I would encourage anyone still in the accumulation phase to read this article. It echoes a strong opinion of mine, which is that return to the mean is inevitable. Don't expect to get 10.5% average annual returns going forward from this point.


Bill Gross at Pimco is certainly a bond market god, and I agree with his thesis. Equity returns just will not be that impressive going forward.

Just be sure to remember that he has a very strong personal interest in getting the public to move more assets from equity to fixed income. Fund fees. Yes, he is insanely rich now after Pimco was bought out and he was tied down with platinum handcuffs...but Pimco still makes its money by attracting fixed income assets under management.

I only mention this because he says the same sort of things every year...broken clock...yada yada....

Again - I still agree with him and this year's piece is especially "on" IMHO.

I guess I just take the message better from people who I know are not incented to have such a view...like Buffett (11/99 Fortune article remains the definitive piece on this topic.)

What a stupid INTJ/P nitpicker I am...don't listen to me....nice article, Mr. Gross.



Euro (who must listen to Bill Gross predictions for a living...for the time being.)

eurotrash01 warns,

I would encourage anyone still in the accumulation phase to read this article. It echoes a strong opinion of mine, which is that return to the mean is inevitable. Don't expect to get 10.5% average annual returns going forward from this point.


Bill Gross at Pimco is certainly a bond market god, and I agree with his thesis. Equity returns just will not be that impressive going forward.

I agree. But the decision to abandon equities in favor of fixed income instruments depends on the length of your holding period. If your holding period is 30 years or longer, there is almost no chance you'll do better in bonds.

The table below shows inflation-adjusted returns for the S&P500 for holding periods from 10 to 60 years

 S&P500 Returns (1871-2000, inflation-adjusted)  
 ------------------------------------ Holding Period -----------------------------------
Percentile  10 Year 20 Year 30 Year 40 Year 50 Year 60 Year  
(Max) 100%   17.72%  13.06%  10.14%  9.84%  9.31%  8.28%  
90%          13.78%  10.54%   8.69%  8.65%  8.38%  7.43%  
80%          11.23%   8.89%   8.26%  7.65%  7.74%  7.12%  
70%          9.87%    8.23%   7.48%  7.26%  7.14% 6.95%  
60%          8.49%    7.28%   6.89%  6.95%  6.91% 6.83%  
(Median) 50% 7.12%    6.76%   6.35%  6.58%  6.54% 6.77%  
40%          5.80%    6.14%   5.94%  6.23%  6.13% 6.60%  
30%          4.62%    5.02%   5.32%  5.81%  5.89% 6.25%  
20%          2.74%    3.40%   5.07%  5.36%  5.70% 6.04%  
10%         -0.10%    2.52%   4.41%  4.89%  5.37% 5.60%  
(Min) 0%    -3.87%    0.89%   3.35%  3.67%  4.83% 5.26%  
   
Periods       120      110     100     90     80     70 

The current yield on 30-Year TIPS is 3.52%. Only 2 out of the 100 30-Year holding periods examined had a CAGR that low. The worst we've seen over the past 130 years is 3.35% per annum for the S&P500 for a 30-Year holding period.

You should only be holding bonds for the long-term if you truly believe you have that rare ability to market-time a top.

intercst

Now this is the kind of stuff I hang out at this board for...

10.5% is the historical norm for the market. You think "...going forward from this point" things will be substantially worse than this?

How much worse? How long is "..from this point forward"? 5 yrs? 20 yrs? pretty much for the rest of the lives of most of the people on this board?

Are you thinking the stock market is not the place for a person to have money for the indefinite future?

I consider this stuff a lot myself. While I don't see any 20-30% multi year runs again any time soon I don't see any 1966-1982 markets either. Not that I have any inside knowledge. I just don't see any meltdowns. In fact I feel the Harry S Dent -population trend- theory is more likely the way "things really work". And even then in 2008 I am not at all sure there will have the meltdown he describes. Population trends driving markets is not exclusively a Dent idea.

Any other points of view?
******************************
Off2Explore....

