I want to spend a little more time on gold here.
Fundamental demand, including Jewelry, Industrial and Dental, is down significantly year over year (8% and 19%, respectively, on a volume basis) while mining supply is up 18% and recycled gold supply is up 31%. Supply is not constrained and the demand from traditional users is very low.
Amidst this fundamental backdrop, investment demand is up 133% and ETF/investment product demand is up 159% year-over-year. At the same time, central bank sales are down 39% year-over-year and the lowest since 1997, meaning a normal source of sales has slowed dramatically. By not selling a normal amount of gold, central banks have become another source of investment demand because of the supply constraints it puts on the gold market.
The data shows that investment (speculation?) seems to be the only source of demand at this point and that its significant growth (and lack of central bank sales) seems to have moved the price higher. One may make money in gold, but only if there is someone later willing to pay a higher price. (This is also known as the greater fool theory.) Gold has a negative yield (it costs money to store), no intrinsic value (it generates no cash flows), and at the current time appears quite speculative despite the claims that it is a good inflation hedge.
We discuss a broad range of issues that are often investment-related, but not always so. We call it a 'thought blog'. Sagacious: Having or showing keen discernment, sound judgment, and farsightedness.
Average Returns are Expected with Stocks at Fair Value
The capital markets and the economy are related, but exhibit disparate behavior. The U.S. economy has not been performing well since March, but that hasn’t stopped the stock market from rallying nearly 60% from the lows. The market rally has not been limited to stocks. Indeed, risk aversion has meaningfully subsided across the capital markets; the least creditworthy stocks and bonds have led the charge higher. High yield bonds are up nearly 50% this year, more than double the S&P 500. These risky bonds now yield less than 8%, close to where very low risk (AA) bond yields peaked early this year. Triple-C bonds, which are “currently vulnerable and dependent on economic conditions to meet [their] commitments,” are up 92% for the year. It appears to us that from current capital market valuations, further (durable) price appreciation will require fundamental economic improvement.
We never know where the markets will move next, but we can make reasonable estimates of their intrinsic value. According to our estimates, the S&P 500 trades at 16 times normal earnings and near the high end of its value range. Using cyclically adjusted earnings for the S&P 500, stocks trade at closer to 20 times. (The price-earnings ratio for the market has averaged roughly 15 over very long periods.) Another measure of market valuation which focuses on the replacement value of assets, is over 0.80, just slightly above the long-term average of roughly 0.75. One measure taken alone may not indicate much, but several arrows pointing in the same direction demand more attention. And on many different measures, the domestic stock market in aggregate is no longer cheap but fairly valued.
Ultimately, investors should be rewarded for providing capital to those who use it. But contrary to popular belief, risk and return do not always follow a linear relationship; that is, high risk does not necessarily equate to a high return. Today, the capital markets appear much riskier than just a few months ago (at lower prices) and implied long-term future capital market returns appear to be merely average from today’s levels. What that means for the near-term direction of markets is anyone’s guess.
We never know where the markets will move next, but we can make reasonable estimates of their intrinsic value. According to our estimates, the S&P 500 trades at 16 times normal earnings and near the high end of its value range. Using cyclically adjusted earnings for the S&P 500, stocks trade at closer to 20 times. (The price-earnings ratio for the market has averaged roughly 15 over very long periods.) Another measure of market valuation which focuses on the replacement value of assets, is over 0.80, just slightly above the long-term average of roughly 0.75. One measure taken alone may not indicate much, but several arrows pointing in the same direction demand more attention. And on many different measures, the domestic stock market in aggregate is no longer cheap but fairly valued.
Ultimately, investors should be rewarded for providing capital to those who use it. But contrary to popular belief, risk and return do not always follow a linear relationship; that is, high risk does not necessarily equate to a high return. Today, the capital markets appear much riskier than just a few months ago (at lower prices) and implied long-term future capital market returns appear to be merely average from today’s levels. What that means for the near-term direction of markets is anyone’s guess.
Gold and Forex, Sitting in a Tree...
There seems to be something dangerous brewing in gold and in foreign exchange markets, at least as it pertains to individuals trading this stuff themselves and betting big. It is now far too easy to “play” in both areas and many of those venturing in now may be setting themselves up to be burned. The foreign exchange market is the world’s biggest casino, where leverage magnifies gains and losses to the point where fortunes can be (and are) won and lost in a matter of seconds. The dollar has been moving lower with remarkable consistency, lulling some to believe in a "can't lose" trend. Danger, Will Robinson.
