Sobering Views of Future US Stock Returns

Those thinking "phew! thank goodness stock markets have returned to normal and happy days are with us again" may want to read John Hussman's A False Sense of Security on the Hussman Funds website and James Montier's What Goes Up Must Come Down on AdvisorAnalyst.com. Both articles just published in March 2012 make a compelling argument that US stocks are richly valued since corporate earnings are artificially (government stimulus) and unusually high, distorting the P/E ratio and prospective returns.

Hussman's bottom line: "... we project total returns for the S&P 500 of just over 4% annually over the coming decade"

Montier's: forecast annual real total return for the S&P 500 over the next seven years of only 0.4% (see Exhibit 2 in his article)

That is woefully weak compared to the long term historical annual average of 6.2% for US stock returns documented in Dimson, Staunton, and Marsh's Credit Suisse Global Investment Returns Yearbook 2012.

Investment Benchmarking & Reporting - It's Time to Get Total Return

Pull up a chart of the S&P/TSX Composite Index from Google, from MSN, from Yahoo, from the Financial Post, from the Globe and Mail, even from the TSX's own website TMX Money, nor even from the S&P itself, which owns and maintains the index, and what do you get? The price index only, that's what. You do not get the Total Return Index, which includes not just the price, it also includes the dividend income from stocks. The same goes for any other stock index.

Why does it matter? The dividend part of the return - currently running at 2.7% on the TSX according to TMX Money - makes a huge difference over time with compounding. When doing portfolio assessment and benchmarking, whether it's your own, or a financial advisor's, a mutual fund or ETF company's, or a discount broker's, it is deception not to use Total Return for whatever index or asset class is in question.

How are the ETFs? - Amongst ETF providers, iShares and Claymore to their credit explicitly use Total Return indices while with BMO it isn't clearly stated (e.g. neither in the download index spreadsheet nor in the index description for its Dow Jones Canada Titans 60 Index ETF), which in itself is bad.

How about Financial advisors? an example - I don't know how widespread this is amongst financial advisors, and I am only picking on this guy because he happened to be a guest on BNN the other day so I looked up his website, but I was horrified to find that David Baskin Financial's performance against the index in the download blurb clearly uses the price only version of the TSX. How do I know? One of the few places we can access free annual Total Return index data is another financial advisor's website, Norbert Schlenker's Libra Investment Management, in this download spreadsheet. Line up the Baskin and the Libra numbers year by year and see the consistent higher performance of the Libra Total Return numbers e.g. 2010 Baskin TSX 14.4% vs Libra TSX TR 17.6%. Do the compounding of the TR numbers using Stingy Investor's Asset Mixer, who has taken Libra's data and turned it into a handy tool, and the 10-year TSX TR performance up to 2010 is 6.6%. Now the Baskin Financial 6.4% 10-year result doesn't look so good as it did against the blurb's TSX number of 4.2%. (It's also interesting that Baskin's "our team" web info mentions no financial designations but emphasizes TV and public appearances while Schlenker is a CFA, CFP, CIM, FMA and emphasizes his adherence to a code of ethics.)

There's another source of daily updated Total Return data buried within GlobeInvestor. Under Investing > Markets, enter stock symbol TSXT-I for the TSX Total Return Index. It allows one to benchmark year-to-date and one-year TR performance for the TSX on any day. The Libra data is annual year-end only.

Why the limited availability of Total Return data? Perhaps it is just the historical momentum that has seen the price index always being the quoted number, a result of the difficulty in computation in the days before computers and databases (which to my mind explains that widely-cited anachronism, the Dow Jones Industrial Index). Perhaps it is the fact that the TSX sells the data and the Total Return data is the meaningful valuable part while the price index is the loss leader.

Update September 15th - Broker BMOIL confirmed to me (at last, it took about two weeks to get the answer) that their benchmarks which compare against the investor's portfolio do actually use Total returns, not just Price Returns. Good, now I wish they would put a note to that effect on the relevant webpages.

Whatever the reason, ordinary investors need this data. It is time for the financial industry, and the media, to start quoting the right numbers.

Bank Research Views on Inflation, Future Rates of Return and TSX Profits

Grist for the planning / expectations mill:

• Inflation - BMO Capital Markets Economic Research in the May 6 Focus on pages 5-6 weighs up likely changes to the Bank of Canada inflation targeting mechanism and 2% target and concludes that for now it will all remain the same, though in few years the BOC might move to a lower target since "CPI provides an upward biased measure of the true cost of living (because people tend to substitute lower- for higher-priced items and many new tech-type goods exhibit significant price decay)".
• Future rates of return - TD Financial Group Economics in the March 17th An Economics Perspective On Long-Term Financial Returns estimates that a long term investor with a diversified portfolio could expect 5 to 7% returns (before inflation, which they estimate at around 2%) on average, with big swings above and below that year by year as the usual result of business and market cycles. The breakdown: T-bills 3.4%, Universe (whole of market) Bonds 4.0%, Canadian/US/International Developed Equities 7.5%. Emerging markets equities get a one-line comment - "the MSCI Emerging Market Index could deliver an annual return of 11% to 12%"
• TSX profit margins - CIBC World Markets in the April 29th TSX Earnings: At the Margin figures that profit margins of companies on the TSX look strong overall in relation to the S&P 500 and their rising trend has some potential to advance yet more. Sectors differ considerably however, with a range of hot 20+% margins in metals and mining at the top of the table to woeful 2% margins in airlines and in machinery.