The Speed 2: Comparing Asset Classes

By: Dmitry Baryshevsky | Thu, Dec 15, 2005
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In the article The Speed [1] published in July 2003 I had analyzed the long-term historical growth rate of the S&P 500 index, earnings and dividends.

Particularly it was shown that the average growth rate of earnings, dividends and S&P 500 index was 1.5% per year at the end of 19-th and first half of the 20-th centuries (see Figures 1, 2, 3 in [1]). But it was not monotonous growth. Variability of both the earnings and stocks market was high, especially at the end of the 20-th and in the 30-th. Nevertheless as it was mentioned in [1] the average long-term growth rate stayed low.

In the second half of the 20-th century the average growth rate of earnings sped up to 5.5%. Thus the more effective development of the economy allowed increasing the average long-term earnings growth rate at 4%. But dynamics of earning growth was unstable . As it is follows from the Figure 1 the earning growth rate is limited by 4.7% curve on the bottom and 6.2% curve on the top.

In the middle of 2003 the value of trailing twelve-month earnings just corresponded to the 5.5% growth curve. Nevertheless, by the fourth quarter of 2005 the earnings had grown up to 67. This value is higher than the corresponding value for the 5.5% growth curve and practically coincides with the 6.2% curve on the top.

It is interesting to note that the value of S&P 500 has being remained close to the 8% long-term growth curve almost three years Figure 2.

The value of the earnings multiple P/E was declined up to 18.5 to the December 2005 that practically corresponds to the average value for the last 25 years.

In [1] I formulated a following question: How much time it could took for the S&P 500 to reach the peak of 2000 year? According to my assumption S&P 500 could reach the maximum value about 1552.87 (which was registered in the beginning of 2000) to 2020. This assumption is based on the idea that market participants could ask higher premium for risk in future. As a result, earnings multiple could decline up to its average value, namely up to 15, which was observed up to the end of 90-th. In turn I suppose that earnings will grow with rate not more than 5.5 % in average. As a consequence the value of earnings corresponding to the 5.5% long-term curve of growth could appear equal to $104 in 2020. Multiplying this value by 15 we can obtain 1560.

If premium for risk stay in coming years at the today's level (it means P/E value equal to 18) S&P 500 would reach the maximum value about 1552.87 to 2017.

So in spite of growth of earnings and stocks market in 2003-2005 I stayed with hypothesis that was formulated in 2003. Namely the stocks market could stay in sideways movement for the long time, when cyclical rises appear replaced by cyclical falls. The similar behavior of the market was already observed at the end of 60-th and in 70-th [2].

However a 10-15 years period is the sufficiently long term. A lot of events could influence the market during this period.

Therefore, an investor (as well as an airplane pilot) should have a number of "devices" or indicators and correct understanding of how to interpret their readings.

In many respects either investor's success or failure depends on choice of the market assets and shares, which these assets borrows in the investor's portfolio.

Really in [3] it was shown that the market is the sufficiently complex structure due to interplay of different classes of assets.

So the reciprocal of the P/E ratio (i.e. current real earnings yield (CREY)) has strong correlation with both the 10-Y Treasury bond yield (TBY) and 10-year average for the CRB Index yield (CRBY) (where the CRB Index yield is the one-year change in the index price).

[1] CREY = a + bt - TBY + bc - CRBYp + ε


a is a constant,

bt is the value of the response of CREY for TBY,

bc is the value of the response of CREY for "pure" yield of CRB Index (i.e. its part which does not depend on TBY),


The above correlation I named the model of alternative investments [3]. In [4] it was shown model correctness, when taking the last 25 years for statistical testing, gives 88% coincidence.

In particular, it is necessary to indicate correlation (see Figure 3) between CREY, TBY and the 10-year average of gold yield (i.e. the one-year change in the price of gold is averaged over 10-year period). So, in [5] it was shown that the correlation coefficient R-squared is equal to 78%.

