Author Topic: Vanguard’s investment tips for 2017  (Read 3467 times)

AdrianC

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Vanguard’s investment tips for 2017
« on: January 06, 2017, 09:09:53 AM »
A quick read:

https://vanguardblog.com/2017/01/04/vanguards-investment-tips-for-2017/

Highlights:

1. Prepare for uncertainty. Several political and economic events caught observers by surprise in 2016, including the results of the Brexit vote in the United Kingdom and the presidential election in the United States. Markets respond to surprises with volatility, and we expect more surprises in 2017. With a new U.S. administration comes the potential for changes to policies that affect investors. Some may be beneficial; some may trigger market volatility. The best approach in any environment is to maintain a long-term perspective and a balanced and diversified portfolio.

2.Save more. In addition to potential near-term volatility, we expect the stock and bond markets to produce lower returns in the next ten years than they have over the past several decades. This will place the burden on investors to save more. We recommend saving 12% to 15% of your income (including any employer match) for retirement. Saving more is an asymmetrical proposition: If you don’t save enough and the markets don’t bail you out, there’s nothing you can do. If you over-save and do well, great—you can retire a few years earlier.


Phenix

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Re: Vanguard’s investment tips for 2017
« Reply #1 on: January 06, 2017, 12:54:03 PM »
Thanks for sharing.  I like sharing these types of articles with my co-workers.  I'm sure many ignore it, but I have had a few people ask me to help them with their asset allocation (and I'm always happy to lend a helping hand).

Gunny

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Re: Vanguard’s investment tips for 2017
« Reply #2 on: January 06, 2017, 05:19:29 PM »
You know, I've been reading and hearing market forecasters calling for lower returns over the next decade due to high valuations for a coule of years now. But what does that mean?  Two or three points below the average real return of 7 to 7.5, are dividends included in those predictions, does these predictions build in higher inflation rates?  I get that regardless of future return expectations equities are the best place to be going forward.  I would just like to nail down what the forecasted real return is based on a consensus of the "experts" so that I can properly manage my expectations.  My personal thoughts are is that we will see 3-4% real including dividends.  What say y'all? 

MrSpendy

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Re: Vanguard’s investment tips for 2017
« Reply #3 on: January 07, 2017, 10:12:34 AM »
gunny, most of the experts are predicting lower returns on account of

1) mean reversion in valuation (valuations are above average)
2) mean reversion in long term margins (margins are well above average)
3) recent low real earnings growth continuing

EDIT:
To provide a little more color

stock returns = dividend yield + real earnings growth + inflation + P/E multiple expansion / contraction

Most long term forecasts will make some assumptions about those 4 factors. Most things that I've seen that are predicting lower rates of real return assume

a) lower real earnings growth from margin contraction, mean reversion in margins, this is the basis for GMO's 7 year forecasts on stock returns being so low for U.S. stocks

b) mean reversion to historical valuations

If neither of those happen, then real stock returns from should be roughly equal to

2% (dividend yield) + 1.7% (LT real earnings growth) = 3.7%, right in line with your expectation

If valuations expand, returns will be higher. If valuations contract they'll be lower. If earnings grow faster than their historical real rate, then returns may be higher, etc.

The bottom line is that when an expert is making a long term return forecast, they are expressing some view of  what research affiliates calls the "4 fundamental building blocks of stock returns"  (dividend yield + real earnings growth + inflation + P/E multiple expansion / contraction)

Earnings growth can be broken down further into: revenue growth, EBITDA margin expansion / contraction, tax rate, leverage

P/E multiple expansion can be broken down further: bond yield & equity risk premium. You can make it as complex or as simple as you like.

https://www.researchaffiliates.com/documents/IWM_Jan_Feb_2012_Expected_Return.pdf
http://fortune.com/2011/06/12/buffett-how-inflation-swindles-the-equity-investor-fortune-classics-1977/
https://www.gmo.com/docs/default-source/public-commentary/gmo-quarterly-letter.pdf
« Last Edit: January 07, 2017, 12:52:50 PM by mrspendy »

Mr. Boh

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Re: Vanguard’s investment tips for 2017
« Reply #4 on: January 07, 2017, 02:58:09 PM »
^ Great post mrspendy.

I like the fourth tip:

"Stay well-informed. Great investors understand how all the pieces fit together. Become familiar with all the funds in your portfolio and know the role that each one plays in your investment plan. Stay abreast of the markets and economy, but don’t be driven by their movements. I realize it sounds paradoxical to say stay current but resist the urge to act. But that’s exactly what you should do."

It seems to me that people sometimes put all their faith in the index approach and then see no need to be otherwise informed. I think this is a mistake.


Dropbear

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Re: Vanguard’s investment tips for 2017
« Reply #5 on: January 07, 2017, 04:59:25 PM »
...stock returns = dividend yield + real earnings growth + inflation + P/E multiple expansion / contraction

Most long term forecasts will make some assumptions about those 4 factors. Most things that I've seen that are predicting lower rates of real return assume

a) lower real earnings growth from margin contraction, mean reversion in margins, this is the basis for GMO's 7 year forecasts on stock returns being so low for U.S. stocks

b) mean reversion to historical valuations

If neither of those happen, then real stock returns from should be roughly equal to

2% (dividend yield) + 1.7% (LT real earnings growth) = 3.7%, right in line with your expectation

If valuations expand, returns will be higher. If valuations contract they'll be lower. If earnings grow faster than their historical real rate, then returns may be higher, etc.

