Investment Wisdom Or Just Grumpy Old Men?

Today, we are now at another extreme, only this time it seems everything is expensive.  The Dow Jones Industrial Average is above 24,000, the S&P 500’s earnings yield, based on 2017 consensus earnings of $132.75, is 5.01%, and the 10 year US Treasury Bond is yielding 2.32%.  This is why us grumpy old men are cautious.  Not because we feel the economy is terrible, debt is unmanageable, or the future is doomed, but because on average, everything is more expensive than it has been for decades.

I want to clarify this difference in expected returns from the early eighties to today based on the S&P 500 index and the 10 Year Treasury Bond.

Expected Returns from a 60/40 portfolio in 1982:

 

Return on Current Price

Portfolio Weight

Portfolio Return

S&P 500 Earnings Yield

12.94%

60%

7.764%

10-Yr Treasury Yield

14.59%

40%

5.836%

 

 

Total Expected Return

13.600%

Standard & Poors as of January 1, 1982

 

Expected Returns from a 60/40 portfolio today:

 

Return on Current Price

Portfolio Weight

Portfolio Return

S&P 500 Earnings Yield

5.01%

60%

3.006%

10-Yr Treasury Yield

2.32%

40%

0.928%

 

 

Total Expected Return

3.934%

Source:  Argus Research and US Treasury 

Being cautious does not mean running for the hills, selling your stocks and bonds, and putting your money in a can buried in the back yard.  It does mean you must be prepared for the possibility of lower future rates of return.  For so many of us, we have become used to double digit returns on our investments.  We may have even increased spending or reduced the amount we are saving based on the returns earned in the recent past.  We should be prepared for an adjustment in prices on both common stocks and bonds.  For example, if you purchase the 10 year treasury and hold it to maturity, all you will earn is 2.32%, the yield today.  For common stocks, you should expect an adjustment in price.  Even if earnings continue to increase, even if the economy continues to improve, even if dividends continue to increase, prices will adjust, and we just hope they do not adjust with a big bang.  If earnings in the next twelve months reach $145.25, the current consensus estimate for the S&P 500, the index could easily decline to its historical multiple of 15 x earnings, or 2178, close to an 18% decline. 

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Disclosure: Anderson Griggs & Company, Inc., doing business as Anderson Griggs Investments, is a registered investment adviser.  Anderson Griggs only conducts business in states and ...

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