John, I guess I am going to have to watch these. Things are starting to get crazy, as California is looking at ending welfare. Time to arm the citizens of California and open the borders so those getting aid can go back home maybe. Looks as if Arizona can't police its own borders, there is nothing left to do but cut off aid to all people getting it, lest it bankrupt the states. We have a president that is aiming at spending us to peonage to support those that are going to be holding the middle class of the US in peonage, namely the connected wealthy, by putting debt on our tab to send to those that really need it, but having the proceeds flow to those that hold the debts in the first place. We are clearly seeing a struggle for the survival of the US middle class in the midst of this transfer of future income.
In the meantime, I have recently read a couple of articles of interest. One is some very solid theory by Steve Keen, neo-keynesian economist of Australia, who seems to understand this mess as well as anyone out there, in an article dated January 31, 2009. http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/#comment-23918, Keen blows holes right through the theory being used by Ben Bernanke and finishes the article by saying "Having failed to understand the mechanism of money creation in a credit money world, and failed to understand how that mechanism goes into reverse during a financial crisis, neoclassical economics may end up doing what by accident what Marx failed to achieve by deliberate action, and bring capitalism to its knees". This is directed at Bernanke and what Marx called the Roving Caviliers of Credit.
On the contrary, Ambros Evans Pritchard has this article: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7857595/RBS-tells-clients-to-prepare-for-monster-money-printing-by-the-Federal-Reserve.htmlIn it, he claims RBS is telling clients Bernanke is about to double the QE to $5 trillion. If you read Keen, you will realize that Bernanke is hastening deflation, while at the same time filling the banks with money to speculate on the stock market and other stuff. One of the problems in Japan has been the banks are stuck in the stock market and can't liquidate to get back into the game of lending. Also, the US bubble was so large that the excess demand created by credit was 30% of GDP and roughly 22% of aggregate demand. Bernanke is ignorant of the fact that the Fed did in the early 30's what he accuses them of not doing and it did no good, because fiat money has very little to do with money in general in the US and instead the credit inside the banking system is the game. Of course, the procedure of buying debt with money isn't any different in general than a bank buying the same debt with money. As you have said in the GD mold, the PTB are going to go over the falls in a barrel to attempt to keep their errors of the past from being laid bare.
Here is a link to a Bank of International Settlement study dated March 2009. Much of it is beyond my comprehension, but the gist of the study is pretty easy to understand, "that there isnt' enough dollars in the world to satisfy the liabilities of international lenders. This clues me into the idea that Bernanke actually bought securities off European banks to solve the big problem funding these liabilities. You might recall all the talk about the TED spread when the mess was really hot. In this article it is pretty easy to see how big a mess this $31 trillion ball of wax is and probably how big a part the failure of Lehman had in depriving the market of all the derivative fake money that is assumed to be out there through these trades. http://www.bis.org/publ/qtrpdf/r_qt0903f.pdf
All this adds up to why this is such an impossible situation and why we are going to see a crash. Ones attention has to move from the idea of money to the idea of liabilities in general. I read an interesting writing by a guy named Lysander Spooner, who lived up in your area back in the 1800's. Of all the things I have read about money, this is one of the more eye opening ideas I have read. I had written over and over again that "This Note is Legal Tender, for all Debts, Public and Private" was the essense of the US currency and what gave it value. Whereas I had argued deflation online for the past 9 years with a bunch of gold bugs, I would bring this phrase up in my writings. It was my understanding that what would cause deflation was the shortage of money, created out of debt itself, to satisfy contracts. As borrowing ran its course, we would be left with contractural liabilities that couldn't be paid once the supply of credit slowed. http://lysanderspooner.org/node/20
Here is the key paragraph of what I believe to be one of the great intellectual pieces ever written on American money: "But it will be said that Congress are authorized “to coin money, and regulate the value thereof, and of foreign coins.” This is true-but its obvious meaning is, that Congress shall fix the value of each kind or piece of coin, relatively with the other kinds or pieces, - that they shall, for instance, decide what weight and fineness in a silver coin, shall constitute it equal in value to a gold coin of a certain weight and fineness. It means that they shall have power to declare that a dollar of silver shall be equal in value to a dollar of gold, and that they shall decide what weight and fineness of each of these metals shall constitute the dollar, or unit of reference. Congress, then, have power to fix the value of the different coins, relatively with each other - or to make them, respectively, standards of each other’s value. But they have no power to make them “standards of the value” of anything else, than each other - or to fix their value relatively with anything, but each other. Nobody will pretend that Congress have power to fix the value of coin relatively with wheat, oats or hay-that they have power to say that a dollar shall be equal in value to a bushel, a peck, or even a pint, of wheat or oats. And it is only in the single case of a “tender in payment of debts,” that the legal value of the coins, relatively with each other, can be set up. In all other cases individuals are at perfect liberty to give more or less for any one of the coins than they would for any others of the same legal value."
