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    Thoughts from the Frontline

    Somewhere Over the Rainbow

    December 31, 2012

    Choose your language

                We are 13 years into a secular bear market in the United States. The Nasdaq is still down 40% from its high, and the Dow and S&P 500 are essentially flat. European and Japanese equities have generally fared worse.

                The average secular bear market in the US has been about 11 years, with the shortest to date being four years and the longest 20. Are we at the beginning of a new bull market or another seven years of famine? What sorts of returns should we expect over the coming years from US equities?

                Even if you have no investments in the stock market, this is an important question, in part because the pensions funded by state and local governments are heavily invested in US equities. In fact, they are often projecting returns in excess of 10% per year. How likely is that to happen? Who will make up the difference if it doesn’t? In nearly all states and jurisdictions, it is against the law to change the terms of a public pension plan once it is agreed upon.

                Even more important to you personally, what will happen to your taxes if the secular bear persists? On this final day of 2012, let’s take a look at the potential returns of the stock market over the next 7-10 years. In previous Thoughts from the Frontline and in my book Bull’s Eye Investing, I have written that stock market returns are a function of valuations (typically, price-to-earnings ratios). Secular bull markets are periods of rising valuations, while secular bear markets are periods of falling valuations. While stock market returns can vary widely over one-year, ten-year, or twenty-year periods, over the long term stock market earnings have tended to correlate very highly with GDP and inflation.

                Since GDP has tended to grow (at least until recently) at 3% per year, predicting long-term returns and secular bull and bear markets has been pretty straightforward. But recently several noteworthy analysts have presented research suggesting that GDP will not grow anywhere close to 3% over the coming decades. In today’s letter we look at the ramifications of slower GDP growth on equity returns. For most investors this is a very important topic, as the stock market tends to be the main driver of their investment returns.

    So Who’s the Optimist Now?

                At the beginning of the last decade I wrote that the US economy would be lucky to grow at 2% for the entire decade. Even though I was called a “big bad bear” at the time, it turns out that I was an optimist. The economy grew at 1.7%. When asked about the present decade a few years ago, I cautiously said that we would be…

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    Page 1 of 2  1 2 > 

    Clara Rosenthal

    Jan. 8, 2013, 8:57 a.m.

    Testing

    evan wilson

    Jan. 4, 2013, 7:04 p.m.

    Happy New Year John and thank you and your team for all your hard work getting your thoughts out to all of us ‘armchair economists’.

    As always everyone is right and will most probably be wrong at some stage as well.

    We see a sense of unjustified euphoria happening right now in our Emerging Markets and deep down in our water some of us are feeling a stirring of past memories when Mr Market made sure that everyone was sucked in before delivering the proverbial ‘lesson’.

    Time to take money off the table me thinks. When the credit limit is maxed the family needs to chop spending. That time is now.

    david@msf1.com

    Jan. 3, 2013, 3:56 a.m.

    It seems that “V” might be the key to getting things back on track.  I’m wondering if the increase in “M” is responsible for the huge, and rapidly growing, income disparity between the top income % and the rest.  “M” seems to be getting into big sterile pockets, rather than the little guy who is more apt to spend it.  The consumer, representing the bulk of demand, is struggling to make ends meet.  I’m not an income-redistribution advocate, but I think the tax burdens should be shifted from those earning less to those earning more, and eliminating tax breaks enjoyed by the wealthy.  Perhaps this would get some money into the pockets of the spenders and out of the stagnant pockets of the wealthy - raising “V” in the process.  I know people will say that the wealthy are more apt to invest money to grow the economy (trickle-down and all that), but currently there aren’t a lot of good sound investment alternatives and money therefore tends toward bubble speculations du jour.

    Dallas Kennedy

    Jan. 2, 2013, 7:22 a.m.

    V has dropped, dramatically. It started dropping in the late 90s, then fell off a cliff after 2008. All that fresh M1 is mostly not circulating. What little of it is circulating is mainly propping up financial markets: stocks, bonds, commodities, etc.

    The gloomy predictions do hold for the current secular bear period. But don’t extend them beyond that to the end of time. That’s the mistake that Gordon, Grantham, et al., are making. Others have made it, in similar periods earlier, like the 1970s or 1930s. There’s no reason to think they’ll be right this time. Gordon’s argument, in particular, relies heavily on cherry-picking and selective use of history.

    David Oldham

    Jan. 1, 2013, 11:16 a.m.

    Yes I agree @ david and I would mention that John has suggested keeping a strict eye on “V” more than once over the last few years.

    Brian McMorris 46364174

    Jan. 1, 2013, 8:59 a.m.

    There is another point to be made by this article and that is to do with Real versus Nominal stock price appreciation.  An example is the last secular bear market of 1968 to 1982.  The DJI30 hit 1000 in 1968 and again in 1982 before starting off on the latest secular bull.  Someone looking at a chart in USD will conclude that a long secular bear might not be too negative and one can just “wait it out”.  However, in Real terms, the DJI30 declined by over 50% from beginning to end due to the relatively high inflation and dollar devalaution during the period.  Alternatively, the DJI30 hit 374 in October 1929 and did not reach that level on a nominal basis again until October 1954, a span of 25 years.  Over that span, the dollar was devalued by 35% according to CPI data.  So even after 25 years of a secular bear market, the price return of the DJI30 was still in bear territory and would remain so until 1960, near the start of the following secular bear.  Of course, this analysis ignores the important role of dividends to total return and therefore, makes the case for dividends during prolonged secular bears like the current one.

    Lawrence Glickman

    Jan. 1, 2013, 1:26 a.m.

    Happy New Year! How about posting something original instead of what has already been graphed and discussed into the ground. Example: Solving the entitlement problem by insisting on “Global Pricing Standards” as published by the OECD comparison chart of developed nations. There is a 30% savings there. Or how about knocking off two years of the initial medical school bachelors program for qualifying students and then giving them scholarships in return for National Service. The same for nurses and “voila” you solve the medical personnel problem. I could go on but first I need to go on an international lecture tour restating the obvious.

    Matt Wilson

    Dec. 31, 2012, 9:24 p.m.

    Easy problem with easy solution, but a lot of pain. You think the problem is financial, but that would be wrong. It’s an old forest that has never had a fire. The problems have spread to every corner of society. Focusing on financial matters misses most of the problems.

    The solution is default. Let it burn out all the problems. Don’t like that? Welcome to Japan.

    Perry Noblett

    Dec. 31, 2012, 6:33 p.m.

    Happy New Year John, to you and all your family.

    Joe Davidson

    Dec. 31, 2012, 5:26 p.m.

    This analysis totally ignores the role played by the demise of cheap oil.  Our standard of living, our economy and our whole civilization were built on 250 years of easy ( read cheap ) resources.  When we ran our of low priced oil in the 70’s we papered the problem over by printing money via easy credit.  That bubble burst in 2008.

    Even though oil is the most visible, water shortages will probably hit us first.  We have been draining aquifers for many decades.  This combined with climate change induced drought will continue the already existing spike in food prices.

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