The Long Run Drivers of Stock Returns...Stocks, Bonds, Bills and Inflation Study ( 1976/1977) 4...

The Long Run Drivers of Stock Returns: Total Payouts and the Real Economy*

Roger G. IbbotsonChairman & CIO, Zebra Capital Management LLC.Professor in Practice Emeritus, Yale School of Management

Co-Author: Philip Straehl, Morningstar Inc.

FTSE Russell World Investment ForumSea Island, GA, May 2016

*Original Title: The Supply of Stock Returns: Adding Back Buybacks

Agenda

2

Stock Return Es timation MethodsStocks , Bonds , Bills , & Infla tion

The Supply of S tock ReturnsIbbotson & Chen (2003) Updated and Extended

A Tota l Payout Model of S tock ReturnsDividends and three buyback Inves tor types

Stock Returns and the Rea l EconomyPayout Growth vs Economy Growth

Forecas ting Stock ReturnsPE Ratios , dividend discount model, tota l yie ld, CAPE, CATY, CANTY

Conclus ions

Stock Return Estimation Methods

3

Historical Risk Premiums: measure over various markets and time periods (Ibbotson & Sinquefie ld)

Consensus forecasts: individual inves tors , economis ts , and ins titutiona l inves tors , e .g., Welch (2001)/(2004), Fernández López

Demand: degree of inves tor risk avers ion and other characteris tics , e .g., Ibbotson, S iege l & Diermeier (1984), Mehra & Prescott (1985), Mehra (2003), Cons tantinides (2003), Kaplan (2016)

Real economy (supply): s tock market is cons tra ined to be part of the economy, e .g., Diermeier, Ibbotson & Siege l (1984), Shille r (2000), Fama & French (2002), Ibbotson & Chen (2003)

Stocks, Bonds, Bills and Inflation Study (1976/1977)

4

Ibbotson/Sinquefie ld (1976/1977) conduct s tudy of drivers of long-run asse t class re turns , us ing the S&P Composite as the measure of la rge cap s tocks (s imila r to this s tudy)

Key re turn building blocks :

• Equity risk premium

• Horizon premium

• Default premium

• Real inte res t ra tes

• Infla tion

Ibbotson® SBBI®Stocks, Bonds, Bills, and Inflation 1926–2015

•Past performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 1926. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © Morningstar. All Rights Reserved.

Presenter

Presentation Notes

Ibbotson® SBBI® 1926–2015 An 90-year examination of past capital market returns provides historical insight into the performance characteristics of various asset classes. This graph illustrates the hypothetical growth of inflation and a $1 investment in four traditional asset classes over the time period January 1, 1926, through December 31, 2015. Large and small stocks have provided the highest returns and largest increase in wealth over the past 90 years. As illustrated in the image, fixed-income investments provided only a fraction of the growth provided by stocks. However, the higher returns achieved by stocks are associated with much greater risk, which can be identified by the volatility or fluctuation of the graph lines. Government bonds and Treasury bills are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes. Furthermore, small stocks are more volatile than large stocks, are subject to significant price fluctuations and business risks, and are thinly traded. About the data Small stocks in this example are represented by the Ibbotson® Small Company Stock Index. Large stocks are represented by the Ibbotson® Large Company Stock Index. Government bonds are represented by the 20-year U.S. government bond, Treasury bills by the 30-day U.S. Treasury bill, and inflation by the Consumer Price Index. Underlying data is from the Stocks, Bonds, Bills, and Inflation® (SBBI®) Yearbook, by Roger G. Ibbotson and Rex Sinquefield, updated annually. An investment cannot be made directly in an index.

Ibbotson® SBBI® Historical Equity Risk Premium?Summary statistics 1926–2015 10.0%-5.6%=4.4%

12.0%-3.5%=8.5%

Past performance is no guarantee of future results.*The 1933 small company stock total return was 142.9%. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2016 Morningstar. All Rights Reserved.

