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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era -- Ignore unavailable to you. Want to Upgrade?

To: Axel Gunderson who wrote (510)	7/13/1998 9:17:00 PM
From: Freedom Fighter	Read Replies (1) \| Respond to of 1722

Axel, I agree with everything you say. >But when we value the "market" should we be considering such short range fluctuations? Or is it more appropriate to say "hey, over the long haul this grows at 6.3% per annum, and darn it, I think that in 20 years we will look back and see that it has grown 6.3% (or maybe a little more) >per annum?" It is a very difficult question. Some people (myself included to some degree) think that all the factors in an economy tend to get priced in over very long periods. (inflation, ROE, interest rates, taxes etc...) In other words, there are interrelationships between all this stuff that eventually takes you to some of sort of mean real after tax, inflation return that is appropriate for the asset class. When it's all priced in, you eventually get to 12x-16x earnings (give or take) of a ROE that is related to the cost of capital. (this is for aggregate stock prices and companies not individual cases) Of course for periods of many years, it doesn't have to be that way. If this assumption is true, then a model that discounts your return from present prices with an ending PE of 12X-16x (give or take) and an appropriate ROE would tell you your return on stocks (I use 5 and 10 years later). This is one of many models I use in addition to the other one. THis model shows stocks as a disaster now relative to bonds. This is also the model that has worked best historically. I'm not so sure that just 6.3% is appropriate though. We have had numerous extended periods of lower growth when we had lower average inflation rates in our past. So I think you have to look at many models and some of the most likey assumptions. That way you can sort of weigh all the possibilities. I use about a half dozen models. >This is where I am uncomfortable with the idea Porc put forth in response to my original post. I inferred from Porc's follow up post that he considered my explanation as somehow supportive of the idea that indexing makes more sense than investing in bonds. The problem is in looking at the implied return by itself. Taken to extremes, all else being equal, if the S&P 500 was at 11,000 today, instead of 1100, it would have an implied return of the 6.3% growth plus a dividend yield of only 0.14%, for a total implied return of 6.44%. All right, who on this >thread will invest in something with a PE approaching 300 if it is >growing its earnings at 6.3% per annum? The problem with saying, since stocks are discounted to return more than bonds you should buy stocks, is that they are always discounted to pay more because they are riskier. Just as corporates give you more than treasuries. Because some corporates default and some businesses go under. But if the relationship (risk premium) is very low, you face substantial losses from stocks if the risk premiums return to average or close to average. This is true even over 10-15 year time horizons. So dollar cost averaging may be a way to outperform stocks in general, but it may still lead to substantial losses relative to other asset classes if you overpay. Even over extended periods. And I would never accept a PE of 300 and such a low earnings yield. Your point is very well taken. Multiple models is the only way.