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Thursday, July 9, 2015

Low Inflation and Historically High Stock Prices Signal Continuing but Lower Stock Gains Ahead ... Borrowing Less and Saving More is the Best Game Plan

The stock market has tripled the past few years. That isn't likely to repeat itself for a very long time. Meanwhile, interest rates and inflation are at historic lows. That can't continue indefinitely either, but it won't change anytime soon either.

For the foreseeable future, worldwide economic growth will be slow as the debts of the past will constrain the buying of the future for countries and individuals alike. What we borrowed must some be repaid. And that repayment period will slow consumer spending and hence business investment. Accordingly, sales growth will be lower than has been the case. So will profits and high paying jobs. As a result, stock returns won't match the ~9 to 10% annual returns of the past several decades. But over time they will still beat everything else by a wide margin.

So what's an individual saver and investor to do? For what it's worth, which may be nothing, here's my 'til death do us part' plan. I will manage my own account and continue to consistently buy blue chip dividend paying stocks. Then I will hold on to them through all the periodic turmoil in the world's trading markets. Nothing else makes sense to me, because no other investment portfolio will come close to the all-in gains of stocks of a diversified group of solid companies over the long haul.

In comparison, bonds aren't a good idea for the foreseeable future as interest rates are low and destined to increase over time. That combination of low rates now and rising rates later suggests that bonds will be a very poor investment for at least the next several years. That's because when interest rate rise, the principal value of the bond declines. It's just math. And if interest rates don't rise, then the individual investor is stuck with the low coupon rate of the bonds he owns.

In rough numbers, it's reasonable to assume that stock market returns may average only ~6 to 7% going forward, with an even split between cash dividends and rising stock prices. Bonds will likely earn less than 3% annually, and perhaps as little as nothing.

That said, minimal inflation will tend to preserve the purchasing power of money and therefore result in a ~6 to 7% annual return on stocks in the future being equal to a ~9 to 10% return in the past. That assumes that inflation going forward will ~2% or less annually compared to the ~4 to 5% in the not-so-distant past.

In any event, stocks win and individuals should plan to save more due to lower returns in the future.

{NOTE: Public sector pension plans which continue to invest in a mix of stocks and bonds and continue to assume a rate of return of 8 to 9% annually will be big losers, along with the unsuspecting taxpayers who will guarantee those benefits.}

At least that's what my crystal ball predicts.

Investors Brace for Fewer Winners is subtitled 'As stocks' returns dry up, some people take more risks. It could be time to save more:'

"Americans are getting some tough news from investment advisers these days: U.S. stocks have risen so fast since the financial crisis that future gains are likely to be weaker.

The S&P 500 index, for example, has tripled from its 2009 low, which is great news. Through this year’s first half, however, it was up only 0.20%. . . .

In the end, . . .  many money managers and analysts say, investors need to accept a hard truth: Future stock returns will be lower than they have been since 2009. To save enough for retirement, people need to rely less on expectations of double-digit market returns, and set more money aside. . . .

Diminishing returns

(One analyst) expects a 6% to 9% annual return for the S&P this year, including dividends, but David Kostin, chief U.S. stock strategist at Goldman Sachs, says investors should expect less.              

Mr. Kostin recently published a report projecting an average annual return of 5% over the next 10 years, with 46% of that coming from dividends. That is roughly half the 9% historical average return, without adjusting for inflation. Removing the effects of inflation, Mr. Kostin expects 3% a year, compared with 7% historically.

He arrives at his forecast by tracking the S&P 500’s price compared with its companies’ average earnings over the preceding 10-year period. . . . Forecasting short-term gains this way doesn’t work well, because stocks can do almost anything in the short run. says. But looking out over a 10-year period, you can get a more reliable forecast of average gains, Mr. Kostin says.

Right now, by this measure, the S&P 500 trades at about 23 times average operating earnings for the past 10 years, well above the historical average of 16. When stocks have been this expensive in the past, average returns over the following 10 years tended to group around 5% a year, without adjusting for inflation. Various predictors including the swaps market for dividends indicate that future dividends should represent 46% of that return, almost exactly their share over the past 25 years, Mr. Kostin says. That means annual price gains would average only 2.7%. . . .

“The return may be modest for the U.S. market relative to history, based on my forecast, but what are the opportunity sets elsewhere?” Mr. Kostin says.". . .

Given all that, some experts have a simple piece of advice: Save more. The logic is simple. If your investments are going to be growing more slowly, the only way to reach your goal is to put more money in the pot."

Summing Up

Saving more is good advice for everybody.

Asset price inflation is not going to be the factor going forward that it has been in the past.

In fact, low inflation and low interest rates should continue for a long time.

So take care of your future financial needs by saving and investing in blue chip dividend paying stocks for the long haul. 

That's my take.

Thanks. Bob.

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