"I would encourage anyone still in the accumulation phase to read this article. It echoes a strong opinion of mine, which is that return to the mean is inevitable. Don't expect to get 10.5% average annual returns going forward from this point."

"Now this is the kind of stuff I hang out at this board for...

10.5% is the historical norm for the market. You think "...going forward from this point" things will be substantially worse than this?
"

Lets define what going forward means first. If going forward means 3 years, or 5 years, okay that seems reasonable to say it'll suck. If going forward means that the S&P500 and the market in general has fundamentally changed for all time, and from now on passbook accounts are the hot ticket, then I'd like to hear about that for sure. So far a mattress would have done my money more good.

I already know this year will suck, and probably the next one too because everyone is determined that it will:

Greenspan would rather see every american singing, "buddy can you spare a dime" rather than allow one jot of inflation.

John Q. Public has heard the word recession and is going to spend less...inventories will blossom, financial pundits will take up bitter residences abroad, and the recession everyone is reverse-clammering for will happen.

Bush is going to get us a tax cut that will help the economy sometime after he leaves office.

If I had the fortitude, I'd delete the DLJdirect software off of my harddrive so I can't look at my miserable holdings and reinstall it in 2003, when there is a chance I'll make a dollar instead of lose one.

There is one thing I'd like to understand:

How is it that people say it is impossible or nearly impossible to time the market and in the same breath quote stats that say its currently overvalued by 40%? Wouldn't that seem to indicate a fundamentally _bad_ time to invest without requiring a crystal ball?

mark

My friend and teacher, intercst writes:

I agree. But the decision to abandon equities in favor of fixed income instruments depends on the length of your holding period. If your holding period is 30 years or longer, there is almost no chance you'll do better in bonds.

There is a 3rd way. Equities does not have to mean the S&P 500.

If the general market were priced at an earnings yield level of 6.5% or greater (15.4 P/E) I suspect I would be very comfortable with a chunk of equity exposure indexed.

As it stands, I see the broad bet as a suckers game. I know others out there think that individual stock/company "picking" is a losers game, but I don't agree. It is all dependent on the price you pay, and what you buy.

Some say, "Euro - you nut - how can you know if the S&P is expensive...nobody can know that with certainty."

I'd say, if you worked in a liquor store and a hunched over, wrinkly, white-haired man with a beard asked for a bottle of Jack Daniels, you wouldn't have to card the guy. You could make a reasonable guess that he was over a certain limit (what is it? 20? 21?) You don't need to know that he is 76.

Or if a guy walked by you who was 6' tall and as big around as he was tall, you could safely assume that he was overweight.

Flipside: There are indeed companies out there with stable growth prospects, decent management with long track records of execution, who treat shareholders fairly...which are not priced at the premium levels seen in the market-cap weighted S&P 500. You can look at these "passersby" and say they look "skinny" or "definitely not over 21" using the previous analogies. They might not get nightly coverage on CNBC and Moneyline, but they make better L/T choices for equity investors now, IMHO.

I am a fan of equities...including REITs. You can model my "equities" in the way that you can the S&P 500. I guess you just have to make your choices and live with them. You need to ask yourself, which gives me greater confidence going forward - 1) 100+ yrs of broad market data measured by looking back from the highest highs of P/E or Tobin Q, or 2) company specific valuation.

I just can't bite on 1) right now - even though I appreciate the Bogle viewpoints out there. My "value override" has not hurt me at all over the years. Just lucky, I suppose.

Euro

re mhtyler re "impossible to time the market":
Strongly recommend you dig around Ed Yardeni's web site http://www.yardeni.com
He uses Alan Greenspan's stock market valuation model and a host of other metrics and updates them regularly. You can find corporate vs treasury bond spreads, foreign market valuations, S&P valuation relative to gov't bonds, and a wealth of other info. And it will show you how an overpriced US market in 1998 became an obscenely overpriced market in 2000, and how an obscenely overpriced Japanese market in 1990 became a grossly undervalued market in 2001.

