Bogle's outlook for the market

Christine Benz  |  01/11/2012Text size  Decrease  Increase  |  

Christine Benz: Hi, I'm Christine Benz for Morningstar.

I recently traveled to the annual Bogleheads event just outside of Philadelphia, where I had the opportunity to sit down with the event's namesake, Jack Bogle, who is the founder of the Vanguard Group of Funds.

Jack, thank you so much for being here.

Jack Bogle: Always glad to be here. It's been a year now. I am glad to be with you again.

Benz: So, let's start with your outlook for the market. Let's start with equities, and talk about what your expectations are and how you arrive at them?

Bogle: Well, I've been using this kind of system, if you will, ever since the early 1990s, when I forecasted returns for the 1990s, and it's very simple, and it is extremely helpful, because I divide market returns into two categories - investment return and speculative return.

Investment return is a dividend yield on the day you buy into the market, and to that is added earnings growth that follows. So, today, the dividend yield is around 2 per cent, and I think we can look forward to 5 per cent in earnings growth - nothing is guaranteed, but basically there is nominal growth, and the country is going to be growing like that rate, I think, nominally. And so that would be a 7 per cent investment return or fundamental return.

Benz: Bonds: I am guessing you are less sanguine, about the bond market.

Bogle: Wait a minute to talk about bonds, to finish the stocks, because stock returns are also affected by speculative return, and speculative return is the amount of dollars, the number of dollars, people will pay for a dollar of earnings. So, for example, in 1980, they paid $10 for a dollar of earnings, a price/earnings multiple so-called. In 1990, it doubled to $20. It had added 7 per cent to the return in the 1980s, and then that 20 times earnings in 1990 went to 40 times essentially in 1999, and added, doubling again, another 7 per cent.

So you know the investment return is going to be fairly stable. You know the initial dividend yield, exactly what it is, and so the question is, will P/Es go up or down by the end of the decade, I don't do this for shorter periods ... there just isn't many merit in shorter periods.

The fact of the matter is, at 40 times earnings the market is unsustainable. Could we double again? We'd have to repeat those 7 per cent annual returns additions, and it would have to go to 80 times, and the market can do anything ... but 80 times is pushing your luck.

Benz: So at current valuation levels ...

Bogle: My basic guess, and it's hard, very hard to guess - first, we don't even know what the current P/E is. There are so many different ways of looking at it: 10-year average, 5-year average, last year's earnings, next year's earnings. A big one is operating earnings versus reported earnings. Operating earnings are before all those charges that companies have; reported earnings after them, and I prefer reported. But something like 16 is probably the P/E that we're at today, rationally looked at.

And I would expect that's not going to go up a lot or down a lot in the next 10 years. So I'm just going to call out arbitrarily, zero. So 7 per cent would be my outlook for stocks.

Bonds is a similar system, except there is no speculative return over 10 years, because a 10-year bond matures in 10 years; you get back the par value. There is no growth in earnings or in appreciation in the value of the bond, so you rest entirely on the interest coupon.

So, today, if you look at a 10-year Treasury bond, for example, at 1.6 per cent - a hypothetic 1.6 per cent - that's going to be your return in the next 10 years. Now, I don't think many people are going to be satisfied with that, and you can increase that return by taking a little more risk - investment-grade corporates, longer maturities, this is kind of a short-intermediate maturity, today, for 10 years, and you can go out to the 12- to 15-year range without getting into real volatility of a 25- to 30-year bond.

So, if you could get a 2.5 per cent return or 3 per cent return on bonds today, that would be the return for the next 10 years. Today's yield is the 10-year return, and the correlation between those two numbers is an incredible 91 per cent, but of course, it has to be. It comports with your ideas of logic.

Benz: How about your inflation expectations? What sort of inflation should investors be baking into their assumptions?

Bogle: I'm using 2.5 per cent. I don't know, and the reason I'm a little bit different from Bill Gross in a lot of ways, but in this way, he gives you real returns, and it's always unclear with him where the return is coming from. I give you the nominal return, and then I basically say, you take your choice on the inflation rate and that will give you a real return. But I think you should be using something like 2.5 per cent, and that would take that nominal return of 7 per cent down to 4.5 per cent, and the nominal return on bonds down to almost zero. So, you'd have about a 2 per cent nominal return on the balanced portfolio, real.

