On Thursday, I referenced a second letter that we’ll be sending to clients, intending to send it out on Friday. Rather than rush it out, and because it scratches the surface of economics and business valuation, I decided to put it in front of some friends and family to see if it really made sense. Obviously, a deep discussion about economics would bore most people to sleep.
So, with the letter written and ready to go out in the next day or two, I’ll ask you the same question I asked my friends and family before I gave them the letter:
Why do you think the stock market will be higher ten years from now?
(Most common answer: That’s what it does – it goes up over time.)
As you consider this question, don’t look at Friday’s close or speculate about where the Dow will close in 2018. Instead, look at averages. The Dow averaged about 10,500 or 11,000 this year. Why should it be much higher than that ten years from now?
Obviously, I don’t have all the answers and I don’t know where the markets will close tomorrow or in 2018. All I can do is shamelessly steal from Warren Buffett’s past discussions on the subject. (And if you’ve read those, don’t spoil the answer for everyone else!)
Feel free to spark a discussion in the comments, or just give the question and your answer some serious thought. I won’t jump in to the discussion until after the letter goes out.
EDIT: Rene brought up some great points; but, I should have clarified this question. I’m assuming that it’s business as usual in the United States. I’m not talking about making fundamental shifts, though one could argue the necessity of those shifts. I’m asking: If it’s business as usual in the United States, why should the stock market be higher ten years from now?
Filed under: Economics & History
“Why do you think the stock market will be higher ten years from now?”
I could be wrong – but it seems as though there’s 2 parts that make up the answer to the question:
1. The symbol or representation
2. The intrinsic value of ’some thing’
In this specific case, the symbol or representation is a stock…and some thing (2 words – some thing) is standing behind this thing we refer to as a ’stock’.
That something, in this case, happens to be a business that produces, quantitatively – in the final analysis – cash that flows in and out of said business (or lack thereof) via many processes and parts interacting to create an “organization”. Subsequently, an “organization” is parts working together to form a whole. In this case, those parts happen to be ‘business parts’ (humans, sales scripts, sometimes inventory etc etc).
In any case, the cash produced by this organization of parts interacting with the environment (the environment containing other ‘organizations’) is then subsequently used, like lubricant exchanged between people, to hopefully produce compounding amounts of further lubricant (cash) which can be further compounded and so on.
My understanding of the desire for compounding money (some paper with some writing on it) is that it is lubricant which allows for the maintenance and growth of a business…kind of the same way blood allows for these same things in an organism.
In essence, the vehicles that produce exchanges of value, with one side receiving paper with writing on it (money) that is akin to lubrication, and the other side receiving some other ‘form’ of value (or perhaps both sides receiving this same form of value represented by some paper with writing on it [money] i.e. banks)…is all produced via this nominalization we refer to as a “business” (a nominalization being a PROCESS that moves through time that we freeze into an EVENT and give it a word). We can buy pieces of “businesses”. We do this by buying what is called “stock” – a piece of paper which REPRESENTS the business…one particular ‘organization’.
The stock is further represented via a ticker symbol.
And on and on we get further separated from the “real thing”. The intrinsic value of the ticker symbol – which is the business. We start to believe the value is in the ’stock’. (i.e. “Oh my god! XYZ’s stock is up 12%!” while the business remains stagnant. We start believing a stock can be separated from its underlying value…the business itself…. [voting machine vs weighing machine]…when in fact, the stock IS the business – over time.)
Enough people buy into the opposite social construct, this sociocultural adaptation, that the stock is separated from the business – all the actions of the business as an organization of parts in an environment – and it becomes real in the minds of many people.
The stock takes on a life of its own.
But it’s not real. Calling a tail a leg does not make it a leg. Flying past the 16th floor off a 30 floor building doesn’t make it safe.
In the final analysis – what’s real is an organization (called a ‘business’) exchanging value with people via processes in an environment of other organizations (also called ‘businesses’) – thus creating industries.
And we have the opportunity to buy little pieces of these businesses. When we do, we buy what is called “stock”…a piece of a business.
It seems to me (and again, I could be completely wrong) – but it seems like the main thing that drives the market is human conception of what the symbol represents.
If enough people buy into it representing something other than the intrinsic innate value of the business…then the stock and its subsequent ticker symbol will move around rapidly – thus allowing a real investor (those who focus on the businesses) – to take advantage of an opportunity when rapid movement gets out of line with reality. The reality being the underlying business, one that can indeed be valued due to its inherent stable nature or some other ability allowing it to be valued within some useful range (i.e. between .8-.9, as apposed to say a useless range of 0-1 [0 being completely uncertain, 1 being completely certain])
No different than if a family member who owns a business has a death in the family, needs to sell immediately, and thus is willing to offer you a ridiculously low price for a business that is clearly (on a scale from 0 to 1) much more valuable intrinsically. Something happens to cause a discrepancy. Your job is simply to recognize it as such and take the opportunity.
