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JohnCLeven (28.50)

Winter is Coming...



May 21, 2014 – Comments (19)

Winter is coming…

…but I’m actually looking forward to it.


Pardon my Game of Thrones reference, but Mr. Market, like the weather, can fluctuate wildly day-to-day.

Also the market, like the weather, follows slightly more predictable patterns over longer periods of time.

I can’t predict what the temperature is going to be next week, but I know there’s a high probability that the weather will be warmer in July than it is in May.

The last few years in the stock market have been like a sweltering summer. Total returns over the past 5 years were 26.5%, 15.1%, 2.1%, 16.0%, and 32.4%.

But what are the next 5 years likely to bring?

Well, S&P 500 earnings are at all-time highs, and history shows that S&P 500 earnings declines occur fairly often.

Corporate profits margins are at all-time highs, and likely to revert.

The market seems (to me) fairly expensive at 18x earnings unjusted earnings, but If we “normalize” those S&P earnings to normal or closer-to-normal margins, then the market is more like 22x-25x normalized earnings, which is VERY expensive, especially if those earnings stagnate or decrease over the next 5 years. (Which seems highly likely with profit margins at all-time highs.)

I wouldn’t be shocked to see the S&P 500 go basically nowhere for the next 5 years or so.

Again, I have no idea what the market is actually going to do between now and 2019, but it seems logical to me that the annualized return of the S&P 500 (not including dividends), between 5/21/14 and 2017-2019, will likely be less than 5% annualized.


So why am I excited for poor returns over the next few years?


Here’s why: as a rookie investor, at 25 years old, and have only been studying investing since about 2011, a raging bull market is really the ONLY market that I’ve ever experienced. (Lucky me)

Buffett said “It’s only when the tide goes out that you see who’s been swimming naked.”

Since I started investing 3 years ago the tide has only been coming in, coming in, and coming in.

The past 3 years have been a gravy train. The next 5 are almost certainly NOT going to be.

Inevitably, the tide will eventually have to go out, and when it does, I will see if I have been swimming naked or not.

That is the EXCITING part. What I’ve learned over the past few years of this bull market will soon be put to the test.

Just as the tide must go out eventually, this “5 year summer” we’ve enjoyed in the stock market must eventually give way.

Winter is coming.

19 Comments – Post Your Own

#1) On May 21, 2014 at 11:08 AM, EnigmaDude (61.48) wrote:

Patience, grasshopper.

(that's a really old reference, but like the weather, still relevant)

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#2) On May 26, 2014 at 11:50 PM, valuemoney (< 20) wrote:

What about the other half of the equation e/p = 10y? I think when you look at the market that way it doesn't look so expensive. Also I never use shiller it makes no sense to me because according to that the market was still to expensive in 2009 and 2010 in which we knew it wasn't. I wouldn't say too many equities that we look at with consistent earnings yields are too expensive right now. WFC and most of the banks in general. WMT BBBY PETM XOM MSFT IBM DE AXP PEP MCD CSCO AAPL DLTR NOV BRK.A all look resonably priced. I would bet in 5 years ALL THESE COMPANIES earnings will be higher. Thus the price if valued the same should be higher. Sure the market multiple could be lower but that is guessing and not putting at fair multiple at any given point in time. I would say the market is more pricey than before but by no means expensive in my mind. Especially when comparing it to 10 years treasury yields. I have to compare equities to the 10 year to get my value I am willing to pay for the equity at any point in time. If the 10 year was yielding let's say 6% I would agree with you that the S&P is fairly expensive. You are right in one way though. Returns won't be great over the next five to ten years. 5% year over year isn't too terrible though. Better than most other options IMO. Just some of my thoughts. 

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#3) On May 27, 2014 at 12:15 AM, valuemoneygreen (50.63) wrote:

One other thing I was wondering (sorry this is off the topic). What would be your top five picks today in the market? 

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#4) On May 27, 2014 at 8:38 AM, JohnCLeven (28.50) wrote:

I don't think we really have much of a disagreement here.

I'm not saying sell your stocks, and i'm especially not saying go sell those consistent, dominant cash cows we like.

What i'm saying, and you agreed with, is that market returns over the next 5-10 years will be lower than we've been accustomed to.

That's not a problem for us, actually it's an exciting opportunity.

In this lower-return market, intelligent stock selection will be more important that ever. I believe people that think about stocks the way people like you and I tend to, will do much better relatively in the next 5 years than the previous 5 years.

As you know, a value-orientation typically does relatively better when were NOT in a raging bull market.

The point of my post is simply that the time for value guys to really shine is on the horizon...and i'm very excited to see how that plays out.

As for my Top 5, i'll have to cheat a bit.

It's really hard to pick winners in tech and retail. So I have baskets in those categories that, in my mind, I sort of view as a single positon. 

Each of these 5 positions/baskets could be allocated at 20% each, and I think you'd do ok.

1.       BRK.B

2.       MKL

3.       Old Tech Basket (CSCO, MSFT, ORCL, IBM)

4.       Underappreciated retail basket (WMT, PETM, BBBY)

5.       PM

I'd expect this portfolio to appreciate roughly 10% annually or so over the next 5 or so years. That should (hopefully) translate into returns that are about double the S&P 500, which probably won't be higher than 5% annualized.


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#5) On May 27, 2014 at 10:42 AM, valuemoneygreen (50.63) wrote:

Yup we are on the same page. I just was curious on some on your picks. Plus it pry seemed to others reading this you were pretty bearish on equities. Thanks for clarifying! Hope you enjoyed the long weekend!

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#6) On May 27, 2014 at 10:43 AM, valuemoneygreen (50.63) wrote:

Yup we are on the same page. I just was curious on some on your picks. Plus it pry seemed to others reading this you were pretty bearish on equities. Thanks for clarifying! Hope you enjoyed the long weekend!

