# Questions about stock investing theory



## james4beach (Nov 15, 2012)

It seems that most of us believe at this point that the stock market can offer us annual real returns of maybe 3% to 5%, or perhaps in nominal terms average returns of 6% to 7%.

Can someone explain to me how the stock market can enrich me, long term, at a (nominal) rate of 7% a year, when the economy is only growing at 2%-3% *at best*?

Are stocks not ultimately a reflection of growth in the general economy?


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## Market Lost (Jul 27, 2016)

james4beach said:


> It seems that most of us believe at this point that the stock market can offer us annual real returns of maybe 3% to 5%, or perhaps in nominal terms average returns of 6% to 7%.
> 
> Can someone explain to me how the stock market can enrich me, long term, at a (nominal) rate of 7% a year, when the economy is only growing at 2%-3% *at best*?
> 
> Are stocks not ultimately a reflection of growth in the general economy?


It's due to a few factors, but it boils down to the fact that economic growth is not evenly distributed, and productivity gains. Oh, and dividends really help.


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## mordko (Jan 23, 2016)

james4beach said:


> It seems that most of us believe at this point that the stock market can offer us annual real returns of maybe 3% to 5%, or perhaps in nominal terms average returns of 6% to 7%.
> 
> Can someone explain to me how the stock market can enrich me, long term, at a (nominal) rate of 7% a year, when the economy is only growing at 2%-3% *at best*?
> 
> Are stocks not ultimately a reflection of growth in the general economy?


Bingo!

Except that the under 2%% growth is typical for the sluggish socialized economies of the developed world in general and Europe in particular. Overall world economy has been growing at a better rate, around about 4-5%, which is consistent with real stock market returns. Listed companies tend to trade internationally and derive their profits worldwide. And in some cases governments have been borrowing to the tilt to inflate their markets, which = borrowing from future returns.


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## Nerd Investor (Nov 3, 2015)

Well, if you look at a specific stock and simplify things, really the only way for the price to increase is a combination of growth and a valuation expansion. I suppose looking at an index as a whole (is that what you mean by "stocks?") it's the same general idea. It's why, at least for Canada and the US, I generally prefer individual stocks to broad indexes. I can focus on fundamentals and do my best to ignore what's going on in the market. 

To bring this back to what I think you are asking though, I think you should check out Research Affiliates website. When forecasting expected returns for equities they essentially look at:
*yield + real earnings growth +/- valuation expansion/contraction +/- foreign currency adjustment * Here is a link to the paper delving into the methodology: https://www.researchaffiliates.com/documents/AA-Equity.pdf

And there is the section of the website with the various expected returns of different equity classes: https://www.researchaffiliates.com/documents/AA-Equity.pdf
US Large caps register as 1% expected real returns and Canada comes in at just over 5% real returns.


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## Eder (Feb 16, 2011)

Stocks tend to be forward looking...


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## Pluto (Sep 12, 2013)

A lot of entities that produce goods or services are not publicly traded companies so I don't think the stock market and gdp correlate.


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## doctrine (Sep 30, 2011)

james4beach said:


> It seems that most of us believe at this point that the stock market can offer us annual real returns of maybe 3% to 5%, or perhaps in nominal terms average returns of 6% to 7%.
> 
> Can someone explain to me how the stock market can enrich me, long term, at a (nominal) rate of 7% a year, when the economy is only growing at 2%-3% *at best*?
> 
> Are stocks not ultimately a reflection of growth in the general economy?


A company with a P/E of 15 can provide you with a shareholder return of 6.7% a year. If it is a large company subject to the real growth of the economy, add that and you have 8.7% to 9.7% a year. Companies historically have the ability to raise revenue with inflation, therefore if inflation is 2% on top of 2-3% growth, said company could return 10.7% to 12.7% a year, which is in line with the nominal return of the S&P 500.

This is what people forget - companies earn return on equity, which is a real return in today's dollars. If you pay a P/E of 20, your real return is 5%, *before any revenue or earnings growth due to economic or inflationary expansion.* 

Wow. That is why equities outperform everything in the long run.


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## mordko (Jan 23, 2016)

Profitability sometimes goes up, sometimes it goes down. Valuations sometimes go up, sometimes go down. On the whole the money you make in the stock market is surely correlated to GDP - unless publicly trading companies are cannibalizing profits from the rest of the economy over time... There could be a bit of that going on as smaller private business are being squeezed out by the red tape.


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## canew90 (Jul 13, 2016)

Dare I mention it again? My current dividends, without any increases or increase in capital are returning me 5.85% (and no there are no High Yielding stocks).


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## agent99 (Sep 11, 2013)

Some good points there! 

How to measure what you call, the "General Economy" is perhaps something to think about. GDP is probably not a good measure. For example, the rebuilding after the fires in Fort McMurray mayincrease the GDP. Same can be said for government spending - it increases GDP, but how does it affect the General Economy?

If markets gain, those that own stocks may be become more positive and increase spending, but I think I read that only about 50% of families have any stock market related income or savings . On the average, the "General Economy" may be higher when markets gain, but for a smaller and smaller percentage. In other words, just more of the economic inequality that is/will plague us going forward.


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## agent99 (Sep 11, 2013)

canew90 said:


> Dare I mention it again? My current dividends, without any increases or increase in capital are returning me 5.85% (and no there are no High Yielding stocks).


Why not? It is relevant. I posted about our average of about 5.25% with a 40-60% fixed income allocation too. But James has a very conservative approach. You can't achieve higher returns without taking some risk. My risk is that I avoid low yield bonds, gics etc and choose to invest in higher yielding fixed income and individual stocks of solid companies that pay good dividends (banks, utilities, pipelines, telecoms) If things change, we change. For example, we were led to believe that the world had almost run out of oil, so we owned energy companies. Not so much these days! No magic formulae - just common sense.


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## canew90 (Jul 13, 2016)

agent99 said:


> Why not? It is relevant. I posted about our average of about 5.25% with a 40-60% fixed income allocation too. But James has a very conservative approach. You can't achieve higher returns without taking some risk. My risk is that I avoid low yield bonds, gics etc and choose to invest in higher yielding fixed income and individual stocks of solid companies that pay good dividends (banks, utilities, pipelines, telecoms) If things change, we change. For example, we were led to believe that the world had almost run out of oil, so we owned energy companies. Not so much these days! No magic formulae - just common sense.


I'm sure you'd be closer to 6% if you were higher on equities. I'm 100% cdn equities with nothing else, except some cash to reinvest if and when the markets dip.


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## Rusty O'Toole (Feb 1, 2012)

james4beach said:


> It seems that most of us believe at this point that the stock market can offer us annual real returns of maybe 3% to 5%, or perhaps in nominal terms average returns of 6% to 7%.
> 
> Can someone explain to me how the stock market can enrich me, long term, at a (nominal) rate of 7% a year, when the economy is only growing at 2%-3% *at best*?
> 
> Are stocks not ultimately a reflection of growth in the general economy?


Suppose you get average returns, for example by buying an ETF that mimics the S&P 500 which is average by definition. Every year it returns 2% or 3% in growth or appreciation plus 4% in dividends from profits. There is your 6% or 7%.

Naturally this will vary from year to year, there may be some years you make 10% 12% or more and others when stocks go down. But on average over 10 or 20 years you will see average returns.


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## james4beach (Nov 15, 2012)

I found this paper that may be useful for others: Is There a Link Between GDP Growth and Equity Returns?

For the global average (or say the average of developed countries), yes real stock returns do track GDP growth. See Exhibit 4. But country by country, there is much variation and they don't track, even over long periods like 40 years.

I think there's still an important implication for us investors: since we diversify internationally, like with Global Couch Potato, this means we really *are* going to see stock returns that approximately match GDP growth. If western economies, which is mainly what we invest in, continue to have lower GDP growth as they currently do, this means that stock returns in developed countries will be lower too.

By the way this MSCI data shows 2% real return in stocks over the long term, matching the approx 2% real GDP growth. I don't know why I've heard number like 5% before ... am I misreading this document, or are real stock returns more in the 2% ballpark?