But if me or you or any other “value” investor [is there any other kind of investing?] – if we see the market for what it really is – A REPRESENTATION OF BUSINESSES which we are to analyze – then we are able to insulate ourselves from false conceptions, focus solely on the qualitative and quantitative factors of all the businesses themselves … and over time, the stock will come to represents exactly what it was supposed to represents in the final analysis:
The intrinsic value of the business which it is represented by.
Again, I’m not an expert and the above is just how I think of the market and the businesses that make up the market.
The market will be higher 10 years from now if those investing in this thing we refer to as ‘a market’ believe the underlying businesses value, that make up the market, are higher 10 years from now.
After all, it seems to me that the intrinsic value of the businesses underlying the market could come out to a value of $90-$100…and the ‘market’, with all our emotional tendencies (our – because we are the market)…we might value the businesses at $60 collectively.
Thus, what the market does is completely dependent on what people think.
But what the businesses do? That’s completely dependent on the businesses themselves and the parts that make up those businesses/organizations.
Arguably, in the end, we humans that make up the market come to recognize, over time, the intrinsic value of businesses. Sometimes, it just takes some time. But as long as we focus on the real thing – the individual businesses – we tend do well over time if we recognize those businesses selling at less than intrinsic value.
So – and again, it’s just my view – it seems the most useful thing to do would be to separate the idea of a ’stock’ and ‘business’ in our mind, and then realize the stock represents a business – and to focus on the business and what it’s actually doing – value it – and then buy or perhaps sell it when the markets get out of line with reality.
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Don’t forget, you also need a steadily, albeit slowly, increasing number of willing participants fueled by a growing population over time. This gives rise to new demand, more workers to increase supply, and also a larger number of people to supply equity. It a perpetual cycle. If we were to have a cataclysmic event, such as a deadly virus that eliminated a large number of people, wealth wouldn’t merely be transferred, it would be destroyed.
That, and what Rene said.
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Realistically, I couldnt say the whole DOW is going up or down.
But I know those wonderful business have a way of realizing value EXCEEDING the price you payed for it initially, assuming you bought at the right price.
But what would be the possible reasons for the dow to be increasing in the next 10 years?
Population growth, demand for all sorts of goods are not going to decrease pre 1995 levels.
Its logical that that these drivers will create value which was being produced by our economy in 2006-2007 levels.
What does that mean to us? The economy has produced higher levels of output in 2007; thus, If your betting on the DOW atm, your betting that we can get out of this mess, bring that false sense of security to ALL investors(to shift market sentiment) WHILE having bet that the economy will someday produce at the same levels it did at its peak.
Why should the market go up in 10 years? Honestly, that’s why you should be in wonderful business purchased at attractive prices; hence, you are betting that your company is so outstanding/excellent that you feel it could easily produce Output levels from 2007 into the future(you have to be careful in this case when you discount the cashflows to decide on a price and NOT overpay based on cashflows from 2007).
Over the long-term, as long as the dollar doesn’t lose A VERY significant amount of its purchasing power, and its business as usual than these things are likely to happen again and again.
The market HAD to crash, its a fact
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Although one can never say for sure, I think history shows that it has a high probability to be higher in 10 years. Crestmont Research (google it) has done an impressive amount of research on stock market performance from an economic, historical/statistical perspective, and the data they have gives me that sense of probability. Although the current economic crisis does ring some bells that sound similar to depression type alarms, there are a few things different that we have going for us now (FDIC, more government support for banking as unethical as it may be). From that I am fairly convinced that although the next few years will probably be pretty bad, 10 years from now will probably put our economy back close to our normal annual GDP growth curve that we’ve seen in the last 60 years, thus propelling the stock market forward.
That’s similar to the most common answer you got, with perhaps a little more explanation.
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Forgot to mention that the current S&P 500 P/E (using an ‘E’ which is “derived” from a smoothed historical GDP curve) is at about 15 or so which is about the average. Even if the P/E is at about the same level in 10 years, the market should be higher due to Earnings growth. Again this assumes no extreme “depression-like” problems in US economy. If the current P/E was higher than 15 then I would be less sure of a higher market value in 10 years.
Joe, I’m getting the feeling you may have reason to believe the level will be less in 10 years. I’m very curious to read your reasoning behind that if you are. Looking forward to reading your pdf either way.
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Why do I think the DOW will be higher in ten years time??
Well I cannot guarantee that the DOW will be higher in ten years time than today. The index’s components may change from now till then. It may change due some some corporations failing and so forth. There is a high probability that the index’s value will be higher in ten years time.
However, I can guarantee you that Strong Financially Capitalized businesses with an Economic Moat will be selling for a higher market cap than they are now. The following are the reasons:
1) American Corporations are well capitalized and have tons of cash on the balance sheet. Well run corporations will deploy this cash and invest it with higher rates of returns than inflation.
