The Financial World Ahead, 2020-2030, Global Equities Edition 9781734911602

Table of contents :
The Financial World Ahead, 2020-2030 1
Relative Valuation 11
Period Forecasts 19
A Historical View on the World´s Major Indexes 25
Market Overview 35
Country Reports 49
Australia
All Ordinaries 51
S&P/ASX 200 61
Canada
S&P/TSX Composite 69
Euro Area
EURO STOXX 50 79
MSCI EMU Index 87
Finland
OMX Helsinki All-Share 95
France
CAC 40 103
 
Germany
DAX 113
Global
MSCI All Country World Index 121
MSCI Emerging Markets Index 129
MSCI World Index 137
Greece
Athens General Composite 147
Hong Kong
Hang Seng 155
India
S&P BSE SENSEX 163
Indonesia
IDX Composite 171
Ireland
ISEQ All-Share 179
Japan
Nikkei 225 187
Malaysia
FTSE Bursa Malaysia KLCI 197
Mauritius
SEMDEX 205
Mexico
S&P/BMV IPC 213
Netherlands
AEX 221
New Zealand
S&P/NZX 50 229
 
Nigeria
Nigerian Stock Exchange 237
Norway
OBX 245
Philippines
PSE Composite 253
Singapore
FTSE Straits Times Index 261
South Africa
FTSE/JSE All-Share 271
South Korea
KOSPI 281
Spain
IBEX 35 289
Sweden
OMX Stockholm 30 297
Switzerland
Swiss Market Index 305
Taiwan
TAEIX 313
Thailand
Stock Exchange of Thailand 323
Turkey
BIST 100 331
United Kingdom
FTSE 100 339
 
United States
Dow Jones Composite Average 349
Dow Jones Industrial Average 357
Dow Jones Transportation Average 367
Dow Jones Utility Average 377
NASDAQ Composite 387
NASDAQ-100 397
S&P 500 405
Wilshire 5000 415
Conclusion 423

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The Financial World Ahead, 2020-2030 Global Equities Edition David J. Howden, Ph.D.

Copyright © 2020 by David J. Howden All rights reserved. No part of this book may be reproduced or utilized in any form or by any means, electrical or mechanical, including photocopying, recording oy by any information storage or retrieval system, without permission in writing from the author. Inquiries should be addressed to David Howden, Ave. del Valle 34, Madrid, Spain, 28009, or electronically to [email protected]. Howden, David J. The Financial World Ahead, 2020-2030: Global Equities Edition / David J. Howden. ISBN 978-1-7349116-0-2 1. Business & Economics—Forecasting. 2. Investments & Securities—Analysis & Trading Strategies. i

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Disclaimer Although the data found in this book have been produced and processed from sources believed to be reliable, no warranty, expressed or implied, is made regarding accuracy, adequacy, completeness, legality, reliability or usefulness of any information. This disclaimer applies to both isolated and aggregate uses of the information. The information is provided on an "as is" basis. All investments, including equities and foreign exchange, are speculative in nature and involve substantial risk of loss. We encourage investors to get personal advice from a professional investment advisor and to make independent investigations before acting on information that we publish. Past performance is not necessarily indicative of future results. All investments carry risk and all investment decisions of an individual remain the responsibility of that individual. There is no guarantee that systems, forecasts, indicators, or signals will result in profits or that they will not result in losses. All investors are advised to fully understand all risks associated with any kind of investing they choose to do. Hypothetical or simulated performance is not indicative of future results. Unless specifically noted otherwise, all return examples provided in in this book are based on hypothetical or simulated investing. We make no representations or warranties that any investor will, or is likely to, achieve profits similar to those shown, because hypothetical or simulated performance is not necessarily indicative of future results.

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Contents The Financial World Ahead, 2020-2030 ............................... 1 Relative Valuation.............................................................. 11 Period Forecasts ................................................................ 19 A Historical View on the World´s Major Indexes ............. 25 Market Overview................................................................ 35 Country Reports ................................................................. 49 Australia All Ordinaries .......................................................................... 51 S&P/ASX 200 ......................................................................... 61 Canada S&P/TSX Composite............................................................. 69 Euro Area EURO STOXX 50 ................................................................. 79 MSCI EMU Index .................................................................. 87 Finland OMX Helsinki All-Share ........................................................ 95 France CAC 40 ................................................................................... 103

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Germany DAX ........................................................................................ 113 Global MSCI All Country World Index .......................................... 121 MSCI Emerging Markets Index .......................................... 129 MSCI World Index ................................................................ 137 Greece Athens General Composite .................................................. 147 Hong Kong Hang Seng............................................................................... 155 India S&P BSE SENSEX............................................................... 163 Indonesia IDX Composite ..................................................................... 171 Ireland ISEQ All-Share ...................................................................... 179 Japan Nikkei 225............................................................................... 187 Malaysia FTSE Bursa Malaysia KLCI ................................................ 197 Mauritius SEMDEX ............................................................................... 205 Mexico S&P/BMV IPC ...................................................................... 213 Netherlands AEX......................................................................................... 221 New Zealand S&P/NZX 50......................................................................... 229

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Nigeria Nigerian Stock Exchange ..................................................... 237 Norway OBX ........................................................................................ 245 Philippines PSE Composite ..................................................................... 253 Singapore FTSE Straits Times Index.................................................... 261 South Africa FTSE/JSE All-Share ............................................................ 271 South Korea KOSPI .................................................................................... 281 Spain IBEX 35 ................................................................................. 289 Sweden OMX Stockholm 30 ............................................................. 297 Switzerland Swiss Market Index ............................................................... 305 Taiwan TAEIX .................................................................................... 313 Thailand Stock Exchange of Thailand ............................................... 323 Turkey BIST 100 ................................................................................ 331 United Kingdom FTSE 100 ............................................................................... 339

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United States Dow Jones Composite Average .......................................... 349 Dow Jones Industrial Average ............................................. 357 Dow Jones Transportation Average ................................... 367 Dow Jones Utility Average................................................... 377 NASDAQ Composite........................................................... 387 NASDAQ-100 ....................................................................... 397 S&P 500 .................................................................................. 405 Wilshire 5000 .......................................................................... 415 Conclusion ....................................................................... 423

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Acclinis falsis animus meliora recusat. - Horace

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The Financial World Ahead, 2020-2030 This book concerns itself with two questions. First, how will global equity markets perform over the coming decade? Are we poised for a global correction like that which followed the Global Financial Crisis or dot.com bust, or can we expect the global economy to continue to hum along as it has been? The second question is more pressing for the investor: which market will reward his capital best over the next decade? One´s investment choices include cash (which yields no return), bonds (which have a return that is known in advance) and equities. The return on holding an equity can only be determined at its point of sale, a future event unknown in the present. In order to determine which of the three investment options is the best course of action for one´s money, a forecast of the future return on equities is required. Indeed, this problem is one of the most challenging and least satisfactorily answered questions in the investment world. This book alleviates the problem. The problem of estimating an equity´s future return can be simplified by decomposing it into two components. The first component is the absolute price of the security. Is it too high or too low relative to some fair-valued alternative? The answer to this question can only be illuminated by analyzing stock variables (i.e., those variables that exist at a given moment instead of over a period) that affect a security´s price, and by identifying relationships between them. These causal relationships will be time variant by their nature, though in most cases will change only slowly over long periods. In this way, one can identify periods of over- and under-valuation of a security relative to other historical periods. An equity´s valuation typically oscillates 1

around some fair-value level, passing through periods of under- and over-valuation as its price dips and rises. As an example, the rate of unemployment, like a share price, is a stock variable. There is a clear negative relationship between the rate of unemployment and future equity returns. Stock market peaks generally occur when business conditions are good, and unemployment low. Stock market bottoms come about during recessions when unemployment is somewhat higher. Periods of low unemployment correlate better than do periods of high unemployment with lower future equity returns. By comparing a security´s price with relevant stock variables, an estimate as to whether its current price is too high or low can be made. This estimate, which represents a fair value forecast of an equity´s price, can be contrasted against its current price to gauge the degree to which the security is under- or over-valued. The second component of forecasting investment returns is the expected future path that a security´s price will take. Will the ex-post yield ten years from now be 5% or 10%? The answer to this question can only be addressed by analyzing flow variables, ones that exist over some given time period, and see how they correlate and contribute to a change in a security´s price over time. In this way, patterns of greater or lower than average returns can be identified. An example of a flow variable relevant to estimating a security´s future return is the current yield on bonds. Periods of low bond prices signal high expected future returns from holding stocks. (Otherwise why would anyone buy a stock when they could buy a bond with a high interest rate?) The current interest rate is one means to estimate the future path that a security´s price will take or, in other words, its rate of return. The problem with these two component variables – stock and flow – is that if they are relevant for estimating the future return from holding a security, they are only probabilistically so. There are no constant and time invariant relations in the financial world. We can, however, use historical data to understand the range of relationships and resultant outcomes that have existed in the past. In this way we can begin to understand probabilistically what current conditions will portend for the future. Consider the following figure, which plots the 10-year return of the S&P 500 on the y-axis against the dividend yield of the index at the start of each 10-year period (on the x-axis) for the last thirty years. Since December 1989 there have been 240 10-year periods. Many investors intuit that there is a positive relationship between the dividend yield and subsequent returns. After all, dividends contribute to total earnings and it follows that higher dividends drive greater returns. The scatter 2

plot illustrates this logic, but with a twist. The relationship is statistically significant, and fairly strong. Each additional percentage of dividend yield increases the subsequent return by 5.5%, at least during the years between 1989 and 2019. A whopping 85% of the 10-year return variance of the S&P 500 can be explained by the dividend ratio at the start of the investment period. This is useful to know, though the time variant nature of the relationship between the two variables introduces a complication.

To choose a different 30-year period at random, we can consider the relationship between dividend yields and subsequent 10-year returns between 1950 and 1980. Here we can see the relationship is strong and positive, though less so than before. Only 70% of the 10year returns can be explained by the starting dividend yield during this period. Furthermore a 1% increase in dividends resulted in an increase of the subsequent 10-year return of only 2.2% during this period. The sign of the relationship between the variables (positive) remains constant in both periods, and both are fairly robust statistically (high adjusted R2 values), but one would derive significantly different forecasts concerning future returns based on the two analysis. The alluded to twist in the preceding analysis is that the relationship described between returns and dividend yields seems to be too intuitive to be of much use. Since dividends contribute directly to the investor´s return, higher dividend yields must automatically result in higher returns. This is true, though one would be speaking of an investment´s total return (including reinvested dividends) to make the claim. The preceding analysis related the dividend yield to the subsequent price return of the index, thus excluding the effects of any reinvested dividends. It´s not immediately obvious why a lower dividend yield in the present should have such a strong relationship with the price return over the following decade. 3

Of course, one could look at the fact that the dividend yield is just the dividend divided by the price per share. Higher dividend yields imply lower share prices, and the lower the share price the more scope there is for price appreciation moving forward. Just as easily, however, it could be that the high dividend yield is the result of a high dividend pay-out and not necessarily a lower share price. The relationship between dividend yields and subsequent returns is more nuanced than it might seem at first glance. The current dividend yield of the S&P 500 is 2.6%. Extrapolating from the relationship between the dividend yield and subsequent return over the past 30 years we could forecast that the index will return 7.8% if held until 2029. Furthermore, given the standard error of the statistical relationship we can estimate the probability that the actual return will exceed this forecast, 22%. Herein lies the problem with the analysis. Explaining 85% of the historical returns by one variable sounds impressive, but in terms of predictive value it leaves much to be desired. The statistical standard error from the model is too large to yield useful results, notwithstanding the fact that the model performs admirably well at explaining the past variance in returns. While it is low, the probability estimate is useful because it allows us to make probabilistic statements about the plausibility of the estimate. For example, from its current dividend ratio the S&P 500 could return 16.8% annually over the coming decade. This is possible, though highly unlikely. Indeed, 16.8% is the highest 10-year annual return the S&P 500 has ever yielded and resulted if an investor bought the index in September 1991. The dividend ratio that month was 4.3%. It could happen that starting from the dividend yield of 2.6% the index returns 16.8% annually, but it is highly unlikely. (In fact, the probability of this happening is only 0.00002% based on the 240 10-year periods under 4

examination.) The probability associated with any forecast made by our model is low, a consequence of the simplistic nature of the approach. What is needed is a sufficient number of variables along with their relationships with the S&P 500 (and each other) to be understood so that a larger majority of the return variation can be explained. This is a difficult feat to achieve, complicated by the threat that we overfit the model and end up with a highly accurate description of some past period, but with little predictive capability of out of sample, or future results. Ultimately, we need to understand the determinants of returns in the simplest terms possible, without including spurious factors that might compromise the statistical value of the results. This book tries to simplify the process for the investor. Instead of detailing the factors that are relevant for future security returns, we focus on the relationship between these factors and the subsequent return. We complete the analysis by providing the forecasted returns and their associated probabilities. The problem of estimating future returns is simplified somewhat by taking recourse in a simple idea, the Efficient Market Hypothesis (EMH). EMH is an example of a theory that drives a wedge between academics and practitioners. Broadly stated, EMH implies that the price of a security at any given time will include all information which is known and relevant to that security. Simple enough. One implication of this is that no one investor can estimate better what the price should be than the current price, at least not based on widely available information. Applied to financial assets, this implies that no individual can “beat the market”, since the market is already priced to include all relevant information. Since most financial practitioners are earning their bread and butter dependent on “beating the market”, such a claim is an obvious affront. More properly understood, it is important to note that EMH doesn´t imply that a price is correct. All it implies is that the price includes all information that is currently available and relevant for its formation. It could be that the price is wrong, as it often looks with the benefit of hindsight, but this is something that would not be known in the present given the current state of information. The use of EMH simplifies the forecasting problem because we can rely on technical price data to summarize the qualitative and at times tacit information that exists and is relevant for a security´s price. EMH thus forms one theoretical pillar upon which we base our analysis. The second pillar is the belief that only broad equity indexes and not individual companies can be forecast with any degree of confidence. Recall that one of the practical implications of EMH is that it will be impossible to “beat the market” if all known and relevant 5

