ÜBER DIESE EPISODE
Ed Easterling joins Coach Pete to discuss Probable Outcomes and Unexpected Returns. Their August 2012 conversation explores secular stock market cycles and the research behind his approach to understanding long-term market conditions.
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Transcript
Automatically transcribed from this episode; timestamps are approximate.
00:00 And welcome back into the Financial Safari. Of course, folks, this is your weekly show looking inside that very complex world. We call it the financial world. And this is the time of the segment when we go out into the nation and we find someone who's made a difference in the financial world, either an author or someone you've seen on the news. Today we're bringing back someone who I had on about three years ago on the show. His name is Ed Easterling. And when I had him on three or four years ago, we were talking about the book that he had out called Unexpected Returns. Understanding Secular Stock Market Cycles. Now, he's got a new book out and it's called Probable Outcomes. And the subtitle is Secular Stock Market Insights. And Ed's joining us from Corvallis, Oregon. Ed, welcome in. Well, thanks, Pete. Good to be here.
00:46 Now, let's talk about this. I mean, it's a confusing world out there in the money world. And a lot of people listening right now are trying to do the best thing, Ed. What they want to do is they want to work hard. They want to put money away. And they want to put money away. And they want that money to grow for when they need it in retirement. Now, what should someone do if they're in this kind of situation? Well, the first thing is to understand the environment that we're in. It's important to understand the landscape that's in front of us. And that's part of what unexpected returns did is it set the principles that help us understand what drives stock market returns over a decade or longer periods. Well, outcomes applies it to this decade. So the first step is to understand that we're in a below average return environment. The second thing to do is to capitalize on all the investment alternatives and skills and techniques available to try and enhance returns so that people don't have to have such subpar return just because the environment is low.
01:40 So, I mean, but the average investor, I know, we see it all the time, Dalbar, the research organization in Massachusetts, say they rank investor behavior. And then they say constantly the average investor is doing the wrong thing at the wrong time. I mean, how can people make sure they're doing the right thing and not fall for some of the fancy brochures that tout averages and how everyone's going to be fine in the future if they just throw all their money in one place? Well, and that's where discipline comes in. And I think that's the hardest part is that people go in with an expectation after reading all that literature that if you just sit back and do the right things, you'll get a 10% return or better. And the reality is the market either gives you well above average or well below average returns. And since the market has some natural volatility to it, human nature drives us to fear and jump out just when it's going down and to get excited and jump in just when it's going up.
02:31 And, of course, in an environment like we're in, which is a very flat, choppy, no-return environment, that leads to even worse returns than what the market would provide passively. You've got a chapter, Chapter 8 in the book, Great Theories and Busted Myths. And some of the myths you talk about are theories, are modern portfolio theory and efficient market hypothesis. Do you want to explain these to the listener and explain if it's a myth or a theory that's correct to follow? Sure. Modern portfolio theory, Harry Markowitz, came out with this theory about 50 years ago. In fact, it's very applicable. What it says is that if you diversify, you will lower your risk profile and increase your return. So the goal is to have better returns with less risk. Now, the dilemma is he led off and said the first step before you use this is to make sure that you pick the right assumption.
03:20 Unfortunately, what we find is that conventional wisdom and all those glossy brochures want to use average returns that are applicable today. And so that theory gets misapplied to lead investors to believe that if you just passively invest today, you'll get your 10%. And the reality is we're not set for anything close to that. Yeah. Ed, as an investment advisor myself, I mean, one of the first things I have to tell someone when we're looking at anything from the past is that past performance cannot dictate future results. Yet they're featured prominently in many of the software programs and brochures, what's happened in the past. Another thing I see a lot is people coming in with Monte Carlo-type simulations. And they believe that everything that happened in the past in the simulation will now go forward and be, I guess, the fairytale ending for their financial plan.
04:08 And that doesn't work a lot of times, does it? No. Actually, Monte Carlo process is one that I also include in that chapter. The concept is basically they go back and take the last 80 years' worth of history or 100 years' worth of history, and they create a million scenarios using a whole bunch of different combinations. So they'll add together 1929, 1938, 1956. I mean, that's like doing a weather analysis of Chicago, of picking a – so you're going to go to Chicago for a week. So we pick a bunch of random days, seven days across the year, and average them together and call that a reasonable scenario. And the reality is if they would instead just do the same analysis but say only, if you're going to go to Chicago in the summer, let's take all the summers for the last 100 years and look at the scenarios on summers or all the winters and look at the scenarios on winters rather than try to mix together a January day and a June afternoon.
