The ghosts of Proust are those brittle couture-clad creatures that haunt the salons of fine hotels where they sip ballet pink Champagne. Perpetually enrobed in an air of melancholy, they climb the spiral staircase to the sacred solitude of their tiny perfect rooms. Drawing the papal purple velvet curtains they turn away from the the noise and the ill-mannered hordes and take to their beds. What else is there to do? As their heavy eyelids close on yet another day, the ghost damask wallpaper shimmers like a spectre.
Oh, the horror of imperfection. If only everyone behaved well and all the flowers were arranged just so life would be so much sweeter. Those who expect perfection and cannot tolerate anything less, suffer.
Take French fashion designer Yves Saint-Laurent. As his lover and business partner Pierre Bergé once said, “Yves was born with a nervous breakdown.” Saint-Laurent would often retreat to their chateau in Normandy to sketch new collections and to recover from the excesses of Parisian night life. One afternoon Saint-Laurent returned to the chateau and noticed that the housekeeper had placed a bouquet of flowers in the dining room. It pained him to see the uninspired arrangement. He took a pair of nail scissors and painstakingly snipped the tops off each stem, a hundred tiny decapitations. Then he took to his room for the rest of the day.
Just as it’s unrealistic to expect perfection from our housekeepers—and even our fashion designers, after all Saint-Laurent was a great designer but not always a good one—it’s equally juvenile to expect that markets will behave the way we wish them to. As the industry mantra goes: past performance does not predict future returns. Yet many investors mentally latch onto past success and expect history to repeat itself.
After the crash in 2008 it took several years for the markets to regain momentum after which they went on a tear. Investors regularly boasted of 15-percent and up returns. DIY investors felt like geniuses and portfolio managers behaved like kings of the universe. But the wheel turns…These days it’s unlikely our quarterly reports show anything like those stellar returns. Where did all those investing geniuses go, I wonder?
According to John Bogle, the famous value investor and founder of Vanguard, we’ll be facing a tough decade ahead. His math is simple but hard to refute.
He divides total return into investment return and speculative return. Investment return is approximately 2-percent. That is the average dividend yield on U.S. equities. Corporate earnings growth adds another 6-percent for an 8-percent return. Pretty good so far.
Speculative return is how the market values a company’s earnings growth (price/earnings). Right now the P/E ratio is 20 but the historical average is 15. A lower P/E means lower stock prices, unless earnings skyrocket. So, based on Bogle’s back-of-the-napkin calculations, that 8-percent investment return plus a negative speculative return of, say, 3-percent, leaves us with an average return of 5-percent before inflation and before portfolio management fees. Throw in a couple of ghosts-in-the-machine like hedge funds, high-frequency traders and massive short-trades and things can get pretty hairy, pretty fast. (Hello Valeant!)
To mix my holiday metaphors, to avoid a fright upon finding a lump of coal in your retirement stocking, consider factoring a lower real return, somewhere between 1-to-4-percent, into your nest-egg calculations. Many companies today are priced for perfection but they could hit a snag.Don’t let your fantasy of perfect get in the way of a perfectly nice arrangement. Save a bit more, (or spend a bit less), as insurance against a decade of fair-to-middling market returns.
But, darlings, whatever you do, never skimp on pink Champagne.
Luck & Gravity 