Occasionally an article will come across my desk and something in it will catch my attention. This week, William Bissett, a wealth manager here at Pinnacle, dropped me an article published in the Morningstar Advisor called, “Asset Allocation Heavyweights Square Off.” The piece, written by Ryan Leggio in the Feb/March 2010 issue, featured a conversation between John Hussman, the manager of the Hussman Strategic Growth Fund (owned by Pinnacle in our managed accounts) and Gus Sauter, the Chief Investment Officer of the Vanguard Group, the famous money management firm overseeing more than $1.4 trillion of managed assets in over 100 mutual funds. Let me just say that John Hussman, in my opinion, has to be one of the smartest people on the planet and his weekly letter about his fund is required reading for Pinnacle analysts. I most definitely would not want to be on the other side of the table debating just about anything with John Hussman.
Towards the end of an interesting interview, Leggio asked both participants how they feel about relative valuations right now. Here is what Sauter had to say:
“A lot of people have asked, what is the equity risk premium looking forward? Is it zero? Is it negative Is it small? Or is it the historic norm, with the historic norm being in the 5.5% to 6% range? I would say that, on average, the equity risk premium is at historic norms all the time. So, I think that we’re looking at average rates of return going forward, and that’s based on the concept that we’re rewarded for investing in stocks because of the inherent risk of investing in stocks. If we weren’t going to be rewarded for that, we’d sell stocks, and we’d sell them down to a price that made them attractive again. In fact, that’s what happened from the end of 2007 to the beginning of 2009.”
Mr. Sauter goes on to argue that the stock market is priced to deliver historically average returns going forward over the next decade. I don’t know how he gets there from here. Based on normalized P/E ratios the stock market is expensive. Hussman says we will basically get the earnings growth rate from stocks over the next decade, which is about 6%. Many other analysts think we will get a lot less. What is blatantly and obviously true is that the rewards for owning stocks depends on the price at which you buy them, and the average risk premium is a useless bit of information used to confuse buy and hold investors. Gus should forget the garbage about “average risk premiums at historic norms” and get in the game. Investors praying for average returns should know that there is little data to support the idea that buying and holding from these prices will be a successful strategy.