Compoundannualreturn

Arithmeticannualreturn

Risk(standarddeviation)

Large stocks

Small stocks*

Governmentbonds

Treasurybills

Inflation

10.0%

12.0%

5.6%

3.4%

2.9%

12.0%

16.5%

6.0%

3.5%

3.0%

20.0%

32.0%

10.0%

3.1%

4.1%

–90 0 90

Presenter

Presentation Notes

Stocks, Bonds, Bills, and Inflation: Summary statistics 1926–2011 This image summarizes, quantitatively, the risk/return tradeoff inherent in investing; that is, the potential return of an asset generally increases with the asset’s risk. The compound annual return shown in the first column reflects the annual rate of return achieved over the entire 86-year time period assuming the reinvestment of all income. It is the average rate of return which, when earned each year, equates the investment’s beginning value with its ending value. The figure in the second column represents a simple, or arithmetic average of the individual annual returns over the past 86 years. Standard deviation, shown in the third column, is used to measure the risk of an investment. It shows the fluctuation of returns around the arithmetic annual return of the investment. The higher the standard deviation, the greater the variability of the investment returns. The “skyline,” or distribution, for each asset class graphically depicts the information contained in the summary statistics table. Riskier assets, such as stocks, have spread-out “skylines,” reflecting the broad distribution of returns from very poor to very good. Less risky assets, such as bonds, have narrow “skylines,” indicating a tight distribution of returns around the average. Government bonds and Treasury bills are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes. Furthermore, small stocks are more volatile than large stocks and are subject to significant price fluctuations, business risks, and are thinly traded. About the data Small stocks are represented by the fifth capitalization quintile of stocks on the NYSE for 1926–1981 and the performance of the Dimensional Fund Advisors, Inc. (DFA) U.S. Micro Cap Portfolio thereafter. Large stocks are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general, government bonds by the 20-year U.S. government bond, Treasury bills by the 30-day U.S. Treasury bill, and inflation by the Consumer Price Index. The data assumes reinvestment of all income and does not account for taxes or transaction costs. Underlying data is from the Stocks, Bonds, Bills, and Inflation® (SBBI®) Yearbook, by Roger G. Ibbotson and Rex Sinquefield (updated annually). An investment cannot be made directly in an index.

Ibbotson® SBBI® This study uses

Summary statistics 1926–2015 inflation adjusted returns

Past performance is no guarantee of future results.*The 1933 small company stock total return was 142.9%. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2016 Morningstar. All Rights Reserved.

Compoundannualreturn

Arithmeticannualreturn

Risk(standarddeviation)

Large stocks

Small stocks*

Governmentbonds

Treasurybills

Inflation

10.0%

12.0%

5.6%

3.4%

2.9%

12.0%

16.5%

6.0%

3.5%

3.0%

20.0%

32.0%

10.0%

3.1%

4.1%

–90 0 90

Presenter

Presentation Notes

Stocks, Bonds, Bills, and Inflation: Summary statistics 1926–2011 This image summarizes, quantitatively, the risk/return tradeoff inherent in investing; that is, the potential return of an asset generally increases with the asset’s risk. The compound annual return shown in the first column reflects the annual rate of return achieved over the entire 86-year time period assuming the reinvestment of all income. It is the average rate of return which, when earned each year, equates the investment’s beginning value with its ending value. The figure in the second column represents a simple, or arithmetic average of the individual annual returns over the past 86 years. Standard deviation, shown in the third column, is used to measure the risk of an investment. It shows the fluctuation of returns around the arithmetic annual return of the investment. The higher the standard deviation, the greater the variability of the investment returns. The “skyline,” or distribution, for each asset class graphically depicts the information contained in the summary statistics table. Riskier assets, such as stocks, have spread-out “skylines,” reflecting the broad distribution of returns from very poor to very good. Less risky assets, such as bonds, have narrow “skylines,” indicating a tight distribution of returns around the average. Government bonds and Treasury bills are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes. Furthermore, small stocks are more volatile than large stocks and are subject to significant price fluctuations, business risks, and are thinly traded. About the data Small stocks are represented by the fifth capitalization quintile of stocks on the NYSE for 1926–1981 and the performance of the Dimensional Fund Advisors, Inc. (DFA) U.S. Micro Cap Portfolio thereafter. Large stocks are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general, government bonds by the 20-year U.S. government bond, Treasury bills by the 30-day U.S. Treasury bill, and inflation by the Consumer Price Index. The data assumes reinvestment of all income and does not account for taxes or transaction costs. Underlying data is from the Stocks, Bonds, Bills, and Inflation® (SBBI®) Yearbook, by Roger G. Ibbotson and Rex Sinquefield (updated annually). An investment cannot be made directly in an index.

