Motivation John Bogle Javier Estrada (On market timing) IESE - PDF document

Long ‐ Term Trends (I): Return Javier Estrada ADFIN – Winter/2014 1. Motivation • Why this topic? 2. Evidence • USA • International evidence • The equity risk premium Motivation – John Bogle Javier Estrada (On market timing) IESE Business School “After nearly fifty years in this Barcelona Spain business, I do not know of anybody who has done it successfully and consistently. I do not even know anybody who knows anybody who has done it successfully and consistently.” ADFIN Winter/2014 1

Motivation – Warren Buffett Javier Estrada IESE Business School “I never had the faintest idea Barcelona Spain what the stock market is going to do in the next six months, or the next year, or the next two. But I think it is very easy to see what is likely to happen over the long term.” ADFIN Winter/2014 Motivation  So, why this topic? Javier Estrada  Most investors are obsessed with the short term IESE Business • But our ability to predict it is near zero (DWM v . GM) School Barcelona  Finance addresses long ‐term relationships Spain • Ours are equilibrium models  The CorpFin notion of risk is very limited • Only two measures of risk (SD and beta) • Little or no mention of the holding period  Long‐term trends provide useful perspectives • How normal/abnormal is a current situation  Several facts useful for your investment decisions ADFIN Winter/2014 2

Motivation  John Raskob Javier Estrada  $15 a month in stocks over 20 years IESE Business • Expected result: $80,000 (GM=24%) School  Observed result Barcelona Spain • $15 a month in stocks would have outperformed $15 a month in bonds in less than four years • After 20 years the stock portfolio would have been more than double the size of the bond portfolio • After 30 years the stock portfolio would have been more than eight times the size of the bond portfolio  Takeaway • For the patient investor, sooner or later stocks do outperform bonds ADFIN Winter/2014 Evidence  What can we learn from the long ‐term evidence? Javier Estrada  For all markets IESE Business • Diversified stock portfolios School • Medium/long‐term government bonds Barcelona Spain  USA Go  Global markets Go  So, the long ‐term global evidence is clear  Stocks enhance purchasing power  Bonds may destroy purchasing power (6/19)  The compounding power of stocks is much higher than that of bonds • The equity risk premium is positive in all markets  AM: 3.1–8.1% / GM: 1.4–5.3%  World ERP ≈ 5% ADFIN Winter/2014 3

Wrapping Up  We will discuss two other pervasive patterns Javier Estrada  Value beats growth IESE Business  Small‐caps beat large‐caps School  But back to the evidence on stocks v . bonds Barcelona Spain  The outperformance in terms of returns is beyond discussion • The question is why?  Why do stocks outperform bonds? • Is it because stocks are riskier than bonds?  Under what definition of risk?  Are stocks really riskier than bonds? ADFIN Winter/2014 Appendix Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014 4

USA – Nominal Returns – 1900 ‐ 2009 Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014 USA – 1900 ‐ 2009 Javier Estrada IESE Business School Barcelona Spain Time to double purchasing power? Approximation ADFIN Winter/2014 5

Compounding Power (Nominal) Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014 Compounding Power (Real) Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014 Back 6

Global Markets – 1900 ‐ 2009 Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014 Global Markets – 1900 ‐ 2009 Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014 7

Global Markets – 1900 ‐ 2009 Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014 Back 8