed by unprecedented monetary stimulus in the form of Quantitative Easing.

So, have we once again merely pulled forward the equity returns we could have expected to earn over the next several years? GMO and others believe that to be true. As of November 2013, GMO expects US large cap stocks to decline 1.3% per year, and US small cap stocks to decline 4.5% per year, for the next seven years, and that is after adjusting for inflation (GMO Asset Return Forecast November 2013). GMO’s expected return forecasts are based on underlying fundamentals and current market prices.

Readers of this blog know that I have periodically published data on Graham/Shiller’s CAPE, Tobin’s Q ratio, profit margins, and other market metrics that all point to an overvalued US market that is likely to deliver low single-digit returns at best over the next seven- to ten-years.

When GMO’s forecasted market returns were low, there was a higher frequency of large declines in stock prices. Wise investors will position their portfolios accordingly.

 Return Histogram Through 2013

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http://amarginofsafety.com/2013/03/01/the-equity-market-annual-return-histogram-updated-for-2012/

Yesterday’s Wall Street Journal Ahead of the Tape column by Spencer Jakab had a chart titled  ”Unhinged,” in which Jakab showed average stock market returns relative to average GDP growth during the last eleven recoveries from a recession. The market return is almost FIVE times GDP growth in the current expansion, but averaged only 1.47 times GDP growth in the previous ten recoveries.

Is 2013 going to be one of the once-every-nineteen-years when the market rises over 40%? Can a market rise that much on Federal Reserve balance sheet growth alone? Perhaps, like in 1928, this party is still in the ten o’clock hour. What will happen when the clock strikes midnight?

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As Michael Mauboussin says, when understanding an investment idea, we should try take an outsider’s big-picture view in addition to our own expert view of the minutiae of the idea. I first came across the equity market return histogram a few years ago and I believe it offers perspective on the feasibility of return expectations.

The ranges at the bottom are the ranges of returns for each annual period. The years highlighted in blue are the years involving the recent Great Recession and those in orange involve the Great Depression. As you can see, there were many more outliers during the Great Depression. The Great Recession looks rather normal in comparison.

My opinion of expected returns is based on data obtained in the Graham-Shiller CAPE index and from Tobin’s Q ratio (plus several other metrics), so I expect low, single-digit equity market returns over the next eight- to ten-years. The CAPE, which measures long-term Price/Earnings ratios, and the Q, which measures Price/Replacement-Cost ratios for the market, are 39.1% and  40.6% higher, respectively, than their long-term averages.

But, if we believe past is prologue, then there is a 75.5% chance that returns this year will fall outside of the range of 0% to +10%. I believe I am rationally pessimistic for the near term (but a long-term rational optimist), but historically there is only a 13.9% chance that an investor will lose more than 10% of their capital in any year in the market. This kind of outsider’s perspective helps me temper my pessimism, but the best way to temper it is to invest with a MARGIN OF SAFETY. Unfortunately, few investments offer a Margin of Safety these days.

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I have attached a link to a terrific article on power law distributions and their ability to explain financial market phenomena as compared with the standard bell curve. Mauboussin has been writing about power laws in finance and economics for a while. (H/T Infectious Greed)

http://www.sciencenews.org/view/feature/id/335383/title/Beware_the_Long_Tail?utm_medium=twitter&utm_source=twitterfeed

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http://online.wsj.com/article/SB10001424052702303627104576409724215192048.html

Stocks Fall. Optimism Stands Tall.

The disconnect between analysts on the one hand and strategists and economists on the other comes largely because analysts are largely focused on their individual companies and industries. That gives them a deeper but narrower view than those who look broadly at macroeconomic factors. As both camps look to the end of 2011, they are seeing very different outcomes.

By JONATHAN CHENG

Stock analysts have a reputation for their rosy outlooks. But to many investors, that optimism may have just scaled new heights.

