Monday, March 28, 2016


Why We Think We’re Better Investors Than We Are (LINK)
Related book: Why Smart People Make Big Money Mistakes and How to Correct Them
A Dozen Things Learned from Dr. Michael Burry about Investing (LINK)

The Motley Fool talks with Ian Cassel about Micro-Cap Investing (LINK)

Philip Tetlock on the Masters in Business podcast (LINK)
Related book: Superforecasting
Google CEO Sundar Pichai talks about his upbringing, legacy, expanding internet access, importance of product, and more in wide-ranging profile [H/T Techmeme] (LINK)

The Economist on high corporate profits in America (LINK)

Brain Pickings: William James on Attention, Multitasking, and the Habit of Mind That Sets Geniuses Apart (LINK)
Geniuses are commonly believed to excel other men in their power of sustained attention… Their ideas coruscate, every subject branches infinitely before their fertile minds, and so for hours they may be rapt. 
...When we come down to the root of the matter, we see that [geniuses] differ from ordinary men less in the character of their attention than in the nature of the objects upon which it is successively bestowed.
Fueling Terror: How Extremists Are Made [H/T @RobertCialdini] (LINK)

You (and Almost Everyone You Know) Owe Your Life to This Man (LINK)

Robert Ebeling, Challenger Engineer Who Warned of Disaster, Dies at 89 [H/T @CGrantWSJ] (LINK)

Books of the day [H/T Ryan Holiday]:

Lincoln's Virtues: An Ethical Biography

Lincoln: The Biography of a Writer

Hussman Weekly Market Comment: Run-Of-The-Mill Outcomes vs. Worst-Case Scenarios (LINK)
Though corporate earnings are necessary to generate deliverable cash to shareholders, comparing prices to earnings is actually quite a poor way to estimate prospective future investment returns. The reason is simple - most of the variation in earnings, particularly at the index level, is uninformative. Stocks are not a claim to next year’s earnings, but to a very long-term stream of cash flows that will be delivered into the hands of investors over time. Corporate earnings are more variable, historically, than stock prices themselves. Though “operating” earnings are less volatile, all earnings measures are pro-cyclical; expanding during economic expansions, and retreating during recessions. As a result, to quote the legendary value investor Benjamin Graham, “The purchasers view the good current earnings as equivalent to ‘earning power’ and assume that prosperity is equivalent to safety.” Not surprisingly, the valuation measures having the strongest correlation with actual subsequent investment returns across history are smoother, and serve as better “sufficient statistics” for the relevant long-term cash flows. 
Across the scores of measures I’ve evaluated or created over three decades of research, the ratio of non-financial market capitalization to corporate gross value added (essentially corporate revenues, including estimated foreign revenues, excluding double-counting of intermediate inputs) is best correlated to actual subsequent market returns over a 10-12 year horizon. The 12-year horizon is notable, because that’s the point where serial correlation drops to zero, and is therefore the most likely point at which full mean-reversion can be expected, on average. 
One of the reasons I created the MarketCap/GVA measure was to incorporate estimated foreign revenues of U.S. companies, as many investors seemed to imagine that international trade has vastly changed valuation relationships. As it happens, the effect on valuations, and their relationship with subsequent returns, is far more modest than seems to be assumed. For data and a detailed discussion on this point, see The New Era is an Old Story. 
In that light, the next chart shows the ratio of nonfinancial market capitalization to GDP. Here, I’ve imputed some of the pre-war data points based on highly correlated proxy data that is available through the full period, as one can do for forward operating earnings and other series. Since the potential effect of estimation error is larger the further one goes back, I’ve presented only data since 1925, where I’m reasonably confident that the estimates are valid. The expanded chart gives further support to Warren Buffett’s 2001 comment in Fortune that the ratio of market capitalization to GDP is “probably the single best measure of where valuations stand at any given moment.” Though MarketCap/GVA performs slightly better in post-war data, GVA is difficult to estimate back to the 1920’s. 

With the S&P 500 still within a few percent of its record 2015 high, investors have a critical opportunity here to understand the difference between a run-of-the-mill outcome and a worst-case scenario. The present ratio of MarketCap/GDP is about 1.2, which we fully expect to be followed by nominal total returns in the S&P 500 of about 2% annually over the coming 12 years. Given the current dividend yield on the S&P 500 actually exceeds 2%, the historically run-of-the-mill expectation from current valuations is that the S&P 500 Index itself will be below current levels 12 years from today, in 2028. 

I realize that a projection like this seems preposterous. Unfortunately, this just reflects objective evidence that has remained reliable over a century of market cycles. Recall that our real-time projection for 10-year S&P 500 total returns in 2000 was correctly negative even on the basis of optimistic assumptions. The basic arithmetic was the same. 

Notice that expected market returns of about 6% have historically been associated with a MarketCap/GDP ratio of 0.8. The historical norm associated with 10% equity returns has been about 0.6. The secular lows of 1949 and 1982 hit ratios about 0.33. So a rather minimal completion of the current cycle would take the market down by about -33% from here (=0.8/1.2-1), a run-of-the-mill cycle completion would be about -50%, and a truly worst-case scenario would take the market down by about -73% to a secular valuation low in the current market cycle. One can’t rule anything out given reckless monetary policy, fragile European banks, excessive covenant-lite lending and so forth, but I don’t expect more than a run-of-the-mill cycle completion here. 

Once we consider market outcomes beyond more than a couple of years, we have to be careful to take GDP growth into consideration. Assuming labor market participation, productivity, and inflation all eventually recover, suppose that nominal GDP growth averages something close to 5% annually in the future. The mapping between valuations and investment returns is then just straightforward arithmetic. For example, a move to normal valuations 12 years from today would result in a change in the S&P 500 Index of: (1.05)^12 x (0.6/1.2) - 1 = -10.2%, or about -0.9% annually. Adding dividend income would bring the total return closer to 2% annually. 

So again, it’s not a worst-case scenario to expect the S&P 500 Index to be slightly lower, 12 years from now, than it is today. It’s the run-of-the-mill expectation.