You can tell when markets become over- or under-valued but you can't tell how far collective fear or greed will carry the trends. Ask intercst why he sold Dell to buy reits in 1996-7 and he will tell you it was because Dell was overvalued and reits were undervalued. Nobody had a clue then that Dell would go ballistically overvalued and reits would go grossly undervalued for three more years.

Don't expect to get 10.5% average annual returns going forward...

I absolutely agree! Be tickled if you get 10.5% but prepare for half that. I take a lot of flak when I join discussions on retirement planning and nest egg valuation because I assume a relatively low average annual return and relatively high inflation both during accumulation and after retirement. My pessimism today is more likely than their optimism to result in a pleasant surprise as retirement nears. William H Gross has an axe to grind, all right, but he has a strong argument against the Pollyanna school of expected economic returns.

KennyO

I've always felt there was a significant difference between "buying the market" and individual stocks - there are "mania markets" and "pickers markets".

We are transitioning from a "mania market" where money keeps flowing into the broader indicies to a picker's market, which reallocates the existing capital between sectors & specific stocks based on business results.

The days of "buying an index fund" are dead....at the present time, the indexed are fully valued using any conventional method of reconciling price-multiples with a realistic earnings growth expectations.

However, underneath these dinosaurs....there are some scurrying little undervalued mammals which have begun to benefit from various demographic, technological, and political shifts. It's similar to the early 1970's.

The 1990's were the decade of large cap buy & hold. The masses moved in & shoveled their 401K cash into large cap mutual funds & Fortune 500 company stock.

The 2000's are going to be the decade of small-cap growth strategies & fixed income investing. It's a whole new era...which will require a focus on value and an eye towards preservation of capital. It's no longer easy to shake the money tree...and the large cap indices no longer have the business fundamentals to support their valuations.

Will the S&P crash...who knows. Can an investor hold these stocks through a crash, confident in the view that they purchased their stocks at a reasonable price & will earn a reasonable return in the long run?

In my opinion. No.

We would need too much growth for too long for these stocks to return a sufficient cash flow to merit the investment in these companies.

<<You can tell when markets become over- or under-valued but you can't tell how far collective fear or greed will carry the trends. Ask intercst why he sold Dell to buy reits in 1996-7 and he will tell you it was because Dell was overvalued and reits were undervalued. Nobody had a clue then that Dell would go ballistically overvalued and reits would go grossly undervalued for three more years. >>


That's worth a rec.


Seattle Pioneer

Why is everyone dinging the author for recommending bonds over stocks? He may be a bond guy, but he clearly states at the bottom of the referenced article that *neither* bonds nor stocks is going to produce anything like the returns we saw from the 1990's for the foreseeable future. I'd hardly call this an "axe to grind"; he notes that currents yields on Treasuries are awful! The only solution is to save more and live with lower returns. (When I run the RE spreadsheet, I've been using figures like 4% inflation and 8% nominal return.)

Personally, I am following the Eurotrash01 route in my taxable account; carefully hand-select stocks by their numbers. And I can tell you that most of the stocks that are passing my informal screens are stuff that most of us have never heard of, not the flashy well-known names that were all the rage in the 90's. If you haven't looked, you'd be surprised how many stocks are trading at P/E's in the vicinity of 10. Not all are good investments, so be sure to dig deeper than the simple PE. But right now I wouldn't touch _any_ stock over a PE of, say, 25. I cashed out all of my Cisco, Intel,and Nokia in order to move the money elsewhere.

My Roth IRAs are almost entirely Berkshire Hathaway at this point. 401K's are a problem because I can't trade them individually the way I do my other accounts.


Off2Explore

Off2Explore writes:
Why is everyone dinging the author for recommending bonds over stocks? He may be a bond guy, but he clearly states at the bottom of the referenced article that *neither* bonds nor stocks is going to produce anything like the returns we saw from the 1990's for the foreseeable future. I'd hardly call this an "axe to grind"; he notes that currents yields on Treasuries are awful! The only solution is to save more and live with lower returns. (When I run the RE spreadsheet, I've been using figures like 4% inflation and 8% nominal return.)

