Several comments in yesterday morning’s post sent me back to GMO’s archive to pull some of Ben Inker’s work.

You should read yesterday morn’s commentary (here), than come back and read Inker. In particular, his piece Explaining Equity Returns.

The five takeaways are as follows:

1) GDP growth and stock market returns do not have any particularly obvious relationship, either empirically or in theory.

2) Stock market returns can be significantly higher than GDP growth in perpetuity without leading to any economic absurdities.

3) The most plausible reason to expect a substantial equity risk premium going forward is the extremely inconvenient times that equity markets tend to lose investors’ money.

4) The only time it is rational to expect that equities will give their long-term risk premium is when the pricing of the stock market gives enough cash flow to shareholders to fund that return.

5) Disappointing returns from equity markets over a period of time should not be viewed as a signal of the “death of equities.” Such losses are necessary for overpriced equity markets to revert to sustainable levels, and are therefore a necessary condition for the long-term return to equities to be stable.

Interesting stuff — worth exploring in greater depth . . .

 

Source:
Reports of the Death of Equities Have Been Greatly Exaggerated: Explaining Equity Returns
Ben Inker
GMO, August 2012 
http://bit.ly/16hROk9

Category: Investing, Valuation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

9 Responses to “Inker: Explaining Equity Returns”

  1. ironman says:

    Link to Inker’s article may be broken. Try this one.

  2. Orange14 says:

    Inker also gives some further elaboration on this in the most recent GMO quarterly report which is also up on their site (along with the most current 7 year asset class forecast published yesterday). Maybe the only thing that we can count on right now is the historical positive correlation of equity prices with a Democratic President. By this gauge we probably have another 18-24 months of solid returns before things start heading south (with all the contradictory information right now, this assessment is as good as any).

  3. carchamp1 says:

    Over time, equities certainly will track nominal GDP growth. There will be times when equities outperform and underperform, but they will always revert back to the mean.

    Item 2 is just not right. Stock market returns can outpace nominal GDP for very long periods, but not perpetually. Why? Profits. Company valuations ultimately hinge on profits, and profits cannot outpace nominal GDP forever. If profits and the stock market grow at, say, 15% and nominal GDP is growing at 5%, at some point “profits” will make up the entire economy. This would be an absurd economic result.

  4. denim says:

    Very interesting stuff indeed. An average investor might ask the following questions re numbers 4 and 5.
    4) The only time it is rational to expect that equities will give their long-term risk premium is when the pricing of the stock market gives enough cash flow to shareholders to fund that return.
    Q: where does one find or compute the stock market pricing and cash flow data?

    5) Disappointing returns from equity markets over a period of time should not be viewed as a signal of the “death of equities.” Such losses are necessary for overpriced equity markets to revert to sustainable levels, and are therefore a necessary condition for the long-term return to equities to be stable.
    Q: how does one determine that the equity markets are overpriced?
    Q: how does one compute the sustainable level?

  5. FlyOver says:

    Takeaway point 1….Especially true now that most SP500 companies generate a large % of income and profit OUTSIDE of the US.

  6. Petey Wheatstraw says:

    As I am uniquely unqualified to comment on most of the above, I will restrain my response to takeaway 2.

    Our entire economy is predicated on economic absurdities. From distorted and blatantly dishonest GAAPs to the One True Religion that is fiat currency (yes, I understand that this modern God is more rational are beneficent than all of those pagan gods that came before it, and that the Gospel is WTF it is, regardless of what a mere mortal thinks of it — God does, indeed, work in mysterious ways), to the rampant criminality that only an insane heretic would dare point out (shortly before they are laughed out of “polite” society and penned in with all of the other middle class losers), to the perpetualized Greenspend/Bernanke Put and the moral hazard that issues forth from that cornucopia of “wealth generation,” absurdities abound.

    Within the universe of the absurd, however, all of the above are quite normal.

    Context is everything. Kind of like this fine citizen:

    http://media.tumblr.com/tumblr_meji0pX4q21qdmisx.jpg

    • carchamp1 says:

      Our entire economy is NOT predicated on economic absurdities. Just because you don’t know how the economy, or our monetary system work, doesn’t make it absurd. You just don’t know what you’re talking about. Don’t worry about that, though. You have plenty of company. Just don’t try to get in the way of the coming economic boom with fear trades like gold or shorting. You will get a beat-down if you try that..

      • Petey Wheatstraw says:

        Hey, man — don’t have a shit hemorrhage.

        I don’t know what I’m talking about? How about refuting, specifically what I was talking about?

        Please enlighten me as to how our economy and monetary system works. If YOU understand it, that shouldn’t be too difficult.

        Please explain why the traditional GAAPs, mark-to-market, for example, were altered to keep certain parties in our “capitalist, free-market” system from going tits up after a decades-long crime fest.

        As for gold (and foreign currencies, for that matter), I’ve made a bundle of money on the trades over the past 6 or 7 years. In fact, at this point, I have locked in a win and nearly tripled my original investments. It would seem to me, your advice sucks. Would I invest in gold now? Of course not. But someday, I believe there will be another huge opportunity there.

        Keep your eye on Abenomics and the value of the dollar during the “coming economic boom.”

        Do you understand that?

      • carchamp1 says:

        Sorry, but there’s no way I’m going to bother refuting things like the Greenspan/Bernanke put conspiracy.