Future Returns on Stocks Aren’t Likely to Be as Great as You Think

Future Returns on Stocks Aren't Likely to Be as Good as You Think

We’ve all heard the old stockbrokers’ adage that equities always appreciate at 10% a year – give or take.  Unfortunately this myth has been repeated so often that many people believe it is a universal Truth.  Every year millions of us dutifully cram whatever money we can afford into our retirement accounts and invest in stocks, hoping against hope that we at least come close to that magical 10% annual return.

Unfortunately, reality can be a brutal place.  Stock returns over the next couple of decades will most likely end up barely positive, in the 0% to 3% range per annum, rather than the 10% we’ve all built our future dreams upon.  As a consequence, many ordinary people will undoubtedly find themselves working until the day they die instead of retiring comfortably as they originally hoped.

I understand that saying stocks will do badly over the next decade is a rather dire prognostication.  So what is the evidence for it?  The major predictor I use is a modified valuation formula shamelessly borrowed from deep thinker and asset manager John Hussman of the Hussman Funds:

((1+Nominal GDP Growth Rate)*(Average Valuation Metric/Current Valuation Metric)^(1/Number of Years))-1+Current Dividend Yield

In this case I like to use the S&P 500 Index as being representative of broad market averages.  I also like to use the price-to-sales ratio as my chosen valuation metric.  Not knowing what the future holds, I have created a baseline scenario and a wildly optimistic scenario.  Keep in mind that these potential return calculations only work over longer (more than 5 year) periods of time.  The stock market could easily rise or fall by double digits next year and it wouldn’t invalidate these calculations in the least.

 

If you plug in all the variables you get something like this for the baseline scenario:

((1+4.0%)*(1/1.81)^(1/10))-1+2.12% = 0.13% S&P 500 return per annum

 

And here is the wildly optimistic scenario:

((1+6.3%)*(1.41/1.81)^(1/10))-1+2.12% = 6.69% S&P 500 return per annum

 

Of course there are a lot of assumptions buried in these predictive formulae.  For one thing, it is predicated on today’s dividend yield being a reasonable proxy for dividends several years from now.  That might – or might not – be the case because dividends can increase, decrease or even be suspended.

Another sizable assumption is the nominal growth rate of the economy over the next decade.  First we’re using this number as a proxy for aggregate corporate growth rates, which I believe to be approximately true, particularly over long periods of time.  Historically, this rate has been about 6.3% in the United States.

This is the value I use in the wildly optimistic scenario above.  However, recent history after the Global Financial Crisis, as well as Japan’s experience during its (ongoing) “Lost Decade” point to a much lower value of no more than 4.0%.  I use this lower value in the baseline calculation above.

Now the heart of the matter is the valuation metric used and the assumption that this metric reverts to the mean over long time periods.  Today, the S&P 500 has a price-to-sales ratio of 1.81.  This value is – to put it charitably – absolutely insane.  It is higher than at any point since the original Dot Com bubble around the year 2000.  The S&P 500’s average price-to-sales ratio over the last 15 years is 1.43.  This is the value used in the wildly optimistic scenario above.  If we exclude the Fed induced period of serial equity bubbles over the last 20 years, then a price-to-sales ratio of around 1 would be very generous.  This is the average value I use in the baseline scenario.

These formulas also assume that any valuation reversion takes place over 10 years.  Returns can be increased or decreased by changing that time frame.  Decreasing the amount of time for the valuation reversion depresses returns while increasing the amount of time gooses them.

Now that I’ve explained the voluminous methodology and numerous caveats attached to these formulae, let’s look at the returns themselves.  The baseline scenario yields 0.13% over the next decade while the wildly optimistic scenario gives 6.69%.  I didn’t bother calculating a pessimistic scenario because I don’t want to be accused of frightening children and kicking puppies.  As you can probably guess, it would have a negative sign in front of it.

Now some people might argue that I am not factoring in future inflation.  And there is a grain of truth in this accusation.  Sharply increased future inflation is not explicitly captured in these calculations.  However, I feel sustained, high inflation in today’s debt saturated economy is close to an impossibility.  Recent history has certainly served to buttress this supposition.  In any case, inflation is not the panacea that central bankers and politician would have us believe.