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#7) On June 04, 2014 at 2:47 PM, ElCid16 (95.43) wrote:

John - your top 4 picks and my top 4 picks are identical (order changed slightly).  I like your #5 but have never invested in tobacco stocks for reasons outside of expected returns.

What do you use to invest in your "stodgy" tech stocks?  My largest position is VGT.  Has been for about 2 years, now...


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#8) On June 04, 2014 at 9:45 PM, JohnCLeven (28.50) wrote:

That's seems like a pretty good basket.

I don't own any ETF's, but if I did, it would probably be this one. 

As you said in your blog post: 

"Sure, you could roll the dice and decide that you want to go with AAPL, GOOG, and QCOM - but why try?  Just take them all."


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#9) On June 08, 2014 at 4:21 AM, CoreAndExplore (60.78) wrote:

Hey John, I like the posts of yours I've been reading on various CAPS picks, and we are pretty much on the same page re: our stock picks as well. As a value investor myself, I like T for the first time in a while (its questionable DirecTV acquisition notwithstanding). And even though I picked up BLK at $158 a couple years ago, it STILL looks cheap IMO. I'm 27, so, like you, I've known mostly a raging bull market for the bulk of my investing career (started in '07 during an internship for an FA ironically), although I did get a taste of the financial crisis, and body did that test one's intestinal fortitude and ability to "stay the course" as John Bogle is so fond of advising. Thankfully, not it looks like it's about time for the prudent value investor to truly shine! Exciting times indeed.

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#10) On June 08, 2014 at 4:22 AM, CoreAndExplore (60.78) wrote:

*supposed to say "boy," not "body" in the post above, lol

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#11) On July 11, 2014 at 11:25 PM, JohnCLeven (28.50) wrote:

Thanks Core, glad to hear from you!

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#12) On July 14, 2014 at 3:45 PM, JohnCLeven (28.50) wrote:

Here's a thought exercise for future reference:

If 1) GDP grows at a hypothetical constant 4% annualized, 2) we assume a historically average 6.5% corporate profit margin as a % of GDP, and 3) a historic median PE of 14.5...

...then where should we expect, roughly, the S&P 500 to be in 15 years, in 2029?

Answer: Pretty much right where it is today.

Conclusion: It would not be surprising if the S&P 500 goes no where for the next 15 years.

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#13) On July 14, 2014 at 3:47 PM, JohnCLeven (28.50) wrote:

Meanwhile, it would not be unreasonable for Berkshire Hathaway or Markel to triple during that same time frame.

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#14) On December 28, 2014 at 10:55 AM, JohnCLeven (28.50) wrote:

After thinking about this more, I think 15 years is probably too pessimistic.

I'd rather be on the record saying that I expect the S&P 500 may trade around today's prices ($2000-$2100) roughly 10 years from now, implying close-to-zero returns from capital gains over the next decade. 

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#15) On December 28, 2014 at 4:23 PM, TransverseSlice (< 20) wrote:

I am a bit late to this party, but I just noticed your blog. I don't really disagree with anything that has been said above. However, I would like to point out that there is one big factor that influences valuation that has not been given much attention in the discussion above: the risk free rate of return. Certainly I am not expecting the interest rates to stay at almost zero forever. But where the S&P500 goes for the next 10-15 years will depend heavily on this. That and that most ephemeral of factors - psychology of market participants (look at what happened 1982-1999).

Furthermore, I should also point out that one of the reasons corporate profits as percentage of GDP are at an all time high is because of bonus-depreciation rules in effect 2008-2013. Essentially companies were able to front load a lot of depreciation in that period . Put differently much of the profit booked this year would have been depreciation expenses had it not been for the bonus-depreciation rule. The effect is not insignificant - if one looks at economic profit (i.e., not accounting profit) adjusted for this, then profits as percentage of GDP are almost 200 basis points lower (i.e., much closer to historic averages).  

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#16) On December 28, 2014 at 7:04 PM, TransverseSlice (< 20) wrote:

I also don't follow the math in your `thought exercise'. Here's a quick back of the envelope calculation:

Assuming GDP grows at 5%, then in 15 years GDP will have approximately doubled. If earnings are 6.5% of this and market P/E is say 13, then for market cap 15 years down the line to be same as current market cap, current market cap would have to be 169% of GDP. Last I looked at the data, market cap was about 120% of GDP.

 So is it me screwing up the arithmetic or you? 

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#17) On July 30, 2015 at 2:38 PM, JohnCLeven (28.50) wrote:

Hi Transverse,

At the time of that writing, I had about $80 as the "smoothed out EPS" of the S&P 500. I then assumed 6% EPS growth, getting us to about $143 in 2024, and slapping on a multiple of 14.5x gets you to $2073 on the S&P 500 in 2024, which would be 0% annualzied returns. Dividends might take total returns up to roughly 2.5% annualized.

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#18) On July 30, 2015 at 2:55 PM, JohnCLeven (28.50) wrote:

Still waiting patienly for winter, by the way.

Winter is *still* coming... 

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#19) On July 30, 2015 at 3:13 PM, ETFsRule (< 20) wrote:

Maybe I'm an optimist, but I think bull markets can be very long-lived. From 1942-1966, there was an almost non-stop bull market. Then you had a flat decade. Then a 20-year, virtually unstoppable bull market through the 80's and 90's. Then a flat decade in the 2000's (with some ups and downs).

Now we are in a 5-year bull market, but we only surpassed the 2008 peak about 2 years ago. So the market has only been running up into "new territory" for a little over 2 years.

We might have a correction, but I think a bear market is unlikely. Extended bear markets are pretty rare. I wouldn't be surprised to see another 15 years of high returns.

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