Author Topic: Where will S&P 500 end up in 2030?  (Read 2788 times)

Cigarbutt

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Re: Where will S&P 500 end up in 2030?
« Reply #10 on: June 13, 2020, 10:12:51 AM »
I am skeptical about this relationship. Assume for example in the past, a GDP of $100 needed $50 of capital investment. In that case profits of 3% of GDP, would generate 6% return on capital. Seems like a fair return. Now assume as the economy changed, it now needs $100 of capital investment to keep up that same $100 of GDP. Then profits have to increase as a percentage of GDP to ensure that those providing capital generate adequate returns.
So to me it does not look like there is any fundamental economic logic to say profits need to be a certain percentage of GDP. Especially does not seem to be useful in any attempt at divining the market attractiveness. I understand Buffett's case but it always seemed to me to be one of his weaker arguments.
Vinod
Interesting.
Perhaps another way to look at this is to look at the profits to GDP using an income statement perspective. When zeroing in a specific investment and 'normalizing' the line items, i often end up with downward adjustments that make the price out of reach. Reversion to the mean may not always exist and may take a long time to revert.
Items (moving bottom to top line):
-corporate taxes: recent trends have been quite favorable (sustainable?)
-interest on debt: despite much higher debt loads, debt servicing trends have been favorable (sustainable?)
-labor compensation costs (declining share of wage income versus increasing capital share) have been on the decline for decades (globalization, automation etc), (will the pendulum come back?)
-corporate profits using GAAP have vastly underestimated (when cross-checked with NIPA profits) the true cost of stock-based compensation for the last 10 years, suggesting that share price increase has been more related to multiple expansion than real earnings as GAAP reported.


vinod1

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Re: Where will S&P 500 end up in 2030?
« Reply #11 on: June 13, 2020, 12:54:12 PM »
I am skeptical about this relationship. Assume for example in the past, a GDP of $100 needed $50 of capital investment. In that case profits of 3% of GDP, would generate 6% return on capital. Seems like a fair return. Now assume as the economy changed, it now needs $100 of capital investment to keep up that same $100 of GDP. Then profits have to increase as a percentage of GDP to ensure that those providing capital generate adequate returns.
So to me it does not look like there is any fundamental economic logic to say profits need to be a certain percentage of GDP. Especially does not seem to be useful in any attempt at divining the market attractiveness. I understand Buffett's case but it always seemed to me to be one of his weaker arguments.
Vinod
Interesting.

A simpler way to say this is that it is ROE that should be mean reverting not profit margins or profits as a percentage of GDP. That seems to make more sense to me.

Perhaps another way to look at this is to look at the profits to GDP using an income statement perspective. When zeroing in a specific investment and 'normalizing' the line items, i often end up with downward adjustments that make the price out of reach. Reversion to the mean may not always exist and may take a long time to revert.
Items (moving bottom to top line):
-corporate taxes: recent trends have been quite favorable (sustainable?)
-interest on debt: despite much higher debt loads, debt servicing trends have been favorable (sustainable?)
-labor compensation costs (declining share of wage income versus increasing capital share) have been on the decline for decades (globalization, automation etc), (will the pendulum come back?)
-corporate profits using GAAP have vastly underestimated (when cross-checked with NIPA profits) the true cost of stock-based compensation for the last 10 years, suggesting that share price increase has been more related to multiple expansion than real earnings as GAAP reported.


This is pretty much my belief as well the better part of the last 10 years. Now, however looking at the data I am not so sure.

If these are really the factors, most of them should impact all or at least the majority of the companies in the US. Instead, we see that for 80% of the companies in the US profit margins are pretty much in line with their historical averages. So you are confronted with the fact that only 20% of the companies have higher profit margins compared to the past and they are concentrated in a narrow set of industries.

This casts doubts on the theory that labor compensation, taxes, interest costs, etc are the contributing factors for the profit margin expansion.

I am quite perplexed and not sure what to make of this.

Vinod
The fundamental algorithm of life: repeat what works. –Charlie Munger

SHDL

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Re: Where will S&P 500 end up in 2030?
« Reply #12 on: June 13, 2020, 02:35:29 PM »
One hypothesis that I know is discussed quite seriously is that several decades of lax antitrust regulations led to industry consolidation and therefore greater market power and higher profitability for major US corporations. I think it’s fair to say that there is quite a bit of resentment in the air about all this and that a major policy reversal is not at all unlikely — especially if Democrats gain enough political power in the coming years.

vinod1

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Re: Where will S&P 500 end up in 2030?
« Reply #13 on: June 15, 2020, 04:26:21 AM »
One hypothesis that I know is discussed quite seriously is that several decades of lax antitrust regulations led to industry consolidation and therefore greater market power and higher profitability for major US corporations. I think it’s fair to say that there is quite a bit of resentment in the air about all this and that a major policy reversal is not at all unlikely — especially if Democrats gain enough political power in the coming years.

Good point. I do agree that it had an impact and does not conflict with the idea of a few firms having higher margins.

Grantham made the same point in a recent interview.

Basic mean reversion is the bedrock idea. So we studied the rate at which asset classes tended to mean revert and around which levels. So asset allocation is profoundly based on history repeating itself or following certain principles. And one principle is that if you have an abnormally high return in an industry or a company or a marketplace, it will attract more competition and drive it down to some historical normal and it should work that way. In a healthy capitalist system, if a subset of an industry starts to make 40% a year return, everyone should drop what they're doing and spend some of their energy and money copying it as faithfully and as quickly as they can. And if they do, you have a dynamic rapidly moving capitalist system. You also have one in which those returns will get bit down pretty fast and more towards be more average returns.

That's a healthy system. Now we've diverged away in recent years from that, last 20 years. And the degree of monopoly, particularly in the US has climbed. The degree of corporate influence of government and regulation has climbed which facilitates monopoly. The willingness of the justice department to break companies up has declined, not surprisingly under those conditions. And consequently, the returns have been above average for much longer than would have been feasible in the old days. They would have been competed down and that process has weakened. And in the short run, it's great for stock prices in the long run, it's bad for the capitalist process. It definitely shows a weakening in the competitive spirit and speed.


Vinod
The fundamental algorithm of life: repeat what works. –Charlie Munger