Gold, on the other hand, strikes me as incredibly bid up, and there are no shortage of brokers there to help (exploit) the individuals scrambling to buy gold. Something tells me when the people facilitating the transactions make more than the investors, there is some froth in this market. While leverage is not inherent to this market as it is with forex, today's "investors" strike me more as the final group in a giant Ponzi scheme. It all comes down to price. Note that investors at the gold's height in the early 80s need a $2,000+ gold price to merely break even on their purchases almost 30 years ago.
Television and radio are now replete with advertisements for gold buying services and forex trading. Some caution is warranted in these areas; I would expect surprises to be the rule rather than the exception as we move forward. Reversion to the mean can be powerful.
The Federal Reserve and the Crisis
“[There is] no longer any fear on the part of banks or the business community that some sudden and temporary business crisis may develop and precipitate a financial panic such as visited the country in former years…We are no longer the victims of the vagaries of the business cycle. The Federal Reserve System is the antidote for money contraction and credit shortage.”
-- Andrew Mellon, Secretary of the Treasury, April 14, 1928
***** ***** ***** *****
What would the world be like without the Federal Reserve System? Why is it commonly believed that they have superior knowledge and always have everything under control? Do they really know exactly what is going on? At least one member of the Federal Reserve Board, Janet Yellen, President of the San Francisco Fed, has admitted they do not. She has essentially confirmed that their “solutions” have been a series of experiments. They threw some things at the wall to see what would stick, and some did. Now comes the far greater challenge – determining when to remove the unprecedented interventions. Will they remove this excess money in time to avoid adverse effects? Unfortunately, the last quarter century does not give us much hope on that front.
By keeping interest rates artificially low during the so-called Great Moderation, or the period from the early 1990s through mid-2000s that saw strong economic growth with little volatility, the Fed signaled investors that there were more savings in the system than actually existed. Without the Fed intervening in markets, interest rates would have fallen when there was a high amount of savings in the system and risen when savings available to fund investments was low. (Like corn, supply and demand for capital would dictate its price, or rate.) Savings rates since the early 1990s were low and falling, so interest rates would likely have been much higher than they were over the past several years. In effect, the price mechanism for capital was (and is) manipulated by the Fed, which creates false signals for investors and savers. This helped asset markets (stocks, real estate) to bubble and led investments to be funneled into unproductive areas for too long. (Higher interest rates – owing to low savings available to fund investments – would have restrained housing market activity, for example.) In effect, the stimulus provided by cheap money was not withdrawn when it should have been and the mess we’re in is at least partially a result. These false signals continue and it is difficult to imagine the Fed withdrawing excess liquidity anytime other than too late. Unfortunately, the Fed has shown they are more likely to be wrong late than right early.
Is the Future Any Less 'Uncertain' Now?
It may not be the time to exuberant just yet.
The winds of popular sentiment appear to be blowing in one direction with respect to the economy – that is, that the economy is stabilizing and things are looking up. We should see stabilization in the latter half of this year and positive economic growth in the first quarter of next year, we hear. True? Perhaps. I will not make those sorts of predictions because I just do not know (and I know it).
The S&P 500 has rallied about 40% off its early March lows. Emerging market stocks are up close to 70% from their March lows and up 42% for the year, versus an S&P 500 that was up about 5% through yesterday. The CBOE volatility index – VIX – which some call the “fear index” is lower than we saw back in September of last year, prior to the collapse of Lehman and the “economic Pearl Harbor,” as Warren Buffett so eloquently says. Granted, the markets are still about 40% below their highs, indicating another 66% gain needed to get back to even. But they have come up pretty far and fast, and the headwinds to corporate earnings mean stocks’ values have fallen since the highs (and record profit margins) of 2007.
As I laid out at the beginning of the year, our economy is not likely to be the same coming out of this crisis. Consumers are not likely to resume their spendthrift ways going forward. Rather, we’ll probably continue to see higher savings rates and years of deleveraging as consumers align their household cost structures to their income levels. This will probably mean smaller homes and less conspicuous consumption. Accordingly, the source of 70%+ of our economic activity (consumer spending) is likely to be much less robust and become a smaller part of the economy. Capacity utilization will probably be sub-optimal for some time, which means higher structural unemployment and lower wage growth (if not wage rate stagnation). If the government continues its profligate spending without commensurate cuts in entitlements (which it’s actually adding), we will not be able to avoid higher taxes down the road. My personal bias tells me higher taxes are likely because tough decisions on public pensions, Social Security, and Medicare/Medicaid, while probably salable to the public by the popular administration, are not as much fun as tackling health care reform and “green” energy. When the public is willing to suspend disbelief, we get trouble.
