"That kind of dumb beta uplift is trickier now."
I love this phrase!
"That kind of dumb beta uplift is trickier now."
By Robin Wigglesworth, an editor at the Financial Times, a London newspaper (that is owned by a private Japanese kabushiki gaisha).
He's referring to the "dumb" way that people look at long-term returns in the stock and real estate markets, and then presume that past returns predict future returns.
The problem with this stupidly-linear approach to investing is that a large part of those long-term returns has consisted of "beta uplift" -- an increase in the valuation multiple of long-term earnings, further multiplied by an increase in the ratio of after-tax earnings to GDP, which has been driven by decreases in both interest rates and tax rates over the past 40 years.
Now that interest rates are going back up, the ratio of after-tax earnings to GDP will need to fall, and the valuation multiple of earnings will also need to fall. Let's assume for the moment that tax rates will not change, despite gigantic (and unsustainable) government debt and deficit levels that have resulted from all those tax cuts ...
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Only two times before in US history before the past few years (2018-2022), did the valuation multiple of corporate earnings exceed 30 --> 1929 and 1998-2002. When the next recession hit each of those past peak valuations, valuations then fell by at least 2/3 before hitting bottom.
This is why I expect stock prices to fall around 2/3 from their recent highs during/after our next recession (a recession I expect to begin within the next year), which is why I'm also keeping only about 1/4 of my retirement funds in stocks right now.
But most people base their retirement investments on the long-term rates of return, which have been highly inflated for stocks over the past 40 years, because the valuation multiple of earnings has quadrupled during those four decades, even as the after-tax proportion of earnings has doubled. If you started saving for retirement at age 25, and put most of your savings into stocks, you made out like a bandit, because stock values increased 8x faster than GDP. Quite the magic trick.
But somebody who is 25 today simply cannot expect to match the stock market returns of the past 40 years, because we cannot quadruple the valuation multiple of earnings again, that's simply not possible, there's no country in the history of the world that has achieved anything like that kind of valuation multiple for any sort of income-producing asset. That would imply valuing $1 of long-term annual earnings at $120. That would imply inflation averaging 0%, and interest rates averaging 0%, and tax rates averaging 0%, over the next century and beyond.
Why would anybody pay $120 for a stream of annual pre-tax income of $1? That's a fantasy.
But when you buy stocks today with the expectation that you will receive the long-term rate of return on stocks in the future, you're expecting that when you retire somebody will pay you $120 for a stream of annual pre-tax income of $1. That's never going to happen.
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What drives stock market bubbles and real estate bubbles and bond market bubbles and crypto bubbles -- what drives all these bubbles is stupid-linear thinking, that the returns of the recent past will continue indefinitely into the future. People see other people making XX%/year and join in the fun.
The reality is that all of these markets turn into Ponzi schemes, in which the early "profits" are funded by the latecomers.
People buying stocks today cannot possibly match the returns of the past 40 years. It's simply not mathematically possible.
Just as the banks who bought long-term bonds during 2020-2021 are now insolvent (including the Federal Reserve, which is losing money on its own bond purchases and is technically insolvent).
And just as T & I were underwater on our house for 15 years after buying it at the peak of the bubble in 2006 ... until another housing bubble came along ...
You can make good long-term returns on stocks and real estate and bonds -- but it is much more about timing than the typical investment advisor admits. This is because they make money from you investing in their stuff, whether you make money or not.
It might not have been last year, but at some point the bubble economy of the past 40 years will reverse itself and valuation multiples will head back down. Earnings as a proportion of GDP will head back down. And maybe tax rates will head back up. And then a future generation will ask why the fuck anybody invested in stocks during the 21st Century, because you would've done as well putting your extra cash into CDs, without all the ups and downs of the Dow.
"That kind of dumb beta uplift is trickier now."
By Robin Wigglesworth, an editor at the Financial Times, a London newspaper (that is owned by a private Japanese kabushiki gaisha).
He's referring to the "dumb" way that people look at long-term returns in the stock and real estate markets, and then presume that past returns predict future returns.
The problem with this stupidly-linear approach to investing is that a large part of those long-term returns has consisted of "beta uplift" -- an increase in the valuation multiple of long-term earnings, further multiplied by an increase in the ratio of after-tax earnings to GDP, which has been driven by decreases in both interest rates and tax rates over the past 40 years.
Now that interest rates are going back up, the ratio of after-tax earnings to GDP will need to fall, and the valuation multiple of earnings will also need to fall. Let's assume for the moment that tax rates will not change, despite gigantic (and unsustainable) government debt and deficit levels that have resulted from all those tax cuts ...
-----
Only two times before in US history before the past few years (2018-2022), did the valuation multiple of corporate earnings exceed 30 --> 1929 and 1998-2002. When the next recession hit each of those past peak valuations, valuations then fell by at least 2/3 before hitting bottom.
This is why I expect stock prices to fall around 2/3 from their recent highs during/after our next recession (a recession I expect to begin within the next year), which is why I'm also keeping only about 1/4 of my retirement funds in stocks right now.
But most people base their retirement investments on the long-term rates of return, which have been highly inflated for stocks over the past 40 years, because the valuation multiple of earnings has quadrupled during those four decades, even as the after-tax proportion of earnings has doubled. If you started saving for retirement at age 25, and put most of your savings into stocks, you made out like a bandit, because stock values increased 8x faster than GDP. Quite the magic trick.
But somebody who is 25 today simply cannot expect to match the stock market returns of the past 40 years, because we cannot quadruple the valuation multiple of earnings again, that's simply not possible, there's no country in the history of the world that has achieved anything like that kind of valuation multiple for any sort of income-producing asset. That would imply valuing $1 of long-term annual earnings at $120. That would imply inflation averaging 0%, and interest rates averaging 0%, and tax rates averaging 0%, over the next century and beyond.
Why would anybody pay $120 for a stream of annual pre-tax income of $1? That's a fantasy.
But when you buy stocks today with the expectation that you will receive the long-term rate of return on stocks in the future, you're expecting that when you retire somebody will pay you $120 for a stream of annual pre-tax income of $1. That's never going to happen.
-----
What drives stock market bubbles and real estate bubbles and bond market bubbles and crypto bubbles -- what drives all these bubbles is stupid-linear thinking, that the returns of the recent past will continue indefinitely into the future. People see other people making XX%/year and join in the fun.
The reality is that all of these markets turn into Ponzi schemes, in which the early "profits" are funded by the latecomers.
People buying stocks today cannot possibly match the returns of the past 40 years. It's simply not mathematically possible.
Just as the banks who bought long-term bonds during 2020-2021 are now insolvent (including the Federal Reserve, which is losing money on its own bond purchases and is technically insolvent).
And just as T & I were underwater on our house for 15 years after buying it at the peak of the bubble in 2006 ... until another housing bubble came along ...
You can make good long-term returns on stocks and real estate and bonds -- but it is much more about timing than the typical investment advisor admits. This is because they make money from you investing in their stuff, whether you make money or not.
It might not have been last year, but at some point the bubble economy of the past 40 years will reverse itself and valuation multiples will head back down. Earnings as a proportion of GDP will head back down. And maybe tax rates will head back up. And then a future generation will ask why the fuck anybody invested in stocks during the 21st Century, because you would've done as well putting your extra cash into CDs, without all the ups and downs of the Dow.