Personally, I am following the Eurotrash01 route in my taxable account; carefully hand-select stocks by their numbers. And I can tell you that most of the stocks that are passing my informal screens are stuff that most of us have never heard of, not the flashy well-known names that were all the rage in the 90's. If you haven't looked, you'd be surprised how many stocks are trading at P/E's in the vicinity of 10. Not all are good investments, so be sure to dig deeper than the simple PE. But right now I wouldn't touch _any_ stock over a PE of, say, 25. I cashed out all of my Cisco, Intel,and Nokia in order to move the money elsewhere.

My Roth IRAs are almost entirely Berkshire Hathaway at this point. 401K's are a problem because I can't trade them individually the way I do my other accounts.

You are aware that the PE of BRK is somewhere around 38 to 46 (at http://quote.fool.com/detailed.asp?symbols=brk.a+BRK.B+&Submit1=Go%21 BRK.A is listed as 38, BRK.B is listed as 46)?

Perhaps there are occasions where the PE alone is not sufficient to make a sell/no buy decision?

PtSurMr - A fellow BRK shareholder

"But right now I wouldn't touch _any_ stock over a PE of, say, 25. I cashed out all of my Cisco, Intel,and Nokia in order to move the money elsewhere.

"My Roth IRAs are almost entirely Berkshire Hathaway at this point. 401K's are a problem because I can't trade them individually the way I do my other accounts."

ptsurmr wrote:
"You are aware that the PE of BRK is somewhere around 38 to 46?"

Actually, it's so hard to compute the intrinsic value and meaningful earnings for BRK, I would seriously question that 38-46 figure. I see much lower values kicked around on the BRK board. In any case, BRK is such an odd case that it defies conventional rules.

"Perhaps there are occasions where the PE alone is not sufficient to make a sell/no buy decision?"

As I stated in the article you just quoted:

"...be sure to dig deeper than the simple PE."

Still, don't underestimate the difficult of showing gains going forward when starting from an astronomical PE. Take Nokia, for example; it's a fantastic company and I like everything about it except the price at which it is currently trading. Given realistic projections for its earnings growth going forward, it's way overpriced (though not as much as it was when I sold it).


Off2Explore

Off2Explore writes:
Why is everyone dinging the author for recommending bonds over stocks? He may be a bond guy, but he clearly states at the bottom of the referenced article that *neither* bonds nor stocks is going to produce anything like the returns we saw from the 1990's for the foreseeable future. I'd hardly call this an "axe to grind"; he notes that currents yields on Treasuries are awful! The only solution is to save more and live with lower returns. (When I run the RE spreadsheet, I've been using figures like 4% inflation and 8% nominal return.)

Personally, I am following the Eurotrash01 route in my taxable account; carefully hand-select stocks by their numbers. And I can tell you that most of the stocks that are passing my informal screens are stuff that most of us have never heard of, not the flashy well-known names that were all the rage in the 90's. If you haven't looked, you'd be surprised how many stocks are trading at P/E's in the vicinity of 10. Not all are good investments, so be sure to dig deeper than the simple PE. But right now I wouldn't touch _any_ stock over a PE of, say, 25. I cashed out all of my Cisco, Intel,and Nokia in order to move the money elsewhere.

My Roth IRAs are almost entirely Berkshire Hathaway at this point. 401K's are a problem because I can't trade them individually the way I do my other accounts.

ptsurmr responds:
You are aware that the PE of BRK is somewhere around 38 to 46 (at http://quote.fool.com/detailed.asp?symbols=brk.a+BRK.B+&Submit1=Go%21 BRK.A is listed as 38, BRK.B is listed as 46)?

Perhaps there are occasions where the PE alone is not sufficient to make a sell/no buy decision?

Off2Explore replies:
Actually, it's so hard to compute the intrinsic value and meaningful earnings for BRK, I would seriously question that 38-46 figure. I see much lower values kicked around on the BRK board. In any case, BRK is such an odd case that it defies conventional rules.