information concerning a company´s value is already incorporated into a stock´s price. One conclusion is that a stock index offers the greatest return possible to the investor, once factoring for fees and related expenses. There is much evidence to confirm this conclusion. The most convincing may be anecdotal in nature. In December 2007, just after the outbreak of the Global Financial Crisis, Warren Buffet entered wagered what might be the most famous bet of recent memory. The bet challenged the hedge-fund industry, representative of actively managed investment portfolios, to beat the return of a passive investment in the S&P 500 over the coming decade. Although initially lagging, the index posted a total gain a decade later of 126%, bettering the total return of not only the average managed portfolio (36%) but also the best one (42%). This result came before fees for the investors were netted away, which were very high for the managed portfolios (2.5% of the total assets managed plus 20% of any resultant profits) but quite minimal for the index (presently the investor can buy the S&P 500 for an annual fee as low as 0.04%). Over shorter periods some managed portfolios had an advantage, but over a longer stretch it was abundantly clear that the market won. Our emphasis on equity indexes is for two distinct, though related reasons. The first is our belief that although equity values accurately reflect the present state of affairs (given our current level of knowledge and understanding), there are secular cycles of over- and under-valuation in all financial asset prices. These cycles are symptomatic of short-term mispricings, whereby investors don´t know what a security´s price should be, and the market undertakes a search process to unearth it. As investors bid on and sell stocks, prices rise and fall around the “correct” value. These valuation cycles also appear over longer periods. Here prices rise and fall due to changing information that concerns the market as a whole, e.g., prevailing interest rates or growth expectations. Mostly these mispricings are governed by the “money illusion” – waves of expectations that stem from central bank monetary policies that raise and diminish investor confidence over longer periods. Under this reasoning, global equity indexes were “correctly” valued in 2000 and 2007. “Correct” in this sense refers to the fact that given all the information available at the time, including expectations about future interest rates, inflation, and optimism, investors actually did believe those lofty valuations to be reasonable. Our emphasis on long-term secular cycles stems primarily from central bank actions that skew important expectations concerning the future, and lead investors to predictably misprice securities. By looking at the foundation of the skewed expectation – monetary 6

policies constructed by central banks – we can identify periods where the major indexes are over- or under-valued relative to those counterfactual expectations that would exist absent such policies. We can look at the valuation of a broad-based stock index relative to some fair-value level that would exist if expectations were not skewed. Our belief that value reverts to a level consistent with real and reasonable expectations in the long term gives our relative valuation model a high degree of accuracy, especially over longer periods. In short, our focus on stock indexes is because, as broad measures of value, they are subject to swings that reflect over- or under-valued conditions in their underlying securities. Since the factors that affect long-term valuation cycles affect all security prices, only broad-based indexes can accurately account for these changes. As we will see, periods of under-valuation presage above average future returns while periods of over-valuation typically portend future equity underperformance. The second reason for our emphasis on broad equity indexes is that this analysis is technical, and not entrepreneurial in nature. Recall that this book concerns itself with two questions: 1) will the future bring a boom or correction in equity markets? and 2) which equity or bond markets will outperform the return on comparable investments moving forward? These are both technical questions that can only be answered probabilistically since they concern the future. The question of whether a company going public will list at $10 billion or $20 billion is not a concern to us, nor is the prospect of future growth for Uber, Facebook or any other company that exists (or could exist). These latter questions are entrepreneurial in nature since they concern supply and demand conditions that are specific to the venture under analysis. By evaluating only broad-based indexes we take recourse in the law of large numbers. An individual stock may over- or under-perform the market over a given period due to factors specific to its operations. But, by definition, the market as a whole must offer the same return as the market over the period. Stated another way, even if the market is generally over-valued, an individual stock´s price may still increase due to factors specific to that company. Understanding these company specific factors is an entrepreneurial undertaking, and one that the investor is not necessarily well-suited for. In contrast, the overvaluation of the general market signals that the average stock´s price must decline moving forward to align this valuation with its fair-level price. This is a technical problem which investors can solve since it involves no knowledge about a specific company´s operations or growth prospects. This is not to say that this is an easy task, but rather that it is manageable by focusing on swings in valuation of the general market. There are, thankfully, large amounts of data that correlate well 7

with average equity returns and can be used with a high degree of confidence to forecast future returns. We have already listed one such datum: dividend yields. We have seen that these cashflows available to investors correlate positively (and fairly strongly) with future S&P 500 returns. To list another intuitive factor, we can focus on interest rates. The interest rate on 10-year U.S. government bonds is currently 1.9%. How reasonable is it to believe that the major U.S. equity indexes are priced to yield returns that are wildly different from this over the coming decade? On the one hand, the bond is surely less risky. Its return is fixed in advance and it is highly unlikely that the U.S. government will renege on its financial obligations over the next decade. On the other hand, the major U.S. stock indexes show very little historical variability over longer time horizons. Since January 1871 the S&P 500 has completed 1,655 10-year investment periods. Less than 20% of them have yielded a negative return. This figure drops to 3% when we look at total returns, including reinvested dividends. There have been some large and drastic short-term volatility in the return to the S&P 500, but over longer time horizons things get ironed out and volatility drops.

The point of the above discussion is that if investors reasonably believed that the return to the S&P 500 was going to be, e.g., -9% annually, they would sell the index (or the constituent companies) and buy the bonds that are expected to yield a higher return. (By the way, 9% is the lowest 10-year return to the S&P 500 and occurred if the investor bought the index in September 1930.) Selling the S&P 500 would cause its price to fall, thus increasing its subsequent future return. Likewise, buying bonds would put upward pressure on their prices, which would depress interest rates. Ultimately the two investments’ returns will equilibrate, ignoring tax, liquidity, and risk 8

concerns. High bond yields cannot exist alongside low expected equity returns. Historical data bear this relationship out. While the fit between the 10-year yield on Treasury bonds and the 10-year return from the S&P 500 is not as good as with the dividend yield, it is still statistically significant, positive and relatively strong. Almost a third of the index´s 10-year returns can be explained by the interest rate on comparable bonds and, at least over the past 30 years, each percentage increase in interest rates has resulted in a 1.9% increase in the S&P 500´s return over the following decade. From a statistical baseline (i.e., if 10-year interest rates were zero) of -4.1%, the S&P 500 could be reasonably expected to yield a return of -0.5% annually over the coming decade. As with the use of the dividend yield to forecast future returns, there are some obvious problems. Not much of the variance in the index´s returns is explained by interest rates, but more strikingly, there is quite a bit of nonlinearity in the model. Every one of the negative 10-year returns from the index (which all occurred between November 1999 and February 2002) coincided with relatively high interest rates of between 4% and 7%. The relationship is not perfect, but when averaged out over long time periods we start to see definite patterns developing. These patterns can be used to create statistical models that shed light on what we can reasonably expect the future to hold for broad-based stock indexes. We have only mentioned two factors affecting future returns: interest rates and dividend yields. In fact, there are dozens of such variables that we make use of in our valuation models. These include economic data, like unemployment rates, inflation, and capacity utilization. Financial data like interest rates are useful, but so too are the yield curve and market volume, among other measures. Finally, forward-looking measures like consumer optimism play a probabilistic role in shaping future returns. Note that all these data are not specific to any one individual company, but exist as averages that stem from, and affect, the economy at large. The rate of unemployment is not relevant for any specific business (though a specific rate of unemployment may be, e.g., the rate of unemployment for technically skilled workers in the Bay Area might be important for the future success of a tech company located there.) But the average rate of unemployment is relevant for the future fortunes or failures of the economy as a whole. The same goes for interest rates, inflation, consumer sentiment and the whole range of factors we use to model future index returns. We focus on equity index returns since they meander through secular waves of above- and below-average returns and also because the key pieces of data that relate to forecasting future returns are 9

relevant only for broad indexes, not individual companies. We end this introduction with a word of caution. The future is fundamentally unknowable with any exactness. At the same time, it is unreasonable to think that the future will not be related to the present or past in any way whatsoever. After all, how often have you read the following statements? 1) Past performance does not guarantee future results. 2) This time is different. Since they are mutually exclusive, which statement is correct? The most defensible answer is that they are both partially correct. The past does not guarantee the future, but it provides a roadmap. This time is surely different than any other moment in history, but not completely so. The successful investor must balance these two philosophies. Today´s state of financial affairs is the result of decisions that were made in the past, dependent as they were on borrowing rates, dividend yields, unemployed workers entering the workforce and a wide range of other economic and financial factors. History may not repeat, but it rhymes. In all the forecasts that follow we list the associated probability of the event. These probabilities are based on historical experience. While not completely applicable to future events (since they are backward looking in nature) they give the investor a starting place to assess the likelihood of the future. Future returns concern outcomes of various likelihoods. Historical relationships don´t tell us the complete story, but they give us a foundation to differentiate between those events more likely to occur in the future from those that are less likely to occur. This book is not and should not be interpreted as investment advice. The investor´s propensity for risk, desire for exchange-rate exposure, as well as local laws governing investments are all beyond the scope of the book. It is aimed solely at shaping expectations of and providing a roadmap to navigate one potential coming decade. In what follows we apply our general methodology to forecast 43 major equity indexes. These 43 indexes represent 30 countries of the world, two regions and 24 currencies. But before delving into these 43 index reports, we must overview briefly the two key components of our forecasting methodology: our relative valuation measure, and our 5- and 10-year forecasting process.

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Relative Valuation The foundation of our analysis is our measure of relative valuation. With the benefit of hindsight that the future provides, it becomes apparent that certain prices were over-valued while others were undervalued in the past. Relative valuation allows us to get a feel for any overor under-valuation in the market not just retrospectively, but in real time. Consider the S&P 500 over the past thirty years. Almost certainly the investor would consider the 1999 and 2007 highs to be over-valued. After all, the index collapsed by 40% after the August 2000 high, and 52% in the 16 months following October 2007. But when the investor says “over-valued” the question that should immediately spring to mind is “compared with what?” Furthermore, what is the magnitude of this supposed over-valuation? Our measure of relative valuation answers both these questions. Most investors have in mind a rapid run-up in the market´s price as their preferred definition of over-valuation. Alternatively, they might think that a new lofty high that the market had not reached previously signals that a decline is at hand. By this definition, however, it is difficult to see how the S&P 500 was over-valued in late-2007. The index had only increased at an annual rate of 11% since the 2002 lows, making it the index´s slowest bull market in over a century. (By contrast, the bull market of 1932-37 witnessed a 33% annual gain!) The October 2007 high of $1,549 barely bettered the previous all-time high set in August 2000 by $30, and even then, maintained it for barely two months. Yet despite the weakness of the advance and the fact that the index was hardly above where it had been seven years earlier, the market collapsed into a 53% loss.

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Our measure of relative valuation normalizes these market highs and lows relative to other prices in the economy. Our prevailing philosophy is that all prices adjust over long periods to stay aligned with other prices. The underlying motive is similar to an arbitrage condition. If house prices increased faster than equity prices today, it must mean that the expected return from a real estate investment will diminish relative to equity investments. Investors working on a long enough time horizon will reallocate capital away from housing and into stocks, until their prices adjust to equilibrate their expected returns. The decision as to where to allocate his funds does not limit the investor to real estate versus equities. Bonds too are a potential investment, as is cash. But note that the investor does not even have to invest at all. He could choose to consume his savings by buying consumer goods. If the price of a car was sufficiently cheap (relative to stocks) the investor would find himself behind a new steering wheel rather than navigating an enlarged portfolio of equities. Again, this process would continue until the price of a car adjusts upwards so that its non-pecuniary return is equilibrated with the purely monetary return of the stock investment. In formulating our relative valuation measure we gauge the level of an equity index against the price of a large basket of alternative goods that the investor could allocate his funds to. This includes real estate (both commercial and residential), bonds, oil, gold, and a wide array of other consumer goods. In this way we can craft a measure that shows periods where equity prices outpace these other goods´ prices, resulting in a market over-valuation. Alternatively, we can also measure periods where equity prices fail to keep up with these other prices, best defined as an under-valuation in the market. When equity prices are under-valued, i.e., low relative to other 12

prices, stocks must “catch up” in the future, implying above-average returns moving forward. Alternatively, when stocks are over-valued, or expensive relative to other goods, equity markets must lag these other goods in terms of price appreciation, or even fall. There are, however, reasons why some goods´ prices might not equilibrate with other prices, even over longer periods of time. Making interest on mortgages tax deductible, or taxing dividend income advantageously to other sources, were important changes that resulted in house and equity prices increasing relative to other goods´ prices. To deal with this challenge of regime change and the fact that there are various and varying reasons why prices might not be arbitraged, each valuation measure is calculated by considering the relationship between the value of the index and these other prices over the preceding 30-year period. In other words, the claim that the S&P 500 is today over-valued by 34% is best interpreted as saying that the S&P 500 is currently more expensive than it has been relative to these other goods over the past 30 years by 34%. (Note that the index could have always been expensive compared to these goods, but it is 34% more expensive now than it was on average in the past.) To use a specific example, at the market´s peak in August 1987 the S&P 500 was over-valued by 48% relative to its average valuation against prices during the preceding 30-year period. Of course, during the thirty years following August 1957 the index went through periods where it was quite cheap relative to other goods the investor could have purchased (1949 and 1982), and other periods where it was quite expensive (1968 and 1972). In 1987 the S&P 500 topped out at 48% more expensive than the average of all these episodes. In the analysis that follows, we never express relative valuation as a percentage variance away from an average previous valuation, but as a normalized z-score. Normalizing the measure as a z-score simplifies several matters and also introduces some complications. We´ll deal with the complications first. First, and most damningly, the average investor doesn´t know what a z-score is, let alone how to interpret it. Statistically speaking, the measure is derived by way of the following equation: 𝑧=

𝑥− 𝜇 𝜎

where µ is the mean of the population and σ is the population´s standard deviation. The measure z represents the distance between a raw score x and the population mean µ in units of standard deviation σ. When a z-score is negative the value under examination is less than the population mean, and when it is positive it is higher. The relative valuation of an index can therefore be interpreted as the number of 13

standard deviations an equity´s price is above or below its fair-value (or average) level. Admittedly, stating over-valuation in terms of standard deviations above the mean is somewhat more convoluted than stating it in pure percentage terms. (To state that the S&P 500 is currently +1.2 standard deviations above its long-term mean doesn´t have quite the same ring as saying that “the S&P 500 is over-valued by 34%.”) Second, even if the investor does understand what a z-score is, he can´t use it in as direct a way as he could a simple percentage over- or under-valuation measure. The S&P 500 is currently over-valued by 34%, or +1.2 standard deviations above its mean valuation. Since the index closed at $3,230, your average investor can probably piece together that its fair-value price should be about a quarter less, or $2,312 to be exact. He would then not only know that the index is overvalued, but also by approximately how much.