The various feedback loops created by all of these elements should result in lower levels of economic growth. Also, corporate returns on equity are likely to be lower and cost of capital higher, meaning price-earnings multiples on stocks might end up structurally lower. Remember, stocks trended strongly upward from 1982 to (roughly) 2007 because of a secular decline in interest rates. We saw interest rates come down from nearly 20% to nearly 0% today. Earnings multiples went from 8 to 20, a roughly 4% annual return solely from multiple expansion. Unfortunately, interest rates are at zero today and a rising interest rate environment is bad for stocks. Look at the market from the early 1940s through the late 1960s – a steady trending market marked by rising P/E multiples and robust corporate earnings growth. From there, the market went nowhere until the early 1980s, paving the way for another strongly upward-trending market. One can argue all they want, but the starting level of valuations plays a major role in long-term stock returns. Judging from this perspective, we clearly lack such tailwinds from where we stand today.
Governments, businesses and consumers do not become aware of all these realities overnight. They take time. It took years for people to go from saving 8-10% of their income (1950s through early 1990s) to 0% (2006), and to double their household debt as a percentage of income. The same goes for businesses and governments (which are run by consumers), who largely didn’t have a “rainy day” contingency plan going into this crisis. I think this is bound to change as we go forward. The result will be a more resilient economy but one that is less optimized should boundless growth and low volatility return.
The market appears fairly valued from both a bottom up and top down standpoint, assuming long-term normal profit margins. That’s not to say it won’t go higher or lower. But from what I’m seeing from a bottom up standpoint, the tremendous bargains we saw in the first quarter of the year are few and far between. Prices at current levels appear to offer only average long-term future return prospects. Yet those willing to dig can find select opportunities available in multiple asset classes.
The winds of popular sentiment appear to be blowing in one direction with respect to the economy – that is, that the economy is stabilizing and things are looking up. We should see stabilization in the latter half of this year and positive economic growth in the first quarter of next year, we hear. True? Perhaps. I will not make those sorts of predictions because I just do not know (and I know it).
The S&P 500 has rallied about 40% off its early March lows. Emerging market stocks are up close to 70% from their March lows and up 42% for the year, versus an S&P 500 that was up about 5% through yesterday. The CBOE volatility index – VIX – which some call the “fear index” is lower than we saw back in September of last year, prior to the collapse of Lehman and the “economic Pearl Harbor,” as Warren Buffett so eloquently says. Granted, the markets are still about 40% below their highs, indicating another 66% gain needed to get back to even. But they have come up pretty far and fast, and the headwinds to corporate earnings mean stocks’ values have fallen since the highs (and record profit margins) of 2007.
As I laid out at the beginning of the year, our economy is not likely to be the same coming out of this crisis. Consumers are not likely to resume their spendthrift ways going forward. Rather, we’ll probably continue to see higher savings rates and years of deleveraging as consumers align their household cost structures to their income levels. This will probably mean smaller homes and less conspicuous consumption. Accordingly, the source of 70%+ of our economic activity (consumer spending) is likely to be much less robust and become a smaller part of the economy. Capacity utilization will probably be sub-optimal for some time, which means higher structural unemployment and lower wage growth (if not wage rate stagnation). If the government continues its profligate spending without commensurate cuts in entitlements (which it’s actually adding), we will not be able to avoid higher taxes down the road. My personal bias tells me higher taxes are likely because tough decisions on public pensions, Social Security, and Medicare/Medicaid, while probably salable to the public by the popular administration, are not as much fun as tackling health care reform and “green” energy. When the public is willing to suspend disbelief, we get trouble.
The various feedback loops created by all of these elements should result in lower levels of economic growth. Also, corporate returns on equity are likely to be lower and cost of capital higher, meaning price-earnings multiples on stocks might end up structurally lower. Remember, stocks trended strongly upward from 1982 to (roughly) 2007 because of a secular decline in interest rates. We saw interest rates come down from nearly 20% to nearly 0% today. Earnings multiples went from 8 to 20, a roughly 4% annual return solely from multiple expansion. Unfortunately, interest rates are at zero today and a rising interest rate environment is bad for stocks. Look at the market from the early 1940s through the late 1960s – a steady trending market marked by rising P/E multiples and robust corporate earnings growth. From there, the market went nowhere until the early 1980s, paving the way for another strongly upward-trending market. One can argue all they want, but the starting level of valuations plays a major role in long-term stock returns. Judging from this perspective, we clearly lack such tailwinds from where we stand today.
