Sunday, July 25, 2010

Is 6.7% inadequete return for stock investments?

John Hussman, in his latest missive, suggests that the S&P500 is poised to return about 6.7% annually over the next ten years, based on historical averages, etc. Furthermore, based on other historical averages, eg the return from the stock market itself, he suggests that this isn't an attractive valuation, and the S&P500 could very well breach the March 2009 lows (not all that an attractive valuation in his viewpoint either).

I certainly don't argue with the idea of 10 year normalized earnings producing a better indication of total return on a forward basis. However, to point at some of these historical examples of market lows and suggest that they might be reasonably attainable, isn't probably all that thoughtful.

Thirty or forty years ago, the average middle class person was not involved in the stock market whatsoever. Period.

That simply is not the case today, and it's doubtful those days would return soon, if ever. Financial advisors, for all their warts, have served a large purpose in educating the public to accept that ownership of a business/share ownership, is a lasting and real way to create wealth. Many savers of yesteryear have been replaced by investors of today.

Therefore, the underlying demand curve is different today - so it isn't logical to expect valuation metrics of the market to be reproduced today - sans very extreme market events, which would need to last a considerable period of time.

Finally, while 6.7% may seem too low for Mr. Hussman, what are the alternatives to that?

  • Real estate - dead money for 5-10 years;
  • Bonds - much lower returns;
  • CD's - don't even go there;
  • T-Bills?
  • Mortgage backed securities - please ...
  • Commodities - perhaps, but very volatile and, realistically, subject to contago for the average investor.

In this environment, 6.7% isn't actually as bad as it may have sounded historically and, anyway, those days are gone, and have been gone for some period of time now. In my book, I suggested some 13 years ago, that having an average S&P 500 return of more than 5% over T-Bills (the then historical average), probably over-stated the risk profile of those companies in their aggregate.

Of course, there are ways to increase your chances of exceeding 6.7% but, realistically, this is the context to think about stocks over the next decade. Does that make them a bad deal? Not when you consider the alternatives. Mr. Hussman needs to tune himself in to the new reality (15 years and counting now).

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