The U.S. economy has slowed noticeably in recent weeks, prompting economists to ratchet down their estimates for growth and investors to drive stocks down 7% since late April. Market strategists started reducing their year-end orecasts for the Standard & Poor’s 500-stock index.

Wall Street analysts are betting that earnings are going to remain high, even as the market falls and economists scale back their outlook on GDP growth, Marketbeat’s Mark Gongloff reports.

But individual stock analysts have remained noticeably upbeat.

As a group, they have not only kept their estimates for corporate earnings for the current quarter intact, but they have raised them.

Analysts expect S&P 500 companies, in aggregate, to earn $24.24 a share in the second quarter, according to Birinyi Associates. Those estimates have increased from $22.18 at the end of March and reflect a 16% rise from the same quarter last year.

Skeptics warn that analysts have set the bar too high, increasing the chances companies may disappoint, triggering more market turmoil.

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My parish, which is Roman Catholic, has been blessed to have the services of three outstanding priests in the eighteen years that my family and I have been members. Father Tom Hagan was a pious and hilarious priest who left us in 1997 to create a Haitian mission called Hands together (http://www.handstogether.org/).

Father Tom always reminded me of comedian Rick Moranis. He used to bring his dog with him to mass and always left him leashless in the vestibule alone during services. The dog wore a bandana around his neck every day. My favorite story that Father Hagan told, probably apocryphal, was of his meeting with the Bishop over the dog. The Bishop was upset about it and asked him several questions about why he brought the dog, why he wore a bandana, and asked whether it safe to have him unleashed, etc. Father Hagan replied, “Bishop, are you upset that I bring a dog to church or are you upset that he is Presbyterian?”

In the embedded video, Father Tom (pink shirt in the stopped action photo below) discusses the schools they are building in Haiti. For obvious reasons, you will not see his trademark humor in the video.

Father Charles Creed, also a pious and humorous priest, left us last year when his home, a Vincentian seminary in Princeton, NJ, was sold. He now lives in Maryland, I think, and he is missed. Father Charlie was a favorite of ours in part because he had the same Queens NY accent that my mother had. My father who also grew up in Queens would crack up at any joke father Charlie told, and he told many.

Today, Father Jude Michael Krill, the third of the trio, gave another brilliant homily. All three have the gift of extraordinary humor. (In a Google search for the school in which he teaches, I found video of a homily he gave last year at Neumann University).

I could not help but make a connection between his homily today and a prominent concept in behavioral finance. His homily was based on today’s Gospel, specifically what Jesus said here:

“Everyone who listens to these words of mine and acts on them
will be like a wise man who built his house on rock.
The rain fell, the floods came,
and the winds blew and buffeted the house.
But it did not collapse; it had been set solidly on rock.
And everyone who listens to these words of mine
but does not act on them
will be like a fool who built his house on sand.
The rain fell, the floods came,
and the winds blew and buffeted the house.
And it collapsed and was completely ruined.”

The part of the homily that struck me was when Father Jude talked about houses built on sand, fault lines, or on cliffs with potential mudslides. From the outside, he said, the person’s house may look glorious because it is so close to the beach or has magnificent mountain views, but it is only a matter of time before it is exposed as worthless. Father Jude even compared it with people who expect the economic conditions of the day to go on forever and who never plan for the day that they will end.

The latter is the epitome of a concept in behavioral finance: we too often project current conditions too far into the future, whether on a macroeconomic, corporate, or individual level. The investment results for companies such as NFLX, MAKO, CRM, LULU, and OPEN have been glorious for the past few years. But, they are priced for perfection at best and at worst are horrifically overvalued based on those far-looking, rosy projections. Current conditions will not go on forever.

Likewise, it is not likely that China, with its myriad ghost cities and escalating inflation, will continue to grow at the same pace for much longer, but investors in Chinese firms seem to believe that it will. The investment results for many Chinese companies, and those outside China that rely on big-ticket sales to Chinese firms, are not likely to be satisfactory.

And, yes, I understand that this was not the purpose of the homily, but it is consilience, no?

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