*Implication*: if developed countries stay at 0% real GDP growth for an extended period, then your stock returns as a developed-countries investor will tend towards 0% real growth too. Actually, probably a bit lower according to the MSCI data.


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## mordko (Jan 23, 2016)

...but like the article says, multinationals make profit all over the world. That includes EM. Apple sells to and makes profit in Russia and Brasil. Besides, right now there is little reason to avoid EM. Political risks these days loom large in the US, Britain, FranceGreece, Italy... How are they better than EM.?


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## Market Lost (Jul 27, 2016)

Do you have a post for the MSCI data? Developed nations have a return of more like 8.5% over a century, this link shows this as of 2012, and I don't think they've lost 6.5% since then.

http://www.moneysense.ca/columns/what-are-normal-stock-market-returns/


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## mordko (Jan 23, 2016)

Market Lost said:


> Do you have a post for the MSCI data? Developed nations have a return of more like 8.5% over a century, this link shows this as of 2012, and I don't think they've lost 6.5% since then.
> 
> http://www.moneysense.ca/columns/what-are-normal-stock-market-returns/


1. Subtract inflation.
2. Historic world GDP growth rates in the 20th century would have been around 4 percent.


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## doctrine (Sep 30, 2011)

james4beach said:


> By the way this MSCI data shows 2% real return in stocks over the long term, matching the approx 2% real GDP growth. I don't know why I've heard number like 5% before ... am I misreading this document, or are real stock returns more in the 2% ballpark?


US S&P 500 has 8% real growth, 11% nominal over the long term. Not all countries are created equal, even if they have GDP growth. Jeremy Siegel studies this in incredible detail in his book Stocks for the Long Run (first published 1994, since which S&P has risen 600%), which I consider a must-read. 

This notion of stock real return = GDP growth is fundamentally flawed and ignoring the basics of equity returns and equity pricing. For example, a country can experience a boom in GDP growth because of a _transfer_ in capital, not growth of in-country capital, and then subsequently experience capital destruction due to corruption, poor regulations, and bad management. Also, companies dramatically overpay for assets in these emerging economies and subsequently destroy capital even faster.

Now average the fast growing countries with poor returns into the more stable ones with higher returns, and you have poorer overall returns when then someone incorrectly correlates with world GDP growth and presto, the flawed perception continues. Virtually all of the long term outperforming countries are consistently advanced countries with less corruption, better regulations and the best management in the world who focus on capital returns, not GDP growth.


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## james4beach (Nov 15, 2012)

doctrine, I wonder why the disconnect then. This is the MSCI article where I'm seeing 3% real growth for the USA over 40 years. And 1.6% real stock price return. See Exhibit 3 on page 4. This time span ends in 2009, and perhaps that's why.
https://www.msci.com/documents/10199/a134c5d5-dca0-420d-875d-06adb948f578

That same table shows that on average for these developed countries, real GDP growth rate is 2.4% and real stock price growth 2.0%

Virtually every developed country in that table shows a *lower* real stock return than their real GDP growth rate. The only ones that "outperform" (meaning stock price > GDP growth) are Sweden, Denmark, Switzerland.

doctrine why is this result so different than what you're saying?


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## doctrine (Sep 30, 2011)

They don't publish the sources for their data, and have claims such as 50 year US stock market real returns of 1.5%, for which they base all of their conclusions on. I have no idea where they came up with that number, but it makes no sense to me. Looking at Jeremy Siegel's book, he uses slightly different time frames, but even 1946-2006 he quotes as 6.9% real compounded return for US stocks, 11.2% nominal. Since the creation of the S&P 500 in 1957, nominal returns have been 10.9%, which is consistent with the larger timeframe. I've never seen anything like 1.5% real US stock returns over 50 year holding periods. They are possibly confusing "growth in corporate profits" or growth in stock earnings with "real stock market returns", which are two entirely different things. S&P 500 growth has consistently provided real, cash-in-your-pocket, compounded annual returns of 7-8%, to which you can then add inflation, for 10-12% nominal returns. This looks to me more linking economic or corporate profit _growth_ with equity _returns_, of which total returns are of course far greater.


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## james4beach (Nov 15, 2012)

Well it's MSCI, you know, the market data & index research firm (as in MSCI EAFE index etc)

Here's an independent source on US real GDP: http://www.multpl.com/us-real-gdp-growth-rate

You can eyeball it from the chart or look at the data tables, which I copied into Excel.
50 year average real GDP growth rate is 2.81%
40 year average real GDP growth rate is 2.77%
30 year average real GDP growth rate is 2.54%

This data is also consistent with statista: https://www.statista.com/statistics/188165/annual-gdp-growth-of-the-united-states-since-1990/

It looks pretty conclusive to me. American real GDP growth is running around 2% to 3% average in modern times. There is nothing close to the realm of 8% real growth.


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## james4beach (Nov 15, 2012)

By the way I understand that stock returns will not equal GDP growth, but I wanted to clarify that issue of US real GDP growth rate


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## doctrine (Sep 30, 2011)

I don't have an issue with the quoted US real GDP growth, it's using 1.5% real stock market returns as a basis of comparison, which is simply wrong by nearly an order of magnitude. Real stock market returns have been double or triple that of the GDP growth.


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## Eder (Feb 16, 2011)

The largest contributor to GDP in BC is from people flipping houses to each other...how is this reflected in the stock market?


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## james4beach (Nov 15, 2012)

Flipping houses -> RE agent income, as well as bank lending & credit


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## Just a Guy (Mar 27, 2012)

I suggest you pick up the latest edition of A random walk down Wall Street. The first several chapters does a great job of explaining, in layman terms, how companies can game the system, how Wall Street tries to fool itself with systems, etc.

It's also written by people who actually study all here things using scientific method to find out if things are faith based or actually grounded in reality...i won't spoil the surprise for you as to what they conclude.


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## Market Lost (Jul 27, 2016)

mordko said:


> 1. Subtract inflation.
> 2. Historic world GDP growth rates in the 20th century would have been around 4 percent.


That still wouldn't account for the difference, and I believe it is in nominal term, and not adjusted for anything.


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## Market Lost (Jul 27, 2016)

doctrine said:


> They don't publish the sources for their data, and have claims such as 50 year US stock market real returns of 1.5%, for which they base all of their conclusions on. I have no idea where they came up with that number, but it makes no sense to me. Looking at Jeremy Siegel's book, he uses slightly different time frames, but even 1946-2006 he quotes as 6.9% real compounded return for US stocks, 11.2% nominal. Since the creation of the S&P 500 in 1957, nominal returns have been 10.9%, which is consistent with the larger timeframe. I've never seen anything like 1.5% real US stock returns over 50 year holding periods. They are possibly confusing "growth in corporate profits" or growth in stock earnings with "real stock market returns", which are two entirely different things. S&P 500 growth has consistently provided real, cash-in-your-pocket, compounded annual returns of 7-8%, to which you can then add inflation, for 10-12% nominal returns. This looks to me more linking economic or corporate profit _growth_ with equity _returns_, of which total returns are of course far greater.


I'm of the same mind. It seems rather dubious to me considering that the returns for the stock market, as Siegel notes are much higher.


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## james4beach (Nov 15, 2012)

For the MSCI data, it might have to do with the time period they looked at, ending at the recent low in 2009. While they started at a relatively low point, they also ended at a low point.

Last night I pulled up S&P 500 total returns and inflation rates since 2000. From this I calculated real returns since 2000, and the stock real return is around 2.5%. This example is starting at a high point, ending at a high point.

I wouldn't rule out 2% real returns going forward


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## Market Lost (Jul 27, 2016)

james4beach said:


> For the MSCI data, it might have to do with the time period they looked at, ending at the recent low in 2009. While they started at a relatively low point, they also ended at a low point.
> 
> Last night I pulled up S&P 500 total returns and inflation rates since 2000. From this I calculated real returns since 2000, and the stock real return is around 2.5%. This example is starting at a high point, ending at a high point.
> 
> I wouldn't rule out 2% real returns going forward


What you say about the study would make sense, but would also mean it doesn't actually do anything to show that stocks will follow GDP over time. This study is too short in time, and ends in period that is far in the fat tail of market returns. It kind of reminds me of the joke about how the engineer proves that all odd numbers are prime numbers by examining all numbers between 1 to 13, and throwing 9 out as a sampling error. Only in this case you use the sampling error to show that stocks follow GDP.


