I am not a believer in past results being predictive of future returns. I want to emphasize that.If you split that chart in 1934, you can see a difference in volatility before and after the end of the gold standard. That difference also seems to come with a more general trend toward decreasing real equity returns. It's also worth noting that the frequent appearance of deflation during the gold standard dramatically bumped real returns in several years -- even masking negative nominal returns.I've suggested one might actually compare TIPS yields and implied expected return from stock valuation as an input to stock/bond allocation. Rational actor theory supports that, and whether inherently fuzzy 'behavioral finance' is a good enough reason *never* to do it: I'm unconvinced. That said, we might ask if TIPS yields of the late 90's should be viewed skeptically because a brand new (1997) small market.The idea is that at market lows stocks offer better alternatives and that people only think we will see 3% TIPS at market lows. They are obviously wrong based on history.
To get an idea we can extend this back approximately at least by plotting a fundamental (aka valuation based) measure of stock expected return* v an estimate of the 10 yr real yield estimated by the 10 yr nominal yield minus survey based expectations of term inflation. Ilmanen did that back to 1900. This online version of the graph only goes to 2017 with stock E[r] 3.5%, 10 yr real 0%, 3.5% expected ERP. The version in 'Investing Amid Low Expected Returns' ends in 2021 at (eyeballing the graph) ~3 and -1, E[ERP] ~4. Now it would be (calculating) 3.6 and 1.84 (using actual TIPS), E[ERP]=1.8. That's not unprecedentedly narrow, lower readings were seen especially in the disinflationary period of 1980's to end of century, but 1.8 is well below avg. As for real yield, 3% was fairly often exceeded, and the implied past 10yr real yield in 2000 is about the same as the all time TIPS peak that year, ~4, IOW that doesn't appear to have been an artifact of a new, small market.
Also those who say 'stock expected return "predictions" (which they aren't) have always been wrong' might eyeball that graph and note a lot of the time since 1900 stock expected return was in be 6 real ballpark. Although for any given period the relationship between ex ante expected return and ex post realized return was highly noisy ('hinted' at by the name *risk asset*). It's not as if fundamentally based expected stock return has always been 3 but realized return 6. And valuation rising (expected return falling) in the right part of the graph means realized return must have averaged higher than ex ante expected, valuation rise tailwind. But it's a biased estimate to assume that continues w/o a rational explanation why it would, which I've never heard (not valuation *could* rise, of course it could: *more likely* to rise than fall). The fundamental measure implicitly assumes valuation ~equally likely to rise or fall. Prognosticators projecting outright poor stock returns assume it more likely to fall.
https://www.bourbonfm.com/sites/default ... 201900.png
*average of the dividend yield and 1/CAPE plus 1.5% avg real EPS growth last century plus in US.
Post-WWII, fixed income started yielding much more -- but with increased volatility. Once the Fed got active about inflation, the general trend there was also downward. The question in my mind is whether the norm of active participation by the Fed will lead to a new norm of lower real yields from both asset classes, combined with (or due to) much more inflation consistency.
). It's not as if fundamentally based expected stock return has always been 3 but realized return 6. And valuation rising (expected return falling) in the right part of the graph means realized return must have averaged higher than ex ante expected, valuation rise tailwind. But it's a biased estimate to assume that continues w/o a rational explanation why it would, which I've never heard (not valuation *could* rise, of course it could: *more likely* to rise than fall). The fundamental measure implicitly assumes valuation ~equally likely to rise or fall. Prognosticators projecting outright poor stock returns assume it more likely to fall.
But if you are, and you believe that 3.5% real is what you can reasonably expect from equities going forward, I would think they would be a hard sell vs. a guaranteed ~2% real return , state tax exempt, from TIPS, with virtually no concern for risk or volatility and a "set it and forget it" portfolio.
Statistics: Posted by protagonist — Wed Aug 14, 2024 4:09 pm — Replies 3594 — Views 872694