This is doubly true for equity investors.  Elevated levels of inflation tend to severely depress stock market multiples (valuations).  The 1970s was a great example of this.  The equity markets – while experiencing significant volatility over the period – spent the entire decade going nowhere.  Collapsing stock valuations completely offset increased revenue and earnings due to inflation.  The only source of return during this period was an indices’ dividend yield.  Today, the dividend yield on the S&P 500 is a unappetizing 2.12%.  So I wouldn’t rely on inflation to boost your stock market returns.

In all probability, a broad equity market return over the next 10 years of much more than about 3% or 4% is hopelessly unrealistic.  This revelation means that you would almost certainly be better off holding corporate bonds rather than stocks – at least if you have a very long investment time-frame.  It also means that if you are looking for a place to allocate the risk-oriented portion of your portfolio in hopes of a return greater than 5% per annum, stocks aren’t it!

So where can the average investor find a reasonable return in exchange for reasonable risk?  Art and antiques are the secret.  This little known asset class has so far escaped both the bubble-crazed mad men of Wall Street and the demented policies of central bankers.  It represents one of the few remaining islands of value in a sea of investment junk.  And with investment-grade art and antiques starting at unbelievably low prices – sometimes as little as $100 an item – you don’t have to be a millionaire to start getting good returns on your money!

The Importance of Build Quality When Buying a Home Safe

The Importance of Build Quality When Buying a Home Safe

Choosing a home safe to store your growing collection of investment-grade antiques is a wise decision.  A safe is an economical alternative to insurance, providing decades of protection via a one-time payment – the purchase price.  However, the kind of safe you buy is incredibly important.

There are a lot of safes on the market – mostly imports from China – that are poorly constructed using sub-standard materials.  These inferior safes will not live up to their security promises.  To have peace of mind, it is necessary to purchase a safe that excels in three critical attributes: a tight door gap, high-quality welds and good bolt support.

When a safe is compromised in a home burglary, it almost always happens via one of five different ways.  The most prevalent method involves a thief removing a safe that hasn’t been properly bolted down to the floor and opening it later at his hideout.

The next most common way is a brute-force pry attack against the door.  The third way is a brute-force sledgehammer attack against the door or body of the safe.  The fourth technique employs power tools like angle grinders or circular saws against the body of the safe.

The final and least common attack uses a cutting torch to cut a hole in the safe.  The last two methods mentioned – power tools and cutting torches – are relatively rare and tend to only be used by professional or semi-professional gangs who like to hit commercial rather than residential targets.  So the illicit entry methods we have to primarily guard against in a home safe, assuming it has been properly bolted down, are the two brute-force possibilities: pry attacks and sledgehammer attacks.

Door gap is one of the most easily discernible build quality aspects of a safe.  As the name implies, it is the space between the door frame and the edge of the door when the safe is closed.  The tighter the tolerances and overall build quality of a safe, the tighter the door gap will be.

Unfortunately, with the proliferation of cheap Chinese import safes, the door gap on the average safe available in most big box stores today is atrociously wide.  Wide door gap makes a safe much more susceptible to a pry attack because it is far easier to insert the edge of a large crowbar or breaker bar into such a large space.

A secondary concern is that an excessive door gap can render an otherwise fireproof safe extremely sensitive to heat and smoke in the event of a fire.  For example, a mid-sized home safe with a door 18″ wide and 20″ high that has a fairly modest 1/8″ door gap exposes 7 square inches of net opening around the perimeter of the door.  This is a fairly large area that cannot be easily sealed in the event of a fire, exposing the interior contents of the safe to damaging smoke and heat.

And door gap can easily be substantially larger than 1/8 of an inch.  In extreme cases door gap can even approach an outrageous 1/2 inch wide!  Conversely, you may barely be able to slide a credit card into the door gap of a very well built safe.

