From John Mauldin’s Investor Insight newsletter, a guest contribution by James Montier, Roadmap to Inflation and Sources of Cheap Insurance. The sources of cheap insurance include TIPS, Gold, dividend and inflation swaps, and Eurozone CDS’s that would hedge against a Euro breakup.
For those of us confused, PPIP explained by David Kotok of Cumberland: Head or Tails?
Mauldin’s Frontline Thoughts letter previews an upcoming article by Rob Arnott titled ‘Bonds: Why Bother?’ In it, he challenges the 5% risk premium normally assigned to equities (as quoted by Mauldin):
“My point in exploring this extended stock market history is to demonstrate that the widely accepted notion of a reliable 5% equity risk premium is a myth. Over this full 207-year span, the average stock market yield and the average bond yield have been nearly identical. The 2.5 percentage point difference in returns had two sources: inflation averaging 1.5 percent trimmed the real returns available on bonds, while real earnings and dividend growth averaging 1.0 percent boosted the real returns on stocks. Today, the yields are again nearly identical. Does that mean that we should expect history’s 2.5 percentage point excess return or the five percent premium that most investors expect?“
Mauldin then states:
Let me be clear here. I am not saying you should put your portfolio in 20-year bonds, or that I even expect 20-year bonds to outperform stocks over the next 20 years. Far from it! The lesson here is to be very careful of geeks bearing charts and graphs (it will be a challenge for my Chinese translator to translate that pun!). Very often, they are designed with biases within them that may not even be apparent to the person who created them.
Professor and Nobel Laureate Paul Samuelson in late 1998 was quoted as saying, a bit sadly, “I have students of mine – PhDs – going around the country telling people it’s a sure thing to be 100% invested in equities, if only you will sit out the temporary declines. It makes me cringe.”
When someone tells you that stocks always beat bonds, or that stocks go up in the long run, they have not done their homework. At best, they are parroting bad research that makes their case, or they are simply trying to sell you something.
As I point out over and over, the long-run, 20-year returns you will get on your stock portfolios are VERY highly correlated with the valuations of the stock market at the time you invest. That is one reason why I contend that you can roughly time the stock market.
Valuations matter, as I wrote for many chapters in Bull’s Eye Investing, where I suggested in 2003 that we were in a long-term secular bear market and that stocks would be a difficult place to be in the coming decade, based on valuations. I looked foolish in 2006 and most of 2007. Pundits on TV talked about a new bull market. But valuations were at nosebleed levels. And now?