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## james4beach (Nov 15, 2012)

I agree, and don't see any clear case for stock returns tracking GDP.

I'm still trying to wrap my head around the core (fundamental) reason why this is. Is it because corporate profit growth doesn't fully get passed into the broad economy?

Or maybe because the economy is so much more than just publicly traded corporations


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## Market Lost (Jul 27, 2016)

james4beach said:


> I agree, and don't see any clear case for stock returns tracking GDP.
> 
> I'm still trying to wrap my head around the core (fundamental) reason why this is. Is it because corporate profit growth doesn't fully get passed into the broad economy?
> 
> Or maybe because the economy is so much more than just publicly traded corporations


As I was pointing out before, the rise in GDP is not even across the board, which mean certain large players can benefit from this inefficiency. Think about how Amazon is growing, but others such as Sears are having their lunch eaten. Many smaller companies that are getting hurt aren't anywhere near the main indexes. In addition, as others point out, many large corporations are multi-nationals, so they benefit from increases in other countries as well. Also, as I point out, companies are able to benefit from productivity increases, which can increase the bottom line faster than the top line increase. Companies will also cut costs to juice the bottom line - this was done to great effect just after the great recession. Finally, returns also benefit from dividend payments, which can be maintained even during times of shrinking earnings, as many corporations are doing now.


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## james4beach (Nov 15, 2012)

I'm mostly with you, but dividend payments do not enhance returns. They are just a ledger transfer to move already-earned income from one place to another. Dividends don't create wealth, they are just a payment mechanism.

A corporation earns profit and net income, which goes into retained earnings. At this point the profit has already been made. From there they can make a dividend payment, but that's just a cash transfer.


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## Nelley (Aug 14, 2016)

james4beach said:


> I'm mostly with you, but dividend payments do not enhance returns. They are just a ledger transfer to move already-earned income from one place to another. Dividends don't create wealth, they are just a payment mechanism.
> 
> A corporation earns profit and net income, which goes into retained earnings. At this point the profit has already been made. From there they can make a dividend payment, but that's just a cash transfer.


Yeah it is a just a cash transfer, but it is a cash transfer to ME. I prefer the cash in my hand rather than in the hands of management.


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## Market Lost (Jul 27, 2016)

james4beach said:


> I'm mostly with you, but dividend payments do not enhance returns. They are just a ledger transfer to move already-earned income from one place to another. Dividends don't create wealth, they are just a payment mechanism.
> 
> A corporation earns profit and net income, which goes into retained earnings. At this point the profit has already been made. From there they can make a dividend payment, but that's just a cash transfer.


Actually, they do enhance returns because people are buying future earnings, not past earnings. This is why you see stocks like Corus with a low PE of 7, while companies like Amazon and Tesla, which couldn't spell profit if you spotted them the 'p' and 'r' seem to rise no matter what happens to them, In addition, cash is the most useless asset a company holds because it does nothing but sit there. Giving cash to your investors allows them to crystallize past profits, and give them the ability to reinvest as they choose, but this is another argument. Dividends are certainly a substantial part of the returns of index investing, whether you agree with dividend investing or not.


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## agent99 (Sep 11, 2013)

james4beach said:


> W
> It looks pretty conclusive to me. American real GDP growth is running around 2% to 3% average in modern times. There is nothing close to the realm of 8% real growth.


Might be interesting to rather look at gdp and market growth per capita. Population growth has varied in the 0.5 to 2% range over past 50+ years. But more recently, growth rate is dropping.


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## agent99 (Sep 11, 2013)

james4beach said:


> I'm mostly with you, but dividend payments do not enhance returns. They are just a ledger transfer to move already-earned income from one place to another. Dividends don't create wealth, they are just a payment mechanism.


Once a dividend is in the hands of the investor, he/she may be more inclined to spend it. With groth stocks, probably only sell off some stock if markkets are up or there is a desperate need for the money. Not cut and dried, but I suspect that dividends have more of a multiplier effect on the economy.


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## Nerd Investor (Nov 3, 2015)

Market Lost said:


> As I was pointing out before, the rise in GDP is not even across the board, which mean certain large players can benefit from this inefficiency. Think about how Amazon is growing, but others such as Sears are having their lunch eaten. Many smaller companies that are getting hurt aren't anywhere near the main indexes. In addition, as others point out, many large corporations are multi-nationals, so they benefit from increases in other countries as well. Also, as I point out, companies are able to benefit from productivity increases, which can increase the bottom line faster than the top line increase. Companies will also cut costs to juice the bottom line - this was done to great effect just after the great recession. Finally, returns also benefit from dividend payments, which can be maintained even during times of shrinking earnings, as many corporations are doing now.


To add to this, think about how an index is weighted: by market cap aka not a great correlation to the economy. There are probably a dozen other metrics that would get you closer to a proxy for the economy (sales, number of employees, etc.) You think of something like the tech bubble and many of the biggest index constituents were companies that weren't even showing a profit yet. An index fund is essentially employing a form of momentum; you own more of a company as it's price increases regardless of fundamentals or impact on GDP growth.


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## Pluto (Sep 12, 2013)

james4beach said:


> I agree, and don't see any clear case for stock returns tracking GDP.
> 
> I'm still trying to wrap my head around the core (fundamental) reason why this is. Is it because corporate profit growth doesn't fully get passed into the broad economy?
> 
> Or maybe because the economy is so much more than just publicly traded corporations


I think we need some input from an economist on this. Where is Harold Crump when we need him?


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## Nelley (Aug 14, 2016)

GDP is an extremely flawed economic stat-people think it measures economic "growth"-they think GDP per capita measures economic standard of living but neither statement is accurate. Example: google GDP per capita-you will see Venezuela is at 13600-99 of 228 countries-Venezuela is totally imploding at the median.


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## atrp2biz (Sep 22, 2010)

I don't know if anyone has mentioned this, but capital structure may play a role. Companies are capitalized with debt and equity, so shareholder return is levered. So using round numbers, if the economy grows by 2%, shareholder value could increase by 4% assuming 50% debt capitalization.

There's also the multiplier effect. I'm not sure if there are parallels of this effect between economic and corporate growth.


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## andrewf (Mar 1, 2010)

james4beach said:


> It seems that most of us believe at this point that the stock market can offer us annual real returns of maybe 3% to 5%, or perhaps in nominal terms average returns of 6% to 7%.
> 
> Can someone explain to me how the stock market can enrich me, long term, at a (nominal) rate of 7% a year, when the economy is only growing at 2%-3% *at best*?
> 
> Are stocks not ultimately a reflection of growth in the general economy?


There is no reason to believe that returns to capital should be the same as economic growth. As long as the net rate of capital formation is higher, there is nothing inconsistent with having a higher return on capital than economic growth.


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## andrewf (Mar 1, 2010)

james4beach said:


> Well it's MSCI, you know, the market data & index research firm (as in MSCI EAFE index etc)
> 
> Here's an independent source on US real GDP: http://www.multpl.com/us-real-gdp-growth-rate
> 
> ...


Maybe they are not using total returns, and are excluding dividends?


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## andrewf (Mar 1, 2010)

Another way of framing future returns on stocks is as follows:

-It assumes that P/E ratio is stable over time (it is mean reverting, so this is reasonable at the limit) and that corporate profits are stable as a % of GDP (also mean reverting, so ditto).

*Current earnings yield + real GDP growth = real return on stocks.*

So at a P/E of 20, you have a current earnings yield of 5%, given 2% real GDP growth, presto you have 7% real return on stocks. Also, it is worth noting, P/E would have to approach infinity for real stock returns to match real GDP growth. Because P/E is a rather flawed measure given its sensitivity to current earnings, CAPE can be used instead. This is how outfits like Research Affiliates forecast future returns on various asset classes.


