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(wow) Words Of Wonders Level 532 Answers – I think it’s clear that we’re deep in bubble territory. Bubbles are usually described at the end of a long bull market when they accelerate and begin to rise at two to three times the average speed of the bull market, which they did last year. Of course, they were always overpriced by average historical standards. Some people will still say that 2000 was higher, but most data points to a new US record for the highest price in history. Then there is the most important thing of all, which is crazy attitude, meme shares, high individual participation, huge volume of penny stock trading, huge volume of options trading, huge level of margin, maximum lending of all kinds, and front page news. All of this is typical of some of the larger bubbles we have. We’ve checked all the boxes. Now the question is, how tall is tall? It is very difficult to always tell which is the highest, but you know that the height of the peak does not affect the actual value. This changes how much pain you experience to return to true value and lower. You don’t want your bubble level to be too high, and you don’t want more than one asset class bubbling at the same time. I’m very clear about what I consider to be the definition of success – and that’s just that sooner or later you can make money without going through a bubble phase. You will rarely recognize the pin that unfolded it. in 1929 no one knew what a pin was. The ultimate cage rattler is everything you never thought could go wrong. And in my opinion, that’s probably why most bubbles deflate. The mechanics of the bubble is that you have the highest borrowing, the highest motivation. And the next day you’re still excited, but not as excited as yesterday. A week later, you’re not as enthusiastic as you were last week and last month. And little by little the motivation decreases, there is no more money to borrow, you are completely in debt, and the pressure to buy is gradually decreasing. Thats all. The next time we are pessimistic, we will have more opportunity to write off asset prices than at any time in history, anywhere. – Jeremy Grantham, GMO, Top of the Cycle, 2021 August
Jeremy Grantham recently observed, “Seriousness is marked by the language you use. I always try to make a big difference, but the difference is often wasted because people don’t remember what you sound like when you’re serious.” . I’m trying to do just the usual “expensive market” and the main thing. Three bubbles are important. It’s serious.
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My concern here is so serious. I expect the next decade – and maybe even the next 12 months – to be a disaster for the US stock market. It is emphasized that our own investment discipline does not require forecasts or rely on forecasts. Instead, our investment behavior changes due to valuations, domestic markets, etc
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Change factors. My real concern is passive investors – especially charities whose missions would be compromised by losing more than 50% of their capital investment (and whose missions could be strengthened by avoiding even a fraction of that) and retiring without enough. excited about their future, but much of it depends on the temporarily inflated prices they see printed on the page or flashed across the screen.
Given the current excesses, I expect the unwinding of this bubble to push the total return of the S&P 500 below Treasury yields for at least a decade, possibly two. However, as with other bubbles, I expect most of the damage to come from above, so market conditions will make sense for investing for a year or two. Right now, the valuation metrics we most closely associate with actual emerging market returns are the worst in US history. Also, as I described earlier, low interest rates do not improve future returns. For an overview, see In Alice’s Adventures in Equilibrium, in the chapter, “Relating Observed Values to Expected Returns Independent of the Interest Rate.”
The chart below shows the valuation measure that we correlate best with actual growth market returns over market cycles throughout history – the ratio of US non-financial stock market capitalization to gross corporate value added, including our estimated foreign earnings (MarketCap / GVA). This measure is now 50% higher than ever before in history
The diagram below shows the two related steps. The blue line shows the ratio of the S&P 500 to the current discounted value of the S&P 500’s actual dividend per share since 1900, using a fixed discount rate of 10% (price / VAT). The diagram assumes that dividends after 2021 will grow at a nominal rate of 4% annually, in line with the trend in S&P 500 earnings, earnings and nominal GDP over the past two decades. The red line shows our margin-adjusted P/E (MAPE), which also greatly eclipses 1929 and 2000. bubble tops.
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The table below shows the correlation between these measures and the actual 12-year total return of the S&P 500 with data dating back to 1928. While the actual total return of the S&P 500 has lagged behind this projection, which is the same as the 12-year bubble. period. 2009-2021 (assuming estimates consistently exceed the 1929 and 2000 excesses), the total return of the S&P 500 will be close to zero.
Notably, faster nominal growth does not improve expected market returns. The level of long-term interest rates in the US is strongly related to subsequent nominal GDP growth. Faster growth—whether in real GDP or inflation—is associated with higher interest rates (and more normal stock market valuations) at the end of the period. As I noted last month, even if we look at periods in US history where nominal GDP, S&P 500 earnings, or cyclically adjusted earnings have averaged more than 10% per year over a decade or more, or that 10-year CPI inflation average. outside anyway. At 4% per year, the S&P 500 estimates are consistently at or below historical norms at the end of 10-year periods, averaging more than 30% below norms.
Think of it this way. MarketCap/GVA is now 3.5 compared to 2000. a peak of 2.4, which has not yet been surpassed.
. Over the past 20 years, from the pre-pandemic peak to now, non-financial gross value added in the US has grown by only 4% per year. Now let’s say that the current level of valuations is not too far off even lower than it was in 1929 or 2000. Even so, the resulting 10-year annual return on the S&P 500 would be:
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Fortunately, the S&P 500’s dividend yield is 1.30%, so as long as bubble valuations can be reliably maintained, at least investors will.
It is a fiction that stocks are better than low yield bonds at any price. If you want to make this argument to investors — I’m talking directly to Wall Street analysts and the Fed here — at least have some intellectual decency
Compare your estimates to decades of actual market return growth and show them side by side. We estimate that the S&P 500 is likely to lag Treasuries by about 8% per year over the next decade, the largest gap on record and worse than the post-1929 and post-2000 performance. For a discussion of equity risk premium (ERP) models, including the Shiller-Black-Jirav “excess CAPE yield”, see a good response to a bad situation.
Yes, bond yields are lower than they were in 2000, but stock valuations are also worse. Final result for
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Returns will likely be similar to previous bubbles. Even with a “error” as large as the one we’ve seen over the past 12 years (which requires future estimates to remain extreme bubbles), the total return of the S&P 500 would be equal to or less than the yield on Treasuries. The main thing the Federal Reserve did was to create a profit-seeking bubble that inflated both bonds.
Another word for analysts: Don’t discount the expected future cash flows of long-term securities with returns that investors don’t really believe.
Of that security, or which is inconsistent with the long-term returns that investors have historically demanded, and then has the audacity to call the resulting price “fair value.” This is simply wrong.
Some of Jeremy Grantham’s observations about speculative bubbles should not be missed. Not only because they agree with our own thinking, but also because they have heard
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