Therefore, investors should carefully select composition of three basic classes of assets - stocks, bonds and commodities.

Moreover, the happy chosen composition of the above indicated assets, for a certain phase of the market allows both to accumulate effectively portfolio income and to reduce essentially general risk of the portfolio.

In [5] the risk of investments in gold and S&P500 index were calculated along with the value of general risk of the portfolio composed of gold and stocks on the base of the Value-at-Risk.

The Value-at-Risk for a portfolio is the maximal loss (or worst loss) that can occur under normal market condition over a target horizon within a given confidence interval.

Really in [4] it was shown that the Value-at-Risk for the $50 million gold investment is

VaR 1 (Gold) = 5.13% × $ 50 millions. = $ 2.56 millions.

The Value-at-Risk for the $50 million stock investment (S&P 500 index) is

VaR 2 (S&P 500) = 5.31% × $ 50 millions = $ 2.65 millions

But the Value-at-Risk for the $100 million portfolio of gold and stocks is

VaR = = $ 3.24 millions.

It is supposed that investments in gold and stocks are equal. To calculate Value-at-Risk I analyzed the data on monthly gold and stock (S&P 500 Index) return from October 1984 to October 2004. Data for 240 months were analyzed during this period.

Let us know answer the question: How to distribute assets in the given phase of the market? As it was already mentioned the value of the S&P 500 earnings is near the top curve of growth now. Therefore, I expect the earnings growth appears slowed. The stocks market is in the up trend (see Figure 4, right scale) since spring 2003, i.e. for two years. Therefore I expect the current cyclic growth of stocks market will stops in the foreseeable future.

FED continues to increase the interest rate. Accordingly I expect that TBY will increase, and therefore the bond prices will decline.

The price of gold is in the up trend since April 2001 (see Figure 4, left scale). However, the values of CRBY and the 10-Y gold yield still appear low. It means, that CRBY and, respectively, gold price will proceed their growth.

In December 2004 I supposed [5] that the yield of investments in gold in coming years of this decade should be at least 6%.

In 2005 gold was the best choice when comparing gold, bonds and stocks. Really since the end of 2004 up to November, 30 2005 the average monthly gold price grew 7,9% (from 441.76 up to 476.67), accordingly S&P500 grew 3% (from 1211.92 up to 1249.48) and the 10-Y Treasury bond yield grew from 4.23 up to 4.53. So, in this year gold gained 2% premium to my long-term estimate [5].

And I proceed thinking that gold is the most attractive asset for long-term investments. Below data are supporting these expectations. Really (see Figure 3) the latest readings show that current real earnings yield is approximately 5.4%. At the same time current value of the 10-year average for the gold yield is only approximately 2%. So 10-year average for gold yield could be expected growing.

Therefore, to my mind, the most part of investments should be done to commodities in general and to gold, particularly.

[1] "The Speed", Dmitry Baryshevsky, SafeHaven, July 14, 2003,,
[2] "Playing On Profits Cycle?", Dmitry Baryshevsky, Gold-Eagle, October 27, 2003,,
[3] "What is hidden in the Fed's model? The second approximation", Dmitry Baryshevsky, Gold-Eagle, August 21, 2003,,
[4] "Pay Attention To Valuation", Dmitry Baryshevsky, SafeHaven, April 1, 2004,
[5] "The interrelation of long-term gold yield with yields of another asset class", Dmitry Baryshevsky, Gold-Eagle, December 22, 2004
[6] "Fight the Fed Model: The Relationship Between Stock Market Yields, Bond Market Yields, and Future Returns", CLIFFORD S. ASNESS, December, 2002,
[6] "Philippe Jorion Value at Risk. The New Benchmark for Managing Financial Risk", Second Edition, McDraw-Hill, 2001


Author: Dmitry Baryshevsky

Dmitry Baryshevsky
Belarus Builders Union
Executive Board, Economic Consulting Department
Chief Executive Manager in the field for International Economic Activities
Minsk, Belarus

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