Is the Trump Rally Warranted?
Hopes, dreams, aspirations, and animal
spirits are what drive the market over the short term making predictions a fool’s
endeavor. However predicting returns over
the long term (more than seven years) for dollars invested today or stocks held
at this level going forward predicting can be done with enough accuracy for financial
planning. The reason for this optimism markets over long periods of time will regress either up or down gravitating to
their mean. Simple algebra is required
along with historical data to draw from forming a very close estimation for
future returns. For those of you who
freak out at any level of math not to worry as moneychimp.com has an
interactive calculator to do all of the work for you.
Ok so where to we stand now? As of 2-03-17 the S&P 500 is at 2297 with
a dividend yield of 1.99% and a Shiller PE10 at 28.47 times earnings. Put the data into moneychip.com’s
calculator and accepted their historical 5% (before inflation) historical earnings growth
and drum roll please…the 10 year annualized estimated total return is 1.56%! The market will be 100 points below 10 years
from now! WOW! What a barn burner! This return is
before fees, commissions, trading impact costs, and the 800 pound gorilla –
INFLATION.
Let’s break down the tyranny of costs:
(1.)
Commissions: Hopefully all of you are using no load mutual
funds or if buying individual stocks are using a discount trading house. I’ll assume there are no up front fees. However money managers at mutual funds will
have to pay commissions on their trades on your behalf that will reduce your
return by the amount paid. I’ll be very
conservative and assume that an actively managed fund manager is not a gun
slinger dancing in and out of the market at a moments notice or better still you
are using an index fund dropping commission costs substantially.
Cost 0.1%
(2.)
Fees - Expense ratio: Fancy language for what percentage the mutual
fund is going to charge you. This can
range greatly from 0.05% (Vanguard’s S&P 500 index fund) and many as high
as 2.0% along with a scattering at 2.5% or higher. Staying conservative I’ll assume everyone has
the average mutual fund expense ratio of 1.25%
Cost 1.25%
(3.)
Trading Impact Costs: Every time a money manger begins to sell or
buy into a stock or bond he will drive up or down the price by his own
doing. This has happened due the immense
size of the funds as he majority of funds are in the multi billion dollar range. Even index funds will suffer from this but at
a far lesser degree as they deal with monies entering or exiting the fund. Active managers who aggressively move in and
out of stocks (or bonds) unwittingly generate this drag on performance increasing
the odds for index funds beating their performance over rolling 5, 7 and especially
10 year returns. Simply put the tyranny of
lesser costs compounds in the favor of index funds.
Cost 0.50%
(4.)
Inflation: The
800 pound gorilla brought to you by our central bank and chronic deficit
spending reducing our future purchasing power all based on the misguided
believe (propaganda) you can achieve something for nothing. I’ll leave that discussion for another post. The Federal Reserve is hell bent on
delivering 2% inflation but as we all know the books are cooked so if they say
2% it is more likely 3% right along the average since 1913.
Cost 3.0%
That
all adds up to 4.85% as compared to our estimated return of 1.56%. So…4.85% minus 1.56% equals negative
3.29%. State and local government
workers have the old style retirement plans.
This is why government pensions are underfunded as most mangers have
made a return assumption of 8%! This
will only get worse as the market valuations remain at nose bleed levels and
then to add insult to an already deplorable situation as the market sells off
45% to 60%. A major pension crisis is
here now and is going to get worse over the next 10 to 15 years! Those who are self funding using such plans
as 401k’s, IRA’s, etc. are in the same boat as well. There is now a pension crisis that is only
going to exacerbate in the years ahead.
This
is why our model portfolio has zero stocks due to massive overvaluation of the
market propelling returns after costs negative.
It is simple as that. So when
everyone is losing their heads with the Trump rally don’t go and lose
yours. This rally is a good time
to reduce your holdings of common stocks.
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