Why a Stock Market Double Would Not be Weird

Why a Stock Market Double Would Not be Weird

September 26, 2016 Macroeconomics Research
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This morning we got a sad note from a famous former hedge fund manager (a friend of the firm who shall remain nameless):

What if the [stock] returns are never positive again? Just a question from a deeply scarred former investor.

Indeed, everywhere one looks there are calls that the stock market and the bond market will have low expected returns.

Logic would suggest that such commentary is “correct;” after all, if prices go up–expected returns go down–and if prices goes down–expected returns go up.

But low expected returns, doesn’t necessarily mean realized low returns, hence the use of the word, “expected.”

Can the stock market double from here?

What if we and all the scared/scarred hedge fund managers (i.e., the so-called pros) are all wrong? What if something “crazy” is on the horizon? Dare we say it — what if this time is “different?”

stock-market-double-dog

Consider the world we live in today:

  • 10-year bond yields are really low and some are even negative.
  • Stock dividend yields are really low (e.g. ~2% on the S&P).
  • Financial repression is in play and hyperinflation bets are likely sucker bets — see this piece we originally wrote in 2011.
  • Most finance professional feel like stocks and bonds are “overvalued” and sentiment is generally “blah.”
  • Much of the investable capital is held by the retiring baby boom generation in search of “yield.”

Now imagine the world in 5 years:

  • 10-year bond yields are flat or negative across the globe. (i.e., not exciting–at all!)
  • Putting money in a bank account has a non-trivial cost of carry (i.e., not a great “feel good” option)
  • Financial repression is in play and banks and insurance companies are structurally non-profitable enterprises.
  • Retiring baby boomers are begging for yield.

What happens in this scenario?

Let’s assume that stock dividend yields seem increasingly attractive to investors and hit 1%.

Did you notice what just happened?

The stock market yield went from 2% to 1% and the stock market just doubled

…and now it might be time to consider investments in gold (without serial numbers), guns, and family compounds.


Note: we have 0% faith in our ability to predict macroeconomic events, but we also recognize that pontificating on these subjects is immensely more entertaining and fulfilling than simply focusing on “all-weather” long-term concepts of value, momentum, and trend-following.

 

 


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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.