Long-run equity returns from today's price levels are likely to be considerably lower than their 10% long-run average.
There is a disagreement about the sustainability of current lofty stock market valuations.
One camp argues that the market is dangerously overvalued. The so-called CAPE ratio—the price-earnings multiple for the market based on cyclically adjusted earnings averaged over the past 10 years—stands at over 25, well above its long-run average of about 15. Today's CAPE has been exceeded only during the market peaks of 1929, early 2000 and 2007.
The CAPE does a reasonably good job of predicting 10-year equity returns. High CAPEs predict low future returns. Low CAPEs are often followed by generous stock-market returns. The CAPE is not useful in predicting returns one or two years into the future.
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Another group of forecasters are convinced that stocks are reasonably valued. The main competitors for stocks in individual and institutional portfolios are bonds. And yields on fixed-income securities are at all-time lows. Short-term interest rates are essentially zero, and the yield on the 10-year U.S. Treasury bond is only 2.4%. Investors seeking a reasonable rate of return have few places to go other than equities. This camp believes equities are a particularly attractive option in the menu offered by today's capital markets.
So who is correct? The answer is that both may be.
In principle, stocks should be priced as the discounted present value of the future cash flows from dividends and capital gains. The discount rate that should be used must reflect the rate on low-risk securities, such as 10-year U.S. Treasury issues, plus some premium to reflect the riskiness of the stock market, which at times generates large losses.
If we add three or four percentage points to the current low Treasury yield, we still get a low discount rate that can justify high stock prices. And today's low interest rates may persist. The world is likely to experience a long period of abundant productive and labor capacity with attendant slow growth, along with low interest rates.
While continued low rates can justify high stock prices, the CAPE followers are correct as well. Long-run equity returns from today's price levels are likely to be considerably lower than their 10% long-run average.
So what's an investor to do?
First, recognize that we are likely to be in a low-return environment for some time. Both stocks and bonds are likely to generate lower long-run returns than in the past. If you have established your retirement savings plan assuming double-digit returns, it is time to recalibrate and save more. The same goes for institutional investors hoping to ensure that their pensions are adequately funded.
Second, don't thinking you can time the market and sell your stocks now, hoping to get back in later after there is a correction. No one can consistently time the market, and you are more likely to get it wrong than right.
CAPE ratios were highly elevated when former Federal Reserve Chairman Alan Greenspan made his famous "irrational exuberance" speech in December 1996, but the market rallied strongly through March of 2000. Stay broadly diversified with a portfolio that is consistent with your age, financial obligations and risk tolerance.
Third, within equity and fixed-income markets, look for opportunities that seem relatively well priced and ensure that they have a place in your portfolio.
All equity portfolios should include emerging markets. Emerging markets, accessible through broadly diversified, low-cost, emerging-market exchange traded funds, represent half of global economic activity. They are growing far more rapidly than the developed economies of North America, Europe and Japan and are likely to continue to do so. They generally have less government indebtedness and much younger populations.
Emerging equity markets also have far more attractive valuations. CAPEs for emerging markets at less than 15 are little more than half the levels in the U.S., and they stand at ratios close to their all-time lows. Just as CAPEs do reasonably well predicting long-run returns in the U.S., so they are also effective predictors in emerging markets, and today they signal generous returns.
Within the fixed-income markets, tax-exempt bonds represent unusually good relative value. The bankruptcy of Detroit and the well-publicized problems of over-indebted Puerto Rico have cast a pall over the entire U.S. municipal bond market, leading to lower bond prices and higher yields.
Tax-exempt bonds of municipalities with excellent credit sell at yields higher than those available on Treasury securities. Closed-end investment companies that hold municipal bond portfolios are traded on national exchanges at discounts from their net asset values and with yields over 6%. While they employ moderate leverage, and therefore do involve some extra risk, they are worthy of consideration in a market where opportunities for generous yields are few and far between.
Mr. Malkiel is the author of "A Random Walk Down Wall Street" (W.W. Norton). The revised 11th edition will be available later this year.
