Expected future returns.
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From the Hussman Funds:
Imagine there’s a $100 bill taped to the far corner of the room, near the ceiling and way above your head. You will receive that $100 bill ten years from today. Suppose that you reach your hand out directly in front of you and pay $46.31 today for that future $100. Assuming no credit risk, you have now bargained for an 8% annual return.Now reach higher, about eye-level, and offer $67.56 for that future $100. You have now bargained for a 4% annual return.Now reach far above your head, jump as high as you can, and offer $84.49 today for $100 ten years from today. You are now an investor in 10-year Treasury securities, which presently yield 1.7% annually.Every security on Earth works like this. The higher the price you pay for a given set of expected future cash flows, the lower your prospective future rate of return. Higher prices essentially take from future prospective returns and add to past returns. Conversely, lower prices take from past returns and add to future prospective returns.At the top of your jump, as you hover like Michael Jordan in mid-air, let’s ask all of the other investors who already hold Treasury securities whether they are “wealthier” because of the elevated price you are paying. At first glance, the obvious answer seems to be yes: each of those investors, individually, could sell their Treasury bond at a price that would enable them to command a greater amount of current output than they could before.But if you think carefully, you’ll realize that regardless of today's price, someone will have to hold that security until it delivers $100 a decade from now - no more, no less. So the price change itself does not create aggregate wealth. Unless something happens to materially change that future cash flow, it is not at all clear that elevating current prices makes investors - in aggregate - any wealthier in terms of consumption. While any individual investor could sell the bond in order to consume today (abandoning the reason they had saved in the first place, which was to provide for their future consumption a decade from now), some other investor now has to defer consumption to purchase the bond and hold it to maturity.An increase in price alters the profile of investment returns by turning prospective future returns into past returns (and vice versa when prices fall), but economic wealth is only created by the generation of additional goods and services (and cash flows from an investment standpoint) that actually emerge in the future. Security prices are a place-holder until the expected future goods, services and cash flows actually arrive. Raising the price that investors pay today for in return for some fixed payment in the future does not create wealth in aggregate....MORE