Spooner later became an early anarchist, as he recognized the corruption of organized government and how it set up favorites in the economy and despite the constitution, passed laws to the contrary. The nature of the piece was "The Constitution of the United States, (Art. 1, Sec. 10,) declares that “No State shall pass any law impairing the obligation of contracts.”" In it, he also said that gold and silver were commodities and that their value fluctuated and were no more stable than the other commodities out there. Thus, with India and China and their roughly 2.5 billion or so people between them having a desire to wear gold rings and other jewelry, there is a high demand to melt down gold and make jewelry. India has historically been a hoarder of silver. They also have their own debt bubble, as does China. Demand around the world is being financed by credit that has a limit. We are certain to see the end of this run soon, to be followed by a collapse in demand for all commodities and a liquidation of positions in these metals due to weak markets. In the meantime, tender for payments of debt, debts to banks and debts owed by banks (both sides of the ledger are liabilies, but the liabilities of the banks are of stated amount, while the value of their assets are not stable) become harder to satisfy.
I think these 4 links put together the idea of what we are looking at, as the entire idea behind the establishment solution to this problem, one that has already failed in Japan, is going to fail. This is going to be a conflict that literally rips the world apart, as maybe China can't collect from the US, as people opposed to the welfare state begin to realize their own pensions, 401K's, bonds and other assets can't be saved. I have thought this situation over and over and the only thing I can see that would work is a declared bankruptcy for everyone that would result in a lower price structure, a legal liquidation of debt and at least some portion of all assets being saved to allow for some kind of retirement. Otherwise I think it could all go up in thin air, the last being the currency, should the various governments survive. We have the making of civil and international strife that few can comprehend and little willingness to make adjustments to shorten the disaster that is certain to come.
Monday, June 28, 2010
Wednesday, June 23, 2010
Double or Nothing
I wrote this post in 3 pieces on Mish Shedlocks Blog. http://globaleconomicanalysis.blogspot.com/2010/06/europe-slams-obamas-stimulus-plan.htmlMish is a daily read for me and a brilliant writer. Needless to say, I agree with about 80% of his reasoning, but I do disagree in part. This current economic collapse is one of paradoxes and I believe one that is going to need some real maneuvering by government to not turn into a total collapse. What government is doing at the present in the US is courting disaster. It is nothing less than what was done in Japan, which has lead to a near destruction of their economy in a time when the world at large had sustained sizable growth. There was a reluctance to call a spade a spade and declare much of the financial system in Japan insolvent. Debt could have been wiped out in bankruptcy, the losses taken and the economy started anew, while the US was inflating a huge debt bubble of its own. There isn't a country that can counterbalance the US deflating and it appears Europe is joining the US in this deflation, while China, Australia, Canada and a few others have created their own deb bubbles. I believe I covered some good bases in this series of posts (series because the software at Mish's doesn't accomodate my novels), though I didn't go into detail. In short, I fell we need a plan, not a plan to throw money at the problem, but a plan to clear out the debt, take the losses and in the meantime buy time. The governments of the world are trying to spend us to prosperity and that isn't going to work, as it will destroy the private sector, where all the ideas that work are. But, I believe government could buy some time and it is clear we are looking at economic disaster of epic proportions which will need assistance, else hundreds of thousands or even millions starve in countries where starvation is currently almost non-existant. The situation is so paradoxical that very few understand it. Here is the post.