The bottom line is that when an expert is making a long term return forecast, they are expressing some view of  what research affiliates calls the "4 fundamental building blocks of stock returns"  (dividend yield + real earnings growth + inflation + P/E multiple expansion / contraction)

Earnings growth can be broken down further into: revenue growth, EBITDA margin expansion / contraction, tax rate, leverage

P/E multiple expansion can be broken down further: bond yield & equity risk premium. You can make it as complex or as simple as you like.

https://www.researchaffiliates.com/documents/IWM_Jan_Feb_2012_Expected_Return.pdf
http://fortune.com/2011/06/12/buffett-how-inflation-swindles-the-equity-investor-fortune-classics-1977/
https://www.gmo.com/docs/default-source/public-commentary/gmo-quarterly-letter.pdf

Great post, thanks mrspendy!

How does inflation impact upon stock prices?  To clarify: I'm not asking for future predictions, but more of a commentary of past financial climates that people might have experienced, where inflation has been high or low / rising or falling.  I'm wondering about this because I've only started investing during the current low interest rate period, and don't understand the implications involved for mustachians if inflation were to change?

maizeman

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Re: Vanguard’s investment tips for 2017
« Reply #6 on: January 07, 2017, 05:16:40 PM »
...stock returns = dividend yield + real earnings growth + inflation + P/E multiple expansion / contraction

...snip...

Great post, thanks mrspendy!

How does inflation impact upon stock prices? 

...snip...

The reason inflation is one of the four factors in that formula is that stock prices inflate like everything else. If inflation in a given year is 10%, the company's nominal revenue should increase 10%, nominal expenses should increase 10% and nominal earnings should increase 10%. For the P/E ratio to remain constant, the price of the company's stock also needs to increase 10%.

Now in reality big increases or decreases in inflation rate have lots of other impacts on the economy that can change profit margins, scare people out of equities, scare people out of bonds and into equities, and who knows what else all of which mean stock prices won't always track inflation from year to year, but all those other factors should all balance out in the super long term.

MrSpendy

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Re: Vanguard’s investment tips for 2017
« Reply #7 on: January 07, 2017, 06:30:49 PM »
ditto maizeman.

Inflation is one of the reasons earnings (and therefore stocks) go up over time. But in the short run, the answer is "who knows?" because heightened inflation may decrease earnings by causing business disruption or cause a decrease in price to earnings because inflation generally increases interest rates, or said another way inflation may increase the rate by which the market discounts future earnings.

1968 - 1982 saw a near 0% real return for equities and bonds because of inflation / corresponding rise in rates. 1982 - 2000 saw an incredibly high real return because of good growth and decreasing inflation / rates. There's more to it than that, but you get my point.

The Buffett article is helpful in thinking about inflation and stocks / bonds. He got a lot of it ( the future taxes and corporate ROEs) wrong. But it illustrates the relationship well.

http://fortune.com/2011/06/12/buffett-how-inflation-swindles-the-equity-investor-fortune-classics-1977/

Then there's the crazy type of inflation where people panic buy stocks because stocks represent productive assets instead of nominal cash

http://www.cnbc.com/2015/05/07/venezuela-stocks-up-300-percent.html
« Last Edit: January 07, 2017, 06:33:08 PM by mrspendy »

Dropbear

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Re: Vanguard’s investment tips for 2017
« Reply #8 on: January 11, 2017, 04:10:46 AM »
Thanks maizeman and mrspendy, it's good to get a better understanding of how these things work.

MrSpendy

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Re: Vanguard’s investment tips for 2017
« Reply #9 on: January 14, 2017, 08:10:46 AM »
Saw this in this mornings barrons and thought of this thread

The long term drivers of stock returns are earnings and dividend growth.

Valuation is a component in the "short term" (which may be 10+ years). Note how this expert leaves out inflation as a component of stock returns. That's simply because it is a component of earnings growth. Companies grow their earnings in real terms over time, but inflation is also a major component of earnings growth.

He highlights that increasing valuation rather than earnings growth has been the dominant factor of stock returns over the past 5 years, which can continue for a long time, but earnings/divvies need to catch up for "normal" equity returns to be "sustainable" from here.

Of course, no one knows the future.

http://www.barrons.com/articles/stocks-could-post-limited-gains-in-2017-as-yields-rise-1484376687?mod=BOL_hp_highlight_1

Quote
Priest: There are only three components of equity returns: dividends, earnings, and price/earnings ratios. In the past five years, the MSCI World Index was up 87%. Of that 87%, 74 percentage points came from P/E-multiple expansion. Earnings were down two percentage points, and dividends were up roughly 15 percentage points. The market was up because quantitative easing [central banks’ asset-buying programs] effectively lowered the discount rate applied to earnings and cash flow. It had a profound impact. The election was an inflection point, as we can see from the postelection rise in bond yields. P/E ratios now face a serious head wind. It can be overcome with accelerated earnings growth, and tax reform will be a part of that, if it happens. Also, dividends are going to grow, probably faster than people think.