The Supply of Stock Returns Long-Run Stock Returns: Participating in the Real Economy

8

Ibbotson & Chen (2003) decompose his torica l re turn of s tocks into diffe rent supply components : dividends , earnings , book va lue , and GDP per capita growth

Most of re turn is a ttributable to the supply of corpora te fundamenta ls (e .g., dividends and earnings e tc.) and rea l economic productivity (i.e ., GDP per capita )

P/E growth and changing factor shares only account for a small portion of his torica l re turns

This next page updates origina l 1926-2000 sample to include 1871-2014, (without s tock buybacks)

Ibbotson & Chen Return Decompositions Updated and Extended (1871-2014)

9

Source: Straehl, Philip U., and Roger G. Ibbotson. 2015. The Supply of Stock Returns: Adding Back Buybacks. Working Paper.

Inflation2.06% 2.06% 2.06% 2.06% 2.06% 2.06%

GDP per capitaGrowth

1.83%

Chg. Factor Share0.41%

Chg. ROE0.33%

BVGrowth1.49%

DPS Growth1.46%

1/ Chg. PO0.36%

EPSGrowth1.83%

P/EGrowth0.41%

Capital Gain2.25%

Income4.50% 4.50% 4.50% 4.50% 4.50%

Risk Free Rate

2.66%

Equity Risk Premium

4.08%

-0.50%

0.50%

1.50%

2.50%

3.50%

4.50%

5.50%

6.50%

7.50%

8.50%

9.50%

1. Building Blocks 2. Capital Gain and Income 3. Earnings 4. Dividends 5. Book on Equity 6. GDP per Capita

Inflation Inflation Inflation Inflation Inflation

Income Income Income Income

P/EGrowth0.41%

P/EGrowth0.41%

U.S. Equity Markets: Dividends & Buybacks (1871-2014)


10

Structural break – 1982 SEC ruling on buybacks

Literature Review

11

Drivers of Rise of Buybacks:

• SEC rule 10b-18 in 1982 provided a safe harbor for firms to conduct share buybacks without a suspicion of share price manipula tion (e .g., Grullon and Michaely, 2002)

• Tax benefits (e .g., Grullon and Michaely, 2002)

• Greater flexibility than dividends (e .g., Guay and Harford, 2000)

• Alterna tive motiva tions : underva lua tion/s igna ling, management of “dilution effects”, EPS management (e .g., Allen and Michaely, 2003, and Brav, Campbell, Michae ly 2005)

International Evidence on Buybacks:

• Increas ing evidence of inte rna tiona l importance of buybacks : European Union (von Eije and Megginson, 2008), Japan (Tong e t a l, 2012), Aus tra lia (Brown and O’Day, 2006)

U.S. Equity Markets: Total Yield (1871-2014)

12


Equity Dividend Yields (1685-1870)

Source: Golez & Koudijs (2014), Four Centuries of Return Predictability, NBER Working Paper

13.5%

8.2%

5.0%

3.0%

1.8%

1.1%

U.K./Netherlands (1685-1809) U.K. (1825-1870)

Average: 4.2% Average: 4.4%

13

Three Buyback Investor Types*

14

1) Buy and Hold Investor• Holds cons tant # of shares in company• Buyback impact: inves tor holds on to shares (ge ts bigger share)• Relevant growth ra te : growth per share

2) Pro Rata Buyback Investor• Buyback impact: tenders proportiona l amount of shares (ge ts cash)• Relevant growth ra te : cash flow growth

3) Cap-Weighted Index Investor • Constant share of aggregate s tock market• Participa tes proportiona lly in buyback and issuance of shares• Relevant growth ra te : aggregate growth

*Value not affected for all 3 investor types under Miller & Modigliani assumptions

A Total Payout Model of Stock Returns (Buy and Hold Investor)

15

The one-period tota l re turn R of a s tock over period t-1 to t is given by:

• 𝑅𝑅𝑡𝑡 = 𝐷𝐷𝑡𝑡𝑃𝑃𝑡𝑡−1

+ 𝑃𝑃𝑡𝑡−𝑃𝑃𝑡𝑡−1𝑃𝑃𝑡𝑡−1

= 𝐷𝐷𝑡𝑡𝑃𝑃𝑡𝑡−1

+ 𝑃𝑃𝑡𝑡𝑃𝑃𝑡𝑡−1

− 1

Div. Yield + Price Return Div. Yield + Price Return

Rewrite as a function of change in price-to-tota l payout ra tio and

the change in tota l payout-per-share (TP)