“I am amazed how little vision most involved have in what causes depressions. Even the guys I read like Mish and Denninger get off track and to say I don't get off track myself would be a lie. The entire matter is so paradoxical that no party is 100% wrong and I doubt any are more then 75% right. I even read where Robert Prechter said that banks had loaned out every penny of deposits, which is in fact true, but only in the reverse, as all deposits are created by lending this day and time. The problem is they have loaned more than deposits and since deposits and currency is all the money there is in the system, as liquid assets, the excess over deposits can't be collected.
In a commercial banking system, all growth that is measured by the nonsense measurements they call GDP is created out of new debt. Absent new debt to create new money, the compound interest equattion swallows itself. With this action, the market value of all marginal assets goes in the tank and with it the credit for these outfits to exist. GM blew a fuse in a hurry. So did some outfits that didn't appear on the face to be marginal and now the countries that are marginal are blowing fuses as well.
Krugman can make his case because he fails to see that the stimulus doesn't fix anything, but is more akin to putting makeup on skin cancer. The cancer is still there, but it is covered up. The fallacy is the cancer is gone and comes back with the removal of the makeup, but if you keep the makeup on long enough, the patient still dies.
Great care has been used to cover up the fact that the problem revolves around debt. Why is it the Rockefeller controlled education system failed to teach anything about debt in the field of economics? The U of Chicago was JDR's baby and who should arise out of this outfit but Samuelson and Friedman? Both of these lines of reasoning run down the line of give the patient another drink and his hangover will go away. They fail to recognize that the organs inside will continue to rot.
The current system is more akin to the gambling game where the loser gets to go double or nothing until he wins. Except only 1 loser gets to do this, while the other pays up. How do we up the ante and go double or nothing again? In the case of the banks, they are insolvent and can't really produce the money to pay the depositors. In the case of the borrowers, they can't pay the banks, because the banks can't produce the money. Both of these outfits are being supported at the expense or benefit, which there are 2 sides of this equation of the depositors and other holders of financial assets. The game of double or nothing has to go on or everyone loses, as the losers of the bets, the debtors can't pay and the creditors can ride on as long as the pretense is they can pay.
The best we can do is buy time and that is what stimulus does. But, stimulus can't be the plan and neither can the actions of the Fed, because the plan leads to more debt and more pretend double or nothing. Anyone who has ever done double or nothing on a bet knows it was done because the loser couldn't pay in the first place after the second or third loss. The problem here is the loser isn't ever going to win to clear the debt.
There are too many things that the establishment needs to happen which can't. One is that prices remain high. We are looking at a pension system that is based on the stock market. Pull out the stimulus and the numbers attached to stocks goes down and with it the pension model collapses. Manufacturers and retailers need price supports to maintain profits, banks need additional credit to keep the system at least appearing to be solvent. The counter side of this is if the debt is reduced, prices go down, not up. Also, the backbone of the political and monetary structures go away.
The Goldman report is flawed as well, not because it can't be true, but because what they studied has never been done at the end of a bubble. Never as in their history. What this tells me is Goldman has probably already set up a trade to make a killing out of a collapse, as I have not read where they put out an honest report to the public for nothing. Again, I am not supporting stimulus, because at this point it is at best rearranging the chairs on the deck of a sinking ship. I would venture that private credit has always pulled the economy out of a spin and the result has been more government revenues and falling expenses related to recession
The point of all of this is what is the final solution. Regardless of the flaws of government stimulus and monetary policy, the question arises as to how we collapse and survive? I happen to believe that the history of keynesian and monetarism solutions has placed us on this edge of disaster where we sit today. The plan has to have an exit that doesn't contain the delusion we are going to have a normal recovery. We won't and it won't be because they quit doing the flawed ideas taught in the Chicago school. It will be because it is just time for a depression. The only way we go forward is if China raises wages 1000% and we give Chinese consumers credit cards and thus collateralize the future earnings of a billion new people. Even then, it would be necessary for the rest of the world to reduce their debt by a corresponding amount. This isn't going to happen, because the compound interest equation won't allow it.