Governments, businesses and consumers do not become aware of all these realities overnight. They take time. It took years for people to go from saving 8-10% of their income (1950s through early 1990s) to 0% (2006), and to double their household debt as a percentage of income. The same goes for businesses and governments (which are run by consumers), who largely didn’t have a “rainy day” contingency plan going into this crisis. I think this is bound to change as we go forward. The result will be a more resilient economy but one that is less optimized should boundless growth and low volatility return.
The market appears fairly valued from both a bottom up and top down standpoint, assuming long-term normal profit margins. That’s not to say it won’t go higher or lower. But from what I’m seeing from a bottom up standpoint, the tremendous bargains we saw in the first quarter of the year are few and far between. Prices at current levels appear to offer only average long-term future return prospects. Yet those willing to dig can find select opportunities available in multiple asset classes.
The Road to 2010 goes through 2009
Another year has come to a close, and another is beginning. And what a year 2008 was. 2009 will prove to be just as interesting, punctuated by more business failures amid bad economic data (and maybe even some good news). Just how bad it can get is anyone’s guess; how good it can get isn’t really on anyone’s mind at this point.
As an investor today it is more important than ever to have a macro viewpoint. For many years, it simply wasn’t necessary because the range of economic fluctuations was pretty narrow. Stability brought investors comfort and, according to popular thought, it was more or less safe to “buy on dips,” because the market would almost inevitably ratchet higher in ensuing years. Downturns were short-lived as the Fed took an aggressive stance, pumping in liquidity, but increasing the moral hazard a bit more each time. Slowly, risk aversion subsided. Investors began paying more for earnings and demanded less interest spread over Treasuries to compensate for the additional risk. Much of the returns of the past 25 years have been driven by investors’ willingness to pay higher multiples on earnings. Going back farther, though – over 100 years –stocks are up less than 5% annually, which happens to be the rate of earnings growth over that time. The rest of the roughly 9% compounded return has come from dividends, which will be back in vogue. (Some companies whose dividends may otherwise be sustainable may still have to temporarily curtail them in the current downturn, even stalwart companies.)
Fast forward to this year. We seen a broad based decline in the stock market, the first such major decline since the early 1980s. (The decline in 2001-2002 was really concentrated in a few sectors – media, telecom, and technology – and thus did not affect all sectors equally.) The market went into the year disjointed – with financials down considerably but energy, materials and industrials still holding up relatively well. Now, the market is no longer quite as disjointed, though the degree of undervaluation in the market is far from homogenous.
The most concerning issues are twofold: confidence and cost of capital. Yes, there are others, but I want to concentrate on these broad themes. Confidence underpins our whole economic system, especially with respect to its lubricant, credit. And confidence has been lost. To use a crude example, when your best friend sleeps with your significant other, it’s going to take a long time to trust either of them again. And I think that’s the case here. Trust is built up over a long period of time as confidence builds that the future will largely resemble the past. Trust in, for instance, underwriting standards, was built up over a long period of time as default rates remained low and leverage ratios were allowed to ratchet higher. The loans made late in the cycle kept it going for longer than would have normally been sustained because of the “Ponzi finance” nature of the activity. That is, new loans were used to pay interest and principal on the old loans. As long as credit was available and lenders were willing to suspend disbelief, this worked fine. Until it didn’t.
We’re going to get back to system that relies on the character of the borrower rather than purely (unreliable) quantitative measures. I’m not sure how exactly this will work, because financial innovations will remain a fact of life. But I know it will mean banks and other finance companies will retain a larger portion of their securitizations and/or provide stronger guarantees to security holders. Business models will evolve (with the help of what is likely to be heavy-handed regulation). Formerly profitable businesses will cease to be so, and the seeds of future banking problems will be planted.