2) The Chinese and Indian etc… (i.e emerging markets) middle class has still yet to flourish.
3) Coca Cola and Pepsi will sell more volume of liquid in 2018 than they do now. Proctor and Gamble and Johnson and Johnson will have higher revenue in 2018 than they do now. Basically strong capitalized businesses with an economic moat will have higher sales (i.e. Free Cash) in ten years than this past year.
4) If strong American corporations (KO, PG, JNJ) are still selling for the same market cap in 2018 as they are now and these companies have greater revenue than they do now… many of these businesses MAY be selling around 5 times free cash and yielding a double digit dividend and the probability of that happening will be a Turquoise Swan Event.
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Well, I’m stumped. I have no idea what you mean by “business as usual” and I’m hard pressed to think of a definition of that phrase that would apply to any ten year period in our history. In this country we live in a constant state of revolution. We are all familiar with the phrase “creative destruction” and with the advise to “make your products obsolete before your competition does it for you”. During every crisis and even minor upheavals, the ideologues loudly decry our fall into socialism from one side and our excessive savage brand of capitalism from the other. Technological advances and globalization alone make “business as usual” impossible.
Maybe by “business as usual”, you mean that we will continue our consumerist ways and will continue to grow our fiscal and trade deficits. That certainly would sink us. I think that is a possibility if one of the candidates gets elected but not the other. I won’t say which, in my opinion, lest this whole site degenerates into one of those deranged political blogs. However, even if the “wrong” guy gets elected, that will only slightly delay the time by which the adults in this country grow up.
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the question “will the stockmarket be higher in ten years?”
Will the composition of the dow be thesame in 10 years? will the stock market have the same companies ? we must into account that we could be see could compose of much better companies in 10 years time?
Certain companies-great ones will definitely be worth more over time and there are a lot (but not all) great companies out there and new ones will emerge,but i believe it would be futile to employ such a broad view of things too far ahead. Information is just too uncertain to say anything with any real conviction.
One could invest (blindly or not)today in a basket of stocks that could end up worthless 10 years from now despite the general stock market being higher.
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I was just wondering, when I look at a balance sheet, how do I tell if a company really does have “tons of cash” on hand vs their commitments. What should I be looking for? I hear people tlak about how these strong companies (coke included) will be up 5 or ten years form now and I should buy them in this downturn and hold them for long period (5 to ten years)…BUT
People talk about Coke being a strong american company with cash…yet I look at their ten year returns..and..well..I was hoping to actually make something…If I bought coke in 1998 and sold before this recent downturn in the markets, I would have made nothing for that ten years…doesn’t seem like a good secure investment..yet people banty names like coke around as if they are sure things.
Any insights as to what to look for…rather than “big american company with cash” whateer that means. Sorry if it’s the dumbest question on earth, but the Coke example is meant to show how confused a newbie can be….
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We’re working off huge financial excesses into the trough of the biz cycle. The economy is now a freight train that can’t be controlled. It wants to contract and will contract until its dirty work is completed. This is a very difficult period. But House prices have to come down. They are simply too high and the market priced out the first time buyer. Not a good idea. Once housing retreats another 25%, the market will stabilize. There are simply too many restaurants and retailers. They are finally liquidating instead of reorganizing. See you later Circuit City. CCity was a terribly managed co. run by one of the worst CEO’s of all time. They will pay the price. Nevertheless, this contraction will be followed by recovery and expansion phases of the business cycle. That’s generally how it worked for the past 200 years in this country. The next expansion will take the Dow to 20K – 25 K and next contraction will pull it back to 15K – 16K. Speaking in generalities of course – I’m not a fortune teller by any means.
So yes the odds overwhelmingly suggest a higher stock market in ten years.
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Question: will the market be higher ten years from now?
I don’t think about that question. I just focus on whether the businesses I am buying will likely be creating more cash from a more secure competitive position ten years from now than past/present and that the price is sensible. Luckily for me being a prudent business buying doesn’t require a confident answer to macro questions.
My two cents, keep the change.
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Because we as Americans will be living better in 10 years than we are living now. Why? Our system of meritocracy, freedom of expression, competition has developed a system that unleashes human potential. This translate to business productivity, growth, creativity, innovation and expansion. To me, there is little doubt that the American Economy is still the strongest in the world and will continue to be the case. If you need proof just ask yourself, did we live better today than 1990s?
What does this have to do with the Dow? The Dow represents a slice of the American Economy thus a slice of America. If you believe the overall picture of America’s future is strong and will increase over time then you have to believe the Dow will too. Why? Because the stock market in the short term is a voting machine and in the long term a weighing machine, the Dow will have to follow the fundamentals of the American Economy. Which to me, I believe will be better in 10 years than today.