It is hard to get new debt out there when the people with brains know there is going to be a haircut against cash. If people understood that failing to take the tax credit for buying a house would allow them to buy the same house maybe $20,000 cheaper in 2 years, while taking the credit puts them in debt by a like amount, the tax credit would have never been utillized. But, the asset bubble is the end game of a debt bubble that has lost its capacity to drive commodity and labor prices, because so much of the new debt is geared, not to consumption as assumed, but toward servicing the compound interest equation itself. This system of double or nothing cannot amount to a real gain, only the delusion one is going to collect what they already own and the other person cannot pay.
The real solution is that FNMA paper is worth maybe 50 cents on the dollar. The stock market is maybe worth a dime on the dollar. I am using these 2 as examples for the broad field of assets. This shows the real depth of the problem, as those in favor of austerity might change their minds when they see their pensions, their financial holdings, the price of their homes and other things go down the drain. They fail to see that collecting on these assets at anywhere near par is impossible, but they are going to insist government make an effort. Most have already compounded double or nothing several times and spent the change. But, remember the debtors can't pay
“I am amazed how little vision most involved have in what causes depressions. Even the guys I read like Mish and Denninger get off track and to say I don't get off track myself would be a lie. The entire matter is so paradoxical that no party is 100% wrong and I doubt any are more then 75% right. I even read where Robert Prechter said that banks had loaned out every penny of deposits, which is in fact true, but only in the reverse, as all deposits are created by lending this day and time. The problem is they have loaned more than deposits and since deposits and currency is all the money there is in the system, as liquid assets, the excess over deposits can't be collected.
In a commercial banking system, all growth that is measured by the nonsense measurements they call GDP is created out of new debt. Absent new debt to create new money, the compound interest equattion swallows itself. With this action, the market value of all marginal assets goes in the tank and with it the credit for these outfits to exist. GM blew a fuse in a hurry. So did some outfits that didn't appear on the face to be marginal and now the countries that are marginal are blowing fuses as well.
Krugman can make his case because he fails to see that the stimulus doesn't fix anything, but is more akin to putting makeup on skin cancer. The cancer is still there, but it is covered up. The fallacy is the cancer is gone and comes back with the removal of the makeup, but if you keep the makeup on long enough, the patient still dies.
Great care has been used to cover up the fact that the problem revolves around debt. Why is it the Rockefeller controlled education system failed to teach anything about debt in the field of economics? The U of Chicago was JDR's baby and who should arise out of this outfit but Samuelson and Friedman? Both of these lines of reasoning run down the line of give the patient another drink and his hangover will go away. They fail to recognize that the organs inside will continue to rot.
The current system is more akin to the gambling game where the loser gets to go double or nothing until he wins. Except only 1 loser gets to do this, while the other pays up. How do we up the ante and go double or nothing again? In the case of the banks, they are insolvent and can't really produce the money to pay the depositors. In the case of the borrowers, they can't pay the banks, because the banks can't produce the money. Both of these outfits are being supported at the expense or benefit, which there are 2 sides of this equation of the depositors and other holders of financial assets. The game of double or nothing has to go on or everyone loses, as the losers of the bets, the debtors can't pay and the creditors can ride on as long as the pretense is they can pay.
The best we can do is buy time and that is what stimulus does. But, stimulus can't be the plan and neither can the actions of the Fed, because the plan leads to more debt and more pretend double or nothing. Anyone who has ever done double or nothing on a bet knows it was done because the loser couldn't pay in the first place after the second or third loss. The problem here is the loser isn't ever going to win to clear the debt.
There are too many things that the establishment needs to happen which can't. One is that prices remain high. We are looking at a pension system that is based on the stock market. Pull out the stimulus and the numbers attached to stocks goes down and with it the pension model collapses. Manufacturers and retailers need price supports to maintain profits, banks need additional credit to keep the system at least appearing to be solvent. The counter side of this is if the debt is reduced, prices go down, not up. Also, the backbone of the political and monetary structures go away.