The economy is a non-equilibrium, evolutionary system where feedback loops play a meaningful role. George Soros calls this “reflexivity.” The cost of capital across the system has risen quite suddenly, not just debt financing, where rates are obviously much higher and capital less available, but equity. What isn’t often considered is that higher stock prices (along with lower interest rates) bring down the cost of capital. And cost of capital has been falling since the early 1980s, which has been a tremendous tailwind for the values of financial assets. Consider the feedback loop here. At a lower cost of capital, there are more potential projects for companies to undertake. For instance, if cost of capital is 6%, projects with a return potential greater than 6% will add economic value. Adding economic value feeds back into higher stock prices, which decreases the cost of capital, and the cycle continues. And undertaking more projects means more capital spending, which feeds back into economic growth in a meaningful way and further lowers the cost of capital. But when cost of capital goes to 10% or 12% for an extended period, old projects will run off and newer ones will be made under more restrictive conditions. That is, projects with return potential higher than 10% or 12% are now needed to add economic value. (Most) companies would not undertake an 8% return project while paying a 10% capital cost since to do so would be value destroying. With the long-run average return on equity at 12-13%, there are far fewer projects when the hurdle rate is 10% than when it is 6%. Less economic value added means lower stock prices, which leads to a higher cost of capital, and the cycle continues. The longer stock prices stay low, the more likely it is we’ll be in a feedback loop that will look very different from the past 25 years.
Furthermore, when cost of capital is higher, the justified P/E ratio on stocks is lower. We’ve lived in a 15-20 P/E market for the past 20 years largely on the basis of lower cost of capital as interest rates have generally been declining and remained low over this period. The cash tax rate and growth rate do not vary much over time. Returns on capital have moved higher, too, but at least partially have been driven by the levering up, through debt, of the country. So as capital costs rise and the feedback mechanism kicks in, justified P/Es, in my view, will be much lower than we’ve been used to.
What does this mean for investors? Active management is going to be very important. Index fund investors are going to be more challenged. This last year should have proven, once again, that the efficient market hypothesis, beta, alpha, the capital asset pricing model, etc., are all garbage. Markets follow power laws, not normal distributions. Markets are open, complex adaptive systems, not closed equilibrium systems. Returns to the stock market are path dependent. They exhibit oscillations and experience periods of punctuated equilibrium that come about largely through endogenous factors that may or may not have exogenous shocks as the initial cause. Small changes can have big impacts (and do). It is not completely different this time, but it will be different for a while and investors must recalibrate their expectations for how stocks behave. We are likely to see a market, akin to the 1970s, that moves in a trading range over time. (Actually, we’ve already seen it – from 2000 forward.) Income from dividends will be more important in this kind of environment. Being willing to buy at high free cash flow yields and sell at lower free cash flow yields and being willing to hold cash at times will be key. If we get back to a market that forgets what has happened over the past year and resumes trading at its 15-18 multiple consistently, I would be very surprised. But I have been wrong in the past and will be wrong again.
Either way, it will be an interesting year, and I will make no explicit predictions regarding the markets. The economy is bound to get worse in the year ahead and geopolitical concerns will become more serious (for instance, a few countries may defect from the Euro currency), but asset prices will turn up well ahead of a recovery in the real economy.
As an investor today it is more important than ever to have a macro viewpoint. For many years, it simply wasn’t necessary because the range of economic fluctuations was pretty narrow. Stability brought investors comfort and, according to popular thought, it was more or less safe to “buy on dips,” because the market would almost inevitably ratchet higher in ensuing years. Downturns were short-lived as the Fed took an aggressive stance, pumping in liquidity, but increasing the moral hazard a bit more each time. Slowly, risk aversion subsided. Investors began paying more for earnings and demanded less interest spread over Treasuries to compensate for the additional risk. Much of the returns of the past 25 years have been driven by investors’ willingness to pay higher multiples on earnings. Going back farther, though – over 100 years –stocks are up less than 5% annually, which happens to be the rate of earnings growth over that time. The rest of the roughly 9% compounded return has come from dividends, which will be back in vogue. (Some companies whose dividends may otherwise be sustainable may still have to temporarily curtail them in the current downturn, even stalwart companies.)
Fast forward to this year. We seen a broad based decline in the stock market, the first such major decline since the early 1980s. (The decline in 2001-2002 was really concentrated in a few sectors – media, telecom, and technology – and thus did not affect all sectors equally.) The market went into the year disjointed – with financials down considerably but energy, materials and industrials still holding up relatively well. Now, the market is no longer quite as disjointed, though the degree of undervaluation in the market is far from homogenous.