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## james4beach (Nov 15, 2012)

Thanks for all these replies.

andrewf - I've seen those studies about using CAPE to estimate forward returns, and that seems to be a promising method. Do you know of a web site that publishes Canada's CAPE? The US figure is still very high.



Nerd Investor said:


> To add to this, think about how an index is weighted: by market cap aka not a great correlation to the economy . . . *An index fund is essentially employing a form of momentum*; you own more of a company as it's price increases regardless


Good points. And yes I absolutely agree that index funds have an element of momentum investing in them. Companies whose market caps grow end up dominating the index. As an aside, I don't think that's necessarily a bad thing. This form of "momentum investing" (by following the largest cap weights) has been very successful in Canada. According to my own study of this where I grab the largest weight stock per sector out of TSX since 2000, this has outperformed the TSX. These big guys really have been the best performers in Canada this century.


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## andrewf (Mar 1, 2010)

Canada is at 18.4 according to this site:

http://www.starcapital.de/research/stockmarketvaluation

High, but not exceedingly so. The US is among the most expensive markets at the moment. I think the important thing to keep in mind is that CAPE is not perfect nor is it a market timing tool. But there are other measures such as price to book, dividend yield, etc. that often mirror CAPE.

I disagree that a market cap weighted index is exploiting the momentum factor. To get any benefit you need to overweight companies exhibiting momentum and *importantly* underweight when the momentum runs its course. The S&P 500 index didn't underweight AAPL after its momentum run ran its course.


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## james4beach (Nov 15, 2012)

On the index exploiting momentum - AAPL peaked at close to 4% of the S&P 500. Currently AAPL is down to 3.1% and MSFT is 2.4% weight so they're getting pretty close, and MSFT could easily overtake. I think that is showing the momentum effect in progress, though it's obviously not very nimble. Soon, MSFT will overtake.

The TSX 60 clearly shows momentum effect, with beautiful results:
- In 2003, CNR displaced BBD.B as the #1 weight in Industrials. Since then CNR has way, way, way outperformed BBD.B.
- In 2010, SU displaced ECA as #1 weight in Energy. Relatively speaking SU has gone on to do much better.
- In 2011, FTS displaced TA as #1 weight in Utilities. Since then FTS has way out-performed, TA crashed.

There have been no further displacement of #1 cap positions since 2011. When those occur in the TSX 60, it seems to be noteworthy. If this isn't exploiting momentum, I don't know what else you would call it.


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## Spudd (Oct 11, 2011)

So maybe a good strategy is just to buy a stock whenever it overtakes to become the #1 stock in its sector. If it is overtaken, ditch it and buy the one that replaced it. I wonder if it would be possible to backtest that.


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## Argonaut (Dec 7, 2010)

I think I remember TD overtaking RBC intraday as market cap leader once in 2011. It didn't hold, though. RBC has outperformed in the last five years since.


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## james4beach (Nov 15, 2012)

Spudd said:


> So maybe a good strategy is just to buy a stock whenever it overtakes to become the #1 stock in its sector. If it is overtaken, ditch it and buy the one that replaced it. I wonder if it would be possible to backtest that.


Yes, I did back test this using iShares XIU year end statements, so I was making that decision on Jan 1. From the {energy, financial, industrial, telecom, utility} sectors, I simply stayed long the #1 stock in each sector. When the year end statement showed a new #1, I sold the previous one and bought the new #1. This results in relatively few transactions and a mostly static portfolio.

The only cheat here is that I excluded tech, health, and materials sectors

Example was that BBD.B was the largest cap industrial stock up until the 2002 year end. That statement showed CNR was #1 as at Dec 31, 2002. Therefore I sold BBD.B and bought CNR on Jan 1, 2003. As it has not been replaced since, it still continues long.

Same is done in each of these 5 sectors, equal weight exposure. Since 2001-01-01 the annualized return is 9.0% for this versus 5.0% return from XIU -- a huge advantage, apparently. The figures include dividends. Here is a chart of the method vs XIU, each starting with $10,000. The reason the first data points are different is that each point is the portfolio value at the end of the indicated year, i.e. first point is 2001 year end which showed a loss in both portfolios.


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## james4beach (Nov 15, 2012)

i.e. quadruple your money instead of just doubling it, only by investing in the largest cap stock in each sector. Can this be true? I'd love it if someone can check my math. If you message me I'd be happy to send you all the iShares statements going back to 2001.


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## doctrine (Sep 30, 2011)

Large companies have significant advantages for maintaining momentum that some people forget about when they focus on smaller companies. For example, they have scale in production, can simply buy out their competition, and of course have scale and can issue shares and debt at lower prices and have access to capital when assets are on sale (i.e. Alberta oil crash) that smaller companies may not have. I own shares in the largest telecom, financial and utility company on the TSX, and have been impressed with the returns. Note Enbridge will almost certainly overtake Suncor as the largest energy company, post-takeover of Spectra Energy.


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## james4beach (Nov 15, 2012)

doctrine does my result (9% return vs 5% in XIU) seem plausible? It's just such a huge outperformance that I am doubtful of my back test. This would imply that the largest companies have had a very significant performance advantage over the rest of the TSX.


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## Market Lost (Jul 27, 2016)

james4beach said:


> On the index exploiting momentum - AAPL peaked at close to 4% of the S&P 500. Currently AAPL is down to 3.1% and MSFT is 2.4% weight so they're getting pretty close, and MSFT could easily overtake. I think that is showing the momentum effect in progress, though it's obviously not very nimble. Soon, MSFT will overtake.
> 
> The TSX 60 clearly shows momentum effect, with beautiful results:
> - In 2003, CNR displaced BBD.B as the #1 weight in Industrials. Since then CNR has way, way, way outperformed BBD.B.
> ...


Except if the stock displaces RY - this always ends in disaster.


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## james4beach (Nov 15, 2012)

In my backtest, MFC did replace RY at one year end, but it went back to normal the next year


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## mordko (Jan 23, 2016)

doctrine said:


> Large companies have significant advantages for maintaining momentum that some people forget about when they focus on smaller companies. For example, they have scale in production, can simply buy out their competition, and of course have scale and can issue shares and debt at lower prices and have access to capital when assets are on sale (i.e. Alberta oil crash) that smaller companies may not have. I own shares in the largest telecom, financial and utility company on the TSX, and have been impressed with the returns. Note Enbridge will almost certainly overtake Suncor as the largest energy company, post-takeover of Spectra Energy.


Except that over the long term shares in "small" companies bring higher returns than shares in large corporations. This may not have been the case over the last decade because of the overabundance of the red tape/entry barriers/lobbing/political patronage but things tend to get back to normal eventually. Indeed, lately small companies have been doing quite a bit better than the large ones.


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## james4beach (Nov 15, 2012)

Right, and long term studies have shown better performance among small caps (or maybe it was mid caps) in the US.

I agree that what we've seen since 2000 is a current theme, but we should be careful about generalizing and assuming it will always be the case. The largest companies don't always do better. In Canada they really have done the best since 2000, but that won't always be true.


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## andrewf (Mar 1, 2010)

james4beach said:


> i.e. quadruple your money instead of just doubling it, only by investing in the largest cap stock in each sector. Can this be true? I'd love it if someone can check my math. If you message me I'd be happy to send you all the iShares statements going back to 2001.


I don't think this finding holds generally. The largest market cap company in the US has typically underperformed the market overall.


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## mordko (Jan 23, 2016)

In the end of the day it's simple common sense. If Apple shares keep clicking at a decent rate, Apple will overwhelm the world stockmarket. Are we really going to spend most of what we buy on Apple products? If Canadian banks were to triple their value over the next decade, they would become more valuable than any other bank in the world while the Canadian economy is in tenth place by GDP. Just not happening. Valiant became rather big, didn't end well. Telephone companies... There is no way even the docile Canadian consumer will allow them to make the same profit ten years on. Meanwhile the larger they are, the less hungry they are and the more bureaucratic and cumbersome.


