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Wednesday, June 8, 2016

When Investing, Everything Is Relative ... Probable Future 'Nominal' Annualized Investment Returns on Stocks of ~6% to ~7% Will Be Lower Than The ~10% They Have Earned Historically ... But When Compared to the Various Alternatives Out There, They Look Really Good to Me

In the play "Hamlet," Shakespeare said this, "Neither a borrower nor a lender be.' He was way ahead of his time. Those are still words to live by, and are especially relevant today.

Yes, unnecessary borrowing is bad for one's financial health and well being, even when interest rates are low. That's because the debt will most probably have to be repaid in low instead of high inflation dollars, by far and away the most expensive form of borrowing.

Here's the deal. When seeking above average investing results, whether by using our own money, aka MOM, or borrowing what we then spend, everything is indeed relative. That's always been the case, and will be in the future as well.

Today's interest rates and inflation are at historic lows. As a result, the returns on real estate, gold, energy, other commodities, bonds, CDs and other fixed income investments will not prove to be nearly as good investments as will owning stocks.

And that's likely to be the case for years to come. The double digit inflation and interest rate days of the 1970s are gone and won't be returning for a very long time to come. That's a good thing.

However, future absolute investment returns for stocks are almost certain to be lower than they have been these past several decades. Compared to other investments, however, they will be great and perhaps return ~7% at an annualized rate. This will beat returns on bonds and other investments by ~3% to ~5% annually over the long haul.

But don't take my word for it. Listen instead to what Bill Gross, a highly successful investor in bonds and other fixed income instruments, has to say on the subject.

Bill Gross: The Past 40 Years Are Unrepeatable is subtitled 'The fund manager writes that economic trends that have fueled outsize returns are coming to an end:'

"Experienced managers that have treaded markets for several decades or more recognize that their “era” has been a magnificent one despite many “close calls” characterized by Lehman, the collapse of Nasdaq 5000, the Savings & Loan crisis in the early 90’s, and so on. 

Since the inception of the Barclays Capital U.S. Aggregate or Lehman Bond index in 1976, investment grade bond markets have provided conservative investors with a 7.47% compound return with remarkably little volatility. . . .

The path of stocks has not been so smooth but the annual returns (with dividends) have been over 3% higher than investment grade bonds. That is how it should be: stocks displaying higher historical volatility but more return.

But my take from these observations is that this 40-year period of time has been quite remarkable -- (an) event that cannot be repeated. . . .

(A bond portfolio) will almost assuredly return between 1.5% and 2.9% over the next 10 years, even if yields double or drop to 0% at period’s end.

The bond market’s 7.5% 40-year historical return is just that – history. In order to duplicate that number, yields would have to drop to -17%! . . .

The case for stocks is more complicated of course with different possibilities . . . . Equities . . . are correlated significantly to the return on bonds. Add a historical 3% “equity premium” to GMO’s hypothesis on bonds if you dare, and you get to a range of 4.5% to 5.9% over the next 10 years ....

Here’s my thesis in more compact form: For over 40 years, asset returns and alpha generation from penthouse investment managers have been materially aided by declines in interest rates, trade globalization, and an enormous expansion of credit – that is debt.

Those trends are coming to an end if only because in some cases they can go no further."

Summing Up

Some of you will recall the 'unfun' double digit interest and inflation rates of the 1970s. I know I do --- vividly!

But none of us can recall an ongoing global economic environment with low economic growth, negative to ~2% interest rates, inflation at risk of turning into deflation, and a global indebtedness that will restrain economic growth for many years to come.

But that's exactly where we are and what we have facing both us and the rest of the world.

Now add in robotics, automation and related technological advances such as artificial intelligence, tomorrow's self driving cars, and the wonders and connectivity of the internet age.

Next combine these things with a globally competitive work force that is willing and anxious to work for much lower wages and at equal or great productivity than ours, and the economic plot really thickens.

The 'old' days saw massive agricultural employment turn into massive industrial employment, but the 'new' days are definitely different as we are witnessing offshore workers and automation replacing low and semi skilled American workers.

For the foregoing reasons and more, I'm staying away from investing in bonds, and both private and public sector pension funds should as well.

When investing, the alternatives to owning shares of stock in a diversified basket of blue chip, dividend paying and growing companies are unattractive at best and financially dangerous at worst.

Maybe a 6% to 7% annualized rate of return over time doesn't seem like much to those of us who are used to the double digit returns on stocks over the past several decades, but money invested at that rate will still double in 10 or 12 years --- and so on.

And that beats whatever ends up in second place by a whole lot!

That's my take.

Thanks. Bob.

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