1a) It's Not a Videogame
After ISIS, can the Democrats be trusted with national security from 2016 to 2020?
By Daniel Henninger
When ISIS made the murder of James Foley into a YouTube video, they transported this outrage to the odd middle-world we inhabit between reality and pixels of reality. People don't ask if you saw the murder of James Foley. They ask if you've seen the video of his murder.
James Foley's beheading has reset this half-real world. After watching screens on their PCs, tablets and smartphones fill with one shocking image after another—Boko Haram's kidnapping of the girls in Nigeria, Russian rebels' shooting down Flight 17 above Ukraine, ISIS's one-week capture of one-third of Iraq, massacres of Yazidis and Christians, Islamic militias fighting to take over Libya, Hamas's casual sidewalk executions—most Americans realize the stakes in the world have become bigger than the four sides of a video.
The world has reframed the politics of the 2016 election.
National security and the U.S. role in the world has pushed toward the top of the decision tree in that election. That is why Hillary Clinton outputted an interview this summer with the Atlantic's Jeffrey Goldberg, repositioning her bland foreign-policy views to the right ofBarack Obama. No more speeches about saving the oceans. That's why first-term Sen.Rand Paul used his time on "Meet the Press" last weekend to re-reposition Mrs. Clinton as a "military hawk."
Even Mr. Obama himself reacted to the new realities. Whether to staunch the president's political bleeding in the polls, which is threatening Democrats this November, or the nightmare of blood elsewhere, the U.S. government is reportedly preparing possible airstrikes against ISIS inside Syria and working to mobilize our "partners" in the region, such as Saudi Arabia.
Of course, the revolt of the Free Syrian Army against Bashar Assad has been on since early 2011, and Saudi Arabia concluded that being a partner of the U.S. was pointless.
ISIS clicks through northern Iraq after declaring a caliphate. Reuters
These foreign-policy fiascoes, and many others, are laid at the feet of Barack Obama. And at the feet of former Secretary of State Clinton, who spent four years and a million miles in flight from all this.
Individual responsibility matters. The U.S. president is commander in chief even if he doesn't want to be commander in chief. If Mrs. Clinton believes what she told the Atlantic, she should have resigned and said what was on her mind then. But she didn't. Doing so would have imperiled her standing—not her standing with the American people, who were losing faith in Mr. Obama's handling of the world, but with the Democratic Party activists who would have demolished her presidential nomination in retaliation for exposing the Obama worldview, which is their worldview.
In a foreign-policy election, as it looks like we are going to have in 2016, the stakes are a lot higher than picking among the one-person brands who populate U.S. presidential politics now. Party matters. Party history and belief shapes foreign-policy decisions in a time of crisis. The word "fortitude" comes to mind.
So one must ask: Can the Democratic Party be trusted with U.S. national security from 2016 to 2020?
At the Republicans' 1984 convention, keynote speaker Jeane Kirkpatrick famously unloaded on the opposition party's foreign policy as "the San Francisco Democrats." What we have learned the past five-and-a-half years is that Jeane Kirkpatrick is still right. It isn't just Barack Obama. It's them. If anything, the modern Democratic Party is more hostile to national defense than it was in 1984.
Let us hypothesize that Mrs. Clinton is a Democratic hawk. Name one other office-holding hawk in the party? California Sen. Dianne Feinstein, sort of. Beyond these two women, none. Former Sen. Joe Lieberman, the party's vice presidential nominee in 2000? They joyously ran him out of the party in 2006. Sam Nunn ? The last of the South's great national-security Senate Democrats retired in 1996. Former Democratic Sen. Pat Moynihan served as a Republican president's U.N. ambassador. Democratic hawks, or even half-hawks, aren't an endangered species. They're extinct.
The military types, pundits and big donors who claim to have spotted appearances of Clinton hawkishness are deluding themselves. Bill Clinton of Kosovo? In 2008, the progressive activists who organized and financed Mr. Obama's candidacy overthrew the Clintons ' centrist triangulation machine and took control of the party. Dutifully, Mrs. Clinton ran as an antiwar candidate.
