Jack Bogle on Minsky Meltdowns and Future Stock Returns

John Bogle is founder of The Vanguard Group, where he launched the first index mutual fund back in 1975. Fortune named him one of the four "investing giants" of the 20th century. He's the author of seven books, including the recently published Enough: True Measures of Money, Business, and Life. In this first of three installments, Bogle talks with Motley Fool retirement expert Robert Brokamp about the current market and future returns.

For the audio version of this interview, click here

Robert Brokamp: We learned from the book that you were born in 1929, around five months before the stock market crashed. You grew up during the Depression. Today, we hear a lot of people invoking the possibility of another Depression. So what is your take on today's crisis? Are we looking at another Depression? Is this a different sort of animal or just another garden-variety financial panic?

Jack Bogle: No, this is not just another variety of financial panic, although I do not believe one can properly conclude that we are in for another Depression. This is my tenth bear market, defined as one that goes down at least 20%. And this is in a lot of ways the most difficult one that we have had because the gross excesses -- the unacceptable excesses in our financial sector -- are carrying over to the economy at large. Or to put it another way, I think the excesses of Wall Street and Wall Street's greed have carried over and done substantial harm to Main Street and the people that make America go, people that provide products and services and have high value throughout our economy.

There was an economist that wrote about this in the '80s and '90s named Hyman Minsky. He worried about what has come to be known as a Minsky Meltdown, where the speculative excesses of the financial system, which is where almost all speculation begins, flow over into the real economy and affect our lives. Of all these 10 bear markets that I have been eyewitness to, this is becoming the closest to that sort of a meltdown that I've seen.

So I look at the existing circumstances in two ways. One, I believe the economy, having been overdone so long with so much excess credit and low credit standards, will take a long time to really recover. I think the best one can hope for is for a recovery to begin maybe in a year and a half, maybe in two years before we get back moving upward again. But a very different matter is the stock market, because the stock market customarily anticipates things. We never know whether it is overanticipated or underanticipated or got it exactly right. The damage to our economy is reflected in the stock market, but I think it is pretty much where it ought to be, given the difficult economic circumstances I see in the next couple of years.

Brokamp: So given all that, what do you think people should expect from the stock market over the next 10 or so years?

Bogle: Well over 10 years, I have been using this formula for a long time that is after Lord Keynes: Don't pay any attention to past returns or historical returns without being aware of the sources of those returns. Keynes has put no numbers on that analysis, but I did. Keynes talked about enterprise, the market returns being composed of enterprise and speculation. I have rewritten enterprise into investment return. For me investment return is the dividend yield at which you buy into the stock market -- the yield in the market the day you buy in -- plus the subsequent earnings growth of all the companies in the stock market. And that gives you the investment return. A few years back, it looked like earnings might grow at about 5%, the dividend yield was only 1%. That would mean you should be looking for a 6% investment return. You probably did a little bit better than that, but that is the way you look at it.

Today, the dividend yield is 3% and not 1%. That is two extra points of future return compared to that old 1% and I think from these somewhat depressed levels, over the next decade, earnings could grow. I am not saying they will, but I think it is not unreasonable to expect earnings to grow at about 7% a year, which of course means they will double in 10 years. So we have a 3% dividend yield and a 7% earnings growth and I don't look for that dividend to be cut a lot. It might be cut a little bit but there are many companies that are doing quite well in America, outside of the financial area. So that would be a 10% investment return.

The other part of return is what Keynes calls "speculation" and what I call "speculative return" and that is at the beginning and the end of the period -- how many dollars will investors be willing to pay for each dollar of earnings? That is just the speculation on their willingness to put their money up, what it will entice them to do. That is what we call, of course, the P/E ratio, price/earnings multiple. If that multiple is unchanged, the speculative return will be zero. I am inclined to think that the P/Es will come down a little bit in the decade ahead, which would give us that possible 9% of 10% investment return, minus one or two percentage points. So that would be 7% or 8% of total returns if that P/E comes down.

In the long run, speculative return amounts to zero. That is to say, there is no particular upward bias in P/Es. They can get very cheap in one decade and very expensive in the next, as happened in the 80s and 90s, but I look for speculative return to play a lower role in determining future market returns than it has in the past. So over a decade, could we get 8% or 9% return on stocks? I think that is a reasonable probability -- no more, no less, but a probability with plenty of bumps along the way. When you think of the alternative, it is pretty attractive.

The long-term government bond today is yielding not much over 3%. The short-term Treasury bill is yielding pretty close to zero; we just want our government to hold our money and we don't want to pay us anything for it, which seems kind of crazy to me, but that is the way the market is today. Corporate bonds are probably around the 6.5% level. Top-quality corporate bonds and muni bonds are a different matter, but corporate bonds are probably about 6.5%. So that stock return looks pretty good compared to corporate bonds, compared to government bonds, and compared to money markets.

So each person will have to figure that out for themselves, but I think the main thing is that when we have this incredible investment ethic, for want of a better word, everywhere involving securities markets, and that is when the market is going up, we expect it to go up forever. That is not going to happen. Similarly, when the stock market goes down seriously, we expect it to go down forever. I guarantee you that that is not going to happen either.

So we have become captives of the emotions of the moment. Or to put it another way, we thought we were investors, but we turned out to be speculators. An investor is someone who owns businesses and holds it forever, maybe all of American business as we do with the all-U.S. stock market index fund. So we own business and hold it forever, if we are investors. If we are speculators, we are betting that somebody else will buy something from us at a higher or lower price somewhere down the road. Speculation is a bet on price, if you will; investment is a bet on value. As the great Benjamin Graham said -- you will be familiar with this one -- in the short run, the stock market is a voting machine and in the long run, the stock market is a weighing machine. Truer words than that were never spoken.

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Robert Brokamp is the advisor for the Fool's Rule Your Retirement service. Give it a 30-day free trial by clicking here. The Motley Fool is investors writing for investors.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 19, 2008, at 8:35 PM, Tak3natheFlood wrote:

    Nice interview!

  • Report this Comment On December 22, 2008, at 8:56 PM, icesword2 wrote:

    Fool All-star Alstry recently posted a blog entry saying that P/E was dead, i.e. that as long as earnings are going down, there's no backward-looking P/E that could possibly make the stock look "cheap".

    I like Bogle's more optimistic approach, saying P/E should take a back seat to real growth potential. While many businesses will continue to post losses over the next two to three years, there are others that will be able to grow over the same time frame. This provides a more-or-less "real" return on investment, as opposed to simple price appreciation.

    Although, in reality, I kind of like price appreciation, too.

  • Report this Comment On December 23, 2008, at 5:43 AM, Babble100 wrote:

    Bogle says bonds beat stocks 1 out of 6 decades in the past. But others have said the frequency of bonds winning is much less. Who is right?

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