Using the z-score of +1.2 is a more contrived process. To come up with the fair-value level of the S&P 500, the investor would need to know (in addition to the current price) the average of the fair-value prices (µ) and their historical variance (σ). These drawbacks notwithstanding, what the z-score lacks in user friendliness it makes up for in analytical usefulness. First, since not all relative valuation measures explain the variance in the underlying index equally well, it is impossible to directly compare their relative valuations if expressed as z-scores. For example, the NASDAQ-100 is currently over-valued by 53%, a significantly higher amount than the S&P 500 (34%). In normalized terms, the NASDAQ100 is only +0.7 standard deviations over-valued, however, roughly half the measure of the S&P 500 (+1.2). The reason for the discrepancy is 14

that our valuation model for the S&P 500 is more accurate than that for the NASDAQ-100 (apparently only barely so given an adjusted R2 of 0.82 versus 0.81, though with a much smaller standard error of 0.25 versus 0.41). The fact that the variance of valuation is greater for the NASDAQ-100 makes it less over-valued once we adjust for the fact that the model is also less accurate and has a higher historical variance, which the z-score allows for. To put it another way, the z-score permits the reader to not concern himself with the accuracy of the relative valuation model for a particular index, but instead focuses on its standardized results. In this way we can compare seamlessly the valuation of various indexes irrespective of the accuracy of the underlying valuation method. Second, not all relative valuation measures can be applied across different time periods without difficulty. Keep in mind that we use a moving 30-year period to calculate relative valuation in order to continually adjust for different economic conditions and legal regimes that might favor some prices over others. In August 1987 the S&P 500 was 48% over-valued, which translated to +1.0 standard deviations above its mean. Just as in the former example with the NASDAQ-100, here we see the difference being that our valuation model is more accurate for the 30 years between 1989 and 2019 than it was between 1957 and 1987. Again, the use of the z-score detracts from these accuracy considerations and allows the investor to compare the results head-to-head. This discussion is not to imply that any of the valuation models are not statistically rigorous. All models are statistically significant at the 95% confidence level. As a rule, about three-quarters of an index´s current price can be explained by the relative valuation models of the 43 markets. Third and finally, the use of a z-score allows us to easily compute the percentage of time that the market has been as over- or undervalued as it is at a given level. We can do this because the relative overand under-valuations are approximately normally distributed, allowing for additional statistical analysis. For the 360 monthly relative valuations since December 1989, over a third (36%) have been approximately fairly valued, i.e., within ±0.4 standard deviations of the mean. Another third (37%) have been undervalued by more than -0.4 standard deviations, and the rest (27%) of the monthly periods have been over-valued by more than +0.4 standard deviations. As the histogram makes clear, most valuations are tightly grouped around the mean, and the average under-valued market is less extreme than is the average over-valued market. The fact that the relative valuations are approximately normally distributed is most useful because we can compute many additional 15

statistics directly from its z-score, for example, what percentage of the time the market has been more over- or under-valued than it currently is. Given that the S&P 500 is currently over-valued by +1.2 standard deviations, it is easy to state that this is more over-valued than 88% of all previous periods. Likewise, when the index was +1.0 standard deviations over-valued in August 1987, this implied the market was more over-valued than 80% of all previous monthly periods.

Despite superficially looking like a more complex and less applicable measure than a pure percentage, the use of a relative valuation z-score allows for different markets to be compared across different time periods easily and without complication. A relatively over-valued market generally yields below average returns in the future and the reverse holds true for relatively undervalued markets. In fact, the S&P 500 has gone through seven valuation cycles since 1909, with each cycle being composed of a long-term bull market and a correction in the form of a bear market. Each bull market started from a relatively under-valued position and ended with the measure signaling over-valuation. Notwithstanding the fact that superior returns are found by investing in under-valued markets, the measure is not a panacea. For starters, the market can be over-valued for a significant time before a correction comes. By 1998 the S&P 500 had become more over-valued (+1.9) than it had been since the late-1920s. This fact notwithstanding the market continued to climb for two more years. The investor who exited the market earlier may have avoided losses during the dot.com bust, but he also would have missed out on two of the most significant years of the largest bull market in history. (The two years between 1998 and 2000 averaged a 16.4% annual return, without even considering dividends.) 16

Perhaps more important is that some large-scale corrections have followed only minor relative over-valuations. The 53% decline after October 2007 was the largest bear market since the 1937-42 correction. Yet the market in October 2007 did not look unreasonably over-valued at only +0.2 standard deviations above its long-term average. Part of the explanation for the magnitude of the decline between 2007-09 is not that the market was significantly over-valued to begin with but that the decline brought the index to deeply under-valued territory. The bear market ended in 2009 by being -2.2 standard deviations under-valued (cheaper, in other words, than 98.5% of all previous months). The only time the S&P 500 has been priced more attractively in over one hundred years was the end of the bear market of 1974. In other words, it´s not necessarily that the market started from unusually lofty heights (it was, after all, peaking barely higher than it had seven years earlier). Rather, the bear market´s severity can be explained by noting that the decline was unusually extreme. This discussion might lead the reader to think that relative valuation is of little use to the investor. After all, it matters not whether the bear market exists because the market was originally too over-valued or because it didn´t end until the market was deeply under-valued. A spade is a spade no matter whether you are looking at it from the top down, or the bottom up. Still, valuation swings that define bull and bear markets are somewhat predictable. Over the past seven valuation cycles, the average bear market in the S&P 500 has seen the index´s relative valuation decrease by -2.7 standard deviations. Between 2007 and 2009 the S&P 500 lost 2.2 standard deviations of relative valuation. Viewed through that lens, the bear market was somewhat less severe than could have been warranted given historical precedent. Relative valuation is a useful tool that tells us much about how cheap or expensive a market is relative to other markets, and relative to other times. It also allows us to make estimates as to the end game for a given bull or bear market. It is not a sufficient measure, however, to judge the potential of all investment opportunities. Its real use, as we will see in the following chapter, is in forming the backbone of our model that forecasts the return of an index over various time horizons.

17

Period Forecasts Relative valuation sheds light on which markets are under-valued relative to their historical norms, and by how much. The measure does little, however, to translate this information into anything other than a qualitative prospect at the market appreciating or depreciating in the future. In other words, it does not inform us on how much the market´s price will adjust in the future. Our period forecasts rectify this omission. Consider a simple problem: the decision whether to buy a shirt. The decision is informed by some idea of what the current “valuation” of the shirt is, as signaled by its price. Is it over or underpriced relative to some historical standard? You could consider at what price shirts sold for last year, or maybe put the past prices in context by normalizing them relative to other goods´ prices. It´s one thing to know if you have a good deal on your hands, but the future price path is also important. If you suspected that shirts would go on sale for half off in one month´s time, you may well decide to wait it out to save some money. In terms of equities this is the same thing as expecting a market to decline in the future and remaining on the side lines until better values materialize. Relative valuation is the single most important factor determining a market´s future return. The more deeply under-valued a market is in the present, the greater the chance that it will yield above-average returns in the future. The challenge in estimating the future return stems from not knowing at what price the market will sell for at a prospective date. There are two ways to approach this problem. First, you know that you can buy a bond of the same maturity as your prospective equity investment. The bond´s interest rate determines the increase in your capital over the future period, and this return is known at the moment the investment is made. Coupled with the relative valuation of the market, a statistical forecast can be made to estimate the future return from an equity investment. Of course, the statistical analysis requires that the relationships (both in terms of their signs and magnitudes) be constant over time, and we know that there isn´t necessarily a constancy in these relationships. 19

Statistically, each standard deviation that the S&P 500 was undervalued in August 1987 increased the subsequent 5-year price return on the index by 4.7%. When we say “statistically” we mean it in the sense that over the preceding 30-year period each standard deviation of under-valuation had that effect. Furthermore, the relative valuation measure explains 62% of the variance in the 5-year returns between 1957-1987 (as per the model´s adjusted R2). Based on this one variable (the relative valuation of the index) we could build a model forecasting the 5-year return that would result from an investment made in August 1987. In the following diagram, the solid black line represents the 5-year returns between August 1957 and August 1982. These 300 data points were all that were available when constructing this model in August 1987. The dashed grey line illustrates the best-fit line for the 5-year returns over this period based only on the starting relative valuation of the index. The dashed grey line also represents the forecasted return going forward. The model predicted that by August 1992 the S&P 500 would have lost -10.7% annually (for a total decline of 43%). We know now with the benefit of hindsight that the S&P 500 did decline, though only by 30%. And it didn´t take five years, but two short months.

The solid grey line shows the actual 5-year returns that would have been known in full only by August 1992. An actual investment made in August 1987 and held for five years would have grossed the investor, before dividends, 4.7% annually. At this point the reader may be unimpressed with the applicability of the model. It did correctly forecast a market decline, but it had also been forecasting that since March 1986, 17 months before the collapse. On the other hand, the market correction didn´t play out over five 20

years, but rather two terrifying months. It would be perfectly reasonable to doubt the usefulness of the model given this dissonance. The reader should consider wo points. First, this forecast was made by only using one variable: the relative valuation of the S&P 500. Of course, there are other factors that determine a market´s outcome besides its valuation relative to some historical standard. Second, keep in mind that the interest rate on 5-year bonds was 8.3% in August 1987. The investor actually would have made a poor investment by investing in the index that month – he would have suffered a 3.6% loss relative to what he could have earned on bonds (and with much more stress). In fact, any investment made in the S&P 500 after February 1987 would have underperformed bonds over the next five years. Viewed with this light, the market may not have declined in absolute terms, but it did relative to the other options that the investor could have pursued Our period forecasting models, both for five and ten years, use relative valuation as their basis. They also make use of several other financial and macroeconomic factors to form their forecasts of future returns. While these models are probabilistic estimates in nature, they provide an objective grounding to form expectations of future market returns. Furthermore, while a variance from a forecasted return will happen, this occurrence has a likelihood that can be quantified at various degrees of confidence given historical price behavior and data. We list the probability of each forecast so the reader can form his own confidence of an event´s likelihood. Forecasting the future return based on past (or in-sample) data is not difficult, but it is challenging to have a robust model that works well with out-of-sample data. The primary problem we encounter is that we just don´t know what the price of the index will be five or ten years from now when the sale is made. The return on the investment is as much a function of the selling price as it is of the purchase price. Relative valuation tells us much about how good a deal the present price is, but doesn´t inform us about the future selling price. Consider the following: The worst 5-year period for the S&P 500 since 1871 was an investment made in September 1929 (-22.3% annually). This has much to do with the fact that the September 1934 low (i.e., the end of the 5-year period) of $8.88 was not far off the actual bear market low made in July 1932 ($5.01). Of course, the terrible return also has to do with the fact that the September 1929 high would not be bettered for any sustained period until July 1954. It takes two to tango – a buy and a sell price. Likewise, the highest 5-year return the S&P 500 has ever provided was for an investment made in September 1924. This was not an extremely under-valued month, but five years later was the bull market high. The best 10-year return was made in the decade following August 21

1990. Again, there is nothing especially unique or under-valued about that month, but the August 2000 high was the bull market peak, and would not be bettered until September 2007. The point we are trying to impress on the reader is that the future selling price is as much a determinant of return as the present purchase price. This creates a challenge when trying to make a forecast today. We have a method to estimate whether the present price is too high or low (relative valuation) but lack a method to make the same claim about a future price. We counter this problem by taking the weighted average of two forecasting models. First, we forecast what the return over the next five or ten years will be given the available returns from the preceding 30year period. Actual market data is the least biased estimate of future returns. Yet during periods of extreme under- or over-valuation the historical data have difficulty estimating future conditions. This should make sense since most of the time the market is approximately fairly valued and it is only in relatively few cases that it becomes severely over- or under-valued (about two-thirds of the time the market is within ±1.0 standard deviations of its long-term mean). Our other model is constructed from non-market data. Instead of using as a basis the actual 5- and 10-year returns from the previous thirty years, we derive the return that would have been realized if the market reverted to its fair-value level (i.e., a relative valuation of 0) at the investment´s point of sale. This counter-factual investment return thus attributes all the return earned to the initial valuation of the investment and ignores any extreme valuation swings of the selling price (since the selling price is assumed to always be at its fair-value level). For example, imagine buying the S&P 500 in August 1995 at its market price of $561. Five years later the investor would have sold it at $1,517 and realized an annual return of 22.0%. Now imagine that the S&P 500 didn´t rise to such a lofty valuation (+2.8 standard deviations above its long-term mean) but instead was fairly valued in August 2000. The investor would have received only $852 when he sold his investment in this case and would have realized a “fair-value” return of 8.7%. From the vantage point of August 1995 the investor had no idea whether the market would increase substantially or remain fairly valued by August 2000. We make use of market data to discover what variables have historically been most able to forecast future returns robustly, in terms of both the actual and the counterfactual fair-value selling price. Each model is then weighted according to its explanatory power (adjusted R2) to provide the forecast given to the reader. This is done for both the 5-year and 10-year forecasts.

