Great piece, thanks. I agree that markets are not in for a smooth ride for the foreseeable future.
One area that is worth digging in more is something you alluded to briefly: “and if market forecasts of earnings are approximately correct”.
I worked as a stock analyst on Wall Street for about a decade and I noticed that forecasts of earnings both for individual companies and the market as a whole are usually wildly off base.
It makes it tricky to analyze things - either you go off of past earnings, but those don’t tell you what future earnings will be, or you try to estimate future earnings yourself. That’s feasible for individual companies, but very hard to do 500x for the entire index.
One other point to note is that historical P/E multiples may not be the best indicator of future multiples. Buyback activity has increased dramatically as a share of capital deployment and this will skew multiples. There are good research papers on this phenomenon, though I don’t think they have been well-understood on Wall Street.
Another factor (or perhaps a different view of the same elephant) is changing time preference. If expected returns are constant, increasing preference for present consumption leads to drops in financial asset prices (or, equivalently, the return that must be offered to attract investment increases).
Over the last few years, the Boomers mostly retired and left the demand side of the market (they're still on the supply side, trying to fund their retirements with proceeds from asset sales). Gen X (my generation) is at its peak earning potential and maximum preference for retirement savings, but isn't nearly big enough to replace them. The Millennials are still mid-career with kids and debts and need the money now.
When demand falls, prices go down. When demand falls in a protracted manner in financial assets (whose prices are largely defined by anticipated future demand) prices crater.
Thanks for the reference. Ilmanen is right to ask for humility in investment. The massification of wealth and the poor knowledge of most investors have created a big industry of financial intermediation in which fund managers are worse than physicians, lawyers and economists as advisers --and much worse than plumbers as executives. To make things worse, and regardless of our opinions about the past, investors and their fund managers have to cope with the increasing uncertainty posed by most politicians and government officials like your senile President and most other elected and non-elected presidents elsewhere.
BTW, those two forces (increasing massification and limited knowledge) are poorly reflected in most descriptions and analyses of financial-market processes since 1980, including the roles of central banks and treasuries on behalf of governments and the policy responses to facilitate government control of intermediaries. Soon you will know about how Chile's quasi-private pension system --the country's largest part of the financial intermediation system-- may end.
William F. Sharpe invited me to give a talk on this topic at Financial Engines in the late 90s. Bill seemed unconvinced, but one of his colleagues (I'm not totally sure, but it might have been John G. Watson) mentioned Robert A. Haugen having written extensively about this.
I just found this product from treasurydirect called I bonds will have a great nominal yield, but it’s all reinvested until sale. in a few days, the new rates should be 9%+, but there are modest maximums per person per year
Great piece, thanks. I agree that markets are not in for a smooth ride for the foreseeable future.
One area that is worth digging in more is something you alluded to briefly: “and if market forecasts of earnings are approximately correct”.
I worked as a stock analyst on Wall Street for about a decade and I noticed that forecasts of earnings both for individual companies and the market as a whole are usually wildly off base.
It makes it tricky to analyze things - either you go off of past earnings, but those don’t tell you what future earnings will be, or you try to estimate future earnings yourself. That’s feasible for individual companies, but very hard to do 500x for the entire index.
One other point to note is that historical P/E multiples may not be the best indicator of future multiples. Buyback activity has increased dramatically as a share of capital deployment and this will skew multiples. There are good research papers on this phenomenon, though I don’t think they have been well-understood on Wall Street.
Lee
Check out Jeffrey Carter, long time Chicago finance & actual commodities trader, now in Nevada.
https://jeffreycarter.substack.com/p/its-risk-off?s=w
He's more specifically pessimistic, and likely with more investment relevant analysis.
Another factor (or perhaps a different view of the same elephant) is changing time preference. If expected returns are constant, increasing preference for present consumption leads to drops in financial asset prices (or, equivalently, the return that must be offered to attract investment increases).
Over the last few years, the Boomers mostly retired and left the demand side of the market (they're still on the supply side, trying to fund their retirements with proceeds from asset sales). Gen X (my generation) is at its peak earning potential and maximum preference for retirement savings, but isn't nearly big enough to replace them. The Millennials are still mid-career with kids and debts and need the money now.
When demand falls, prices go down. When demand falls in a protracted manner in financial assets (whose prices are largely defined by anticipated future demand) prices crater.
Thanks for the reference. Ilmanen is right to ask for humility in investment. The massification of wealth and the poor knowledge of most investors have created a big industry of financial intermediation in which fund managers are worse than physicians, lawyers and economists as advisers --and much worse than plumbers as executives. To make things worse, and regardless of our opinions about the past, investors and their fund managers have to cope with the increasing uncertainty posed by most politicians and government officials like your senile President and most other elected and non-elected presidents elsewhere.
BTW, those two forces (increasing massification and limited knowledge) are poorly reflected in most descriptions and analyses of financial-market processes since 1980, including the roles of central banks and treasuries on behalf of governments and the policy responses to facilitate government control of intermediaries. Soon you will know about how Chile's quasi-private pension system --the country's largest part of the financial intermediation system-- may end.
Thank you Arnold. Good basic lesson about asset valuation and 1 price theorem in financial markets. About being old: economic laws are timeless.
William F. Sharpe invited me to give a talk on this topic at Financial Engines in the late 90s. Bill seemed unconvinced, but one of his colleagues (I'm not totally sure, but it might have been John G. Watson) mentioned Robert A. Haugen having written extensively about this.
I just found this product from treasurydirect called I bonds will have a great nominal yield, but it’s all reinvested until sale. in a few days, the new rates should be 9%+, but there are modest maximums per person per year