Returns on investment: a historical approach

Posted by on November 26, 2008 in Misc.

I do not believe anyone is taking what is happening in the economy lightly. But there also needs to be a matter of perspective and context factored into the equation. If nothing else, what appears to be unfolding is actually a return to historical normalcy after a decade of bubble economies, unrealistic expectations and an entitlement to spectacular returns. To wit:

  • Yale economist Robert Shiller, who’s become the god of bubble economics (he of the “I told you so” when it came to the real estate market), recently looked at price to earnings ratios historically. From 1890 to the late 1990′s, the average p/e was 14.6 before consistently being over 20 (in other words, $1 invested in a stock would take 20 years to return). As of early November, after the two of the worse months in the S & P 500′s history, it is back down to slightly over (yes, over) historical norm at 15.7 (here’s the full article on Shiller’s price to earnings analysis).
  • From 1960-2006, corporate profits represented 4.9% of America’s income. In 2006, it represented 6.4% of American’s income- a 30% increase over historical norms (another Morningstar stat).
  • This has been posted many times in other blogs but home values are abnormally high even with the correction in the last 12 months. The chart suggests a very long correction before real estate even approaches historical pricing norms (strangely, housing values actually rose during the depression).

Finally, more anecdotally, I read an article last week indicating that small business’ largest concern was readily available access to capital quoting a member of a small business association that members were feeling the squeeze at prime plus 3% and prime plus 4% business loans. I almost spit out my tea reading that.

If an entrepreneur had to rely upon that cheap of capital to stay in business then it shouldn’t be in business. Cheap cost of money should not be why someone should stays in business.

…my point being, even with prices on everything plunging, we are only still at or near historical norms. So are we in a free-fall to a depression or has the weight of history finally asserted itself on a market drunk on a mixture of entitlement, greed and hubris?

6 Comments on Returns on investment: a historical approach

By Dividends4Life on November 27, 2008 at 2:42 pm

Very nice read! As a dividend investor, I am enjoying the ability to buy stocks at a reasonable fair value.

Best Wishes,

By MoneyGrubbingLawyer on November 27, 2008 at 9:04 pm

I’m starting to think it may be the latter- we’re not plunging into the depths, we’re just returning back to earth. Our economy was falsely inflated, driven by the cheap credit you mention. With that disappearing, the artificially high markets drop as well.

One question about the housing prices chart- what is considered a “standard house”. The “standard” houses of the past 10-15 years are notably larger and more elaborate than those of even 20-25 years ago; the standard 1950′s house is puny by comparison. While I’m sure that this has been adjusted for, I can’t help but think that this upward pressure on house size has also resulted in upward pressure on home values.

By admin on November 28, 2008 at 10:11 am

MGL: That would be a good point about housing. Even if we assumed price per sq. ft. remained constant, housing prices through would go up just based on sizing alone.

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