When people ask me why invest in a S&P 500 index fund? I answer, the index represents America’s future and if you’re long the S&P 500, you are long America.
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All great points. But consider this: The american economy grew faster from 1961 through 1981 than it did from 1981 through 2000 (and 2007), and yet the stock market barely moved during the first twenty year period, and moved much faster than the economy during the second 20/27-year period.
Why?
A mass influx of investors can account for the bubble of 1999; but, why would it have grown by leaps and bounds from 1981 through, say, 1987. Standing still in 1981, most investors were looking back over the past twenty years and seeing no growth; so, they did not rush in en masse in the early 1980s.
It can’t be just a bet on the US economy. GDP growth was 5.9% a year from 1981 through 2007, and 9.1% from 1961 through 1981. It can’t be more rapid earnings growth alone — corporate profits grew an average of 7.04% a year from 1961 through 1981, and an average of 8.08% a year from 1981 through 2007.
For the markets to be higher, the businesses have to be more valuable. As interest rates fall, your discount rate drops, naturally increasing the value of the businesses. As interest rates rise, your discount rate must rise with it. When rates are 4% or 6%, you need not change your discount rate if you are using 9%, 10%, or more. If interest rates rise to 14% again, you wouldn’t want to discount at 9%. Using a higher rate drops the value of the business.
The markets will be higher if the businesses in the Dow and/or S&P 500 are more valuable…not just bigger. Play around with your discount rate to see how the value is affected.
Mind you: This is all a discussion on the markets in aggregate. As a few of you have said, it doesn’t matter for the business investor; but, it will matter for Americans in general.
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I often check in and read the updates on Fwallstreet. I’m not much of a poster. But I have a link here for you guys that’s I think many of you will enjoy. I think it is excellent!!! It explains the economy drivers, how bubbles are created etc… I watched all the lessons back to back but you may want to watch a couple a day. There is a lot of content but it is explained so that any layman can understand it. I don’t know who this guy is or why he bothered to make all the lessons available online, whatever his reasons are I am more knowledgeable because of it.
Let me know if you enjoyed the link. Otherwise I wont bother in the future.
TIM
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As to the topic…
The only reason why the stockmarket would be up is because those selling and buying stocks, as a group, perceive businesses as a group to have a greater value.
This change of perception would cause those selling and buying stocks to negotiate higher prices.
I think it is safe to say the current market is fearfull. Publicly traded businesses as a group are perceived to be risky operations. It is not unlikely that in ten years time, there will be a more favorable perception of business value.
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The markets are cheap right now, assuming damage to the economy is not catastrophic. So, the markets will be higher ten years from now — if interest rates don’t go back to 1982 levels.
If, however, interest rates make a swift (ie. ten year), large move upwards to the low or mid-teens, it would put tremendous pressure on valuations and keep the markets flat because stocks would have to offer higher returns at that time, meaning lower prices relative to their future cash flows.
That is, of course, from “rational” level to “rational” level — temporary bubbles and panic aside.
As to the number of people in the markets, that will affect prices in the short-term, creating bubbles and panic levels. In the long-term, the price of a company is not affected by how many people hold the business, only by how many are pushing the outstanding shares around on a daily basis.
In “normal” market conditions, they wouldn’t be beating JNJ down to $10 a share. So, in “rational” market conditions (from a broad perspective), a company would be expected to trade right around its intrinsic value whether its daily volume was 1,000 or 1,000,000.
Remember: The markets are mostly efficient, except in times of pure fear and greed.
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As long as world economic growth continues, stock market growth will continue.
As long as their isn’t a natural or un-natural calamity, i.e. nuclear fallout or an asteroid strike, over the long haul the stock market should rise.
10 years however is not the long haul. If I had to, I would speculate a higher market in 10 years, but if history teaches us anything it’s that stock market returns within a 10 year time frame are still quite volatile and don’t have to spell growth.
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One word, productivity. The low hanging fruit (temporarily) of productivity is cheap labor, but the ultimate driver is technology. By technology I don’t mean just software, hardware and scientific advances, but also business processes, worker education and infrastructure improvements.
My thesis is that if we survive the current crisis in any kind of timely manner and we begin to rebuild our infrastructure, re-direct our smart people from financial engineering to real engineering, reverse the anti intellectual climate of the last few years and start to work on the challenges the world faces, we have a very good chance of regaining our financial preeminence. If not, or if we don’t get it right, there are other countries and they have stock markets too.
I’m betting on the U.S. because I believe we are still way ahead of everyone else in our system of government, transparency, judicial system, education institutions, free press and yes, even financial system. The U.S. is still the best place in the world by far to be an entrepreneur or a businessman in general. I fully expect that the solutions to global warming, energy generation, world hunger and health and a host of other challenges and opportunities will be provided mostly by the U.S.
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