05:04 Yeah, that's a good point. I like that example right there. Now, folks, we're talking to Ed Easterling. He's author of a book called Unexpected Returns and a new book called Probable Outcomes, Secular Stock Market Insights. Ed, in the Probable Outcome book, you have a chapter there or a subtitle saying that hope is not a strategy. You want to explain that to the listener? It is, and I think there are a lot of investors that lead out sort of looking at it and saying, gosh, if you can't predict the next year or two, how can you possibly predict the next decade or two? But the reality is that although the years are very unpredictable, the starting point has a lot of insight into what returns you can expect over the longer term, over what are investors' horizons. So rather than kind of lead into it and just sort of blindly pick a portfolio and hope that it gets you a good return, investors need to be a little bit more thoughtful and diligent.
05:59 Look for ways to enhance returns. Look for ways to either themselves or with assistance, professional assistance, to bring skill and discipline to portfolios. And that then provides a much more businesslike approach to investing that has a greater chance of success rather than a more random approach that has a very hopeful chance of success. I think people in the hopes of diversification end up collecting way too many financial products. And there's a show on TV that's very popular called Hoarders where someone just goes out and collects things and never throws anything away. And so I believe in financial decluttering, making sure that you have the right products in place and not too many of them. And you call it clean up your room, don't you? Yes. Yeah. And by the way, room in this case is all caps, R-O-O-M, which is run out of money.
06:45 And the one thing we want to do is to make sure we avoid the room. And one of the things exactly is just that you've got to clean up your room. You've got to make sure you do the right things so that you can ensure financial success and not be in the employment line at Walmart at 80. Well, Ed, I've had people come in and they have a collection of products. They've got these glossy binders with all these products in it, but not a single one guarantees a lifetime income. And so income strategies, as people get older, they're more important these days, aren't they? It really is. When we're in an environment that has a low single-digit return profile, and I think everyone looks today and says, if I get a bond portfolio, I'm going to have very low returns. Because if you get long bonds, you get low returns. If you get real short, hoping they're going to go back up, you're earning no return.
07:32 Most stocks are financial assets like bonds. And so when you put all of those together in a low return environment that has a lot of risk, cash flow is king. And that constant cash flow goes a long way to helping you meet your obligations and avoiding principal loss. I say having a real income plan in place takes the worry out of living in retirement. If you have a check that's in the mailbox each and every month, then a lot of the worry goes away, and it's a lot easier to invest the money that you have left over, isn't it? Well, it is. And a big part of this is that people want to be able to withdraw 2%, 3%, 4%, 5% a year from their portfolios. And if you're counting on capital gains, it means that you're drawing principal all the time. If you have an income strategy, then there's that income available to help supplement that withdrawal so your principal can be there to work for you, not get swung around in the marketplace or risk being lost.
08:21 Absolutely. So vitally important. Now, one final topic I want to talk about is Chapter 12 in your book, The Four Bears. I mean, because I think you did a real good job of, I guess, making the illustration visible to most anyone out there by using the four bears that we all know about when we grow up. That's right. In this case, if we look out, there are two main drivers. I'm going to give away the secrets of the book at this point. The two main drivers of stock market returns are economic growth, which drive earnings growth, and inflation. And we can put all of the scenarios together and create basically four scenarios, the four bears. One of them is the proper bear. That's where we have slower growth and inflation or deflation. And if that happens, returns are negative for the decade. Mama bear is a little less than that.
09:06 There's baby bear, which means we still have pretty poor returns. Only if we have good economic growth and low inflation do we get moderate returns. But there's no scenario that gives us a bull. That's a good way to look at it. Certainly not a super bull. Now, we're going to have periods of bull. Let me just qualify that. In secular bear markets, in these long-term bear markets, we do get periods like 2009 and 10, where the market soars upward. But they usually follow periods where the market plunges downward. And that seesaw back and forth that we've seen now over the last 13 years is likely to continue because we're starting out with such high valuations in the market, such low interest rates and such low inflation, that we're set to endure this for quite a bit longer. Unfortunately, the only periods of bull I've seen in the last 12 years are from the people telling you just to buy and hold and not even look at your financial plan at all.
09:57 I like that. That's good. Now, again, folks, this was Ed Easterling. Ed's got two books, Unexpected Returns and Probable Outcomes. Ed, are these both available on Amazon? They are. They're both on Amazon and available nationally. And all of the charts and graphs in both books are available online at CrestmontResearch.com and updated every year, free for readers to be able to continue to track this information into the future. And, folks, if you joined us late in this interview, we'll post this up on our website, FinancialSafari.com. You'll be able to listen to the complete interview. And we'll also have links to Ed's website, Crestmont Research, as well as how to get his books on Amazon. Ed, thanks for your time today. Absolutely. All the best, and I look forward to visiting again. And, folks, we'll be right back after this.
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