The Goldman report is flawed as well, not because it can't be true, but because what they studied has never been done at the end of a bubble. Never as in their history. What this tells me is Goldman has probably already set up a trade to make a killing out of a collapse, as I have not read where they put out an honest report to the public for nothing. Again, I am not supporting stimulus, because at this point it is at best rearranging the chairs on the deck of a sinking ship. I would venture that private credit has always pulled the economy out of a spin and the result has been more government revenues and falling expenses related to recession
The point of all of this is what is the final solution. Regardless of the flaws of government stimulus and monetary policy, the question arises as to how we collapse and survive? I happen to believe that the history of keynesian and monetarism solutions has placed us on this edge of disaster where we sit today. The plan has to have an exit that doesn't contain the delusion we are going to have a normal recovery. We won't and it won't be because they quit doing the flawed ideas taught in the Chicago school. It will be because it is just time for a depression. The only way we go forward is if China raises wages 1000% and we give Chinese consumers credit cards and thus collateralize the future earnings of a billion new people. Even then, it would be necessary for the rest of the world to reduce their debt by a corresponding amount. This isn't going to happen, because the compound interest equation won't allow it.
It is hard to get new debt out there when the people with brains know there is going to be a haircut against cash. If people understood that failing to take the tax credit for buying a house would allow them to buy the same house maybe $20,000 cheaper in 2 years, while taking the credit puts them in debt by a like amount, the tax credit would have never been utillized. But, the asset bubble is the end game of a debt bubble that has lost its capacity to drive commodity and labor prices, because so much of the new debt is geared, not to consumption as assumed, but toward servicing the compound interest equation itself. This system of double or nothing cannot amount to a real gain, only the delusion one is going to collect what they already own and the other person cannot pay.
The real solution is that FNMA paper is worth maybe 50 cents on the dollar. The stock market is maybe worth a dime on the dollar. I am using these 2 as examples for the broad field of assets. This shows the real depth of the problem, as those in favor of austerity might change their minds when they see their pensions, their financial holdings, the price of their homes and other things go down the drain. They fail to see that collecting on these assets at anywhere near par is impossible, but they are going to insist government make an effort. Most have already compounded double or nothing several times and spent the change. But, remember the debtors can't pay
Saturday, June 12, 2010
So, Pension fund yields going to be 8%?
I got on this subject the last time around the tub in 2003. I read a lot, saw the projections then and did a total compound analysis on the data on the market Robert Shiller posts on his site monthly. http://www.econ.yale.edu/~shiller/data.htm . This could get really long, so I might move it to my blog.
Firat of all, I believe the Fed at that time estimated underfunding at $400 billion, but underfunding was marked at 90% of full funding and the use of actuarial returns of 8% to 9%. I believe 10 year treasuries were in the 4% range at the time, so any assumption of returns 4% to 5% over risk free would in itself be on shaky ground. I might add that it is difficult for the true, sustainable monetary base to grow in excess of risk free rates, which adds fuel to the fire.
To demonstrate the truth revealed in Shillers data, one must suspend from the nonsense about growth fundementals and get down to real facts. The first proposition, contrary to argument, is that the stock market is nothing more than a discount of a future stream of income known as dividends. Earnings is about nonsense, timing of losses, control fraud and other matters, but the dividend check goes in the bank. One could propose the companies have a salvage value, but once a company goes broke, shareholders are generally wiped out. That idea is for bond holders.
To make matters simple, I am going to use a 40 year holding period, March 1970 to March 2010. This will eliminate some noise, even though valuations are inflated today. To equate the matter, one has to either adjust the price in 1970 upward to reflect the current dividend rate or adjust the most recent downward. Many of you will wonder why, because it has been preached that dividends don't matter, only capital gains matter. This is nonsense, because the company's profits have to be liquidated in some fashion and without dividends over time, the company has no financial value.
Through careful though, I have deduced that the dividend is the basis of growth over time, thus has little present relation to inflation or anything else, including growth prospects. The market can't see 40 years, only what the current mania or downturn reflects. Inflation and the risk premium is reflected in the growth rate, so we could have a relatively low dividend and higher inflation or a high dividend and low inflation. History of these prices have provided us with both situations. IN any case, I am going to make the price of the 1970 market equal the value of what the dividend yield is now on the dividend of 1970. Then I am going to find the 40 year inflation rate based on the CPI and adjust the 1970 price up to today CPI. The division of the current price by the 1970 price should provide the compounded factor of growth over inflation. This should provide 3 rates, the inflation rate, the real growth rate and the dividend rate. The dividend rate will be what the current yield is. An easier way to do this and probably more accurate as well, as adding the compound inflation factor and the compound real growth factor will overstate the return slightly.