22

Each index report also contains a range of forecasts for the relevant time period. This range is a function of both the raw forecast and the fair-value forecast. The current 10-year forecast for the S&P 500 is an annual gain of just 1.6%. The fair-value estimate calls for a loss of 1.0% annually by December 2029. Historically, since December 1989, the actual forecast model has explained 90% of the variance in the 10year returns of the index, and the fair-value forecast model has explained 90% of the variance in the 10-year fair-value returns of the index. (This equality is just a coincidence.) The actual forecast we provide is the weighted average of these two estimates (0.3%) with a range of -1.0% to 1.6%. Generally, the tighter the range the more accurate both valuation models are. Each index report also illustrates the model graphically. The solid black line always represents the actual 5- or 10-year returns of the market over the previous 30-year period. The grey dashed line illustrates the forecast model so the reader can see how well it fits the past data, and also so that he can judge for himself the model´s prediction of the market´s future. We end this explanation with one final note on the use of the period forecasts. Historically, negative 5-year returns have started to occur several years prior to the actual decline in the market. For example, although the market topped in October 2007 the 5-year return was negative as early as August 2006. Any investment made after December 1998 yielded a negative 5-year return notwithstanding the market topping 20 months later. Any time between September 1926 and May 1931 would have yielded a negative return five years later, though the market made its top in September 1929. In other words, the market typically continues to rise even after it is priced to offer negative returns over the coming five years. 23

Negative returns over ten years are fairly rare. In fact, of the 1,668 10-year periods since January 1871, only 326 of them (19.5%) have yielded negative returns. This nearly 150-year history includes some severe and frequent bouts of deflation that happened before the creation of the Federal Reserve. These negative returns could have been, and often were, positive in real (inflation-adjusted) terms. Of the past 100 years, only 144 months (12%) have posted negative 10-year returns. In other words, negative 10-year yields don´t happen except in the deepest of contractions. In sum, forecasts for declines in the market over the coming 5-year period typically presage actual corrections, and forecasts of negative 10year returns only accompany the most significant of bear markets.

24

A Historical View on the World´s Major Indexes Before diving into the forecasts, it may prove instructive to overview the 43 indexes and their historical performance. While the primary focus of this report is forecasting the future returns over the coming decade, some historical perspective is necessary to understand the implications of these estimates. There are two primary reasons for this. On the one hand, there is a strong correlation between returns from the past and those from the even more distant past. In general, those markets that performed most strongly in the 1970s relative to other markets also yielded the best relative performance in the 1980s. There were, of course, anomalies to this, such as the great bull market in south-east Asia in the 1990s, or Japan´s late-1980s bubble. These examples are exceptions to the rule, however, and the picture is much different if one focuses on average or longer-term results. The fact that returns are correlated over longer periods should make some intuitive sense. Ultimately the return on equity is a product of the strength of the economy, both in terms of its ability to generate cash flows to pay out as dividends today and to drive growth in the future. Investments made in the present, and which drive current profitability, also provide the capital stock that will drive future economic growth. As such, present returns are linked to the future by today´s capital investments. On the other hand, although there are 43 markets analyzed herein, there is some degree of overlap. Many of the world´s markets focus on the same industries: technology and financials being two of the most 25

common. It is not unreasonable to think that if the prospect for the future is bleak for the American technology industry, the same holds true for the Taiwanese technology industry. Understanding the correlations between the various models provides an additional method for the reader to verify the veracity and likelihood of the forecasts that follow.

Historic Highs Let´s start with a historical look at the all-time monthly closing highs in these 43 markets. For some markets, 2019 was a bumper year. Indeed, both the MSCI All Country World Index (focusing on the all the markets of the world) and MSCI World Index (which focuses more narrowly only on the developed countries of the world) posted new highs at year end. Likewise, every single U.S. based index, except for the Dow Jones Transportation Average, registered new highs. Canada´s TSX uncovered new territory, as did a smattering of markets in Europe´s periphery, including Sweden and Switzerland. South of the equator, Australia and New Zealand continued their advances throughout the year. Finally, bolstered by nearly 10% inflation, India´s BSE SENSEX Index also rounded out the year by posting new highs, at least in nominal terms. One striking anomaly to many readers will be that MANY of the world´s indexes are still lower than they were several decades ago. The last significant global equities boom ended in 2007 and several indexes still trade below those highs, not to mention the previous booms that ended in 2000 and before. Ireland and Spain, two countries that took center stage during the Global Financial Crisis, are still trading lower than they were 12 years ago. While those are somewhat predictable stories, Singapore too has not been able to surpass its 2007 highs. Emerging markets, as proxied by MSCI´s Emerging Market Index, have also stalled and been unable to breakout past their previous highs. If the failure to forge new highs in these markets seems odd given the recent strength in both the American and Global equity markets, consider that there are still many countries that have been unable to move beyond their 1999-2000 highs. This includes most of continental Europe, e.g., Finland, France, Greece and the Netherlands. We don´t even need to refer to Japan, where the Nikkei 225 is still trading below its December 1989 peak. And keep in mind that Japan´s bubble swept up some neighbors along with it, notably Taiwan where the TAIEX is still trading lower than it was 29 years ago. All told, a little over a third (38%) of the markets covered herein 26

made a new all-time high in 2019, and most of those were in the United States. About 10% posted their all-time high during the 2007 peak, mostly within the euro area and emerging markets. An additional 15% of the markets have yet to surpass their 2000 peaks (also mostly contained within the euro area). For the median market, however, 2018 was a boom year and 2019 finished a little soft. Of course, this discussion is difficult for the investor to grabble with since all these highs are expressed in terms of different currencies, 24 in total. A high in terms of one currency might not be so when expressed in terms of another if the reference exchange rate has been sufficiently weak. We can compensate for this by looking at real, or inflation-adjusted, highs. Inflation, at least over long periods, is the primary factor responsible for changes to a country´s exchange rate. By looking at the timing of these markets´ real highs we can see which global markets have dominated the return landscape. The United States is the only country in the world to have made new highs recently in inflation-adjusted terms. This is due to two factors. The first is that inflation has been relatively low in the U.S., averaging 2.4% annually since 1989 (against more than 4% on average for all the regions we cover). Secondly, the boom in the United States since 2009 has been quite robust, more than compensating for any inflation that might drag the real averages lower. The Dow Jones Utility Average is the lone exception to this rule. The index has yet to better its peak made in August 1929 in real terms. In part this is because the 1929 peak was so extreme. Perhaps more important was the fact that the ensuing bust in the Utilities was much more severe than any of the other broad-based indexes. The index didn´t bottom until April 1942, by which time the index had lost over 92% of its value. Even ignoring the 1929 peak, the Utilities are still lower today (in real terms) than they were May 1969, 50 years ago. (So much for stocks for the long run!) Low-inflation Switzerland (1% annually over the past 30 years) was the only other country to post new real highs last year. The rest of the world is a mixed bag. The euro area and its periphery made their real highs in 2000, as did most of the rest of the developed world´s markets including Australia, Canada, Hong Kong, New Zealand and Singapore. Most of south-east Asia formed their real highs in the early 1990s and are still significantly down from those valuations. In sum, the investor should be aware that the global norm is for real stock market highs to be a thing of the past. The fact that the U.S. based markets are the only ones (along with Switzerland) to post both new nominal and real highs is a testament to the strength of their recoveries since 2009.

27

Markets, historic highs Historic Date of Historic Monthly High High Nominal

Real

565 2,358 1,337

Dec-19 Dec-19 Oct-07

Dec-19 Dec-19 Oct-07

9,386 28,538 11,379 879 8,733 9,150 3,230 32,886

Dec-19 Dec-19 Sep-18 Dec-19 Dec-19 Dec-19 Dec-19 Dec-19

Dec-19 Dec-19 Sep-18 Aug-29 Dec-19 Dec-19 Dec-19 Dec-19

Euro area EURO STOXX 50 Euro area MSCI EMU Finland OMX Helsinki France CAC 40

5,317 205 17,734 6,625

Mar-00 Mar-00 Apr-00 Aug-00

Mar-00 Mar-00 Apr-00 Aug-00

Germany DAX Greece Athens Composite Ireland ISEQ All-Share Netherlands AEX Spain IBEX 35

6,270* 5,712 9,854 689 15,890

Oct-17 Nov-99 May-07 Aug-00 Oct-07

Feb-00 Nov-99 May-07 Aug-00 Feb-00

Norway OBX Sweden OMXS30 Switzerland SMI Turkey BIST 100 United Kingdom FTSE 100

517 1,771 10,616 119,528 7,748

Sep-18 Dec-19 Dec-19 Jan-18 Jul-18

Oct-07 Feb-00 Dec-19 Apr-00 Dec-99

Australia All Ordinaries Australia S&P/ASX 200 Hong Kong Hang Seng India S&P BSE SENSEX Indonesia IDX Composite Japan Nikkei 225 Malaysia FTSE Malaysia KLCI New Zealand S&P/NZX 50 Philippines PSEi Singapore FTSE Straits Times Index South Korea KOSPI Taiwan TAIEX Thailand SET

6,948 6,846 32,887 41,253 6,605 38,916 1,882 4,924 8,764 3,805 2,566 12,054 1,830

Nov-19 Nov-19 Jan-18 Dec-19 Jan-18 Dec-89 Jun-14 Dec-19 Jan-18 Oct-07 Jan-18 Jan-90 Feb-18

Oct-07 Oct-07 Oct-07 Dec-07 Apr-90 Dec-89 Dec-93 Aug-89 Dec-93 Oct-07 Mar-89 Jan-90 Dec-93

Mauritius SEMDEX Nigeria NSE All Share South Africa FTSE/JSE All-Share

2,292 65,652 59,772

Feb-18 Feb-08 Nov-17

Feb-08 Feb-08 Feb-15

Canada S&P/TSX Composite Mexico S&P/BMV IPC

17,063 51,210

Dec-19 Aug-17

Nov-07 Jan-13

World MSCI ACWI World MSCI World World MSCI Emerging Market United States United States United States United States United States United States United States United States

*

DAX price index

Dow Jones Composite Avg. Dow Jones Industrial Avg. Dow Jones Transportation Avg. Dow Jones Utility Avg. NASDAQ-100 NASDAQ Composite S&P 500 Wilshire 5000

28

Historical Annual Returns The preceding discussion gave a bird´s eye view of where equity markets are relative to their longer-term levels, but the investor requires rates of return to make investment decisions. By making use of the same starting date for all indexes, 31 December 1989, we can compare all 43 markets to compare their performance over the past 30 years. While the investor is future-oriented, this historical overview is important since there is a correlation between past and future returns. In nominal terms, one of the primary drivers of the stock market is inflation. Indeed, many investors in high inflation countries buy equities specifically as an inflation hedge. Since 1989 inflation has been tame in most of the markets under analysis. In the United States, prices have increased annually by only 2.4% over the past 30 years. Most of the euro area has seen even more subdued price increases, averaging 2.0% annually for the whole bloc. The European periphery is filled mostly with low inflation regimes, though Turkey has averaged over 30% annual price increases since 1989. (It should be noted, however, that the majority of that is due to very high inflation during the 1990s. Since the early 2000s Turkish inflation has been somewhat more subdued, under 10% annually.) Likewise, most of Asia has experienced low levels of inflation, with only India, Indonesia and the Philippines averaging higher than is generally thought economically comfortable.

