The year nineteen sixty six is not a typo. According to Larry Summers, adjusting for inflation,
``Earlier this week, the Dow Jones Industrial Average, adjusting for inflation according to the standard Consumer Price Index, was at the same level as it was in 1966''.
This, of course, ignores dividends, which were substantial at various times and less so substantial at other times. But it underscores that blind buying of stocks "regardless of price" can lead to very mediocre results.
By the way, this speech is excellent and very easy to follow. I saved it on my webpage just to give this link (I received it on a mailing list that I read).
The most obvious problem is that the Dow only includes 30 companies. I like Shiller's data, but I wish he would adjust the closing prices for dividends like Yahoo does. Fortunately, it's pretty easy to do, oneself. Adjusted for inflation AND dividends, I get:
March 1966: $154.68 March 2009: $696.33
That doesn't include dividends for the past 3 months, but I can't imagine they would make a huge difference. The annualized, real return is ln(696.33 / 154.68) / 43 = 3.5%
However, that's assuming you only bought in March 1966. If you practiced dollar-cost-averaging over the past 43 years, your IRR would be 4.12%. And if you did a least squares fit, your model would have an interest rate 6.71%. Does that suggest the stock market is currently undervalued? By as much as 50%?
"All models are wrong, but some are useful." - George Box
Note, however, that dividends have always been taxed, so the return to a taxable investor was considerably less than 3.5%
This compares apples to oranges.
If you were to retire in 1966, with one million dollars, and invested it, you would have almost the same amount of money from capital appreciation (adjusted for inflation) plus you would get dividends.
Conversely, If you started off with one million dollars in 1966, and were "dollar cost averaging" that million, investing portions of it year after year, so that you would have your cash invested by 2009 (a contrived scenario) your after inflation return would be far below the return on money fully invested in 1966.
I would also like to know where you got that 4.12% number.
"Dollar cost averaging" means that you were investing small amounts of money at various points of time, as opposed to investing all money in
1966. This is not at all a valid comparison with market return from
1966.
It does not suggest that at all. I cannot see how it could suggest that.
However, it likely is undervalued, for other reasons, having to do with price, and not with past returns.
Yes, but some people are interested in apples and some people are interested in oranges. You're only considering the scenario where you have the money to begin with. What if you started saving for retirement in 1966? You'd put away some money every month or every 2 weeks or something like that. That's dollar cost averaging, perhaps not in the strictest sense, but more or less, it is.
Just take Shiller's data and simulate dollar cost averaging with it. In the end, you'll have to solve a transcendental equation. I can send you a spreadsheet detailing all this, if you like.
I guess its competitive entertainment now to discover the gloomiest economic story. But that doesnt have much bearing on the best place to invest at the current moment.
?? Yahoo adjusts individual stocks and mutual funds for dividends, not indices such as the SP500 ... but in view of everything else you said, I reckon you knew that :-)
My results vary somewhat from yours (which I suspect may be due to slightly differing data going into the calculations), but for the sake of staying on topic -- yes (more or less).
Your conclusion is not only correct, but more importantly, it is so for the right reason :-)
Extend your regression to the entire stock market history -- you will find that your erstwhile assessment (based on the past 43 years) is low-balling the market's current degree of undervaluation by roughly 20%! The long-term outlook is even better than you stated :-)
Times when the stock market was similarly undervalued (roughly 2 standard deviations below the historical mean) were rare: 1865-67, 1920-22, 1941-42,
1947-49, and 1980-82. On two occasions, the market slightly breached the lower
3-standard deviation boundary: 1857, and 1932; those who argue the SP500 may drop to 500 basically think 2009 will join that exclusive "blood in the streets" club. I strongly doubt that, but even if that should happen history shows that the market did not linger at those depths for more than 2 months, each time followed by a swift 1-standard deviation rally.
To round out the big picture, the upper 2-standard deviation boundary was only breached two times: 1929, and 1999-2000. This makes it a no-brainer, when attempting to compare the present market to the Great Depression (if must be), to line up 1929 not with 2007 but with 1999, which in turn highlights salient similarities and differences in terms of both prelude and aftermath.
Finally, consider how the current dismal trailing 43-year stock performance stacks up against the historical record. There have only been 22 months in history with a 43-year real total return below 4%: 1932, 1933, 1942, 1943,
1948, 1949 (plus the first 3 months of 2009). From these rare historical seasons of gloom, the future real total return of stocks was decidedly positive. The lowest levels of subsequent returns were: 10 yrs 7.1%, 20 yrs 9.7%, 30 yrs 6.9%, 40 yrs 6.4%. On average: 10 yrs 14.0%, 20 yrs 12.0%, 30 yrs 9.0%, 40 yrs 7.9%. The highest levels obviously even better than these, but why pile it on.
ISTM these are not seasons but tend instead towards reflecting a single season.
I do not think one can talk about the market being undervalued or overvalued, at this moment in time, without wild guesses about future earnings. They are particularly prone to being poor guesses because the credit crisis has reduced transparency.
I think it is okay to buy now, as long as one has a 15+ year timeframe and can psychologically bear another 30% decline or so in the S&P 500 etc.
Morgan Stanley China A Share Fund (CAF) It's up about 40% year to date and I think it has much further to go.
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still have a 7% (approx) growth rate and the people are believing in their markets. As far as I know, CAF is the only China fund that invests in A shares. All of the other funds are down year to date but they are starting to rise.
.... 1932-33, 1942-43, 1948-49? I see how you might gain that impression, but those commas (not dashes) were there for a reason. "Season" here is figurative, each "season" being comprised of variable stretches of months, including 1-month "seasons": 3 single months, 1 2-months, 2 3-months, 1 5-months, 1 6-months. Mid-1948 through mid-1949 might be viewed as one single "season" interrupted by
3 discrete bouts of >4% performance, but other than that there were no cross-year stretches. Be that as it may, the main point had nothing to do with seasonal minutia but was simply: dire long-term performances of
This is your guess. Mine is: I will not bet on what short-term (one- day to ten-years) earnings will do. I think my guess on long-term (15 years or more) earnings will prove more accurate: I expect long-term earnings to rise, as a fact of economies.
Perhaps we do agree on the conventional wisdom: Do not buy stocks unless you can stay invested for the long term.
One point of clarification/correction: The US stock market is currently undervalued by almost 42%, which would require a rally of 70% (adjusted for dividends and inflation) to return to "fair value."
Strategically, the current global recession is working in America's favor in that the menacing gallop of China's economy has been slowed to the extent that it has bought us perhaps an additional 10-20 years (on top of our current lead) before China has a chance of catching up to us. Add to that the fact that an economy's growth slows as it matures, America may well remain the leader of the pack into the latter part of this century ... whoat a cohntry!
Paraphrasing a dictum from someone whose market analysis has taught me much: "A free market system rewards those products and services which are both useful and scarce and penalizes those which are not." What our economy needs at present (and what seems to be in scarce supply at the moment) is clear heads, trust in what is deserving of trust, and purposeful action. Just as the present mess was the inevitable lesson of "you reap the foolishness you sow," planting well in spring time lays the foundation for a decent harvest down the road. Consider the courage and faith a farmer must have ... year in, year out.
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