"Perhaps there are occasions where the PE alone is not sufficient to make a sell/no buy decision?"

As I stated in the article you just quoted:

"...be sure to dig deeper than the simple PE."

Still, don't underestimate the difficult of showing gains going forward when starting from an astronomical PE. Take Nokia, for example; it's a fantastic company and I like everything about it except the price at which it is currently trading. Given realistic projections for its earnings growth going forward, it's way overpriced (though not as much as it was when I sold it).

Off2Explore,

Surely you can see how a reasonable person might be confused with you stating, on the one hand, that you "wouldn't touch _any_ stock over a PE of, say, 25. I cashed out all of my Cisco, Intel...", and on the other hand, telling us that your Roth IRAs are "almost entirely" in a stock with a PE listed as 50 - 90% greater than 25?

Note that BRK has a PE of nearly twice INTC (PE = 22, plus pays a small dividend, unlike BRK)

I agree that PE (as publicly defined and reported) may not be a good measure of BRK's value. You obviously do to, since you own it but indicate you wouldn't touch a stock with such a PE. Just maybe there are other companies out there with a PE of greater than 25 that are stocks to own too?

You are correct when you state you mention to "...dig deeper than the simple PE". However, you misrepresent the original context of your statement. The original context was after having discarded all stocks with a PE of "say, 25". In other words, the logical interpretation is that you a) would not "touch" any stock with a PE > 25 and b) even if the stock had a PE lower than 25, you would only touch it with due diligence.

Given the context, I do not get how this comment adds any insight into the apparent contradiction I was asking you about. Thus I do not get why you restate it in explanation for your earlier position.

I am not arguing any one stock is better than another, nor do I "underestimate the difficult of showing gains going forward when starting from an astronomical PE". I am just trying to understand the seeming contradiction where on the one hand you describe a process that discards from your "touch" the entire universe of stocks with a PE > 25. You then take what is left and perform due diligence on the remainder to find good picks (to buy or keep). Holding BRK seems, deductively, to be at odds with this statement.

I personally do not think there is any single metric, PE or otherwise, for which it is safe to say I will not touch _any_ stock in violation thereof. It seems as though you are conflicted in this regard, despite your original assertions otherwise.

PtSurMr

I am amused at the posts regarding bonds vs stock, low PE stocks vs high PE stocks, etc. I had a soul searching, gut wrenching inner discussion with myself about this whole matter about 3 years ago. I came to the following conclusion:

You CANNOT predict the future and THE MOST EFFICIENT WAY to hedge all bets is to be 60/40 stocks-bonds, and to be indexed (US TOTAL MARKET-Wilshire 5000, plus some international) in the stocks. I also include 10% REITS (Vanguard REIT Index Fund) as part of my 60% stocks, so my real allocation is 50% indexed stocks, 10% REITs and 40% bonds (Vanguard Muni Bond Funds and taxable bonds in my IRA). I figure my CAGR should end up being 6-8%.

Now remember, 3 years ago the bull was raging (although, for a time in the late summer of 1998, the bear came out and forced my thinking, above). It was hard to accept the above as the gospel. But when you think about it, in the end every investment is likely to revert to the mean (even DELL stock).

So I quit all the guesses and games and did the above. I still worry that I am missing something better, but I really think I am "there". Oh, my return for 2000 was plus 3% although my three year average was 7.5% annual return. About what I projected in the beginning.

Daryll40

Note that BRK has a PE of nearly twice INTC (PE = 22, plus pays a
small dividend, unlike BRK)

This is an area of valuation which many out there don't understand. BRK and its "high" P/E.

One very big thing clouding the picture on BRK's reported earnings is its massive equity holdings. The "earnings" from KO, AXP, and other equity holdings are limited entirely to dividends for reporting purposes.

By the same token, if you had a publically traded shell company called XYZ, which did nothing other than own a million INTC shares, it would "earn" 8 cents per year per share, or $80,000. If you assume XYZ would trade approximately at the same market cap as 1,000,000 INTC shares, then the P/E of XYZ would be about 430, while INTC's trailing P/E would be about 23.