One prediction of our relative valuation model is that price changes should, especially over long periods of time, be approximately equal between the various investment opportunities, including equities. Here we see a variant of this idea, as price inflation has accounted for 74% of the variance in the price returns of our 43 markets over the past 30 29

years. Of course, the price return is only a portion (and in some cases a relatively insignificant portion) of the investor´s total return. Reinvested dividends must also be accounted for. The total return represents what the investor would have actually earned by reinvesting dividends in the index, before taxes, fees, headaches and heartbreaks. Since we are concerned with the 30-year period since 1989, there are many indexes that haven´t tracked their total returns for a sufficient amount of time, or for which the data is not publicly available. Still, we can get a feel for almost half of the markets. The best performing index in terms of its total return since 1989 has been the Dow Jones Industrial Average. An average dividend yield of 2.7% bolstered its annual price return of 8.1% to gross the investor nearly 11% annually. (Actually, the investor would have fared somewhat better investing in the NASDAQ, but which we exclude since its dividend yield since 1989 is not known. The -100 and the Composite indexes gave price returns of 13.0% and 10.5%, both higher than the Industrials even before taking the effect of dividends into consideration.) All American markets returned more than 9% annually, about 2% higher than the world as a whole. The source of the returns differs depending on the market. The Dow Jones Utility Average depended on dividends for more than half of its historical return, while (presumably, and as is the case presently) the NASDAQ indexes relied on them least heavily. Indexes in the euro area averaged total returns a little over 7% and were all tightly bound around this value. Asian indexes, in contrast, are a mixed bag, mostly because inflation is more variable than it is in Europe with its resultant effect on price returns. As quick and easy shorthand the internationally minded investor can look at real total returns to find out where the grass was greenest. In this respect, there was not much variation between countries and regions. This fact is also consistent with our underlying philosophy that investors arbitrage excess returns in markets over long periods notwithstanding any short-term mispricings. The world as a whole yielded a real total return of nearly 5% and the American markets bettered this by anywhere from 2% to 3%. Since inflation was wellcontrolled and fairly even across the euro area, all euro-denominated markets offered real total returns tightly ranged between 5.1% and 5.5%. We lack long-term data on the dividend yields in most Asian markets, but Australia, New Zealand and Hong Kong all offered broadly similar real returns (6.7 – 7.4%). Canada´s TSX, in an allegory similar to its very existence, cut the difference in the returns of the European and American markets down the middle. 30

Markets, historic annual returns (since Dec. 1989) Inflation Dividend Historic Average Yield Annual Returns Price

Total

Real Total

World MSCI ACWI

2.4*

2.4

4.8

7.2

4.8

World MSCI World

2.4*

2.4

4.9

7.3

4.9

World MSCI Emerging Market

2.4*

2.8

5.6

8.4

6.0

2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.4

2.7 1.5 4.7 2.2 2.2

7.6 8.1 7.7 4.5 13.0 10.5 7.7 7.8

10.8 9.2 9.2 9.9 10.0

8.4 6.8 6.8 7.5 7.6

Euro area EURO STOXX 50

2.0§

2.9

4.3

7.2

5.2

Euro area MSCI EMU Finland OMX Helsinki France CAC 40 Germany DAX Greece Athens Composite Ireland ISEQ All-Share Netherlands AEX Spain IBEX 35

2.0§ 1.6 1.5 1.8 4.6 1.9 2.0 2.7

3.1 3.3 2.2 2.6 -

4.0 6.4 3.7 4.7 2.3 4.8 5.1 3.9

7.1 7.0 6.9 7.4 -

5.1 5.5 5.1 5.5 -

Norway OBX Sweden OMXS30 Switzerland SMI Turkey BIST 100 United Kingdom FTSE 100

2.2 1.9 1.0 32.4 2.5

3.8 -

5.3 7.4 6.2 33.0 3.9

9.1 -

6.9 -

Australia All Ordinaries Australia S&P/ASX 200 Hong Kong Hang Seng India S&P BSE SENSEX Indonesia IDX Composite Japan Nikkei 225 Malaysia FTSE Malaysia KLCI New Zealand S&P/NZX 50 Philippines PSEi Singapore FTSE Straits Times Index South Korea KOSPI Taiwan TAIEX Thailand SET

2.5 2.5 3.4 7.5 8.9 0.5 2.6 2.0 5.7 1.6 3.4 1.6 3.0

4.6 4.4 2.8 6.5 -

4.8 4.8 8.0 14.1 9.6 -1.6 3.5 2.3 6.7 2.6 3.0 0.7 2.0

9.4 9.2 10.8 8.8 -

6.9 6.7 7.4 6.8 -

Mauritius SEMDEX Nigeria NSE All Share South Africa FTSE/JSE All-Share

6.6 20.5 4.0

5.0 -

10.2 15.9 10.3

15.2 -

8.6 -

Canada S&P/TSX Composite Mexico S&P/BMV IPC

2.0 9.3

2.7 -

5.0 16.7

7.7 -

5.7 -

United States United States United States United States United States United States United States United States

*

Dow Jones Composite Avg. Dow Jones Industrial Avg. Dow Jones Transportation Avg. Dow Jones Utility Avg. NASDAQ-100 NASDAQ Composite S&P 500 Wilshire 5000

United States inflation.

§

Euro area average inflation.

31

At the end of this 30-year period the market the investor would have performed best in real total terms was… Mauritius. This tiny African island located in the Indian Ocean just east of Madagascar provided a triple package for investors: high inflation/high price appreciation and high dividends. In real terms it eked out the Dow Jones Industrials for the top place in the real total return table at 8.6% annually. We´ll finish with a few words about the composition of the returns of the various indexes. We can see that what differences do exist in total real returns over long time horizons are minimal. One reason is that the dividends paid out by the various markets are quite similar (an average of 3.2%, somewhat higher in Asia and slightly lower in the rest of the world). We can also see that real price returns are also broadly similar (an average of 2.8% across the world, slightly higher in the United States, lower in Asia and right on par for most of Europe), the result of nominal price returns being tightly linked to inflation. The result is a relative constancy in the real total returns across the sample countries. So much for the past, the rest of the book concerns the future. But before moving on there is one last consideration to keep in mind when interpreting the results that follow.

Index Compositions There is a fair amount of overlap in the industries that these 43 indexes focus on. The technology sector claims the largest share of the component companies in nearly a third (13/43) of the markets. Close to half (16/43) of the indexes focus on the financial sector, and the rest find their primary industry to be health care, industrials, oil and gas, etc. All told only nine industries are represented. There might be a lot of geographic diversification in the indexes, but they mostly focus on technology and financial companies. There is also a lot of overlap in the dominant companies. Apple, the American technology giant, and world´s largest company by valuation, is the largest component company in five of the indexes. The German technology company SAP appears in three euro area indexes. Even the Spanish bank, BBVA, though not the largest component of the IBEX 35 makes an appearance through its Turkish subsidiary, Garanti BBVA. Although there are many market-specific factors affecting valuations and forecast returns, there are also some commonalities. The average market cannot, by definition, grow any faster than the world, so the fate of the individual indexes is constrained by the three global

32

Markets, overview Currency Largest Component Company World MSCI ACWI World MSCI World World MSCI Emerging Market

Largest Industry

USD USD USD

Apple Apple Alibaba

Technology Technology Financials

USD USD USD USD USD USD USD USD

Boeing Boeing Norfolk Southern NextEra Energy Apple Apple Microsoft Apple

Technology Technology Transportation Utilities Technology Technology Technology Technology

Euro area EURO STOXX 50 Euro area MSCI EMU Finland OMX Helsinki France CAC 40 Germany DAX Greece Athens Composite Ireland ISEQ All-Share Netherlands AEX Spain IBEX 35

EUR EUR EUR EUR EUR EUR EUR EUR EUR

SAP SAP Nordea Bank LVMH SAP Coca-Cola Hellenic Bottling CRH plc ASML Holding Banco Santander

Technology Financials Industrials Consumer goods Financials Financials Construction and materials Technology Financials

Norway OBX Sweden OMXS30 Switzerland SMI Turkey BIST 100 United Kingdom FTSE 100

NOK SEK CHF TRY GBP

Equinor Atlas Copco Nestlé Garanti BBVA HSBC Holdings

Oil & gas Industrials Health care Financials Financials

Australia All Ordinaries Australia S&P/ASX 200 Hong Kong Hang Seng India S&P BSE SENSEX Indonesia IDX Composite Japan Nikkei 225 Malaysia FTSE Malaysia KLCI New Zealand S&P/NZX 50 Philippines PSEi Singapore FTSE Straits Times Index South Korea KOSPI Taiwan TAIEX Thailand SET

AUD AUD HKD INR IDR JPY MYR NZD PHP SGD KRW TWD THB

Commonwealth Bank Commonwealth Bank Tencent HDFC Bank Bank Central Asia Fast Retailing Public Bank Berhad Fisher & Paykel Healthcare SM Prime Holdings DBS Bank Samsung Electronics Taiwan Semiconductor Mfg. PTT Public Company

Financials Financials Financials Financials Financials Technology Financials Health care Industrials Financials Technology Technology Oil & gas

Mauritius SEMDEX Nigeria NSE All Share South Africa FTSE/JSE All-Share

MUR NGN ZAR

Dangote Cement Naspers

Financials Basic materials

Canada S&P/TSX Composite Mexico S&P/BMV IPC

CAD MXN

Royal Bank of Canada América Móvil

Financials Consumer goods

United States United States United States United States United States United States United States United States

Dow Jones Composite Avg. Dow Jones Industrial Avg. Dow Jones Transportation Avg. Dow Jones Utility Avg. NASDAQ-100 NASDAQ Composite S&P 500 Wilshire 5000

indexes. Nor is it reasonable that the technology industry in, e.g., America, performs poorly while the same technology industry in, e.g., Taiwan, enjoys stellar returns. There is a large degree of overlap and their returns are correlated loosely. All that said, it´s difficult to gauge what the correlation between the same sector in different countries will be moving forward. It´s also hard 33

to state, just based on the historical record, which countries will offer superior returns to the global markets and which will lag. With that in mind, the numbers don´t lie and they offer the least biased approach to making these forecasts, so let´s get on with the results.

34

Market Overview In the pages that follow are individual reports for the 43 markets covered. We report on each market in a consistent manner, and a brief explanatory note will navigate the reader through the general approach. Each report starts with an overview of the results for the country. This overview table gives a snapshot of the index´s current price, dividend yield and interest rates on government bonds. The relative valuation of the index and actual fair-value price allow the reader to judge for himself the extent to which the index is under- or over-valued relative to historical standards. We next list a series of forecasts for both 5- and 10-year durations. For each time frame there are three forecasts of interest to the investor. First, we list the forecasted annual price return (ignoring dividends) for the index, as well as the forecast range. The adjusted R2 of the forecast model is given so that the investor can get a feel for the extent of its explanatory power. The explanatory power is also alluded to by providing the probability that the index will break-even over the relevant period. This price return is of interest to the investor, as is the chance that the index will not decline in the future, but total returns (including reinvested dividends) are more relevant. The total return is estimated by summing the forecast price return and the index´s current dividend yield (if available). The total return is that which can be compared directly against the interest rate on bonds, since they represent the two alternative investments facing the investor. (There is also cash with a 0% return, which we exclude for simplicity.) The probability that the total return on an index will exceed that of bonds of comparable maturity signals to the investor where he can expect his investment to be maximized. Since both price and total returns are listed in terms of the index´s 35

currency, a cross-border comparison is difficult to make. To simplify this process, we list the real total return (adjusted for inflation). The rate of inflation, at least over longer periods, is closely linked to the rate of change of the exchange rate and the adjustment allows the investor to compare forecasts listed in various currencies head-to-head. A brief analysis of the index follows along with two charts: the historical price history and relative valuation for the past 30 years. This gives the investor a bird´s-eye view of where the index is today relative to some historical episodes. For example, the reader can see the strong recent performance of the S&P 500, including the doubling of the index since 2011. The recent corrections of 2000-2002 and 2007-2009 are also more than apparent. The relative valuation graph allows the investor to put these past corrections in historical perspective. The S&P 500 is more over-valued today than it was in 2007, though notably less so than in 2000. For those indexes with more than 50 years of price data we include a historical look at its booms and busts. A long data set is necessary to value the index sufficiently far back so that enough valuation cycles can be assessed in a meaningful way. By looking at the extent and duration of past cycles, as well as their starting and ending valuations, the reader can get a taste for what to expect from future cycles. Onward to the 5- and 10-year return forecasts. Each country´s forecasted price returns (ignoring dividends) are listed and explained, as well as graphs that show the reader how well our model explains the past 30 years of price movements. We include dividends to create a forecasted total return, and also provide probabilities that the forecasts will break-even or better the return available on bonds. We conclude each report with a qualitative assessment relative to the other markets covered. Each market is until this point explained in quantitative terms, with associated forecasts and probabilities. These forecasts will all contain some degree of error which we try to minimize by maximizing the robustness of our valuation and forecast models. The error in the individual market forecasts will contain, however, a large degree of correlation. By this we mean that it is likely that an overestimation of one country´s returns will probably be related positively to an over-estimation of other markets´ returns. One way to correct for this is to compare all 43 markets against one another and rank them according to the various forecasts. In this way we can see how a specific market stacks up against the competition. The specific rankings include the relative valuation, forecasted total returns and the probability that the index will offer a total return in excess of comparable government bonds. We also give the actual estimates for each of these data as well as the average for the 43 indexes contained herein so that the reader can gauge for himself the 36

prospective relative performance over the coming five and ten years. As such, the reader can form an estimation as to how likely it is that a given index will out- or under-perform the global average moving forward.

Market results, a summary view The table on the next page provides a comprehensive ranking of the total results of all 43 markets, grouped by geographic region. Blackshaded cells denote data that are less conducive to the investor´s future returns: positive relative valuations and negative forecasted returns. Dark-grey shaded cells highlight those data that are beneficial to the investor moving forward: negative relative valuations and positive forecasted returns. In this way the investor can quickly visualize those markets expected to provide superior future returns (with more greyshaded cells) and contrast them with those markets expected to lag in the future (illustrated with a greater number of black-shaded cells).

In the summary table we first draw attention to the negative correlation between returns and relative valuation. Those indexes that are the most over-valued (shaded in black) are also the ones most likely to under-perform in the future, or even yield outright losses. This is most apparent with the Japanese Nikkei 225, New Zealand´s S&P/NZX 50 and the Swiss SMI. Not only are these three indexes some of the most over-valued but they are also forecast to yield negative returns across all time frames, even including reinvested dividends. This negative correlation should make some intuitive sense. Relative valuation is, after all, the foundation of our return models and the primary determinant of subsequent returns. All else equal, under37

valued markets provide better value moving forward. The correlation is especially apparent on the 5-year returns. Indeed, nearly two-thirds (62%) of the variance of the 43 forecasted 5-year price returns can be explained just by the indexes´ relative valuation. The relationship is less strong yet still negative with the 10-year forecasts, a fact reasonably explained by the smaller degree of price variance over longer-term periods.

