No free lunch, part 2 electricity bill cost


Matching the stock market’s long-term average returns sounds like it should be easy, if you’re patient enough. But in fact it is remarkably difficult. In last week’s letter, Ed Easterling and I showed you why it is a longshot bet in almost every market environment. Returns over a decade or two are usually well above or well below average. Most of all, it’s fairly predictable which side electricity vs gasoline of average will occur.

Ed founded Crestmont Research in 2001 to research secular stock market cycles and graphically explain everything about them. You can find a treasure trove of his fabulous charts and articles on cycles and market returns at Longtime readers know that I’m a big fan of Ed’s work and highly recommend both of his books, especially Unexpected Returns.

The price/earnings ratio (P/E) has a multiplier effect on stock returns. Over 10 – 20 years, P/E can dramatically increase or decrease, resulting in a significant addition or reduction in total return. This can either help or hurt investors. In the secular bear market of the 1960s and ’70s, the decline in P/E virtually eliminated the return from earnings growth and dividend yield. In the 1980s and ’90s, the increase in P/E more than doubled the return for many of the decade-long periods during that secular bull market.

The chart below shows a high correlation between P/E ratio and dividend yield. P/E is plotted on the left axis and dividend yield runs across the bottom axis. Each dot on the graph represents the combination of P/E and dividend yield for each year since 1900. The resulting pattern provides insights about the relationship across a full range of conditions. High P/E is closely associated with low dividend yields and low P/E coincides with high dividend yields.

This is one of those rare instances when correlation reflects causation. P/E is the relationship of price to earnings. Dividend yield is the relationship of dividend payments gas out game instructions to price (D/P). Therefore, with price as the variable that both ratios have in common, we can mathematically eliminate it for comparison and recognize that P/E and dividend yield actually reflect the relationship of earnings to dividends.

Since dividends are paid from earnings, and since the share of earnings paid as dividends varies in a relatively narrow range over time, we see a close relationship between the two ratios. Valuation drives dividend yield. For example, the same dividend amount when price is based upon P/E at 20 has twice the yield when price is driven by P/E at 10.

Looking only at actual reported earnings (without subjective adjustments and future forecasts), most reports of P/E stand near 20 and up to 30 in a few instances. The long-term historical average is around 15. P/E has declined below 10 during periods of high inflation or significant deflation and generally rises toward the mid-20s when inflation is low and stable. Therefore, P/E is currently above average, but is it fairly static electricity examples valued near 20 or overvalued near 30?

The next chart shows a long history of economic growth (measured with nominal gross domestic product o gastronomico) and earnings growth (measured with earnings per share for SP 500 companies). We see the effects of business cycle fluctuations in EPS around a steadier economic progression in GDP. This graph visually reinforces why some analysts prefer to normalize earnings in order to moderate distortions. Averaging earnings over a period of time, typically 10 years, removes the recessions and business cycle outliers.

Some analysts and investors believe corporate earnings have recently upshifted and are unlikely to revert. They cite tax changes, trends in service industries, technology, and other causes. Yet all those factors and more have affected earnings, margins, and the economy for more than a century and none have conquered business cycle-driven reversion. Nonetheless, if we were earlier in the cycle, P/E would be near 20 and the market would be fairly valued.

Others think profit margins will again revert as they consistently did in the past. While profit margins and earnings may be surging, competitive processes will ultimately drive returns on equity grade 6 science electricity unit test back in line with debt yields plus equity risk premiums. The current elevated profits offer handsome returns and attract new competitors or predatory responses from existing competitors. Regardless, using various methods to normalize the business cycle shows us that P/E is near 30 and the market is vulnerable to correction.

On the other hand, analysts and followers of CAPE P/E10, Crestmont’s P/E, and other normalizers disagree that this time is different. History rarely repeats but it does provide a powerful laboratory of experiences to assess plausibility. For now, the adage regarding history repeating has the upper hand over the adage that this time is different.

(The CAPE or cyclically adjusted price to earnings ratio is a valuation measure that uses real earnings per share (EPS) over a 10-year period to smooth out fluctuations in corporate profits that occur over the business cycle. It was popularized by Yale University professor Robert Shiller electricity will not generally cause so it is also known as the Shiller P/E ratio. While John and Ed both believe the Crestmont ratio is superior, the CAPE is better known.) Implications for Your Portfolio Today

For example, note the trough in the 1970s, just over halfway across the series of green bars. The lowest point is the 10-year period from 1966-1975. The annualized compounded total return (i.e., capital gains plus dividends on a nominal basis) over that decade was 3.3%. The corresponding point directly above that bar is normalized P/E at the beginning of 1966, when CAPE P/E10 was slightly over 24.

As the bars fill in under the P/E line in the coming years, we can expect their height to generally decline to reflect the market’s rising valuation of the market across the nine years. This does more than demonstrate the inverse relationship between valuation and performance; it provides a forward-looking view of what to expect in the future.

There are many ways to manage portfolio risk and control losses. The tools include direct hedges (e.g., options), portfolio structure (e.g., diversification), and active management (e.g., dollar cost averaging, rebalancing, value investing). Some investment funds and financial advisors provide these for investors gas variables pogil worksheet answer key who don’t have the time or interest in actively managing their portfolios.

Graham and Dodd recognized that markets and related financial series fluctuate. Changes in valuation affect investment decisions and outcomes. Markowitz recognized this as well. He started his presentation of Modern Portfolio Theory by separating the need for relevant assumptions from his model for portfolio construction. Nonetheless, conventional wisdom soon oversimplified the crucial assumption-setting step.

The stock market’s long-term average return is a centerline around which the returns from almost all periods fluctuate. The profile of returns over periods of a decade or two looks like a barbell, with the likely outcomes concentrated away from the center. The profile is not a bell-shaped curve with most instances near the middle. Empirically, above- and below-average outcomes are much more common than average, as seen in this chart we shared last week.

Average is a convenient guess 76 gas credit card account login when outcomes are random. Statistically, average gets closest to the actual result when there is no order or pattern in the data. This may be why followers of stock market randomness use the century-long assumption for average stock market returns. If they pick the middle, they’re likely to have a small variance to explain. But if they predict in one direction and it ends up in another, they look like a weatherman.

Most financial assets, especially stocks, rise toward their highest relative value (and lowest expected return) when the inflation rate is low and stable. Bond prices rise as yields fall in response to declining inflation. Stocks, as perpetual securities, react especially well to low inflation. Coupons and dividends are most valuable when the inflation villain is subdued.

For now, inflation and bond yields are relatively tame. The stock market is currently somewhere between relatively high and overvalued by most measures. Either way, we think investors should assume below-average returns over the next decade or two. Even if today’s relatively high valuation is near fair value due to low inflation, fair value doesn’t produce average returns. Fair value delivers a return commensurate with starting valuation.

In a low-return environment, incremental enhancements that control risk and boost returns have more significant impact than in high-return environments. A small enhancement during the ’90s might have been overlooked, while the same over the past 20 years would have had a material effect electricity 101 video for accumulators and retirees. Diversifying Your Trading Strategies