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## Market Lost (Jul 27, 2016)

james4beach said:


> In my backtest, MFC did replace RY at one year end, but it went back to normal the next year


Is that in actual market cap? The only companies I knew of that had a higher market cap than RY in the past few decades have been NT, RIM, and VRX, so I'm a bit surprised to hear this. I've even heard it called the Royal Bank Curse. 

Then again, MFC did get crushed a few years ago, so...hmmm..


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## mark0f0 (Oct 1, 2016)

james4beach said:


> It seems that most of us believe at this point that the stock market can offer us annual real returns of maybe 3% to 5%, or perhaps in nominal terms average returns of 6% to 7%.
> 
> Can someone explain to me how the stock market can enrich me, long term, at a (nominal) rate of 7% a year, when the economy is only growing at 2%-3% *at best*?
> 
> Are stocks not ultimately a reflection of growth in the general economy?


No. You don't need growth in order for stocks to provide a return greater than zero. A stock has a P/E ratio, which inverted, is E/P. If a stock has an E/P of 20, that means, every year, at the current price, it is converting $1 into $1.05 after all taxes, salaries, interest, and depreciation charges are taken. If there's no re-investment (beyond replacement of worn/depreciated capital), such a business could indefinitely pay a dividend of 5 cents a year.

With no growth, there's no reason that the business won't continue converting $1 into $1.05 for its owner. A 5% return is what we'd call this.

Now, when there is growth, that means that the business, over time, will be able to convert $1 into more than $1.05 for its owner. If you run the math, using 2% inflation and 2% growth, a stock index that has a P/E of 20 is priced to provide a total return of $0.09 annually. Or 9%/annum. 

The contemporary TSX is priced at a P/E ratio of approximately 15, which is an E/P of 6.67%. Inflation is generally targeted at 2%, and the economy grows at 2-3% *real*. So 6.67 + 2 + 2 ~= 10.67% implied annualized total return on the TSX. 

Of course, multiple expansion or alternatively multiple contraction will reduce actual experienced yearly returns. This is only of particular relevance if one re-invested some of their dividend cashflows or new funds into the index at either the reduced valuations (ie: multiple contraction), or at the elevated valuations (ie: multiple expansion).


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## mark0f0 (Oct 1, 2016)

humble_pie said:


> wondering what makes any of you believe that XIU is ever holding common shares in exactly the proportion each maintains in the actual reality ranking of the top TSX 60 stocks?


The amount of tracking error experienced makes it very unlikely that they're drifting meaningfully away from the actual TSX60 index. The creation/destruction mechanism for XIU, where baskets of index shares are traded for "creation-unit"-sized blocks of XIU (or vice versa) keeps the ETF manager honest. The whole thing is audited by PwC or Deloitte. Being that it is Canada's largest mutual fund, and over half of it is institutionally (ie: professionally) owned, it seems incredibly unlikely that there's any shenanigans. 

I'd be far, far more worried about some of the 'other' structures pushed by the 'other' companies in the marketplace which, for reasons of tax avoidance, or leverage, use structures which involve counterparties.


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## james4beach (Nov 15, 2012)

mark0f0 said:


> No. You don't need growth in order for stocks to provide a return greater than zero.


Well that's good news, because we're probably in a period where we'll get very low real GDP growth for a long time.

It seems that everyone is pointing me to the stock market earnings yield. Yes, there is corporate earnings growth, I agree.



> The contemporary TSX is priced at a P/E ratio of approximately 15, which is an E/P of 6.67%. Inflation is generally targeted at 2%, and the economy grows at 2-3% real. So 6.67 + 2 + 2 ~= *10.67% implied annualized total return on the TSX*.


If you really believe the TSX is going to keep providing a 10% to 11% total return, well ... you'd better go leverage that up.

Here's another question for everyone and it's a serious one.

*Why do corporations and traditional businesses even bother continuing to exist?* If corporations can produce 5% to 6% earnings, with all the effort that goes into it, how can that possibly be better than just converting into a TSX holding company that can get mark0f0's 11% return going forward?

e.g. lets say that I used to bust my *** running a retail business. Maybe I got 5% earnings in the past (as mark0f0 says converting $1 into $1.05 for owners). I can scrap this whole thing, and use my corporate structure to hold stock shares instead. Now I can tell my investors: good news everyone! Now I can annually convert your $1 to $1.11 and we'll all get 11% annual return, perpetually, and get rich while doing no work.

Surely that's superior to running a business?

Why would anyone bother running a company? Maybe the solution to our economy is to turn most existing companies into stock holding companies, so they can all do as well as the TSX stock pickers on our forum (who are reliably earning more than corporations do)


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## Eder (Feb 16, 2011)

Return on equity.


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## humble_pie (Jun 7, 2009)

james4beach said:


> *Why do corporations and traditional businesses even bother continuing to exist?* If corporations can produce 5% to 6% earnings, with all the effort that goes into it, how can that possibly be better than just converting into a TSX holding company that can get mark0f0's 11% return going forward?




i think james4 is onto something.

if shares in a business are destined to thrive better than the business itself - if a national stock exchange aggregate or index will outperform the economy itself - then what are we doing following an archaic economic model that dates back to the industrial revolution.

a forward-looking state would just run a bunch of robo businesses. Would give every citizen an endowment of common shares at birth. No jobs. No paid work. The state would provide some policing, some medicare & plenty of culture/recreation.

wait, i believe Tygrus has been posting along these lines.

.


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## humble_pie (Jun 7, 2009)

mark0f0 said:


> The amount of tracking error experienced makes it very unlikely that they're drifting meaningfully away from the actual TSX60 index. The creation/destruction mechanism for XIU, where baskets of index shares are traded for "creation-unit"-sized blocks of XIU (or vice versa) keeps the ETF manager honest. The whole thing is audited by PwC or Deloitte. Being that it is Canada's largest mutual fund, and over half of it is institutionally (ie: professionally) owned, it seems incredibly unlikely that there's any shenanigans.
> 
> I'd be far, far more worried about some of the 'other' structures pushed by the 'other' companies in the marketplace which, for reasons of tax avoidance, or leverage, use structures which involve counterparties.




so sorry but i beg to differ. Baskets of index shares can be disposed of in a second, can also be pre-disposed of via the generous derivative trading parameters set forth in the XIU prospectus.

the prospectus (page 60) states that XIU may "use derivative instruments to obtain exposure to the performance of the applicable index."

the prospectus further states that XIU may "invest in or use derivative instruments, including options, futures contracts, forward contracts and swaps."

the prospectus does not limit or restrict derivative usage other than to specify that they are not to be used for speculative purposes. According to the terms of the prospectus, XIU has the right to hold 100% derivatives but no actual shares, in order to approximate the stated index return.

that XIU manages to return the index with low tracking error does not prove that the fund is actually holding the common stocks. Rather, it proves how advanced is the math which is holding this ETF together.

https://www.blackrock.com/ca/indivi...ctus/ishares-index-funds-prospectus-en-ca.pdf


re "other" companies whose funds are tied to counterparties, might you be referencing horizons betaPro. 

as it happens, as a small retail investor i have found horizons betaPro to be the most transparent & the most fair-minded in my admittedly-anecdotal sample of querying fund companies. On the other hand, Black Rock was the most aggressive in denial. 

may i mention one other item, just to be clear. It's not indexing i oppose. Any investor can set up a close-to-index portfolio for himself & this will work efficiently. What i oppose is the massive opaqueness of the ETF vendors to date. I'm critical of the fact that regulators are not yet calling for full & fair disclosure to consumers.

again to be clear, what i would like to see are prominent notes in the audited financial statements, almost like coloured post-it notes. Security by security, these notes would say (a) this security is not presently held in this fund because it has been loaned to a broker/hedge fund combination.

or the notes would say (b) this security is not presently held in this fund because it has never been held in this fund. What is held instead is a representational sample.

or the notes would say (c) this security is not presently held in this fund because it has never been held in this fund. What is held instead is an index proxy which has been leased from another financial institution. The other financial institution is guaranteeing an index-equal return.

.


