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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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shiller's data is no good and we have talked about why on this board before. better to use the CRSP database.

this is in my opinion "groping for grunions" and you can get any answer you want depending on what you think earnings will be in the aggregate the next few years and what discount rate you want to use....i am not an investor in the aggregate but if you beleive that equities in aggregate have negative numbers in front of them 10 years out then you are counting on a level of outperformance by AAA's over equity that would be more extreme than at any time in history (11600 BP over 15 years, 116%)- you would be betting on an extreme outlier to occur.

good luck.

tr
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my personal a/d line is thus - out of 18 positions, 6 are above april 01 lows, 10 above 9/01 lows, and all but one (AMAT) above july 02 low. noting even poster child of bubble CSCO above 9/01 lows and right near april 01 lows. bear markets end when stocks stop going down.

doing my own groping for grunions to counter pimco propaganda. looked at long term records of snp earnings post 1945. regressing on semi-log yields 45 dollars of earnings for 2003. snp therefore selling at 18 times long term earnings trend line. looking back at last few decades when P/E similar i note that interest rates were much, much higher then than now. so back to groping - maybe low interest rates will support higher P/E for stocks or maybe stocks continued P/E contraction indicating that bonds overvalued or you believe long term earnings trend broken permanently and 45 unrealistic number.

looking at those three alternatives, i would bet on supposition 1 or 2 long before supposition 3.

tr
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I was just trying to give Gross a fair shake based on historical data, but with SPX at 800 I'm not looking for further drops to allocate capital. I'm more like Buffett's "oversexed man in a whorehouse".

Starting points for historical analyses are so important (even 100 years worth). Going back and re-reading Graham, I'm reminded that in the 30's and 40's "you could buy the present at a discount and get the future for free." IMO, it would take an unprecedented liquidity failure for that to happen again.

I think there was a lot of fluff in the recent $50 earnings of SPX, so I'm uncertain about $45 for 2003. But there are certainly lots of individual companies that seem dirt cheap right now. And with volatility so high, I'm tempted to use short puts to add to positions in MRK, SWY, SGP, and maybe GMT, PEP & CUM.

I'm a little hesitant to rely too heavily on the fed model to justify stocks being cheap (i.e., historically low bond yields), because you know the problem with ratio variables. It isn't always what's happening in the numerator.

Todd
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