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I found an aspect of the summary of the article encouraging. If there
has been a LT 8% real return in the market, we may be close to a bottom.
I estimate an 8% real return from the 1974 low to come in about 1000
today, so we seem to be safely under that level, and can now look
forward to a regression to the mean!
Regards
DanG
Gary Funck wrote:
>
> There's been a lot of discussion in the press, and elsewhere regarding this
> paper, penned by Arnott and Bernstein.
>
> I was able to find it online via SSRN (570KB):
> http://papers2.ssrn.com/sol3/delivery.taf?24038&_UserReference=FB534036A2488C79
> 3D3084F9
>
> SSRN has a wealth of info, if only I had time to read it all. :)
>
> I find it interesting that only now these valuation articles are coming out in
> the refereed journals. Some of the articles that I've seen were authored in
> 2000!, but are filtering out only now. With the market down, I guess it is more
> socially acceptable
>
> ----------------------------------
>
> What Risk Premium Is "Normal"?
> Robert D. Arnott
> Managing Partner
> First Quadrant, L.P.
> Peter L. Bernstein
> President of Peter L. Bernstein, Inc.
> Consulting Editor at The Journal of Portfolio Management
>
> Introduction
>
> We are in an industry that thrives on the expedient of forecasting the future
> by
> extrapolating the past. As a consequence, investors have grown accustomed to
> the idea
> that stocks "normally" produce an 8% real return and a 5% risk premium over
> bonds,
> compounded annually over many decades.1 Why? Because long-term historical
> returns
> have been in this range, with impressive consistency. Because investors see
> these same
> long-term historical numbers, year after year, these expectations are now
> embedded into
> the collective psyche of the investment community.2
> Both figures are unrealistic from current market levels. Few have acknowledged
> that an
> important part of the lofty real returns of the past has stemmed from rising
> valuation
> levels and from high dividend yields which have since diminished. As this
> article will
> demonstrate, the long-term forward-looking risk premium is nowhere near the 5%
> of the
> past; indeed, it may well be near-zero today, perhaps even negative. Credible
> studies, in
> the US and overseas, are now challenging this flawed conventional view, in
> wellresearched
> studies by Claus and Thomas [2001] and Fama and French [2000, Working
> Paper], to name just two. 3 Similarly, the long-term forward-looking real
> return from
> stocks is nowhere near history's 8%. Our argument will show that, barring
> unprecedented economic growth or unprecedented growth in earnings as a
> percentage of
> the economy, real stock returns will probably be roughly 2-4%, similar to
> bonds. Indeed,
> even this low real return figure assumes that current near-record valuation
> levels are
> "fair," and likely to remain this high in the years ahead. "Reversion to the
> mean" would
> push future real returns lower still.
> Furthermore, if we examine the historical record, neither the 8% real return
> nor the 5%
> risk premium for stocks relative to government bonds has ever been a realistic
> expectation, except from major market bottoms or at times of crisis, such as
> wartime.
> Should investors require an 8% real return, or should a 5% risk premium be
> necessary to
> induce an investor to bear stock market risk? These returns and risk premiums
> are so
> grand that investors should perhaps have bid them away a long time ago -
> indeed, they
> may have done so in the immense bull market of 1982-1999.
> Intuition suggests that investors should not require such outsize returns, and
> the historical
> evidence supports this view. This is a topic meriting careful exploration.
> After all,
> according to the Ibbotson data, stock market investors earned 8% real returns
> and stocks
> have outpaced bonds by over 5% over the past 75 years. So, why shouldn't
> investors
> have expected these returns in the past and why shouldn't they continue to do
> so?
> Expressed in a slightly different way, we examine two questions. First, can we
> derive an
> objective estimate of what investors should have had good reasons to have
> expected in
> the past? And, why should we expect less in the future than we've earned in the
> past?
> [...]
>
>
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>
>
>
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>
> ------------------------------------------------------------------------
> Name: equity_prems.pdf
> equity_prems.pdf Type: Portable Document Format (application/pdf)
> Encoding: base64
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