The most concerning issues are twofold: confidence and cost of capital. Yes, there are others, but I want to concentrate on these broad themes. Confidence underpins our whole economic system, especially with respect to its lubricant, credit. And confidence has been lost. To use a crude example, when your best friend sleeps with your significant other, it’s going to take a long time to trust either of them again. And I think that’s the case here. Trust is built up over a long period of time as confidence builds that the future will largely resemble the past. Trust in, for instance, underwriting standards, was built up over a long period of time as default rates remained low and leverage ratios were allowed to ratchet higher. The loans made late in the cycle kept it going for longer than would have normally been sustained because of the “Ponzi finance” nature of the activity. That is, new loans were used to pay interest and principal on the old loans. As long as credit was available and lenders were willing to suspend disbelief, this worked fine. Until it didn’t.
We’re going to get back to system that relies on the character of the borrower rather than purely (unreliable) quantitative measures. I’m not sure how exactly this will work, because financial innovations will remain a fact of life. But I know it will mean banks and other finance companies will retain a larger portion of their securitizations and/or provide stronger guarantees to security holders. Business models will evolve (with the help of what is likely to be heavy-handed regulation). Formerly profitable businesses will cease to be so, and the seeds of future banking problems will be planted.
The economy is a non-equilibrium, evolutionary system where feedback loops play a meaningful role. George Soros calls this “reflexivity.” The cost of capital across the system has risen quite suddenly, not just debt financing, where rates are obviously much higher and capital less available, but equity. What isn’t often considered is that higher stock prices (along with lower interest rates) bring down the cost of capital. And cost of capital has been falling since the early 1980s, which has been a tremendous tailwind for the values of financial assets. Consider the feedback loop here. At a lower cost of capital, there are more potential projects for companies to undertake. For instance, if cost of capital is 6%, projects with a return potential greater than 6% will add economic value. Adding economic value feeds back into higher stock prices, which decreases the cost of capital, and the cycle continues. And undertaking more projects means more capital spending, which feeds back into economic growth in a meaningful way and further lowers the cost of capital. But when cost of capital goes to 10% or 12% for an extended period, old projects will run off and newer ones will be made under more restrictive conditions. That is, projects with return potential higher than 10% or 12% are now needed to add economic value. (Most) companies would not undertake an 8% return project while paying a 10% capital cost since to do so would be value destroying. With the long-run average return on equity at 12-13%, there are far fewer projects when the hurdle rate is 10% than when it is 6%. Less economic value added means lower stock prices, which leads to a higher cost of capital, and the cycle continues. The longer stock prices stay low, the more likely it is we’ll be in a feedback loop that will look very different from the past 25 years.
Furthermore, when cost of capital is higher, the justified P/E ratio on stocks is lower. We’ve lived in a 15-20 P/E market for the past 20 years largely on the basis of lower cost of capital as interest rates have generally been declining and remained low over this period. The cash tax rate and growth rate do not vary much over time. Returns on capital have moved higher, too, but at least partially have been driven by the levering up, through debt, of the country. So as capital costs rise and the feedback mechanism kicks in, justified P/Es, in my view, will be much lower than we’ve been used to.
What does this mean for investors? Active management is going to be very important. Index fund investors are going to be more challenged. This last year should have proven, once again, that the efficient market hypothesis, beta, alpha, the capital asset pricing model, etc., are all garbage. Markets follow power laws, not normal distributions. Markets are open, complex adaptive systems, not closed equilibrium systems. Returns to the stock market are path dependent. They exhibit oscillations and experience periods of punctuated equilibrium that come about largely through endogenous factors that may or may not have exogenous shocks as the initial cause. Small changes can have big impacts (and do). It is not completely different this time, but it will be different for a while and investors must recalibrate their expectations for how stocks behave. We are likely to see a market, akin to the 1970s, that moves in a trading range over time. (Actually, we’ve already seen it – from 2000 forward.) Income from dividends will be more important in this kind of environment. Being willing to buy at high free cash flow yields and sell at lower free cash flow yields and being willing to hold cash at times will be key. If we get back to a market that forgets what has happened over the past year and resumes trading at its 15-18 multiple consistently, I would be very surprised. But I have been wrong in the past and will be wrong again.
Either way, it will be an interesting year, and I will make no explicit predictions regarding the markets. The economy is bound to get worse in the year ahead and geopolitical concerns will become more serious (for instance, a few countries may defect from the Euro currency), but asset prices will turn up well ahead of a recovery in the real economy.
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