Hussman's Column: We Should Already Have Learned How This Will End
Let’s translate this into an estimate of prospective 10-year total returns, assuming underlying nominal economic growth rate of about 6.3% (which may be optimistic, but is a robust peak-to-peak norm across economic cycles, and is unlikely to be pessimistic), and a dividend yield of about 2.2% on the S&P 500. With that, a 65% overvaluation in quoted shares, reverting to fair valuation a decade from now, would imply a 10-year annual nominal total return on the S&P 500 of 1.063*(1/1.65)^(1/10) + .022 – 1 = 3.3% annually.
mornin jad, i love it when brk experts go back to the 1800s and talk about returns etc like nothing happened in 2006 to effect the supply -demand equation in brkb. iv, bv, i know, what about the FLOAT in the Bs ? from 750 million shs in 2006 to 1.1 BILLION B shs now in the float, i wonder what buffetts current thoughts are on this issue ? Would he do anything different if he could go back to 2006 ? does supply and demand matter, even in brkville ? buffett and munger work FREE, ZERO options, they take almost ZERO cash, and still, brk doesnt blow the index away the past 5 years, why ? maybe kass will ask ?
I agree with Hussman here. I think stocks are more overpriced than they quantitatively appear.
"For example, back in 1999, Warren Buffett correctly warned “In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%... Maybe you’d like to argue a different case. Fair enough. But give me your assumptions. The Tinker Bell approach – clap if you believe – just won’t cut it.”
Yet today, with corporate profits near 11% of GDP – a level that is clearly explained by massive federal deficits and depressed personal savings – not a peep.
The “hook” today is the dramatically elevated, deficit-induced level of profit margins. While the complete faith of investors in the Federal Reserve may prove to be the hook for ordinary investors, it’s not enough to draw in more careful observers. The real hook, in my view, is the absence of a bubble in any individual sector, and instead a bubble in profit margins across the entire corporate sector. That is the hook that serves to keep investors and traders thinking that everything is going to be all right."
TF, you can get a crude estimate of current normalized earnings for the S&P 500 by doing the following:
Go to the multpl site, click on "more" and under "S&P 500 Stats", click on "Earnings".
The 142 year chart is a semi-log plot of trailing twelve month, inflation corrected (to February 2013), earnings vs time.
Using a thin dark piece of thread held tautly, fit the best straight line you can to the data.
On my monitor, with the font I use, the earnings grid lines are 16 mm high.
At the start (left side) of the graph, 1Jan1871, my best fit line crosses the left edge 15 mm above the $4 per share grid line, which calculates to $7.7 per share, exp(15/16*((ln(8)-ln(4))+ln(4)).
At the end (right side) of the graph, 1Sep2012, my best fit line crosses the right edge 15 mm above the $32 per share grid line, which calculates to $61 per share, exp(15/16*((ln(64)-ln(32))+ln(32)).
So, if you find that credible and believe that the S&P 500 should trade for roughly 15 times normalized earnings, that would put the price at $915 per share, not the current $1569. Which implies that the S&P 500 is currently priced about 71% too high.
You also have enough data now to estimate the real (net of inflation) earnings growth rate over the last 141 and 2/3 years. I get about 1.5% per year, ($61/$7.7)^(1/141.67)-1.
You can mentally check your estimate of the real growth rate using the "Rule of 72" and noting that earnings doubled roughly three times over roughly 150 years, for roughly one double every 50 years, and that 72 divided by 50 is roughly 1.5.