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## mordko (Jan 23, 2016)

james4beach said:


> Why would anyone bother running a company? Maybe the solution to our economy is to turn most existing companies into stock holding companies, so they can all do as well as the TSX stock pickers on our forum (who are reliably earning more than corporations do)


That is an awesome idea. CMF should formally approach the Government with this proposal.


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## james4beach (Nov 15, 2012)

humble_pie said:


> i think james4 is onto something.
> 
> if shares in a business are destined to thrive better than the business itself - if a national stock exchange aggregate or index will outperform the economy itself - then what are we doing following an archaic economic model that dates back to the industrial revolution.


And this is where I feel some unease. It doesn't seem like this should be the case. If it's true that the shares are expected to perform better then it seems that we should rethink the whole economy and capitalism: that lands us in funny-sounding logical end, like tearing down industry and replacing businesses with stock holding companies. That weird result suggests to me that something is wrong with the argument that shares will perform better than corporate earnings.

_Here's what I think solves some of the conundrum_: there has been a significant multiple growth (rising P/E) over the last few decades. Shiller PE or CAPE (see this link) started at below 10 in the 1980s, and expanded to 27 currently. This growing multiple is what made stock returns far superior to corporate earnings performance. We're talking here tripling the valuation, the premium vs earnings.

The only conclusion I reach from this is that I have no idea what P/E or CAPE the future will bring, and that stock market returns are entirely at the whims of that multiple even though corporations might have steady/predictable growth.


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## Rusty O'Toole (Feb 1, 2012)

humble_pie said:


> i think james4 is onto something.
> 
> if shares in a business are destined to thrive better than the business itself - if a national stock exchange aggregate or index will outperform the economy itself - then what are we doing following an archaic economic model that dates back to the industrial revolution.
> 
> ...


?????? Where do you suppose the profits come from that provide the earnings or dividends? It would be just as logical to say as long as my employer deposits my salary to my bank account automatically there's no reason to go to work. In case you can't figure it out, your salary deposits will stop if you stop work, and likewise the earnings and dividends will stop if a business stops selling products or services.

The funny thing is, if your economy was large enough it would be possible to follow this plan for years, eating up capital and consuming it, until suddenly for no reason at all, the economy collapses. The US has actually been doing this for years. Sending jobs overseas since the seventies and eighties, keeping the economy going on borrowed money until consumer credit expansion hit the wall in 2007, eking out an economy since then on government borrowing and running up debts to the Chinese. An economy that has seen practically no growth in twenty years if you back out government borrowing and statistical adjustments. And not one person in 1000 can see it. Oh well so far so good.


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## james4beach (Nov 15, 2012)

Rusty I agree with you that the US has entered a period of virtually no growth (16 years and counting) and I do think their economic collapse is under way. I generally avoid US stocks because I'm not comfortable with investing in that environment. But I'm considered an oddball.


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## mordko (Jan 23, 2016)

Well, CAPE, although high, is a lot lower than the recent pre- crisis conditions, like in 2008 or 2000. It might also be ok at the current levels because of the unusually low treasury yields. Still, long term potential has to be lower.

Then again, I get worried when people explain that market is a sure thing and how they borrow 100s of thousands to buy stock.


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## mordko (Jan 23, 2016)

... also find it peculiar that people would avoid US stocks but buy Canadian when our market is 15% more expensive based on multiples. 

And IF the new US president is even more protectionist than the current administration then Canada would suffer more than the US.


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## mark0f0 (Oct 1, 2016)

mordko said:


> ... also find it peculiar that people would avoid US stocks but buy Canadian when our market is 15% more expensive based on multiples.


Can you explain how you came to such a view that Canadian stocks are "15% more expensive based on multiples"? 

From everything I've seen, Canadian stocks (ie: the TSX index) is significantly cheaper than the US indicies (S&P500) on a CAPE, current P/E, P/B, and dividend yield (relative to sovereign debt) basis. With far less "financial engineering" involved to boot.


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## mark0f0 (Oct 1, 2016)

james4beach said:


> e.g. lets say that I used to bust my *** running a retail business. Maybe I got 5% earnings in the past (as mark0f0 says converting $1 into $1.05 for owners). I can scrap this whole thing, and use my corporate structure to hold stock shares instead. Now I can tell my investors: good news everyone! Now I can annually convert your $1 to $1.11 and we'll all get 11% annual return, perpetually, and get rich while doing no work.


Given that most small businesses produce sub-optimal returns and destroy capital compared to long-term buy and hold of the stock market indices, that's actually pretty good advice. 

Your question is basically along the lines of "why do people play the lottery when lotteries usually destroy personal value". Or "why do people buy actively managed funds when we know the indices beat the active managers most of the time". There are people who believe they're 'different', or that their particular business idea is 'special'. Similar to how the lottery player, despite the odds, holds an inane internal belief that they'll hit the jackpot. Obviously most end up failing at that, but the belief still persists nonetheless.

I would not advise anyone to start a small business unless they could project at least a 15-20% pro-forma ROE without leverage. After all, at current prices, you're getting 10-11% implied from a very simple investment in an index fund. 



> Why would anyone bother running a company? Maybe the solution to our economy is to turn most existing companies into stock holding companies, so they can all do as well as the TSX stock pickers on our forum (who are reliably earning more than corporations do)


If they can come up with a business plan with projected returns significantly greater than index investing, adjusted for risk, then by all means, starting one's own business is perfectly rational. Many small business rationalize owning a small business not through a high return on limited capital investment, but rather, for the fact that such provides them a 'job' as a manager.

There are a few exceptions, ie: people starting a business hoping to sell it to a sucker at the height of a mania (ie: we see this in the technology sector). But as a general rule, a lot of small businesspeople would have been better off merely working for someone else and building a portfolio over the years.


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## Oldroe (Sep 18, 2009)

After I exchange my Canadian for US I'm down 30%. So I'm looking for stock that will go up 60%.

Not interested.


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## mordko (Jan 23, 2016)

mark0f0 said:


> Can you explain how you came to such a view that Canadian stocks are "15% more expensive based on multiples"?
> 
> From everything I've seen, Canadian stocks (ie: the TSX index) is significantly cheaper than the US indicies (S&P500) on a CAPE, current P/E, P/B, and dividend yield (relative to sovereign debt) basis. With far less "financial engineering" involved to boot.


If you look ar the actual current profits and valuations, then TSX is 15% overvalued vs S&P. http://bloombergtv.ca/2016-09-30/news/canada-stocks-most-expensive-in-14-years-as-commodities-surge/

If you look at 5-year averages or projections or dividends then things are not quite so bad. However that's equivalent to making a bet that resource prices will recover rather than looking at how much money the company actually makes in the current conditions.


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## mordko (Jan 23, 2016)

Oldroe said:


> After I exchange my Canadian for US I'm down 30%. So I'm looking for stock that will go up 60%.
> 
> Not interested.


Are you saying this because CAD isn't at parity with USD? When you exchange you are only down by whatever fee you paid, usually a fraction of 1% if you use Norberts gambit. At any point you can exchange back into CAD and "recover your loss" in numerals, except that it could be a bit more or less depending on what the exchange rate has done.

What you are saying is equivalent to claiming that a kg of cheese is 1000 times lighter than 1000 grams of cheese. The currency is but a measuring stick for actual assets.


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## mordko (Jan 23, 2016)

The discussion about owning a business vs investing in stocks is missing the point. I thought it was a joke at first, but seems to be getting serious.

People start a business to succeed and find fulfillment in life, because they believe in themselves, as well as to make money. Stockmarket returns are far from certain and you depend on others rather than yourself. If you want to rely entirely on someone else for your livelihood then stockmarket is the way to go.

Incidentally, good investors who have ability to do so, invest in private companies rather than the stockmarket. One of several reasons is that the stockmarket is being played with by guys who are very good in maths and physics with very powerful computers.


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## Eclectic12 (Oct 20, 2010)

james4beach said:


> It seems that most of us believe at this point that the stock market can offer us annual real returns of maybe 3% to 5%, or perhaps in nominal terms average returns of 6% to 7%.
> 
> Can someone explain to me how the stock market can enrich me, long term, at a (nominal) rate of 7% a year, when the economy is only growing at 2%-3% *at best*?
> 
> Are stocks not ultimately a reflection of growth in the general economy?



