What About Foreign, Bob?

Robert Arnott has an article up at IndexUniverse that explores whether the equity risk premium still exists and if so what should investors expect from it. This is important in terms of understanding the dynamics of a stocks/bonds/cash allocation and how to structure one that is suitable for yourself or for your clients.

Arnott brings out some stats that show for 10, 20 and 30 years US equities have annualized out at 1.41%, 9.14% and 10.71% respectively. Over those same time frames bonds annualized out at 6.44%, 8.44% and 10.18% respectively. If you could into the wayback machine 30 years and knew you would make no active decisions then owning bonds probably would have made more sense, the idea being that if you can get close to equity-like returns without taking equity market risk then you would avoid equities.

In his conclusion Arnott says “we aren’t saying that we should expect bonds to beat stocks over the next 10 or 20 years. Rather, this brief history lesson illuminates that the much-vaunted 4–5% risk premium for stocks is unreliable and a dangerous assumption on which to make our future plans.”

Maybe I missed this elsewhere in the post but the conclusion seems very incomplete. While we do not know the future we do know the past. In the last 30 years long term yields fell from 15% down to almost 2% and now are back over 3%. This is where that 10.18% comes from. This is not repeatable unless yields first go back up to 15%. Maybe that will happen, though I doubt it, but if it yields did go to 15% first there would be unbelievable carnage in both the capital markets and on the ground. Again this is not what I think will happen.

So the bond market’s performance is not repeatable from here; ten point whatever percent annualized for many years cannot happen from here. Further we also know that US equities had a crappy ten years. “Crappy” might continue for a while. But after crappy there are a couple of possibilities IMO. One would be that things go back to “normal” for US equities which I doubt. I think the more realistic possibility is that when crappy ends we have below “normal” results for US equities. Nowhere in the article that I saw was the point I’ve been writing about repeatedly which is that in a decade of crap there were puh-lenty of markets around the world that did very well; better than normal even. I have no idea if Arnott does much with foreign investing, but assuming I did not miss it in the article he did not mention foreign and many of these types of conversations from other investors/pundits don’t cover this ground.

This is a positive for anyone willing to do the work required to own foreign equities (individual stocks or ETFs). From the you-can’t-solve-world’s-problems file, I am very optimistic that world equity markets can again be productive in the new decade as they were in the last decade where many (so ex-big Europe and ex-Japan) foreign markets did well without the US going along for the ride. This can absolutely happen again even if it is not the same countries doing well.

The first picture is of Pep settling in at Canine Conservation with some day-one kong fetching (if you have dogs you know what kongs are). The changed is name to Pips as in pipsqueak because he is the smallest dog there now and another dog there is named Pepsi although I am not sure there is much difference between Pep and Pips. The second picture is a very cool coffee/house doughnut shop that was just down from our hotel. The interior was very cool as is the sign. The doughnuts were awesome, but not like Honey's Doughnuts in Deep Cove near Vancouver, and the mochas were incredibly smooth.