Statistically, each additional standard deviation of under-valuation increases the 5-year price return by 6.9% annually, and by 4.0% when stretched out over ten years. The models have baseline, i.e., fair-valued, 5- and 10-year returns of 4.4% and 4.6%. We point out these baseline returns to reinforce the validity of the models since over long periods the annual returns of different durations should be approximately the same, on average. (The S&P 500, for example, could not have grown by 10% annually over all 10-year periods for the last century, and at the same time have grown by only 5% annually over all the 5-year periods.) Relative valuation matters not just in assessing the subsequent performance of an index relative to its own historical experience, but also in forecasting returns relative to other indexes. The markets in the United States are the most over-valued in the world. The European markets are generally quite close to being fairly priced (apart from Switzerland). Asia is a bit of a mixed bag, but its markets are generally fairly priced once one looks beyond Japan, New Zealand and Taiwan. Africa and the Americas, taken as a whole, are the most under-valued regions of the world. The world market is also quite over-valued, as gauged by MSCI´s World and All Country World indexes. (The former focuses on the developed world while the latter covers the whole world.) This is consistent with what one might expect given that nearly three-quarters of the MSCI World Index is weighted in over-valued U.S. and Japanese 38

equities. Markets, summary Relative Dividend Inflation Valuation Yield

Forecast Price Returns

Forecast Total Returns

Forecast Total Real Returns

5-Year

10-Year

5-Year

10-Year

5-Year

10-Year

World MSCI ACWI

0.9

3.2

2.3Ɨ

-1.1

1.3

2.1

4.5

-0.2

2.2

World MSCI World

1.0

3.2

2.3Ɨ

-1.8

0.9

1.4

4.1

-0.9

1.8

World MSCI Emerging Market

-0.3

3.5

2.3Ɨ

5.3

6.0

8.8

9.5

6.5

7.2

1.3 1.1 0.9 2.1 0.7 1.1 1.2 1.1

2.9 3.0 2.0 4.0 1.5 1.5 2.6 2.5

2.3 2.3 2.3 2.3 2.3 2.3 2.3 2.3

-0.9 -1.2 -0.1 -5.0 0.7 -2.1 -2.3 -1.6

2.0 0.9 4.3 -0.7 2.6 1.1 0.3 1.1

2.0 1.8 1.9 -1.0 2.2 -0.6 0.3 0.9

4.9 3.9 6.3 3.3 4.1 2.6 2.9 3.6

-0.3 -0.5 -0.4 -3.3 -0.1 -2.9 -2.0 -1.4

2.6 1.6 4.0 1.0 1.8 0.3 0.6 1.3

United States United States United States United States United States United States United States United States

Dow Jones Composite Avg. Dow Jones Industrial Avg. Dow Jones Transportation Avg. Dow Jones Utility Avg. NASDAQ-100 NASDAQ Composite S&P 500 Wilshire 5000

Euro area EURO STOXX 50

-0.3

4.6*

1.3§

0.2

-2.2

4.8

2.4

3.5

1.1

Euro area MSCI EMU Finland OMX Helsinki France CAC 40 Germany DAX Greece Athens Composite Ireland ISEQ All-Share Netherlands AEX Spain IBEX 35

-0.1 -0.4 0.2 -0.1 -0.8 0.4 0.0 -0.8

4.1 5.8 4.1 3.9 2.9 2.5 4.6 4.8

1.3§ 0.9 1.5 1.5 -0.2 1.3 2.7 0.8

-0.6 -1.0 -0.9 2.3 7.2 2.5 -3.0 4.8

-1.5 0.1 -2.0 3.7 1.6 1.2 -3.0 0.3

3.5 4.8 3.2 6.2 10.1 5.0 1.6 9.6

2.6 5.9 2.1 7.6 4.5 3.7 1.6 5.1

2.2 3.9 1.7 4.7 10.3 3.7 -1.1 8.8

1.3 5.0 0.6 6.1 4.7 2.4 -1.1 4.3

Norway OBX Sweden OMXS30 Switzerland SMI Turkey BIST 100 United Kingdom FTSE 100

-0.4 -0.3 1.0 -0.3 -0.3

4.7 5.0 4.2 4.3 5.2

1.4 1.8 0.2 11.8 1.3

8.9 4.6 -8.7 15.9 2.2

6.3 3.9 -7.3 14.3 3.6

13.6 9.6 -4.5 20.2 7.4

11.0 8.9 -3.1 18.6 8.8

12.2 7.8 -4.7 8.4 6.1

9.6 7.1 -3.3 6.8 7.5

Australia All Ordinaries Australia S&P/ASX 200 Hong Kong Hang Seng India S&P BSE SENSEX Indonesia IDX Composite Japan Nikkei 225 Malaysia FTSE Malaysia KLCI New Zealand S&P/NZX 50 Philippines PSEi Singapore FTSE Straits Times Index South Korea KOSPI Taiwan TAIEX Thailand SET

-0.1 -0.2 -0.6 -0.1 0.8 1.3 -0.5 3.0 0.5 -0.2 0.4 1.2 0.9

5.0** 5.0 4.0 1.5 2.8 2.5 3.1 4.4 4.9 2.5 5.6 3.3

2.0 2.0 3.0 9.6 2.7 0.8 1.2 2.0 5.3 0.8 0.7 0.6 0.7

4.5 4.7 8.2 12.3 3.6 -10.4 6.4 -13.8 1.6 4.1 0.8 -4.1 -5.7

4.4 4.6 6.3 11.6 7.5 -3.2 5.5 -5.0 3.7 4.8 2.1 -0.1 -1.2

9.5 9.7 12.2 13.8 6.4 -7.9 9.5 -9.4 9.0 3.3 1.5 -2.4

9.4 9.6 10.3 13.1 10.3 -0.7 8.6 -0.6 9.7 4.6 5.5 2.1

7.5 7.7 9.2 4.2 3.7 -8.7 8.3 -11.4 8.2 2.6 0.9 -3.1

7.4 7.6 7.3 3.5 7.6 -1.5 7.4 -2.6 8.9 3.9 4.9 1.4

Mauritius SEMDEX Nigeria NSE All Share South Africa FTSE/JSE All-Share

-0.7 -1.3 -0.6

3.2 5.0

3.1 12.4 4.0

11.5 29.7 12.4

12.3 21.5 11.8

14.7 17.4

15.5 16.8

11.6 13.4

12.4 12.8

Canada S&P/TSX Composite Mexico S&P/BMV IPC

-0.6 -0.4

3.7 3.4

2.2 2.8

5.8 13.4

3.8 24.7

9.5 16.8

7.5 28.1

7.3 14.0

5.3 25.3

*

Estimated gross dividend yield.

§

Euro area average inflation. Ɨ United States inflation.

**

ASX 200 dividend yield

All else equal we should expect the returns, especially the 5-year returns, to correlate closely with these relative valuations. In sum we should expect the African, Canadian and Mexican markets to yield superior performance to the American markets, with Europe and Asian markets somewhere in the middle. Broadly speaking, this is what the forecasted results show. In terms of their own currencies, Turkey, South Africa, Mexico, India, and Norway take the top five top positions in the total return ranking. Some of this high placement is bolstered by high inflation, which knocks Turkey and India down significantly once adjusted for, as in the real total return column. On the other hand, Japan, New Zealand, Switzerland, Thailand and the American markets (especially American utilities, though all U.S. markets lag in this regard) are all 39

expected to provide negative total returns over the coming five years. Since inflation is positive in all these countries, the real returns are even worse. Not even the best performing American market, the NASDAQ100, is expected to break-even by 2024 in real terms. Comparing the outlooks over ten years gives less variance. It has been quite rare for any of the markets to yield negative 10-year total returns. For example, since 1871 the S&P 500 has not had a single 10period period (out of 1,668) that yielded a negative total return. Even over-valued markets tend to offer low, though positive, long-term results. The 10-year forecasts bear this out with only four of the 43 markets estimated provide negative total returns over 10-year periods. We see some of the same countries cropping up in the top and bottom of the 10-year forecast table. The top five spots in terms of total returns go to Turkey, South Africa, Mexico, Mauritius and India (with Norway nipping at its heels). This is basically the same ranking as we forecast for the 5-year returns. Again, inflation is a large driver of returns and one that harms international investors. By adjusting for inflation and focusing on real total returns the top five markets become Mexico, South Africa, Mauritius, Norway and Singapore. Real total returns are more likely to yield losses to the investor. While the S&P 500 has never suffered a 10-year total return loss during the 148 years under consideration, nearly one-third of its 10-year real returns were in the red (512 out of 1,668). Most recently, any investment placed between February 1998 and March 2002 resulted in a real 10-year loss. So too did any wagers placed between November 1963 and July 1974, January 1936 and April 1940, October 1927 and March 1932, and a smattering of other shorter-term periods. Of course, for the investor the negative impact of inflation during these periods also compromised the returns on bonds and holding cash. Our 10-year real total return table illustrates the greater chance of real losses. The bottom five total return markets are Japan, Switzerland, New Zealand, the Netherland and a tie between France and Thailand. Again, inflation harms these returns somewhat, but not sufficiently to alter the bottom end of the table: Japan, Switzerland, New Zealand, the Netherlands still come out at the bottom, where they are joined by the NASDAQ Composite Index. One challenge in comparing these forecasts is that not all models explain their respective markets equally well. One method to describe how well a given model explains a market, or at least its past returns, is by way of its adjusted R2. This measure tells us the goodness of fit of the model or, in other words, how much of the variation of the output is explained by the variables under examination. A higher R2 signifies that a larger percentage of the model´s output is explained (up to a

40

Markets, relative valuation ranking Relative Valuation Nigeria NSE All Share Greece Athens Composite Spain IBEX 35 Mauritius SEMDEX Hong Kong Hang Seng South Africa FTSE/JSE All-Share Canada S&P/TSX Composite Malaysia FTSE Malaysia KLCI Finland OMX Helsinki Norway OBX Mexico S&P/BMV IPC World MSCI Emerging Market Euro area EURO STOXX 50 Sweden OMXS30 Turkey BIST 100 United Kingdom FTSE 100 Australia S&P/ASX 200 Singapore FTSE Straits Times Index Euro area MSCI EMU Germany DAX Australia All Ordinaries India S&P BSE SENSEX Netherlands AEX France CAC 40 Ireland ISEQ All-Share South Korea KOSPI Philippines PSEi United States NASDAQ-100 Indonesia IDX Composite World MSCI ACWI United States Dow Jones Transportation Avg. Thailand SET World MSCI World Switzerland SMI United States Dow Jones Industrial Avg. United States NASDAQ Composite United States Wilshire 5000 United States S&P 500 Taiwan TAIEX Japan Nikkei 225 United States Dow Jones Composite Avg. United States Dow Jones Utility Avg. New Zealand S&P/NZX 50

41

-1.3 -0.8 -0.8 -0.7 -0.6 -0.6 -0.6 -0.5 -0.4 -0.4 -0.4 -0.3 -0.3 -0.3 -0.3 -0.3 -0.2 -0.2 -0.1 -0.1 -0.1 -0.1 0.0 0.2 0.4 0.4 0.5 0.7 0.8 0.9 0.9 0.9 1.0 1.0 1.1 1.1 1.1 1.2 1.2 1.3 1.3 2.1 3.0

maximum of 100%). Our 5-year forecast model for Hong Kong´s Hang Seng Index only explains 29% of the past returns since 1989, while our model of the U.K.´s FTSE 100 explains 85% of its 5-year variance. Likewise, we only understand the determinants of 30% of New Zealand´s S&P/NZX 50 Index while we can explain 91% of the changes to Finland´s OMX Helsinki Index over 10-year periods. Relying on the forecasted return misses the feeling of confidence that we should sense given how robust the models are. We can assign probabilities that a certain return will be exceeded by making use of the statistical standard error of the models. For example, if the price return over a 5-year period was 0%, the index would breakeven (before dividends). The models are as certain that South Africa´s FTSE/JSE All-Share Index will break-even by 2024 as they are that New Zealand´s S&P/NZX 50 Index will not. Inflation again matters since it is easier for an index to break-even when helped along by higher inflation. This bodes well for countries like India or Turkey and creates significant headwinds for places like Greece or Switzerland. We can normalize these differences in inflation by looking at the probability that the total return will outperform a government bonds from the same country. To the extent that bonds trade with a built-in inflation premium, this probability adjusts for the benefit that inflation provides from a break-even point-of-view. It also allows the investor to gauge whether bonds or equities will likely be the better investment over the relevant period. Generally speaking, only the American, Japanese, New Zealand, Swiss and Taiwanese markets fail to offer the investor better than even odds that their equities will outperform bonds by 2024. On the other hand, we assign a greater than 70% probability that equities will beat bonds in nearly half of the markets covered. In some countries, like Australia, Canada, Norway, South Africa and the United Kingdom, it is almost a sure thing. To separate the wheat from the chaff, we can move the goal posts a little to create a challenge. By doing so we can really get a feel for what markets will out-perform in the future. Instead of just outperforming bonds, we can see which markets can be expected to outperform their government´s bonds by more than 5%. Roughly half of the markets surveyed give better than even odds at bettering government bonds by 5%. It´s expected to be all but impossible for the Japanese and New Zealand markets to achieve this goal, and highly unlikely that any of the American markets will. Still, Australian, Canadian, Mauritian, Norwegian, South African and Swedish markets are all expected to do so with probabilities in excess of 80%. The results are mostly the same for the 10-year forecasts, though 42

with some compression in the probabilities. Equity returns over 10year periods are much less volatile than over shorter time spans, making the associated probabilities across countries quite similar. Nearly onethird (30%) of the indexes are expected to almost assuredly break-even over the next decade (i.e., have a break-even probability of 99%). Only the Swiss market is expected to not be able to achieve this feat. Only 11 of the 43 markets give less than even odds. Dividends are important, especially over long periods where their power to bolster returns is compounded. The yields on alternative investments, like government bonds of similar maturity, are also important. Over the coming decade almost all markets are expected to better their country´s bonds once dividends are included. Indeed, only the Japanese, New Zealand and Swiss markets give less than even odds to beat bonds by 2029. Finally, as we did before, we can create a challenge by seeing which markets are most likely to better their bonds by more than 5% over the next decade. In many countries long-term interest rates are low by historical standards, easing this challenge somewhat. However, given the constancy of many 10-year returns we can still consider it to be a herculean task to better bonds by this amount over such a prolonged period. In a third of countries this challenge is all but impossible to meet (probabilities of less than 10%). At the other end of the spectrum, eight countries can be expected to offer this return relatively easily (probabilities of greater than 90%). At the end of the day, all these rankings lead to similar results. Over both 5- and 10-year horizons, it is often the same countries expected to out- or under-perform the average global market. Nothing is guaranteed in the investment world, but the results point to a portfolio of Australian, British, Norwegian, Mexican and South African equities outperforming a portfolio of American, Swiss, Japanese, New Zealand and Taiwanese stocks in the near and more distant future. That all said, propensity for risk, foreign-exchange exposure, local investment laws and taxes all play a role when the investor makes his choice of which market to allocate his savings to. Plus, there are many factors specific and relevant to the individual markets that the raw rankings don´t shed light on. For a more detailed understanding of the financial world ahead, read on.

