I think John Bogle is a national treasure. That doesn’t mean I agree with him of course on everything (huge difference of opinion in foreign stock investing). But he’s been a strong positive influence on our industry for 40 years. I was scanning this recent article from the WSJ on the plane flight to Vancouver, and a couple notes caught my eye. One, he thinks Fidelity will be acquired in the next five years (by Cambria?), and two, his dreadful forecast for US stocks. How bad?
2% a year for the next decade. And that’s nominal!
Now, lots of the top research outfits in the country have come out in support of low equity returns (GMO, AQR, Research Affiliates, Meb, etc etc.) but he has to be one of the lowest forecasters. And that’s interesting to me since his advice is to always buy and hold and weather the storm. But that got me wondering at what point valuations would get to the point where he would alter his advice – 0% forecast? -2%? -4%? Remember, stocks have declined 50-80% regularly, so placing a negative expectancy bet with high chances of losing 50% isn’t a great wager.
Here’s his equation for those that want to play around at home. He published this I believe about 25 years ago, and here is an updated white paper with more info, but it’s pretty simple.
10 year annualized stock returns = dividend yield + earnings growth + change in P/E ratio.
Well dividend yield is 2%, and we can use his estimate for earnings growth of 4.7%. We can use current CAPE ratio of 27 to estimate mean reversion there. Going back to historical value of 17 gives you -4.5% per year headwind on valuation multiple contraction. However, considering we’re in a low inflation environment, let’s say it only goes back to 21 then you get a smaller number of -2.5%.
2% per year with CAPE going back to normal full history valuation.
4% per year with CAPE going back to normal low inflation valuation.
So, either way pretty low. Much lower than the historical 8.5% or so (with 2% inflation estimate). By the way, you can use any valuation indicator (1 year PE, etc) and they will say the same thing.
Just for fun, I’ll include a 1999 scenario where Elon Musk discovers free energy and we find the secret to world peace and CAPE goes to 45.
11% per year with CAPE going back to 1990s bubble top (45).
And another one where Trump and Hillary decide to share the office of Presidency.
-9% per year with CAPE going back to lowest reading in US (5).
I’ve got following forecasts for US stocks next decade w/ 2% inflation:
GMO: -1%
Hussman: 1%
Bogle: 2%
RA: 3%
AQR: 6%
JPM: 7%
I think I remember Colombia forecasts over 10%. If you email me any others I’m happy to add to the list.
So, remember valuation is a blunt tool. That doesn’t mean you shouldn’t try to be reasonable about placing good bets. (You know my opinion, low returns in the US foreign much better, emerging even better, and cheapest countries best.)
So even with this tool you need to be prepared for any market outcome (which is why I’ve always been a big trend following guy.) Anything can happen, and it’s hard to predict the emotions and psychology of investors. Look back to one of my (unintentional) favorite investing passages from the great late Kurt Vonnegut.
From Galapagos, circa 1985:
The thing was, though: When James Wait got there, a worldwide financial crisis, a sudden revision of human opinions as to the value of money and stocks and bonds and mortgages and so on, bits of paper, had ruined the tourist business not only in Ecuador, but practically everywhere…Ecuador, after all, like the Galapagos Islands, was mostly lava and ash, and so could not begin to feed its nine million people. It was bankrupt, and so could no longer buy food from countries with plenty of topsoil, so the seaport of Guayaquil was idle, and the people were beginning to starve to death…Neighboring Peru and Columbia were bankrupt, too…Mexico and Chile and Brazil and Argentina were likewise bankrupt – and Indonesia and the Philippines and Pakistan and India and Thailand and and Italy and Ireland and Belgium and Turkey. Whole nations were suddenly in the same situation as the San Mateo, unable to buy with their paper money and coins, or their written promises to pay later, even the barest essentials. ..They were suddenly saying to people with nothing but paper representations of wealth, “Wake up, you idiots! Whatever made you think paper was so valuable?”
The financial crisis, was simply the latest in a series of murderous twentieth century catastrophes which had originated entirely in human brains. From the violence people were doing to themselves and each other, and to all other living things, for that matter, a visitor from another planet might have assumed that the environment had gone haywire, and that people were in such a frenzy because Nature was about to kill them all.
But the planet a million years ago was as moist and nourishing as it is today – and unique, in that respect, in the entire Milky Way. All that had changed was people’s opinion of the place.