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Author: Lammergeier40 Big red star, 1000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 297  
Subject: Dow 5000, by Bill Gross Date: 9/7/2002 7:19 AM
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tr,

This is a reply to your Dropout's Den post, but I'm putting it here because it has some numbers in it. The offending article, for anyone else that's interested, is Bill Gross's latest sermon for staying in bond funds at the peak of a 40 (120?) year bond bubble:

http://www.pimco.com/pdf/io_0902.pdf

First off, yes I acknowledge that Gross is shamelessly talking his book, but Bogle is talking his book everytime he rails against high fee mutual funds, yet that doesn't diminish the truth of what he's saying. So I want to ask, rhetoric/propaganda aside, is there any truth to what he's saying?

http://boards.fool.com/Message.asp?mid=16540624

At the beginning of the year, I tried to argue (not very pesuasively) that the equity risk premium has been bid out of stocks, and might even be negative now, due to the enormous gains we've seen in the last 2 decades. This is Gross' point, and let me try to develop it again with some data this time.

I'm relying on Shiller's data, and frankly I don't know how reliable they are for the first several decades, but they're all I have. I'm looking at decadal returns, using 5-year year-end averages (e.g. 1990 = [Dec 1988+89+90+91+92]/5) to help smooth out some of the bumps (for 2000, it's a 4-yr average 1998-2001).

Here are the input data, including index price (P), dividend (D), earnings (E), CPI (C), and annualized growth in each of these metrics (e.g. PGrw).

Decade P D E C PGrw DGrw EGrw CGrw
1880 5.21 0.26 0.41 9.51 1.00 0.99 0.97 0.98
1890 5.20 0.23 0.31 7.82 1.03 1.02 1.05 1.00
1900 6.91 0.27 0.49 7.76 1.03 1.05 1.03 1.02
1910 9.37 0.45 0.67 9.40 0.98 1.01 1.01 1.07
1920 7.94 0.52 0.74 17.80 1.07 1.05 1.03 0.99
1930 15.06 0.82 1.00 15.62 0.97 0.97 1.00 1.00
1940 10.77 0.62 0.96 14.90 1.06 1.07 1.10 1.05
1950 20.19 1.27 2.46 25.18 1.12 1.04 1.03 1.02
1960 60.75 1.94 3.28 29.70 1.05 1.05 1.06 1.03
1970 100.87 3.12 5.76 39.32 1.02 1.07 1.09 1.08
1980 120.12 6.08 14.00 84.46 1.11 1.07 1.04 1.05
1990 355.60 11.49 20.61 132.04 1.14 1.04 1.07 1.03
2000 1273.65 16.23 40.25 170.73

Growth 244.37 63.38 98.16 17.94 1.047 1.035 1.039 1.024

As well as key metrics at the beginning of each decade (Yield, PE, and dividend payout ratio). I wish I had book value so I could see whether retained earnings are actually converted into something of tangible value for shareholders, versus frittered away.

Decade Yld PE POR
1880 4.9 12.7 0.62
1890 4.3 16.7 0.72
1900 3.9 14.2 0.56
1910 4.8 13.9 0.67
1920 6.5 10.7 0.70
1930 5.5 15.1 0.83
1940 5.8 11.3 0.65
1950 6.3 8.2 0.52
1960 3.2 18.5 0.59
1970 3.1 17.5 0.54
1980 5.1 8.6 0.43
1990 3.2 17.3 0.56
2000 1.3 31.6 0.40

And here's the crux of my argument. I'm following Bogle in decomposing total stock market returns into 5 components: initial yield, dividend growth, growth in retained earnings, speculative return (increase in P/E, or total return less the previous 3 "tangible returns), and inflation. ATRR is "after-tax real return", a worst case scenario against dividends assuming 35% tax on dividends and no turnover (0% cap gains).

Retained Non- Real AT
Decade TotRet Yld DivGrw Earnings Spec Spec Return RR
1880 4.60 4.91 -0.29 -0.65 0.63 3.97 6.54 4.92
1890 7.03 4.35 0.44 1.25 0.99 6.04 7.11 5.66
1900 7.48 3.94 1.30 0.03 2.21 5.27 5.55 4.02
1910 4.02 4.82 0.34 0.02 -1.17 5.18 -2.58 -4.56
1920 12.59 6.50 1.94 -0.33 4.48 8.11 13.89 11.79
1930 2.32 5.47 -0.68 0.54 -3.02 5.34 2.79 0.82
1940 12.51 5.75 3.03 3.94 -0.22 12.73 7.12 5.01
1950 16.39 6.30 1.64 0.40 8.05 8.34 14.73 13.07
1960 8.34 3.19 0.97 1.07 3.12 5.23 5.50 4.40
1970 5.84 3.09 1.47 2.62 -1.34 7.18 -2.11 -3.53
1980 15.61 5.06 2.25 0.50 7.80 7.81 11.04 9.59
1990 15.86 3.23 0.67 2.10 9.87 5.99 13.26 12.47
2000 1.27

Averages 9.38 4.72 1.09 0.96 2.62 6.77 6.90 5.30

Then you can plug in numbers and say "what would the index have to be right now to justify stock prices in 2000, based only on tangible gains in the 90's". The answer is S&P = 460. Obviously, you can bump that up by looking out 20, 30 or 40 years instead of 10. But my question is, do you look out more than 10 years? Does anybody?

So I look at the numbers and conclude it's still a bubble, even though it's been chopped nearly in half from spring 2000.

Todd

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