43

Markets, 5-year return ranking Relative Forecast Valuation Price Returns Mexico S&P/BMV IPC South Africa FTSE/JSE All-Share Norway OBX Mauritius SEMDEX Greece Athens Composite Hong Kong Hang Seng Spain IBEX 35 Turkey BIST 100 Malaysia FTSE Malaysia KLCI Singapore FTSE Straits Times Index Sweden OMXS30 Australia S&P/ASX 200 Australia All Ordinaries Canada S&P/TSX Composite World MSCI Emerging Market United Kingdom FTSE 100 Germany DAX India S&P BSE SENSEX Finland OMX Helsinki Indonesia IDX Composite Ireland ISEQ All-Share Euro area EURO STOXX 50 South Korea KOSPI Euro area MSCI EMU France CAC 40 Taiwan TAIEX United States NASDAQ-100 World MSCI ACWI United States Dow Jones Composite Avg. United States Dow Jones Transportation Avg. United States Dow Jones Industrial Avg. World MSCI World Netherlands AEX United States Wilshire 5000 United States S&P 500 United States NASDAQ Composite Thailand SET United States Dow Jones Utility Avg. Switzerland SMI New Zealand S&P/NZX 50 Japan Nikkei 225 Nigeria NSE All Share Philippines PSEi *

Estimated gross dividend yield.

§

-0.4 -0.6 -0.4 -0.7 -0.8 -0.6 -0.8 -0.3 -0.5 -0.2 -0.3 -0.2 -0.1 -0.6 -0.3 -0.3 -0.1 -0.1 -0.4 0.8 0.4 -0.3 0.4 -0.1 0.2 1.2 0.7 0.9 1.3 0.9 1.1 1.0 0.0 1.1 1.2 1.1 0.9 2.1 1.0 3.0 1.3 -1.3 0.5

13.4 12.4 8.9 11.5 7.2 8.2 4.8 15.9 6.4 4.1 4.6 4.7 4.5 5.8 5.3 2.2 2.3 12.3 -1.0 3.6 2.5 0.2 0.8 -0.6 -0.9 -4.1 0.7 -1.1 -0.9 -0.1 -1.2 -1.8 -3.0 -1.6 -2.3 -2.1 -5.7 -5.0 -8.7 -13.8 -10.4 29.7 1.6

Euro area average inflation. Ɨ United States inflation.

44

Forecast Total Returns 16.8 17.4 13.6 14.7 10.1 12.2 9.6 20.2 9.5 9.0 9.6 9.7 9.5 9.5 8.8 7.4 6.2 13.8 4.8 6.4 5.0 4.8 3.3 3.5 3.2 1.5 2.2 2.1 2.0 1.9 1.8 1.4 1.6 0.9 0.3 -0.6 -2.4 -1.0 -4.5 -9.4 -7.9 -

**

ASX 200 dividend yield

Forecast Total Real Returns 14.0 13.4 12.2 11.6 10.3 9.2 8.8 8.4 8.3 8.2 7.8 7.7 7.5 7.3 6.5 6.1 4.7 4.2 3.9 3.7 3.7 3.5 2.6 2.2 1.7 0.9 -0.1 -0.2 -0.3 -0.4 -0.5 -0.9 -1.1 -1.4 -2.0 -2.9 -3.1 -3.3 -4.7 -8.7 -8.7 -

Markets, 10-year return ranking Relative Forecast Valuation Price Returns Mexico S&P/BMV IPC South Africa FTSE/JSE All-Share Mauritius SEMDEX Norway OBX Singapore FTSE Straits Times Index Indonesia IDX Composite Australia S&P/ASX 200 United Kingdom FTSE 100 Australia All Ordinaries Malaysia FTSE Malaysia KLCI Hong Kong Hang Seng World MSCI Emerging Market Sweden OMXS30 Turkey BIST 100 Germany DAX Canada S&P/TSX Composite Finland OMX Helsinki Taiwan TAIEX Greece Athens Composite Spain IBEX 35 United States Dow Jones Transportation Avg. South Korea KOSPI India S&P BSE SENSEX United States Dow Jones Composite Avg. Ireland ISEQ All-Share World MSCI ACWI World MSCI World United States NASDAQ-100 United States Dow Jones Industrial Avg. Thailand SET United States Wilshire 5000 Euro area MSCI EMU Euro area EURO STOXX 50 United States Dow Jones Utility Avg. United States S&P 500 France CAC 40 United States NASDAQ Composite Japan Nikkei 225 Netherlands AEX Japan Nikkei 225 New Zealand S&P/NZX 50 Switzerland SMI Nigeria NSE All Share Philippines PSEi *

Estimated gross dividend yield.

§

-0.4 -0.6 -0.7 -0.4 -0.2 0.8 -0.2 -0.3 -0.1 -0.5 -0.6 -0.3 -0.3 -0.3 -0.1 -0.6 -0.4 1.2 -0.8 -0.8 0.9 0.4 -0.1 1.3 0.4 0.9 1.0 0.7 1.1 0.9 1.1 -0.1 -0.3 2.1 1.2 0.2 1.1 1.7 0.0 1.3 3.0 1.3 -1.3 0.5

24.7 11.8 12.3 6.3 4.8 7.5 4.6 3.6 4.4 5.5 6.3 6.0 3.9 14.3 3.7 3.8 0.1 -0.1 1.6 0.3 4.3 2.1 11.6 2.0 1.2 1.3 0.9 2.6 0.9 -1.2 1.1 -1.5 -2.2 -0.7 0.3 -2.0 1.1 -5.7 -3.0 -3.2 -5.0 -3.2 21.5 3.7

Euro area average inflation. Ɨ United States inflation.

45

Forecast Total Returns 28.1 16.8 15.5 11.0 9.7 10.3 9.6 8.8 9.4 8.6 10.3 9.5 8.9 18.6 7.6 7.5 5.9 5.5 4.5 5.1 6.3 4.6 13.1 4.9 3.7 4.5 4.1 4.1 3.9 2.1 3.6 2.6 2.4 3.3 2.9 2.1 2.6 -3.2 1.6 -0.7 -0.6 -3.1 -

**

ASX 200 dividend yield

Forecast Total Real Returns 25.3 12.8 12.4 9.6 8.9 7.6 7.6 7.5 7.4 7.4 7.3 7.2 7.1 6.8 6.1 5.3 5.0 4.9 4.7 4.3 4.0 3.9 3.5 2.6 2.4 2.2 1.8 1.8 1.6 1.4 1.3 1.3 1.1 1.0 0.6 0.6 0.3 -0.7 -1.1 -1.5 -2.6 -3.3 -

Markets, 5-year return probabilities Gov´t Bond Yield

price return exceeds zero

Probability that: total return total return exceeds exceeds 5-year gov´t 5-year gov´t bond bond plus 5%

Norway OBX Australia S&P/ASX 200 South Africa FTSE/JSE All-Share Australia All Ordinaries Mauritius SEMDEX Sweden OMXS30 Canada S&P/TSX Composite Hong Kong Hang Seng United Kingdom FTSE 100 Spain IBEX 35 Mexico S&P/BMV IPC Singapore FTSE Straits Times Index Germany DAX

1.4 0.9 7.2 0.9 3.6 -0.2 1.7 1.7 0.6 -0.1 6.7 1.6 -0.5

98 93 99 92 96 81 96 87 81 75 95 80 68

99 99 99 99 96 97 99 92 99 91 89 94 91

96 88 88 87 83 82 81 77 76 74 73 70 64

World MSCI Emerging Market Greece Athens Composite India S&P BSE SENSEX Malaysia FTSE Malaysia KLCI Turkey BIST 100 Finland OMX Helsinki Ireland ISEQ All-Share

1.7* 0.6 6.5 3.2 11.3 -0.4 -0.3

82 70 93 88 76 45 61

89 75 81 88 65 75 72

64 63 61 60 57 51 51

Euro area MSCI EMU France CAC 40 United States NASDAQ-100 Netherlands AEX

-0.2§ -0.3 1.7 -0.4

45 44 53 32

77 72 52 62

42 40 33 32

Euro area EURO STOXX 50 South Korea KOSPI Indonesia IDX Composite Thailand SET United States NASDAQ Composite United States Dow Jones Industrial Avg. United States S&P 500 United States Wilshire 5000 United States Dow Jones Composite Avg.

-0.2§ 1.5 6.4 1.3 1.7 1.7 1.7 1.7 1.7

30 22 69 26 39 39 32 37 40

65 62 50 34 38 51 39 44 53

31 29 26 16 16 13 11 11 10

World MSCI ACWI United States Dow Jones Transportation Avg.

1.7* 1.7

38 49

56 52

10 9

World MSCI World Taiwan TAIEX Switzerland SMI Japan Nikkei 225 United States Dow Jones Utility Avg.

1.7* 0.6 -0.6 -0.1 1.7

32 19 2 4 6

48 19 18 10 20

8 3 2 2 1

New Zealand S&P/NZX 50 Nigeria NSE All Share Philippines PSEi

1.4 4.0

0, %

4.7 (4.1. 5.0) 0.54 93

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

9.7 99

5-Year Annual Forecast Real Total Return, %

7.7

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

4.6 (3.7, 5.3) 0.63 99

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

9.6 99

10-Year Annual Forecast Real Total Return, %

7.6

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The ASX currently offers a dividend yield of 5.0%, implying a 5-year total return of 9.7% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Australian government bonds presently allow the investor to lock in a 1.0% annual yield. We forecast that the ASX will outperform comparable bonds by December 2024 with a 99% probability. The forecast 5-year total return of 9.7% contrasts with the current inflation rate of 2.0%. We forecast that the ASX will offer a real total return (including reinvested dividends) of 7.7% annually over the next five years. 62

Over the coming 10-year period, we expect the ASX to rise by 4.6% annually. The forecasted range of 10-year annual returns is bound around this level, running from 3.7% to 5.3%. Our forecast model explains 63% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 99% probability. The S&P/ASX 200´s current dividend yield of 5.0% implies a 10year total return of 9.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10year government bonds. 10-year Australian government bonds presently allow the investor to lock in a 1.4% yield. We forecast that the ASX Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 9.6% contrasts with the current inflation rate of 2.0% to result in an estimated real total return of 7.6% annually over the next decade.

Analysis The all-time monthly closing high of the ASX was $6,846 in November 2019. In real, or inflation-adjusted terms, the market peaked in October 2007. Over the 30 years since December 1989, the index has yielded a price return of 4.8% annually, and a total return (including reinvested dividends) of 9.2%. Since inflation over this same period has averaged 2.5%, the investor has earned an annual real total return of 6.7%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the 63

S&P/ASX 200. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the ASX is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the ASX started in February 2009 at a price of $3,340 and a relative valuation of -1.4 standard deviations under the average of the preceding 30-year period, more under-valued than 93% of all previous months.

Since that low, the ASX advanced to its November 2019 high of $6,846. At this high, the market was fairly valued with a relative valuation of 0.0. Thus, the index swung by +1.4 standard deviations since its bull market advance started. The index´s current advance has gained 6.0% annually since the 2009 low, and 10.7% including reinvested dividends.

Forecast Returns The return from holding an Australian government bond is defined in advance. What is needed is an estimate of what the return on the ASX will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the ASX is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under64

valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the ASX over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 9.2% on the ASX over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the ASX as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the ASX to increase by 4.7% annually. The forecasted range of annual returns is strictly positive, running from 4.1% to 5.0%. Our forecast model explains 54% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 93% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The ASX currently offers a dividend yield of 5.0%, implying a 5-year total return of 9.7% annually. We can compare this 65

total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Australian government bonds presently allow the investor to lock in a 1.0% annual yield. We forecast that the ASX will outperform comparable bonds by December 2024 with a 99% probability. The forecast 5-year total return of 9.7% contrasts with the current inflation rate of 2.0%. If the investor made investments denominated solely in Australian dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the ASX will offer a real total return (including reinvested dividends) of 7.7% annually over the next five years. Over the coming 10-year period, we expect the ASX to rise by 4.6% annually. The forecasted range of 10-year annual returns is bound around this level, running from 3.7% to 5.3%. Our forecast model explains 63% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 99% probability.

