Another Lost Decade For Market Returns

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In their latest episode of the VALUE: After Hours Podcast, Taylor, and Carlisle discussed Another Lost Decade For Market Returns. Here’s an excerpt from the episode:

Tobias: What’s your update on the pieces that moved? You don’t have to give us an update? Just a reminder of it, you know margin rates.

Jake: Yeah. Well, there’s not really an update per se. I had backward looking numbers for 10 years that showed the decomposition of returns. Is that what you’re talking about?

Tobias: Yeah.

Jake: And then I’ve put my own theories together as to what I would be willing to underwrite for the next 10 years. But any of that time period in between that small doesn’t really have– there’s not much to speak about.

Tobias: Do want to give us an update? Let us know where we are.

Jake: [laughs]

Tobias: Where is the most pressure do you think in there? Margins, multiple?

Jake: Yeah, I think certainly, I’m comfortable underwriting 3% for the growth rate top line sales. So, basically GDP growing. Who knows? There’s a fair amount of government printing that happens in that 3% previously. So, if that keeps going, I don’t know. But long, long term, that 3% has been pretty solid. We can underwrite that. Profit margins, yes, that currently like 13% is way over. And if you believe that Grantham is not stupid when he says that “Profit margins are one of the most mean reverting datasets in all of finance,” if you believe Buffett’s not an idiot when he says that, “Do not expect more than about 6% to be yielded to capitalism share of the pie to the owners.” So, we’re at 2x that and we have been for quite a while. I have a hard time imagining underwriting it growing from 13% to 20% or something to give you a bunch of returns.

And then lastly, yeah, share count is another component there. We’ve levered up a bunch in the last 10 years to do share count to do buybacks, which if rates are rising and corporate debt doubled over that time period to do those buybacks, I’m not sure you can pull that lever again for the next 10 years. And then lastly, the multiple which as you know has a very high– The multiple from 2011 to 2021 gave you almost 6.5% of per annum compounding return for you in the expansion of the multiple from 2011 to 2021.

As you mentioned, Cape is high. They all sit like Cape is a crap that doesn’t tell you anything about timing, but it does rhyme with all the other valuation metrics like market cap to GDP, Tobin’s Q. They all tell you the same thing that things are still very expensive. So, you probably have to fake multiple a little bit. You add all those things up– And the dividends will probably give you a good 2%-ish, I would think. But it’s hard to get a much above zero for the next 10 years in one of these levers. And I don’t know which of these, where I’m wrong on these, but I’m sure I’m wrong somewhere. I just don’t know how wrong am I and in what direction. [chuckles]

Tobias: Looking back in 10 years’ time with the Shiller P/E at 60. You’ll say, “Well, that was the problem.”

Jake: Yeah. You’d say– [crosstalk]

Tobias: You didn’t expect margin expansion, too.

Jake: Well, yeah.

Tobias: I mean, multiple expansion.

Jake: Yeah, exactly. We get full Japan 1989 Shiller P/E at 100 or something. “Oh, well, that’s how we were wrong.”

Tobias: China hit a 100, Japan hit a 100. The US has never hit a 100, 44 is the top in April 2000. If you take that Shiller P/E and you assume that it mean reverts to the average over 10 years that’s John Hussman’s method and I use that– It’s just I calculated on a rolling basis. I have a little app that calculates that for me. The expected return now, so that assumes 2% in interest rates sorry, 2% in dividends, you get multiple compression over 10 years from– It’ll be 30 to about, I think it’s 16.6 or 16.7.

Jake: Yeah, 17-ish is the long run right now, I think.

Tobias: You get 3.3% compound including about 1.7% in dividends. And so, when we look back, the highest that it’s been in recent memory was March 2020 when it got to like 5.3, I think, as a forward return that was at the very bottom. But before then, we’ve had periods of time where it’s delivered reasonably good forward returns. It’s just that we’re not now. Late last year, it was at 0.6%, which is just insane.

Jake: Oh, yeah.

Tobias: Particularly, when the 10-year is at a discount– The 10-year gave you more yield.

Jake: Yeah. Well, that’s not good [laughs] if you’re right back there.

Tobias: Is it a zero-forward return from your calculation?

Jake: My underwriting, I’m looking at more like a minus two.

Tobias: Yeah. For 10 years compound?

Jake: Yeah.

Tobias: Is it 10 years? Is that the period?

Jake: That’s minus 20, total-

Tobias: Yeah. Well.

Jake: -which is sobering. I hope I’m wrong. I hope that that’s a little too pessimistic on one of those variables and that we don’t see– Maybe margins don’t compress as much. Who knows? You can see five different ups and downs in the middle of a decade. But it’s just the starting point of this particular decade. It started at such a tiptop similar rhyming to 99, how that looked and how it took. It was the last decade from 2000 to 2010 as well. So, it wouldn’t surprise me to have that same phenomenon play out.

Tobias: The weird thing was, we now remember the dotcom boom as being dotcom boom. That was fairly localized into a handful. They got very big, but it wasn’t just a dotcom bubble. It was that bubble in all the other really high-quality stocks, too. The ones that I always remember a lot.

Jake: Even just big versus small, the large cap was very, very expensive at that point.

Tobias: Once I always mentioned at Microsoft, Walmart, and GE, because that was right at the end of the Neutron, Jack’s reign, and everybody loves GE, even though it was– I do remember some articles at the time saying, “The return on equity has deteriorated quite a lot in GE and it’s taken on quite a lot of debt.” So, those two things together weren’t good. But it was one of the most respected companies around. And then he had Walmart. It had been winning for 25, 27, 28 years, something like that at that point. And Microsoft, of course, went really expensive. And 15 years later, they were trading exactly where they were in 2001, not on a multiple basis, the stock price was trading where it was-

Jake: Yeah.

Tobias: 15 years later.

Jake: You have to grow into those kinds of lofty expectations that are baked into a high stock price. That can take a while.

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