+ 𝑇𝑇𝑃𝑃𝑡𝑡𝑇𝑇𝑃𝑃𝑡𝑡−1

𝑥𝑥𝑃𝑃𝑡𝑡𝑇𝑇𝑃𝑃𝑡𝑡𝑃𝑃𝑡𝑡−1𝑇𝑇𝑃𝑃𝑡𝑡−1

− 1

Dividend Yie ld TP Per Share Growth Change in Price -to-TP

DY Nom gTP gP/TP

Does not participa te in cash buyback, increas ing Buy and Hold Inves tor’s proportion (corp cash used to decrease share count) and TP per share growth

Total Yield Model (Pro Rata Buyback Investor)

16

The buyback yie ld is defined as :

• 1 + 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑡𝑡 = 1 + 𝑃𝑃𝑡𝑡𝐵𝐵𝑡𝑡𝑃𝑃𝑡𝑡𝑆𝑆𝑡𝑡

= 𝐵𝐵𝑡𝑡+𝑆𝑆𝑡𝑡𝑆𝑆𝑡𝑡

• Where S is the number of shares outs tanding, B is the number of shares repurchased

Write re turn as a function of tota l payout-per-share (TP) and buybacks yie ld:


+ 𝐵𝐵𝑡𝑡+𝑆𝑆𝑡𝑡𝑆𝑆𝑡𝑡

𝑇𝑇𝑃𝑃𝑡𝑡𝑇𝑇𝑃𝑃𝑡𝑡−1

𝑆𝑆𝑡𝑡𝐵𝐵𝑡𝑡+𝑆𝑆𝑡𝑡

𝑃𝑃𝑡𝑡𝑇𝑇𝑃𝑃𝑡𝑡𝑃𝑃𝑡𝑡−1𝑇𝑇𝑃𝑃𝑡𝑡−1

− 1

Tota l Yie ld + TP Growth (Adj.) + Change in Price -to-TP

TY + Nom gTPexB + gP/TP

Payout tota l yie ld is higher, but have less shares , offse tting each other

Net Total Yield Model (Market-Cap Index Investor)

17

Net is suance is defined as :

• 1 + 𝑁𝑁𝑌𝑌𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐵𝐵𝐵𝐵𝐼𝐼𝐵𝐵𝑌𝑌𝑡𝑡 = 1 + 𝑃𝑃𝑡𝑡(𝑆𝑆𝑡𝑡−𝑆𝑆𝑡𝑡−1)𝑃𝑃𝑡𝑡𝑆𝑆𝑡𝑡−1

= 𝑆𝑆𝑡𝑡𝑆𝑆𝑡𝑡−1

• Where S is the number of shares outs tanding

Write re turn as a function of tota l payout-per-share (TP) and ne t is suance :


+ 𝑆𝑆𝑡𝑡−1𝑆𝑆𝑡𝑡

𝑇𝑇𝑃𝑃𝑡𝑡𝑇𝑇𝑃𝑃𝑡𝑡−1

𝑆𝑆𝑡𝑡𝑆𝑆𝑡𝑡−1

𝑃𝑃𝑡𝑡𝑇𝑇𝑃𝑃𝑡𝑡𝑃𝑃𝑡𝑡−1𝑇𝑇𝑃𝑃𝑡𝑡−1

− 1

Net Tota l Yie ld Aggregate TP Growth Change in Price -to-TP

NTY Nom gTPAgg gP/TP

NTY includes cash outflow for is suance purchase with new capita l into company benefiting aggregate growth

Three Total Payout (TP) Models: Summary

18

Dividend Per-Share Model (Buy and Hold Investor)

• Return = Dividend Yie ld + TP Per Share Growth + Change in Price-to-TP

• More growth per share from decreas ing buyback share count, but less corpora te cash

Dividend and Cash Buyback Model (Pro Rata Buyback Investor)

Return = Tota l Yie ld + TP Growth + Change in Price-to-TP

• Tota l yie ld includes dividends plus buybacks , but corpora tion has less cash and lower TP growth

Dividend Less Net Issuance (Market-Cap Index Investor)

• Return = Net Tota l Yie ld + Aggregate TP Growth + Change in Price -to-TP

• Buybacks and issuance somewhat offse t each other

19

Historical Return Decompositions by Total Payout (TP)The supply of tota l payouts a lmos t entire ly expla ins his torica l re turns

