Over the past several decades, the stock market has become an enormously popular vehicle for retirement savings.
I rest my case.
Okay, you want more detail. First consider the graph in this link. You will note that during most of the past century, stocks have traded with P/E’s between 5 and 25 although it would be more fair to say that the range tends to stay between 10 and 20. There has been a total of two stock bubble runaways: 1929 and 2000. On top of that it should be clear than the market runs in a 30 year cycle. This is about the duration of a generation which suggests that each generation needs to relearn the mistakes of the older generation.
Next consider the graph in this link. You will note that unless the market has been seriously dunked (like in 1930 down to a P/E of 5), the expectation yield is on the order of a couple percent at best. It may even be negative.
Using the average annual return based on either for select periods (like the previous stock bubble) or even for the entire run which included the anomalous period from 1980 or so with its significantly longer and wider run up in prices (see first link again) is in my opinion not very wise.
You don’t pick returns based on the low end of the distribution (P/E~10, see second link) if you have more information available indicating that you are closer to the high end.
Well, that is to say, you can do what you want, I don’t care.
The current stock market is simply just not as good an indicator of the underlying economy as it used to be. One of the reasons is that people are treating it as a savings account without a second thought as to what they are buying. This works on the same principle as baseball cards or art. They only have value as long as some greater fool is willing to buy them. This has the following consequences. However, in principle it really would work as long as everybody was willing to go along. And so it does, for now. There is little difference between that and the way many buy stocks today. In the same way we can pretend that the emperor is still wearing clothes.
Ask yourself why it is that stocks which are inherently more risky actually pays out less money to the shareholders than bonds?
Hasn’t something gone topsy turvy at some point?
Yet everybody accepts this as being normal!
That is not to say that all stocks are bad. In my opinion, only stocks that are primarily valued based on their earnings are dangerous. The high the growth rate or the higher the earnings multiple the worse. I trust stocks that can be handled with a discounted cash flow analysis of their dividends more. I trust them even more if their yield is high. If so, that means it’s probably not growing much and so I don’t have to add in a growth estimate as well. I consider this investing.
Conversely, trying to estimate future stock prices based on future earnings is a speculative game which slowly drifting assumptions.
At least that’s how I see it.
Originally posted 2010-04-27 23:12:37.