BRK just requires a little more digging and understanding. It is not appropriate to look at its P/E and do a comparison to other companies. The corporate structure of BRK is odd, and not entirely efficient...and straight P/E tells you very little.

"Owner earnings" are more important. Book value analysis offers some clues as well.

Euro

eurotrash01 writes:
This is an area of valuation which many out there don't understand. BRK and its "high" P/E.

One very big thing clouding the picture on BRK's reported earnings is its massive equity holdings. The "earnings" from KO, AXP, and other equity holdings are limited entirely to dividends for reporting purposes.

By the same token, if you had a publically traded shell company called XYZ, which did nothing other than own a million INTC shares, it would "earn" 8 cents per year per share, or $80,000. If you assume XYZ would trade approximately at the same market cap as 1,000,000 INTC shares, then the P/E of XYZ would be about 430, while INTC's trailing P/E would be about 23.

BRK just requires a little more digging and understanding. It is not appropriate to look at its P/E and do a comparison to other companies. The corporate structure of BRK is odd, and not entirely efficient...and straight P/E tells you very little.

"Owner earnings" are more important. Book value analysis offers some clues as well.

I agree with everything you state above. That is why I: (a) own BRK and (b) do not automatically discard from consideration all stocks with a PE of say, over 25.

Each stock is its own animal and as such needs to be studied from more than one dimension.

PtSurMr

Note that BRK has a PE of nearly twice INTC (PE = 22, plus pays a small dividend, unlike BRK)

You can never take a straight reported PE at face value. You need to be able to convert to "economic earnings" from reported GAAP earnings and it is only after making this adjustment that PE becomes meaningful.

It is just that BRK requires a lot more adjustment than most companies.

I don't see any inherent contradiction.

--Boffo

Off2Explore wrote:
"But right now I wouldn't touch _any_ stock over a PE of, say, 25."

*sigh* Yes, you are correct. I did overstate the case in the first post; I am not a person who invests by rigid rules. I need to feel comfortable with the overall position of the company and value of the stock. (What do you expect from an NF? :-)

I think your zeroing in on one line is really a distraction from the main point I was trying to make.


Off2Explore

I suspect many are being overly pessimistic now that the game has turned.

In all actuality, I'm expecting market average returns for my positions out of the NASDAQ and SP500.

The reason is simple. The NASDAQ has already corrected. It may correct a some more. However, lookig at the average for the last 5 years shows a compound growth rate of 13.5%. About what you would plan for small cap growth stocks. Given that much of the averages growth is really tied up into a few highly recognized large stocks, I think it is reasonable to think the market of the long term will average the historical expected average. The next one or two may be rough as the DOW continues to correct or hopefully, merely flatlines to let the average catch up.

However, it is possible that the DOW will correct another 15-20% in order to drive itself back into line with the historical growth rate averaged over the last 5-7 years.

Still, I doubt that the above was the authors point. In general, many investors have become jaded in 94-98 market. Those years were markets were 10 baggers in three months the expected and anything else was a loser. Markets where the averages soared 40-100% over the course of the year.

Compared to 100% of the NASDAQ 100 prior to the correction, 13.5% will seem paltry. The fact that so many are now pessimistic is in itself a good sign.

-donut

Compared to 100% of the NASDAQ 100 prior to the correction, 13.5% will seem paltry. The fact that so many are now pessimistic is in itself a good sign.
-donut

They were pessimistic at the end of 1929 too, and that turned out to be only the beginning. Same for the end of 1973, which also required a relatively long period before the market started doing good things again.

I am NOT saying that this is that, but only that we can't rule it out.

Daryll40

The biggest obstacle in buying BRK for me is understanding it. I have read the owners manual, his wonderful letters, the fools analysis, and I still don't really have any idea how to value the company.

Last spring, I put in an limit order to buy it at ~48K and it didn't get filled, now at 70K it seems expensive given that the stock prices of many of its holding have decreased. I am curious for people who have bought it, who aren't Berkshire fanatic, how they figured out if it was good investment.