The next important aspect of home safe construction is weld quality.  A safe is essentially just a steel box that has been welded together.  So weld quality has important implications for the security of a safe for obvious reasons.  If a safe is constructed with cheap, flimsy spot welds instead of more expensive and robust continuous welds, it is far more fragile overall.  This makes cheap, improperly welded safes very susceptible to brute force sledgehammer attacks.  In extreme cases, a poorly made safe can literally disintegrate into its component steel plates during an aggressive sledgehammer assault.

The final crucial characteristic of safe construction is good bolt support.  The bolts engage the door frame of a locked safe, preventing the door from opening.  However, many import safe manufacturers have resorted to saving money by making these bolts too short and anchoring them to an inadequate 12 gauge (0.1046 inches thick) or thinner steel support bar.  These shortcuts are generally not visible to the consumer unless the inside door panel is removed to allow inspection of the interior boltwork.

Instead, these unscrupulous safe companies will manufacture safes with large numbers – sometimes dozens – of bolts to give the impression of being pry-proof.  However, the number of bolts is largely irrelevant to the security of a safe.  Generally only two or three bolts are really needed to properly secure the door of a well-designed and manufactured safe.

Inadequate boltwork or bolt support makes a safe extremely vulnerable to pry attacks.  Short bolts mean the door frame can often be bent far enough out of line for the stubby bolts to clear the damaged frame.  And a flimsy supporting bolt bar will usually fail from prying well before its attached bolts.  On the other hand, a high quality home safe with long bolts and good bolt support is quite resistant to pry attacks, even with only two to four bolts securing the door.

A high quality home safe can be a great complement to an impressive collection of fine art or antiques.  It can provide protection against both theft and fire while also giving you peace of mind.  But it is vitally important that you buy a safe with a tight door gap, high-quality welds and good bolt support.  These attributes often make the difference between a good safe that will perform exactly as you expect it to and a poor safe that will fail just when you need it most.

Antique GIA Cert .63ct Diamond & Sapphire 18K White Gold Deco Engagement Ring

Antique GIA Cert .63ct Diamond & Sapphire 18K White Gold Deco Engagement Ring
Photo Credit: DiamondTen

Antique GIA Cert .63ct Diamond & Sapphire 18K White Gold Deco Engagement Ring

Buy It Now Price: $1,185 (price as of 2016; item no longer available)

Pros:

-This is a 1.6 gram, 18 karat white gold ring set with a 0.57 carat diamond and two small flanking accent sapphires.  The diamond is an old European cut stone which is the correct cut for a ring of this era.

-This 1920s antique ring displays phenomenal art deco style – sleek angularity abounds. The beautifully engraved fluting on the shoulders may reflect a very slight Egyptian revival influence.  The Egyptian revival style came into vogue after the discovery of Pharaoh Tutankhamun’s tomb in Egypt’s Valley of the Kings in 1922.

-The central stone is a stunning, investment-grade specimen of an old European cut diamond, with good color and few inclusions.  The charming, slightly warm, rock crystal-like appearance of this stone is typically of old cut diamonds.  However, old mine and old European cut diamonds are often visibly yellow or brown to the naked eye.  They are also commonly more heavily flawed than modern cut stones.  This stone suffers from none of those flaws, making it a superior example of an antique cut diamond.

-The central diamond has J color (nearly colorless) and SI1 clarity (eye-clean) according to the accompanying GIA diamond certification.  The GIA (Gemological Institute of America) is a well known and respected diamond grading company.  The GIA certification for this diamond increases the desirability of the ring.

-The white gold mount is in good condition, with only modest wear on the ring’s filigree shoulders and the base of the shank.  This is somewhat unusual; rings of this age often have heavy wear, sometimes to the point where decorative elements are nearly obliterated or the bottom of the shank is nearly worn through.

-The vast majority of the intrinsic value of this piece is concentrated in the central diamond.  This is both normal and desirable for a piece of high quality, investment-grade jewelry.  In fact, I would guess that the central diamond is conservatively worth $1,000, meaning you aren’t paying much for the setting or its value as an antique.  $1,185 is a very good price for this ring; it strictly limits your downside risk.