Late to this thread but my two cents is that it depends on the basket one is holding ... and more importantly, putting aside things like how good management is, what drives the underlying business.

Thinks like generic brand makers or discount operations tend to have their business slow down when the economy is booming then pick up when the economy is slowing down. Or similar like paying for premium fast delivery.


The way most reports and news shows go about measuring the growth lumps all of these together into a single number but within the economy itself - there can be huge winners and losers.


Cheers


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## mark0f0 (Oct 1, 2016)

mordko said:


> If you look ar the actual current profits and valuations, then TSX is 15% overvalued vs S&P. http://bloombergtv.ca/2016-09-30/news/canada-stocks-most-expensive-in-14-years-as-commodities-surge/


That 'bloomberg' link really doesn't tell me anything, other than the opinion of some commenter that the TSX is 15% overvalued. Looking for hard statistical data, or at least something to contradict the fact that the dividend yield, earnings, etc., of the TSX index are significantly more favourable for much higher returns than the current valuation of the US (S&P500) markets.


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## mordko (Jan 23, 2016)

mark0f0 said:


> That 'bloomberg' link really doesn't tell me anything, other than the opinion of some commenter that the TSX is 15% overvalued vs S&P. Looking for hard statistical data, or at least something to contradict the fact that the dividend yield, earnings, etc., of the TSX index are significantly more favourable for much higher returns than the current valuation of the US (S&P500) markets.


You may find that pretty much every link and every expert calculated that TSX is 15% overvalued based on recent profits and current current share prices. Here is another example: http://www.theglobeandmail.com/globe-investor/investment-ideas/gi-newsletter/article32099588/

This is not an opinion at all; it's past profits and share prices. There is nothing more solid than price to earnings ratio, which is what 15% is based on.

Dividend yield can be high even when companies make losses; it depends on dividend policies. And yes, Canadian companies have been borrowing to pay dividends. This works only when interest rates are low and could hurt us long term.

Earnings... If you take forward earnings into account then that IS an "opinion".


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## mark0f0 (Oct 1, 2016)

mordko said:


> You may find that pretty much every link and every expert calculated that TSX is 15% overvalued based on profits and valuations. Here is another example: http://www.theglobeandmail.com/globe-investor/investment-ideas/gi-newsletter/article32099588/


No citation, no data or analysis. For all we know, the guy is just repeating the Bloomberg article (or vice versa). 



> This is not an opinion at all; it's past profits and valuations.


And from the data I have, with the TSX60 index trailing P/E ~=16, dividend yields dramatically in excess of the S&P500, and a significant chunk of the index trading closer to its cyclical bottoms than cyclical tops, it looks significantly undervalued. Falling earnings in the energy sector have been nicely compensated for by rising earnings in the heavily weighted financial sector. And the worst quarter of energy earnings, where prices fell to $28/barrel, are probably behind us.




> Dividend yield can be high even when companies make losses; it depends on dividend policies. And yes, Canadian companies have been borrowing to pay dividends.


Please cite some examples. I'm aware of some Canadian companies with negative or zero earnings paying dividends, but generally they are doing it out of cashflow, allowing their plant to deplete rather than re-investing. Which makes perfect sense in many industries. 




> Earnings... If you take forward earnings into account then that is an "opinion".


Earnings in Canada look great to me. The banks put up great numbers. The golds, now at ~8% of the index, are posting blow-out numbers. The O&G sector had a rough time earlier this year, but appears to be stabilizing as they get their headcounts under control. Telecoms (SJR, TU, BCE, Rogers) are still powering ahead. To be able to buy the TSX index for a mere 16X earnings in the midst of a severe resource downturn across the board is an absolute steal. 

But again, if you know of what sort of framework those people used to arbitrarily determine the TSX was 15% 'overvalued', please point me towards.


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## mordko (Jan 23, 2016)

> Equities in the S&P/TSX Composite Index traded at 23.6 times earnings Friday, the highest since September 2002.


If you think Bloomberg's data are wrong you should write to them.


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## mordko (Jan 23, 2016)

Also, 



> Profit for companies in the S&P/TSX retreated 11 percent in the second quarter amid lackluster economic growth. Energy producers in particular have been a drag, with earnings plummeting to a loss for the industry last year for the first time since at least 2002 pushing valuations past 300 times profit.


If you things earnings are doing great... Well, we have difference of opinions.


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## mark0f0 (Oct 1, 2016)

mordko said:


> If you think Bloomberg's data are wrong you should write to them.


Blackrock says:

https://www.blackrock.com/ca/indivi...0-index-etf?nc=true&siteEntryPassthrough=true

"P/E Ratio * 
as of 30-Sep-2016 
15.92 
P/B Ratio * 
as of 30-Sep-2016
1.94 
"

For the TSX60. 

The bank analysts are still saying TSX earnings of ~900-1000 this year, which puts us back at that 16 number.

P/B may seem high, but the very long term nature of many of the underlying assets makes that entirely justifiable. Canada's railways, for instance, have plenty of assets on their books, namely in right of way, at pennies on the dollar. Telecom assets, oilsands assets, mining assets, similar deal.



> If you things earnings are doing great... Well, we have difference of opinions.


Considering the depth of the downturn in that sector, and the nature of their assets, that they still have GAAP-compliant earnings is rather amazing, IMO.


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## Eclectic12 (Oct 20, 2010)

mordko said:


> The discussion about owning a business vs investing in stocks is missing the point. I thought it was a joke at first, but seems to be getting serious.
> 
> People start a business to succeed and find fulfillment in life, because they believe in themselves, *as well as to make money.*


{Bolding is mine ... }

I'll have to go through the thread to follow the discussion in full.

It is to to point that that for some business owners, this is true. 

On the other hand, for others I have spoken with - job one was to make money where they didn't really care whether they were stocking a range of goods, stuffing cold cuts into buns or fill coffee cups.





mordko said:


> Stockmarket returns are far from certain and you depend on others rather than yourself. If you want to rely entirely on someone else for your livelihood then stockmarket is the way to go.


I'd have said it was a mix that was mostly the "others".




mordko said:


> Incidentally, good investors who have ability to do so, invest in private companies rather than the stockmarket. One of several reasons is that the stockmarket is being played with by guys who are very good in maths and physics with very powerful computers.


Manipulation or not - I am not sure this is a hard and fast rule. Some investors I know have access to both and are in both markets. Where the slant is varies year to year based on their projections for where profits will come from as well as the prospects for the underlying business, among other things.


Cheers


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## mordko (Jan 23, 2016)

> https://www.blackrock.com/ca/individ...ssthrough=true


You keep referring me to TSX 60, which is a small fraction of TSX composite. TSX 60 is driven by banks. Yes, Canadian banks have reasonable valuations based on P/E. That's because they are very profitable right now and everyone is scared that their loans will go south. Also their growth potential is very limited because Canadians cannot possibly borrow any more than they already have.


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## mark0f0 (Oct 1, 2016)

mordko said:


> You keep referring me to TSX 60, which is a small fraction of TSX composite. TSX 60 is driven by banks. Yes, Canadian banks have reasonable valuations based on P/E. That's because they are very profitable right now and everyone is scared that their loans will go south. Also their growth potential is very limited because Canadians cannot possibly borrow any more than they already have.


The TSX60 and the TSX Composite are highly correlated. Anyways, you can look at the XIC ETF, which represents the TSX Composite. The P/E ratio is slightly higher there, reflecting the more speculative nature of the small caps that make up a slightly greater percentage of the index than the "big-stock" TSX60:

https://www.blackrock.com/ca/individual/en/products/239837/?referrer=tickerSearch



> P/E Ratio *
> as of 30-Sep-2016
> 16.54
> P/B Ratio *
> ...


Banks are 38% of XIU (TSX60), but 33% of XIC (TSX Composite). As far as their growth prospects go, take a look at the chart 1990-2000 for the big-5 (most of them tripled or quadrupled!). They did quite well in the environment of house price declines and were able to find replacement lines of business that proved to be much more profitable than chasing pennies on mortgages. It takes a lot less bank overhead to write a billion dollar loan to, for example, BCE, than it does to write 4000 $250k mortgages!


