Hussman's Market Commentary
I recently purchased Hussman's Strategic Growth mutual fund (HSGFX) because I began reading and really enjoying John Hussman's weekly market commentary. This guy is really smart and thoughtful (two qualities that rarely find themselves together in great quantities).
Here's a sample from this week's commentary:
USA Today ran a piece noting that the historical average return on stocks has been 10.4%, with various analysts voicing the opinion that, basically, last year's sub-par return increases the odds that future market performance will revert higher. That's the “gambler's fallacy” if I've ever heard it – the notion that a string of bad rolls raises the probability of a good one.
Unfortunately, in stocks, the things that produce above average returns are a) below average valuation or b) a propensity of investors to accept increasing amounts of risk, which can be largely read out of the quality of market action. Presently, we have neither. That's not to say that 2006 is destined to remain in this particularly negative Climate, but here and now, there's little to suggest the probability of above average returns until the evidence changes.
The fact is that the 10.4% historical return on stocks breaks into three simple pieces: an average earnings growth rate (measured from peak-to-peak across market cycles) of about 6%, a mild secular uptrend in price/earnings ratios over the past century, which added about a half percent to annualized returns, and an average dividend yield of just under 4%. Those pieces, by the way, are exhaustive. Mathematically, you can fully characterize the total return on stocks with a) earnings growth, b) changes in the P/E multiple, and c) the dividend yield. Note in particular that factors such as stock buybacks are already taken into account in the calculation of index fundamentals such as earnings and dividends for the S&P 500. The three factors above really are exhaustive.
Given a durable, robust historical peak-to-peak earnings growth rate of 6%, a current dividend yield of 1.8%, and a starting price/peak earnings multiple of
19, stocks are currently priced to deliver long-term returns of 7.8% annually provided that price/earnings multiples stay at a “permanently high plateau” indefinitely. Allow that multiple to contract to anywhere close to historical norms (historically, when trailing net earnings on the S&P 500 have been at a new high, the P/E ratio has averaged just 12), and stock returns have the capacity to be very unsatisfactory even over periods of 5-10 years or more. Suffice it to say that 10.4% returns are not inherent in stock ownership. Rather, long-term returns are, and always have been, a function of initial valuations (and as a tautology, ending valuations).
This is great stuff and you should make Hussman's site a weekly destination.