Risk and Returns, Before and After the Fact

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• Swings in valuation can happen, too; P/E ratios went from ~20x in the late 1920s (on low-quality earnings that were increasingly from financial engineering) to the mid-single digits in the late 1940s, back to 20+ in the 60s, back to single digits by the late 70s, and so on.

• There are two ways to talk about long-term returns from investing in a given asset class. One is easy because it has limited utility, and the other is a useful intellectual exercise, but impossible to get right.

• Why do these generally accepted truths change? For one thing, the longer the time series, the more prone it is to survivorship bias.

• Long-term returns are, in a simplistic model, the current dividend yield plus long-term growth in dividends per share—where “long-term” is very long-term, like a lifetime or longer. And growth in dividends per share is, also in the very long term, a function of growth in revenue per share: margins tend to be surprisingly stable over long periods, and multiples can only go so far in one direction or another.

• another issue with using historical data to predict future returns: starting periods matter!

• The long bull market meant that people were buying a decent expected return and realizing a better one. Every repetition of that made the historical rate of returns from holding long-term bonds better, but also made the expected return from continuing to hold them worse.

• Anyone allocating money to an asset class needs to construct some view on what that asset's returns are, and why. Historical data supplies the "what," but it's market participants' behavior and underlying economics that create the "why."

• The discussion of fundamental drivers of equity returns hammered home the idea that valuation is not a driver of returns, because it moves so slowly. Even if the market switched from trading at ~10x earnings in the early 20th century to ~25x today, that's 70 basis points per year of annual return. But the flip side of this is that over shorter periods, valuation's role as a return driver goes way up.

• In the very long run, stocks tend to go up. But that's only sustainable if that long-term gain is compensation for some shorter-term variability. You can know roughly what you're getting into by looking at broad valuation metrics, which tell you that stocks are fairly expensive right now, especially in the context of higher rates. But you can't get much more information than that—the difficulty of timing the market is a function of how all the easy ways have been arbitraged away, and what's left is a bedrock of uncertainty that, over short timescales, dominates fundamental drivers and long-term trends.