Any hawklike initiative she might attempt will be vetted and opposed by the Obama-Warren Democrats in Congress and across the blogosphere. They abhor Mrs. Clinton's "international liberalism." The MoveOn.org website has posted an online petition exhorting President Obama to "Keep America Out of Iraq!" These hearts and minds belong wholly to the domestic-spending accounts. National security needs diminish their reason for being.
As to the Republicans, Rand Paul's foreign-policy minimalism remains a fringe movement, with multiple challengers. The Democrats have the opposite problem. What ought to be the party's foreign-policy fringe has seized its center, and no one in the party will challenge it. In times of peace, this tension between the we-won't-go left and everyone else gets indulged as a political videogame. Win some, lose some. In a world of spreading disorder, as now, that is asking too much.
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| As Operation Protective Edge enters its eighth week on Tuesday, Hamas has taken a severe military and morale blow, but its military arm is preparing for another round of fighting believing the price its people are paying is tolerable as long as its goals are achieved. This is the assessment of senior Israeli security officials who nevertheless say there is growing skepticism among Hamas operatives about whether the fighting continues to be worthwhile considering the number of Hamas fighters who have been killed, the destruction of key military installations, the hit on the rocket manufacturing capabilities, and the destruction caused to the terror tunnels, which Hamas viewed as its “Day of Judgement” weapon. According to these assessments, the IDF attacks in Gaza -- including damage to the homes of senior Hamas commanders -- the killing of commanders as well as damage done to the more junior military level led in many instances to a breakdown in Hamas’s chain of command, and even the abandonment of the rank and file on the battlefield. According to these assessments, in some cases, mid-level commanders – concerned that their homes would be destroyed – preferred to flee with their families from the areas of fighting. As a result, those fighters who remained often felt abandoned and lost the will to continue to fight. In other cases, according to the assessment, some of the Hamas fighters felt their superiors completely abandoned them. One instance was reported where 14 Hamas fighters were trapped for 20 days in a tunnel, surviving only on water and dates – with no effort by their commanders to rescue them. Some of the men starved to death. According to information obtained by the security services, immediately after the kidnapping of the three Israeli youths in Gush Etzion in mid-June, various Hamas commanders went underground, making it impossible to consult with them. While there was dissatisfaction toward the commanders from the rank-and-file, there was also often dissatisfaction from the commanders toward the fighters, especially in the eastern sector of Gaza where there was displeasure among the senior ranks to the resistance put up against the IDF ground incursion. According to these assessments, the intensity of the Israeli attacks, the damage down to the commanders, the intelligence and the destruction of the tunnels surprised Hamas officials, some of whom did not believe that Israel was prepared to make a ground incursion into Gaza. The targeted assassinations and the intelligence information regarding the tunnels created a great deal of suspicion of people collaborating with Israel, and this suspicion led often to abandoning the use of advanced technological equipment, which made management of the fighting for Hamas's top brass even more difficult. According to the assessments, the prevailing mood in the street is one of bitterness and anger toward Hamas, whose leaders were among the first to hide and left the civilians to fend for themselves. In one instance, women at Shifa Hospital beat up Hamas spokesman Sami Abu Zuhri and prevented him from speaking, as they shouted at him that while their sons were killed and homes were bombed, he was hiding in the hospital. Hamas's grave condition, and its need to motivate its people, led to a situation where it confiscated aid allowed into the Strip and passed it over to its own people, at the expense of others. Meanwhile, numerous Hamas activists have been arrested and interrogated over the past seven weeks, and described the degree to which mosques and hospitals were used as staging grounds and hiding places, and where areas near pre-schools were commonly used as starting points for tunnels and as hiding places for arms. Among the prominent examples: Abd al-Rahman Balousha, from Khan Yunis, said that the Alsafa and Alabra mosques there serve as a staging ground for Hamas terrorists. Muhammad Ramadan from Khan Yunis said his anti-tank weapons training took place in a hall located under the Alshafi mosque in Khan Yunis. He added that the hall serves as an Izzadin Al-Kassam Brigades training and instruction facility, and is closed to non-military personnel. Muhammad Alqadra, from Khan Yunis, said “everyone knows that Hamas leaders are hiding in hospitals,” where they have armed bodyguards, visible to all, usually wearing police uniforms. He estimated that Hamas head Ismail Haniyeh was hiding in Shifa hospital in Gaza, apparently in an area not accessible to citizens, and accompanied by security guards in civilian clothes. 2a) Terrorism as Theater By Robert D. Kaplan
The beheading of American journalist James Foley by the Islamic State in Syria and Iraq was much more than an altogether gruesome and tragic affair: rather, it was a very sophisticated and professional film production deliberately punctuated with powerful symbols. Foley was dressed in an orange jumpsuit reminiscent of the Muslim prisoners held by the United States at Guantanamo Bay. He made his confession forcefully, as if well rehearsed. His executioner, masked and clad in black, made an equally long statement in a calm, British accent, again, as if rehearsed. It was as if the killing was secondary to the message being sent.