Video Archive...

How Greek mythology can make you a better investor
07/12/2016  Don't be over confident or follow the herd, and like Odysseus, learn to have yourself "tied to the mast" when it comes to long-term investing.
Supermarket headwinds prompt fair value cut for majors
06/12/2016  Growing competitive pressures and a declining revenue outlook for Australia's two grocery giants now look to be part of a longer-term, structural shift.
What returns should you expect from markets?
01/12/2016  As market risks rise, investors must adjust their profit expectations--gone are the days of 8 per cent returns. But there are still growth opportunities out there if you know where to look.
Why healthcare stocks got a bump from Trump
28/11/2016  Australian healthcare and pharmaceutical companies continue to enjoy a purple patch, and for various reasons including the recent US election result, explains Morningstar's healthcare equities analyst Chris Kallos.
Equity and hybrid investors react as bond prices tumble
24/11/2016  The negative correlation between bonds and equities is reasserting itself following the US election of Donald Trump, according to John Likos, Morningstar's senior credit analyst.
2 global themes that are finding favour among ETF investors
15/11/2016  Australian retail investors are increasingly turning to ETFs for specific tactical exposures to global themes, particularly in the context of large-scale market events such as US election 2016.
Maintain discipline and stick to fundamentals when selecting stocks
14/11/2016  Steer clear of fads, maintain a disciplined approach and focus on company fundamentals in building and maintaining your investment portfolio, says Anton Tagliaferro, investment director, Investors Mutual
How Trump could impact economic growth
10/11/2016  Slowdowns in trade and immigration could hold back the US, and infrastructure spending could boost GDP, but it's too early to make any major changes to our economic forecast, says Morningstar's Bob Johnson.
President Trump: What should you do?
10/11/2016  Donald Trump has beaten Hillary Clinton to become the 45th US president. What should investors do?
Software companies worth watching amid tech deployment phase
08/11/2016  Kate Howitt, portfolio manager at Fidelity International discusses some of the core phases in technological disruption and identifies software companies among those currently presenting opportunities.
Kerr Neilson hot, cold and tepid on Europe, US and China
07/11/2016  Platinum co-founder and CEO Kerr Neilson explains his views on the major global markets and outlines where he sees opportunities--and where he doesn't.
Is Inghams a moat-worthy investment?
02/11/2016  Morningstar's Ravi Reddy discusses the upcoming float of poultry product producer Inghams, and whether it's in investors' interests to subscribe for shares in the IPO.
3 best ideas in healthcare
26/10/2016  Morningstar's Chris Kallos looks at some of the most compelling ideas in Australian healthcare, while also reaffirming the importance of the uncertainty rating and how it pertains to the sector.
Exercise caution and let some cash build
24/10/2016  Morningstar's Peter Warnes provides a near-term outlook for equities markets, while also sharing his thoughts on the upcoming Ingham's IPO.
Bogle forecasts low stock and bond market returns
21/10/2016  Warning of "much lower market returns" ahead, Vanguard founder Jack Bogle urges investors to seek low-cost investment products. From Morningstar US.
Finding the right flavour ETF amid expanding ETP menu
13/10/2016  From a relatively vanilla selection of exchange-traded funds (ETFs) on offer in the early 2000s, Australian investors can now choose from a wide range of exchange-traded products to suit various tastes.
Bright outlook for Aussie banks despite parliamentary committee and looming Basel IV regulations
12/10/2016  Australia’s ‘big four’ banks’ share prices have held up after their CEOs recently fronted a parliamentary committee, and have already absorbed the potential impact of more stringent capital requirements
Dividend, cashflow challenges hit investors but yield opportunities remain
06/10/2016  Technology, healthcare and telecoms hold opportunities for global equity investors even as utilities and energy stocks disappoint, says Jane Shoemake, director for global equity, Henderson
No place for set-and-forget asset allocation
04/10/2016  A 2016 company reporting season overview and explanation of why dynamic asset allocation is so important, from Dr Shane Oliver, chief economist and director of investment strategy, AMP Capital.
The search for bond yields
27/09/2016  Morningstar's Hybrid Handbook: Navigating the Australian Hybrid Market pulls back the curtain on corporate and bank hybrids, as John Likos, Morningstar's senior credit analyst, explains.