(change in va lua tion is small)1871-2014 1901-2014

Dividend-Per-Share Model(Buy and Hold Investor)Dividend Yield DY 4.50% 4.29%TP Growth gTP 2.05% 2.02%Change in Price-to-TP gP/TP 0.20% -0.01%Inflation CPI 2.06% 3.06%

Interaction 0.25% 0.28%

Dividend and Cash BuybackModel (Pro Rata Buyback Investor)

Total Yield TY 4.89% 4.78%TP Growth (BuybackShare Decrease Adjusted) gTPexB 1.67% 1.54%Change in Price-to-TP gP/TP 0.20% -0.01%Inflation CPI 2.06% 3.06%

Interaction 0.24% 0.27%

Dividend Less Net Issuance Model (Cap-Weighted Index Investor)Net Total Yield NTY - 3.03%Aggregate TP Growth gTPAgg - 3.27%Change in Price-to-TP gP/TP - -0.01%Inflation CPI - 3.06%

Interaction - 0.29%

Total Return 9.05% 9.64%

Buy and Hold (Lower yield because no buyback, but higher growth)

Pro Rata Buyback (Higher yield because of selling of buybacks, but lower growth)

Market Cap Index (Lower net yield because of buying of net issuance, but higher growth)

For illustrative purposes only.. Source: Straehl and Ibbotson (2015), The Supply of Stock Returns: Adding Back Buybacks, Working Paper

Stock Returns and the Real Economy

20

Returns on asse ts a re re la ted to the productivity of economic factor inputs

In aggregate , the re turn on any financia l asse t (s tocks , bonds , rea l es ta te e tc.) is linked to the performance of the economy

• Asse ts cannot indefinite ly outperform/underperform the economy

The equity inves tor, as part of the capita l s tructure , ge ts the res idual product of the economic process , ge tting the grea tes t ups ide (and downside)

A Simple Model of Aggregate Growth

21

Let’s assume tha t the output (Y) of the economy is described by a Cobb-Douglas production function:

𝑌𝑌 = 𝐴𝐴𝐾𝐾1−𝛽𝛽𝐿𝐿𝛽𝛽

A=Tota l factor productivity K=Capita l s tock L = Labor (hours ) β= Output e las ticity

Taking log diffe rences , we ge t an express ion of the growth drivers of aggregate output (GDP):

∆𝐵𝐵 = ∆𝐵𝐵 + 𝛽𝛽 − 1 ∆𝐵𝐵 + 𝛽𝛽∆𝑌𝑌

GDP Growth = Productivity Growth + Growth in Capital + Growth in Labor

Aggregate total payout growth should be related to aggregate output growth, barring differences in factor share of capital

Aggregate Total Payout vs. GDP Growth, 1901-2014

22

For illustrative purposes only. Source: Straehl and Ibbotson (2015), The Supply of Stock Returns: Adding Back Buybacks, Working Paper

Aggregate Tota l Payout grows in line with GDP

Growth in aggregate payouts

A Simple Model of Productivity Growth

23

Part of overa ll growth is financed by new capita l (e .g., purchase of a new machine)

Dividing Y by K we ge t express ion for output per unit of capita l input:

𝑌𝑌𝐾𝐾

= 𝐴𝐴𝐾𝐾1−𝛽𝛽𝐿𝐿𝛽𝛽

𝐾𝐾= 𝐴𝐴(𝐿𝐿

𝐾𝐾)𝛽𝛽

Taking log diffe rences to obta in growth ra tes :

∆𝐵𝐵 − ∆𝐵𝐵 = ∆𝐵𝐵 + 𝛽𝛽∆𝑌𝑌 − 𝛽𝛽∆𝐵𝐵

Growth Y/K= Productivity Growth + Growth in Labor − Growth in Capita l

If Labor-Capita l Ratio (L/K) is cons tant, express ion reduces to productivity growth (∆𝐵𝐵)

Inves tors ’ tota l payout growth is na tura l s tock market equiva lent of productivity growth

Total Payout Growth vs. GDP-Per-Capita Growth, 1872-2014

24

For illustrative purposes only. Source: Straehl and Ibbotson (2015), The Supply of Stock Returns: Adding Back Buybacks, Working Paper

Tota l Payout per share (adj. for buyouts and new issuance) grows in line with productivity

Total payout per share

Forecasting Stock Returns

25

Compare One-Year Forward and Five-Year Forward Returns:

Price-Earnings Ratios (PE)