The killing, in other words, became merely the requirement to send the message. As experts have told me, there are more painful ways to dispatch someone if you really hate the victim and want him to suffer. You can burn him alive. You can torture him. But beheading, on the other hand, causes the victim to lose consciousness within seconds once a major artery is cut in the neck, experts say. Beheading, though, is the best method for the sake of a visually dramatic video, because you can show the severed head atop the chest at the conclusion. Using a short knife, as in this case, rather than a sword, also makes the event both more chilling and intimate. Truly, I do not mean to be cruel, indifferent, or vulgar. I am only saying that without the possibility of videotaping the event, there would be no motive in the first place to execute someone in such a manner.
In producing a docu-drama in its own twisted way, the Islamic State was sending the following messages:
Welcome to the mass media age. You thought mass media was just insipid network anchormen and rude prime-time hosts interrupting talking heads on cable. It is that, of course. But just as World War I was different from the Franco-Prussian War, because in between came the culmination of the Industrial Age and thus the possibility of killing on an industrial scale, the wars of the 21st century will be different from those of the 20th because of the culmination of the first stage of the Information Age, with all of its visual ramifications.
Passion, deep belief, political protests and so forth have little meaning nowadays if they cannot be broadcast. Likewise, torture and gruesome death must be communicated to large numbers of people if they are to be effective. Technology, which the geeky billionaires of Silicon Valley and the Pacific Northwest claim has liberated us with new forms of self-expression, has also brought us back to the worst sorts of barbarism. Communications technology is value neutral, it has no intrinsic moral worth, even as it can at times encourage the most hideous forms of exhibitionism: to wit, the Foley execution.
We are back to a medieval world of theater, in which the audience is global. Theater, when the actors are well-trained, can be among the most powerful and revelatory art forms. And nothing works in theater as much as symbols which the playwright manipulates. A short knife, a Guantanamo jumpsuit, a black-clad executioner with a British accent in the heart of the Middle East, are, taken together, symbols of power, sophistication, and retribution. We mean business. Are you in America capable of taking us on?
It has been said that the murder of Czar Nicholas II and his family in 1918 in Ekaterinburg by Lenin's new government was a seminal crime: because if the Bolsheviks were willing to execute not only the Czar but his wife and children, too, they were also capable of murdering en masse. Indeed, that crime presaged the horrors to come of Bolshevik rule. The same might be said of the 1958 murder of Iraqi King Faisal II and his family and servants by military coup plotters, and the subsequent mutilation of the body of Iraqi Prime Minister Nuri Said by a Baghdad mob -- events that presaged decades of increasingly totalitarian rule, culminating in Saddam Hussein. The theatrical murder of James Foley may appear as singular to some; more likely, it presages something truly terrible unfolding in the postmodern Middle East.
To be sure, the worse the chaos, the more extreme the ideology that emerges from it. Something has already emerged from the chaos of Syria and Iraq, even as Libya and Yemen -- also in chaos -- may be awaiting their own versions of the Islamic State. And remember, above all, what the video communicated was the fact that these people are literally capable of anything.
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