 

Cons:

-The seller claims that the small (0.03 carat each), triangle-cut sapphires on each side of the main stone are natural.  This cannot be independently verified, but would be unusual given the time period and cut.  Most calibre-cut, accent sapphires from this era are synthetic.  However, while unlikely it is not impossible for them to be natural either.  In any case, regardless of whether the sapphires are synthetic or natural, the value of the ring is not significantly impacted.

-This ring is not explicitly hallmarked as 18 karat gold.  Instead it has been tested by the seller as 18 karat gold.  We are taking the seller’s word that the ring is as described, although I should note that the large diamond and excellent workmanship are completely consistent with a high karat setting.

-The ring is size 5.5, which is only appropriate for slim fingers.  Of course, the ring could relatively easily be resized.  In fact, the seller offers resizing for an additional $75.

Most Collectibles Will Never Be Good Investments

Most Collectibles Will Never Be Good Investments

One mistake that a lot of well intentioned people make when first investing in alternative assets is confusing fine art and antiques with pedestrian collectibles.  Differentiating between the genuine asset class of art and antiques on the one hand and knick-knacks and collectibles on the other is vital considering that failing to do so can be a potentially very expensive error.

Art and antiques have a proven track record as investments, sometimes spanning not merely decades, but centuries.  Collectibles, in contrast, usually quickly burst into the public consciousness and then flair out of existence just as quickly.

So what makes something a collectible instead of a legitimate antique?  First, collectibles tend to be created solely, or primarily for the purpose of being sold directly to naive collectors.

Think of your Uncle Ned’s “Champions of NASCAR” plates from the Franklin Mint.  You may love your Uncle Ned dearly, but the sad fact is that his limited production-run plate “collection” has no real value, besides its vanishingly small utilitarian value as dinner plates.  They were produced by the thousand and hold no allure for most NASCAR fans, much less the average person.

Compare this to something like the Hope Diamond.  Many people may not know a lot about diamonds, but almost everybody has heard of the famous blue stone and the exciting lore surrounding it.  And a lot of wealthy people – even those that don’t normally spend much time thinking about diamonds – wouldn’t mind owning such a renowned and beautiful gem.

Collectibles also have a tendency to be faddish.  A great example of this is Beanie Babies.  Do you remember those small, cute plush animals that everyone was stockpiling at the turn of the millennia?  It doesn’t make a whole lot of sense now, but everyone was absolutely convinced that these tiny lumps of brightly-colored fabric and synthetic beans were going to allow them to retire on the French Riviera.  Once the insanity receded, the Beanie Baby fad dissipated with incredible speed, leaving tens of thousands of bitter “investors” with nothing but junk stuffed animals and regrets.

True antiques are real items that were created to be used by real people in real situations.  Life isn’t easy and that rule applies doubly to antiques.  Actual antiques have been worn smooth, accidentally dropped, forgotten in basements and attics for years and generally abused in almost any way imaginable.  As a result, it isn’t surprising that relatively few survive today.

In contrast, it is a safe bet that almost every mass-produced collectible ever made is immediately squirreled away into a dresser drawer, display cabinet or hope chest.  This ensures that, regardless of the size of a collectible’s initial production run, the exact same number is still available today – and invariably in excellent condition too.

Collectibles are often made to commemorate well-known people or events.  Why is this so?  Because the marketing team behind the collectible knows these famous individuals and occurrences are a hook.  They play upon the emotions of ignorant suckers who want to “own a piece of history”.  The only problem is that the collectible commemorating the event has no real connection to that history whatsoever.

Let’s look at an example.  What do you think most civil war buffs would rather own – a recent, mass-manufactured bronze medallion commemorating Confederate general Robert E. Lee, or his personal 1860s era officer’s side-arm, complete with provenance?  One of the items has a true, personal link to the famous man while the other is the mass-produced vision of a marketing maven with dollar signs in his eyes.  Is it any surprise that the real antique is destined to appreciate far into the future, while the collectible will eventually find its way into the trash heap where it belongs?