The price of the SPX in March 1970 was 88.65, the CPI was 38.20 and the dividend was 3.17. That gives us a dividend yield of 3.58%. The March 2010 SPX price was 1152.05, the CPI 217.63 and the dividend 21.91. This gives us a dividend yield of 1.902%. To adjust the 1970 price to current valuation would require the division of 3.17 by .01902, which gives a yield adjusted price of 166.68. I could do the reverse and divide the current dividend by the yield 40 years ago, which would provide a current price of 612.01. You might note this price is below the bottom price of 666 and I might add that a price that provides a 3.58% yield has been historically a high price to boot.
The CPI factor is 217.63/38.20. This equals 5.697, meaning it takes $5.70 to make a 1970 dollar. If I take the yield adjusted price of the SPX from 1970, 166.68 and adjust by the CPI, the current back inflation/dividend adjusted price from 1970 would be 949.59. This would be the current price if everything merely followed inflation. By being in the stock market from 1970 using the current dividend yield you would have made a compound 1158.05/949.59 or 1.2132 times your original investment. Subtracting 1, we have a total real growth in dividends of 21.95% over 40 years. I won't get exact in the compound factor, but simple math of 21.32% divided by 40 years gives us roughly 1/2%.
One might wonder, why the practice. What this series of calculations reveal is the real long term return on stocks is dividends plus inflation plus around 1/2%. Without going into the math directly I will add that I developed a longer term model, I believe from the January 1926 base that so many academic studies use. It it, I deduced that dividend plus real growth should equal around 6%. This would give the 9% return so talked about when adding a 3% inflation rate. As one might be able to see, real growth has fallen short of that model and if we adjusted the stock market to reflect 6% growth plus dividends, we would arrive at a price of 21.91/.055 or 398.36. Though this sounds shocking, an adjustment of stock prices to this model is 100% sure to happen at sometime in the next 10 years and the only factor is going to be what the CPI factor is at the time.
So, what have stocks, under this model made over the past 40 years? 1.902% plus (1152.05/166.68)^1/40. I will make an estimate on the 40 year factor of 6.91174. Dividing this number by 1.0495 forty times gives 1.00066 making the after inflation return 4.95%. This gives an adjusted 40 year return on the SPX of 6.852%. I might add the inflation rate or the 40 year factor for 5.697. This is somewhere between 4.44% and 4.45%, meaning we are looking at a long term yield adjusted return in stocks of inflation plus 1.902% plus 1/2%. For anyone who has ever studied finance, you know the risk free return is 3% and we are looking at stock returns in the 2.4% range. The theoretical return on treasuries has beaten stocks.
What this tells me is we aren't looking at 8% returns out of the market, but something on the order of inflation plus 2.4%. This would be fact if we are going to get a long term inflation rate of 5.6%, but can anyone fathom financing the pile of debt in the US or for that matter, the dollar denominated debt around the world at 10%? We are more likely to adjust downward to somewhere between the 391 I mentioned and the low 600's on the SPX. That is if the credit system holds up.
Firat of all, I believe the Fed at that time estimated underfunding at $400 billion, but underfunding was marked at 90% of full funding and the use of actuarial returns of 8% to 9%. I believe 10 year treasuries were in the 4% range at the time, so any assumption of returns 4% to 5% over risk free would in itself be on shaky ground. I might add that it is difficult for the true, sustainable monetary base to grow in excess of risk free rates, which adds fuel to the fire.
To demonstrate the truth revealed in Shillers data, one must suspend from the nonsense about growth fundementals and get down to real facts. The first proposition, contrary to argument, is that the stock market is nothing more than a discount of a future stream of income known as dividends. Earnings is about nonsense, timing of losses, control fraud and other matters, but the dividend check goes in the bank. One could propose the companies have a salvage value, but once a company goes broke, shareholders are generally wiped out. That idea is for bond holders.