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## mordko (Jan 23, 2016)

Well, perhaps Bloomberg and Globe & Mail don't know what they are talking about. There is quite a difference between 16 and 23. 

Alternatively we are not comparing like with like and they are looking at earnings over a different period of time, taking into account the recent drop in profits.


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## mark0f0 (Oct 1, 2016)

mordko said:


> Well, perhaps Bloomberg and Globe & Mail don't know what they are talking about. There is quite a difference between 16 and 23.
> 
> Alternatively we are not comparing like with like and they are looking at earnings over a different period of time, taking into account the recent drop in profits.


https://www.nbc.ca/content/dam/bnc/.../economic-analysis/monthly-equity-monitor.pdf

Page 6 claims a trailing P/E ratio of 19.9 for the TSX Composite. With the S&P500 having a trailing P/E of 18.7.


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## mordko (Jan 23, 2016)

Getting warmer, but Bloomberg disagrees. And even Bloombergs number is based on misleading self reported earnings which don't follow standard accounting rules http://www.theglobeandmail.com/globe-investor/investment-ideas/gi-newsletter/article32050057/


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## Oldroe (Sep 18, 2009)

Banks are a big part of TSX.

Commodity's the other. Scrap cars has drop $60 MT in 3 months. I know you like 3 month old Bloomberg charts and calculations . This is on the ground today info.

I'm not worried yet but watching.


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## Oldroe (Sep 18, 2009)

I didn't think you would understand!


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## Pluto (Sep 12, 2013)

mordko said:


> Are you saying this because CAD isn't at parity with USD? When you exchange you are only down by whatever fee you paid, usually a fraction of 1% if you use Norberts gambit. At any point you can exchange back into CAD and "recover your loss" in numerals, except that it could be a bit more or less depending on what the exchange rate has done.
> 
> What you are saying is equivalent to claiming that a kg of cheese is 1000 times lighter than 1000 grams of cheese. The currency is but a measuring stick for actual assets.


Your analysis is based on the premise that exchange rates are static. If cdn $ goes up, then us investments lose relative to cdn $. He is saying that in order to get a 30% gain, he would need a 60% gain in us stocks if the cdn went back to par. Your cheese illustration is therefore flawed.


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## mordko (Jan 23, 2016)

CAD could go back to par, or it can drop 30 percent from current exchange rates. You could win or lose on exchange rate in the short term. Right now the chances of winning are higher. In the long term it's irrelevant, because the actual value of assets is the same, whatever measuring stick you are using to purchase it. Did you notice how the cost of everything we import goes up when CAD drops? Well, not really, it's just that your measure is a bit smaller.


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## mark0f0 (Oct 1, 2016)

mordko said:


> Getting warmer, but Bloomberg disagrees. And even Bloombergs number is based on misleading self reported earnings which don't follow standard accounting rules http://www.theglobeandmail.com/globe-investor/investment-ideas/gi-newsletter/article32050057/


If the P/E of the TSX were truly at 50, wouldn't we have a smokin' hot IPO scene? The article basically doesn't pass the smell test in so many ways.


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## Pluto (Sep 12, 2013)

mordko said:


> CAD could go back to par, or it can drop 30 percent from current exchange rates. You could win or lose on exchange rate in the short term. Right now the chances of winning are higher. In the long term it's irrelevant, because the actual value of assets is the same, whatever measuring stick you are using to purchase it. Did you notice how the cost of everything we import goes up when CAD drops? Well, not really, it's just that your measure is a bit smaller.


You seem to be lost in some ivory tower. You need to get down to earth. 
1. In the long term we are all dead, so it is relevant, especially to older people. 
2. Yes I notice prices of imports going up when CDN goes down. that means that Canadians have to work longer to buy the same imported item. So it is not just a different measuring stick. You are trying to say it is inches vs centimeters, but really it isn't like that when you have to work more hours for the same item.


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## mordko (Jan 23, 2016)

Pluto said:


> You seem to be lost in some ivory tower. You need to get down to earth.
> 1. In the long term we are all dead, so it is relevant, especially to older people.
> 2. Yes I notice prices of imports going up when CDN goes down. that means that Canadians have to work longer to buy the same imported item. So it is not just a different measuring stick. You are trying to say it is inches vs centimeters, but really it isn't like that when you have to work more hours for the same item.


OK, this needs plain English.

1. If you need the money soon then you shouldn't have your money in stocks. And yes, they should be in CAD so that you are not exposed to unnecessary currency risk.

2. They idea that by changing money from CAD to USD and buying US stocks you are instantaneously losing 30% = wrong + extremely silly.


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## Pluto (Sep 12, 2013)

mordko said:


> OK, this needs plain English.
> 
> 1. If you need the money soon then you shouldn't have your money in stocks. And yes, they should be in CAD so that you are not exposed to unnecessary currency risk.
> 
> 2. They idea that by changing money from CAD to USD and buying US stocks you are instantaneously losing 30% = wrong + extremely silly.


1. I want my money soon that's why I have it in dividend paying stocks. I get the dividends soon, and keep the stocks. But the stocks doesn't have to be all cdn as I bought US $ back around par. So I use that US$ for US stocks. But buying US$ now, for long term us investment is not worth the risk for some people, especially older folks. 
2. You are losing if the CAD$ then goes up. Your view only works if the exchange rate stays static, or cdn drops more.


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## mordko (Jan 23, 2016)

1. Whatever.

2. No, my view works if the investment is long term. 

If you buy a product or socks in another currency then over the long term the impact of currency nets out at zero. This is because while there could be short-term deviations, over long periods of time currencies always revert to trade at purchasing power parity. 

If you really think that US stocks are "more expensive than the actual value" if one were to change from CAD to USD then the reverse is true too - Canadian stocks are magically "cheaper than the actual value" if one were to change from USD into CAD. That would make millions of clever Americans buy up Canadian stocks and the prices on TSX-traded stocks would go up. Bingo - we are back to equilibrium.


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## mordko (Jan 23, 2016)

mark0f0 said:


> If the P/E of the TSX were truly at 50, wouldn't we have a smokin' hot IPO scene? The article basically doesn't pass the smell test in so many ways.


There are good reasons why companies are shunning the IPO market. At the time of IPO companies undergo a lot of scrutiny and misrepresenting profits with accounting tricks is much harder. 

Whether the real P/E is 50 or less, we know for a fact that a lot of creative accounting is going on. It's not just because the economy is under pressure and profits are hard to come by. One of the major reasons is that we don't have a national securities regulator.


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## Pluto (Sep 12, 2013)

mordko said:


> 2. No, my view works if the investment is long term.
> 
> If you buy a product or socks in another currency then over the long term the impact of currency nets out at zero. This is because while there could be short-term deviations, over long periods of time currencies always revert to trade at purchasing power parity.


How do you know it always reverts to purchasing power parity? what if the investor you are advising is 85, and long term is 50 years? 
for example in 1953 the GBP was about 2.7 to the US. Now it is 1.3. So when are the Brits going to get purchasing parity by reverting back to 2.7? How long is long term?


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## mordko (Jan 23, 2016)

> what if the investor you are advising is 85


See above. He should not be in stocks, unless he is planning to leave it for children.



> for example in 1953 the GBP was about 2.7 to the US. Now it is 1.3.


And in both cases it's close to purchasing power parity. Certainly in case of shares, anyone can see it by comparing prices for stocks trading in London and New York. Forget it, I am sorry I started this.


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## humble_pie (Jun 7, 2009)

mordko said:


> There are good reasons why companies are shunning the IPO market. At the time of IPO companies undergo a lot of scrutiny and misrepresenting profits with accounting tricks is much harder.
> 
> Whether the real P/E is 50 or less, we know for a fact that a lot of creative accounting is going on. It's not just because the economy is under pressure and profits are hard to come by. One of the major reasons is that we don't have a national securities regulator.



my goodness. Are you saying there will not be any more IPOs until we have a national securities regulator ... each:


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