Dividend Yie ld (DY) 𝑟𝑟 = 𝑑𝑑

𝑝𝑝+ g

Tota l Yie ld (TY) DY + Buybacks

Net Tota l Yie ld (NTY) ne t of new issues

Shille r’s CAPE (10 Years )cyclica lly adjus ted PE ra tio

Cyclica lly adjus ted Tota l Yie ld (CATY)

Cyclica lly adjus ted Net Tota l Yie ld (CANTY)

Predictive Regressions of One-Year Forward Returns

26


Simple Variables

PEDiv. Yield

(DY)Total Yield

(TY)Net Total

Yield (NTY)Since 1871Intercept 11.34 1.34 -2.83 -Tstat 2.98 0.32 -0.53 -Coeff. -0.19 1.60 2.30 -Tstat -0.83 1.80 2.19 -R2 0.49% 2.24% 3.30% -

Since 1881Intercept 10.80 0.64 -4.21 -Tstat 2.69 0.14 -0.74 -Coeff. -0.17 1.75 2.57 -Tstat -0.71 1.82 2.28 -R2 0.38% 2.46% 3.82% -

Since 1911Intercept 10.78 2.22 -2.22 8.64Tstat 2.43 0.46 -0.34 4.50Coeff. -0.15 1.45 2.17 0.37Tstat -0.61 1.37 1.72 1.82R2 0.36% 1.82% 2.84% 3.17%

Tota l Payout Yie lds (TY & NTY) are more predictive than PE and DY

Genera lly have higher ts ta ts and R-squares

Predictive Regressions of One-Year Forward Returns

27


Cyclically-Adjusted (CA) Variables

PE (CAPE)

Total Yield

(CATY)

Net Total Yield

(CANTY)Since 1871Intercept - - -Tstat - - -Coeff. - - -Tstat - - -R2 - - -

Since 1881Intercept 17.97 -2.95 -Tstat 4.24 -0.66 -Coeff. -0.60 2.44 -Tstat -2.49 2.68 -R2 4.51% 5.19% -

Since 1911Intercept 17.09 -1.85 1.64Tstat 3.70 -0.37 0.45Coeff. -0.54 2.20 2.09Tstat -2.08 2.22 2.20R2 4.09% 4.66% 4.55%

Shille r’s CAPE is based on 10-year average rea l earnings per share

CATY and CANTY (based on 10-year average tota l payouts per share) a re a t leas t as predictive as CAPE

Have higher t-s ta ts and R-squares

1/CAPE and 5-Year Forward Return (1970-2010)

28

For illustrative purposes only.

R² = 0.1172

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00%

5-Year Fwd Return vs…

5-Ye

ar Fo

rwar

d Re

al Re

turn

1/CAPE

CATY and 5-Year Forward Return (1970-2010)

29

For illustrative purposes only.

5-Ye

ar Fo

rwar

d Re

al Re

turn

CATY

R² = 0.2531

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% 8.00%

5-Year Fwd Return vs…

Long-Term Forecasts

30

Total Yield CATY Dividend YieldCurrent Yield* 4.83% 3.66% 1.92%Hist. Growth 1.63% 1.63% 1.46%Expected Inflation 2.00% 2.00% 2.00%

Expected Return (Geometric) 8.50% 7.33% 5.41%

S&P Composite (1871-2014)

SBBI US Large (1926-2014)

Hist. Real Return 6.84% 6.98%Expected Inflation 2.00% 2.00%

Expected Return (Geometric) 8.98% 9.12%

Historical

Supply Models

*Current yie lds a re a ll a s of 12/31/2014. Tota l yie ld is the dividend yie ld plus the buyback yie ld for 2014, CATY is the

10-year average of rea l tota l payout pe r sha re (dividend plus buybacks) divided by the current price .

Conclusions

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Long-run s tock re turns a re driven by• Tota l payouts cash• Tota l payouts growth

The supply of tota l payouts a lmos t exactly matches• Stock re turns • Real Economy

Dividend Discount Model his torica l da ta• Underes timates expected re turn

Cyclica lly Adjus ted (10 Year) Tota l Payouts (CATY)• Predict forward re turns s lightly be tte r than CAPE

The Long Run Drivers of Stock Returns...Stocks, Bonds, Bills and Inflation Study ( 1976/1977) 4...

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Transcript of The Long Run Drivers of Stock Returns...Stocks, Bonds, Bills and Inflation Study ( 1976/1977) 4...