To make matters simple, I am going to use a 40 year holding period, March 1970 to March 2010. This will eliminate some noise, even though valuations are inflated today. To equate the matter, one has to either adjust the price in 1970 upward to reflect the current dividend rate or adjust the most recent downward. Many of you will wonder why, because it has been preached that dividends don't matter, only capital gains matter. This is nonsense, because the company's profits have to be liquidated in some fashion and without dividends over time, the company has no financial value.
Through careful though, I have deduced that the dividend is the basis of growth over time, thus has little present relation to inflation or anything else, including growth prospects. The market can't see 40 years, only what the current mania or downturn reflects. Inflation and the risk premium is reflected in the growth rate, so we could have a relatively low dividend and higher inflation or a high dividend and low inflation. History of these prices have provided us with both situations. IN any case, I am going to make the price of the 1970 market equal the value of what the dividend yield is now on the dividend of 1970. Then I am going to find the 40 year inflation rate based on the CPI and adjust the 1970 price up to today CPI. The division of the current price by the 1970 price should provide the compounded factor of growth over inflation. This should provide 3 rates, the inflation rate, the real growth rate and the dividend rate. The dividend rate will be what the current yield is. An easier way to do this and probably more accurate as well, as adding the compound inflation factor and the compound real growth factor will overstate the return slightly.
The price of the SPX in March 1970 was 88.65, the CPI was 38.20 and the dividend was 3.17. That gives us a dividend yield of 3.58%. The March 2010 SPX price was 1152.05, the CPI 217.63 and the dividend 21.91. This gives us a dividend yield of 1.902%. To adjust the 1970 price to current valuation would require the division of 3.17 by .01902, which gives a yield adjusted price of 166.68. I could do the reverse and divide the current dividend by the yield 40 years ago, which would provide a current price of 612.01. You might note this price is below the bottom price of 666 and I might add that a price that provides a 3.58% yield has been historically a high price to boot.
The CPI factor is 217.63/38.20. This equals 5.697, meaning it takes $5.70 to make a 1970 dollar. If I take the yield adjusted price of the SPX from 1970, 166.68 and adjust by the CPI, the current back inflation/dividend adjusted price from 1970 would be 949.59. This would be the current price if everything merely followed inflation. By being in the stock market from 1970 using the current dividend yield you would have made a compound 1158.05/949.59 or 1.2132 times your original investment. Subtracting 1, we have a total real growth in dividends of 21.95% over 40 years. I won't get exact in the compound factor, but simple math of 21.32% divided by 40 years gives us roughly 1/2%.
One might wonder, why the practice. What this series of calculations reveal is the real long term return on stocks is dividends plus inflation plus around 1/2%. Without going into the math directly I will add that I developed a longer term model, I believe from the January 1926 base that so many academic studies use. It it, I deduced that dividend plus real growth should equal around 6%. This would give the 9% return so talked about when adding a 3% inflation rate. As one might be able to see, real growth has fallen short of that model and if we adjusted the stock market to reflect 6% growth plus dividends, we would arrive at a price of 21.91/.055 or 398.36. Though this sounds shocking, an adjustment of stock prices to this model is 100% sure to happen at sometime in the next 10 years and the only factor is going to be what the CPI factor is at the time.
So, what have stocks, under this model made over the past 40 years? 1.902% plus (1152.05/166.68)^1/40. I will make an estimate on the 40 year factor of 6.91174. Dividing this number by 1.0495 forty times gives 1.00066 making the after inflation return 4.95%. This gives an adjusted 40 year return on the SPX of 6.852%. I might add the inflation rate or the 40 year factor for 5.697. This is somewhere between 4.44% and 4.45%, meaning we are looking at a long term yield adjusted return in stocks of inflation plus 1.902% plus 1/2%. For anyone who has ever studied finance, you know the risk free return is 3% and we are looking at stock returns in the 2.4% range. The theoretical return on treasuries has beaten stocks.
What this tells me is we aren't looking at 8% returns out of the market, but something on the order of inflation plus 2.4%. This would be fact if we are going to get a long term inflation rate of 5.6%, but can anyone fathom financing the pile of debt in the US or for that matter, the dollar denominated debt around the world at 10%? We are more likely to adjust downward to somewhere between the 391 I mentioned and the low 600's on the SPX. That is if the credit system holds up.
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