The S&P/ASX 200´s current dividend yield of 5.0% implies a 10year total return of 9.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10year government bonds. 10-year Australian government bonds presently allow the investor to lock in a 1.4% yield. We forecast that the ASX Index will outperform comparable bonds by December 2029 66

with a 99% probability. The forecasted 10-year total return of 9.6% contrasts with the current inflation rate of 2.0% to result in an estimated real total return of 7.6% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The S&P/ASX 200´s relative valuation of -0.2 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is approximately fairly valued. As such, the ASX is the 17th most under-valued market of the group, just about the middle of the pack. We forecast that the index will yield an annual real total return of 7.7% over the coming five years, and 7.6% over the coming decade. Both returns are far superior to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the ASX ranks 12th and 6th out of 43 markets for the 5- and 10-year total real return forecasts.

S&P/ASX 200 rankings, out of 43 markets

Relative Valuation

S&P/ASX 200 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

17th

12th

6th

2nd

4th

-0.2 +0.3

7.7 3.3

7.6 4.5

88 46

97 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is 67

an 88% probability that the ASX can achieve this return by the end of 2024 and 97% by the end of 2029, ranking the index 2nd and 4th out of the 43 markets for the two probabilities. On balance, it is highly likely that the ASX will out-perform the average global market over both the coming 5- and 10-year periods.

68

Canada S&P/TSX Composite The S&P/TSX Composite Index (TSX) is the benchmark index for Canadian equities. It is currently composed of 231 large, publicly owned companies listed on the Toronto Stock Exchange. The index´s composition is rebalanced on a quarterly basis. The TSX is a floatadjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares, and covers over 70% of the available market. Royal Bank of Canada, the Canadian financial firm, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the TSX averaged 3.7% in 2019. The index is denominated in Canadian dollars.

The Bottom Line The TSX finished 2019 at $17,063. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $18,753, implying an under-valuation of -0.6 standard deviations. The last time the index was this under-valued during a rising market was in June 2016, and historically it has been more over-valued than it is today 72% of the time. Over the coming 5-year period, we expect the TSX to rise by 5.8% annually. The forecasted range of annual returns is strictly positive, running from 4.5% to 6.7%. Our forecast model explains 64% of the 69

variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 96% probability. S&P/TSX Composite Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

17,063 18,753 -0.6 3.7

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.7 1.7 1.7 2.2

5-Year Forecasts 5-Year Annual Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

5.8 (4.5, 6.7) 0.64 96

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

9.5 99

5-Year Annual Forecast Real Total Return, %

7.3

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

3.8 (1.8, 5.5) 0.74 99

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

7.5 99

10-Year Annual Forecast Real Total Return, %

5.3

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The TSX currently offers a dividend yield of 3.7%, implying a 5-year total return of 9.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Canadian government bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the TSX will outperform comparable bonds by December 2024 with a 99% probability. The forecast 5-year total return of 9.5% contrasts with the current inflation rate of 2.2%. We forecast that the TSX will offer a real total return (including reinvested dividends) of 7.3% over the next five years. Over the coming 10-year period, we expect the TSX to rise by 3.8% 70

annually. The forecasted range of 10-year annual returns is bound between 1.8% and 5.5%. Our forecast model explains 74% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The TSX´s current dividend yield of 3.7% implies a 10-year total return of 7.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Canadian government bonds presently allow the investor to lock in a 1.7% yield. We forecast that the TSX index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 7.5% contrasts with the current inflation rate of 2.2% to result in an estimated real total return of 5.3% annually over the next decade.

Analysis The all-time monthly closing high of the TSX was $17,063 in December 2019, though the highest close in inflation-adjusted terms came over a decade ago, in November 2007. Over the 30 years since December 1989, the index has yielded a price return of 5.0% annually, and a total return (including reinvested dividends) of 7.7%. Since inflation over this same period has averaged 2.0%, the investor has earned an annual real total return of 5.7%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the 71

TSX. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the TSX is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the TSX started in May 2012 from a relative valuation of -0.7 standard deviations under the average of the preceding 30-year period, more under-valued than 76% of all previous months. Since December 1974 the TSX has undergone six complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market. Each bull market since 1974 has begun from a relatively undervalued position, on average -0.7 standard deviations below its longterm mean. The median duration of these bull market phases has been 4.3 years, with a median total gain of 113%. On an annual basis, these advances have offered a median price return of 22% (ignoring the effect of dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued territory, 72

typically completing their cycle +1.5 standard deviations over-valued relative to the long-term average. The median cycle sees its relative valuation swing by +2.7 standard deviations. The index´s most significant bull market took place between October 1990 and August 2000. Over this decade, the TSX never suffered a decline that pushed its relative valuation into negative territory, an event necessary to mark the end of a long-term advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 265% over this period, or about 14% annually (in price terms, ignoring reinvested dividends). The 1990 low saw the index under-valued by -0.4 standard deviations, and the 10-year rally would not be completed until the TSX was +4.4 standard deviations over-valued. The change in relative valuation of +4.8 standard deviations is the most extreme swing on record. S&P/TSX Composite Index: Bull and Bear Market Summary Declines Start Date

End Date

Advances

Start TSX

End TSX

Nov-80 Jun-82

2,402

1,366

-43

-30

Dec-83 Jul-84

2,552

2,139

-16

-26

Jul-87

Oct-90

4,030

3,081

-24

-8

Aug-00 Sep-02

11,247

6,180

-45

-25

May-08 Feb-09

Total Annual Change, % Change, %

14,714

8,123

-45

-54

Feb-11 May-12 14,136

11,513

-19

-15

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

1.4 -33.3 -25.5 1.5 -2.7

Start End Date Date Dec-74 Nov-80

Start TSX 835

End TSX 2,402

Jun-82 Dec-83

1,366

2,552

87

52

Jul-84

Jul-87

2,139

4,030

88

24

Oct-90 Aug-00

3,081

11,247

265

14

Sep-02 May-08

6,180

14,714

138

17

Feb-09 Feb-11

8,123

14,136

74

32

May-12 Dec-19

11,513

17,063

48

5

4.3 113.2 21.5 -0.7 2.7

Total Annual Change, % Change, % 188 20

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

While the 1990-2000 bull market was the largest in absolute terms, it was also the longest in duration. The swiftest bull market was the year-and-a-half-period between June 1982 and December 1983. Starting from an under-valuation of -1.9 standard deviations, the TSX rallied 87% to finish its cycle +0.5 standard deviations over-valued. The annual gain of 52% (again, ignoring reinvested dividends) is the sharpest annual gain of all six bull markets on record. The most significant bear market was the 45% decline in the index between May 2008 and February 2009. During this 8-month period, the TSX lost value at an annualized rate of -54%. It also lost nearly three standard deviations of valuation, starting at +2.0 standard deviations over-valued and finishing -0.7 under-valued. While 2008-09 is well-known as the most significant bear market on record, the average decline over the six bear markets has been 73

somewhat more subdued. On balance, the median depreciating phase of the TSX´s valuation cycle lasted a little about a year-and-a-half, and shaved 33% off the value of the index, resulting in a 26% annual loss. These bear markets have started from a median position of +1.5 standard deviations above the long-term average and have not ended until the index was under-valued by -0.7, for a median swing of -2.7 standard deviations. Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent December 2019 high of $17,063 the index had gained 48% over the seven preceding years. Starting from the May 2012 low valuation of -0.7 standard deviations the index has posted 5% annual gains and is still under-valued at -0.6 standard deviations, implying a valuation swing of only +0.1 standard deviations. In terms of duration and extent the present bull market has been quite long but shallow. Its 48% total gain pales compared to the bull market average of 113%. The 5% annual gain is also weak by historical standards. The current advance started from a moderately under-valued market (-0.7), and its current under-valuation of -0.6 standard deviations under the long-term average has never coincided with any previous major market peaks. The valuation swing of only +0.1 standard deviations is nowhere close to the advance we should expect in a bull market, and on balance it is likely that the TSX still has further room to climb in its current bull-market phase.

Forecast Returns The return from holding a Canadian government bond is defined in advance. What is needed is an estimate of what the return on the TSX will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the TSX is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the TSX over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 7.7% on the TSX over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor 74

also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the TSX as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the TSX to rise by 5.8% annually. The forecasted range of annual returns is strictly positive, running from 4.5% to 6.7%. Our forecast model explains 64% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 96% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The TSX currently offers a dividend yield of 3.7%, implying a 5-year total return of 9.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Canadian government bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the TSX will outperform comparable bonds by December 2024 with a 99% probability.

The forecast 5-year total return of 9.5% contrasts with the current inflation rate of 2.2%. If the investor made investments denominated solely in Canadian dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between 75

equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the TSX will offer a real total return (including reinvested dividends) of 7.3% over the next five years. Over the coming 10-year period, we expect the TSX to rise by 3.8% annually. The forecasted range of 10-year annual returns is bound between 1.8% and 5.5%. Our forecast model explains 74% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The TSX´s current dividend yield of 3.7% implies a 10-year total return of 7.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Canadian government bonds presently allow the investor to lock in a 1.7% yield. We forecast that the TSX index will outperform comparable bonds by December 2029 with a 99% probability.

The forecasted 10-year total return of 7.5% contrasts with the current inflation rate of 2.2% to result in an estimated real total return of 5.3% annually over the next decade.

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Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The TSX´s relative valuation of -0.6 standard deviations below its long-term mean is significantly less than the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the TSX is the 5th most under-valued market of the group. We forecast that the index will yield an annual real total return of 7.3% over the coming five years, and 5.3% over the coming decade. Both returns are far above the averages for the 43 other countries (3.3% and 4.5%). Consequently, the TSX ranks 14th and 16th out of 43 markets for both total real return forecasts.

S&P/TSX Composite rankings, out of 43 markets

Relative Valuation th

5 S&P/TSX Comp. 43 Country Avg.

-0.6 +0.3

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

th

14

7.3 3.3

10-Year

th

16

5.3 4.5

5-Year

th

7

81 46

10-Year

13th 74 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the explanatory power of our forecast models we estimate that there is an 81% probability that the TSX can achieve this return by the end of 2024 and 74% by the end of 2029, ranking the index 7th and 13th out of the 43 markets for both probabilities. On balance, it is highly likely that the TSX will out-perform the average global market over both the coming 5- and 10-year periods.

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78

Euro Area EURO STOXX 50 The EURO STOXX 50 Index is the benchmark blue chip stock market index for the euro area and is composed of the 50 largest companies based therein. The index´s composition is rebalanced on an annual basis. The EURO STOXX 50 is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. The index captures 60% of the total market capitalization of companies listed in euro area markets. SAP, the German technology company, is currently the largest component of the index and technology is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the EURO STOXX 50 averaged 4.6% in 2019. The index is denominated in euros.

The Bottom Line The EURO STOXX 50 finished 2019 at €3,745. Based on historical valuations dating to December 1989 (360 months), we estimate the fairvalue price to be €4,125, implying an under-valuation of -0.3 standard deviations. The last time the index had this valuation during a rising market was in December 2014, and historically it has been more overvalued than it is today 61% of the time. Over the coming 5-year period, we expect the EURO STOXX 50 to increase by 0.2% annually. The forecasted range of annual returns is bound between -5.8% to 4.7%. Our forecast model explains 73% of 79

the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 52% probability.

EURO STOXX 50 Current Price Fair-Value Price Relative Valuation, σ

3,745 4,125 -0.3 4.6

Dividend Yield, %§ Government Bond Yields*, % 1-Year 5-Year 10-Year Inflation

-0.6 -0.5 -0.2 1.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % 0.2 5-Year Forecast Range, % (-5.8, 4.7) 0.73 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 52 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

4.8 91

5-Year Annual Forecast Real Total Return, %

3.5

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

-2.2 (-6.6, 1.8) 0.90 14

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

2.4 90

10-Year Annual Forecast Real Total Return, %

1.1

§

Estimated gross dividend yield.

*

German government bond yields. Euro area average inflation.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The EURO STOXX 50 currently offers a dividend yield of 4.6%, implying a 5-year total return of 4.8% annually. We can compare this total return to that which the investor could earn on an 80

alternative investment, e.g., 5-year government bonds. 5-year German government bonds presently allow the investor to lock in a -0.5% annual yield. We forecast that the EURO STOXX 50 will outperform comparable bonds by December 2024 with a 91% probability. The forecast 5-year total return of 4.8% contrasts with the current euro area inflation rate of 1.3%. We forecast that the EURO STOXX 50 will offer a real total return (including reinvested dividends) of 3.5% over the next five years. Over the coming 10-year period, we expect the EURO STOXX 50 to fall by -2.2% annually. The forecasted range of 10-year annual returns is bound between -6.6% and 1.8%. Our forecast model explains 90% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 14% probability. The EURO STOXX 50´s current dividend yield of 4.6% implies a 10-year total return of 2.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10year government bonds. 10-year German government bonds presently allow the investor to lock in a -0.2% yield. We forecast that the EURO STOXX 50 Index will outperform comparable bonds by December 2029 with a 90% probability. The forecasted 10-year total return of 2.4% contrasts with the current euro area inflation rate of 1.3% to result in an estimated real total return of 1.1% annually over the next decade.

Analysis The all-time monthly closing high of the EURO STOXX 50 was €5,317 in March 2000, the same month the index peaked in real, or inflationadjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 4.3% annually, and a total return (including reinvested dividends) of 7.2%. Since inflation over this same period has averaged 2.0% annually in the euro area, the investor has earned an annual real total return of 5.2% Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the EURO STOXX 50. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index.

81

Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the EURO STOXX 50 is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The current bull market phase of the EURO STOXX 50 started in February 2009 at a price of €1,976 and a relative valuation of -1.0 standard deviations under the average of the preceding 30-year period, more under-valued than 84% of all previous months. Since that low, the EURO STOXX 50 has advanced to its March 2015 high of €3,697 At this high, the market was still under-valued with 82

a relative valuation of -0.1. Thus, the index swung by +0.9 standard deviations since its bull market advance started. From the 2009 low until today the index has gained 6.1% annually, and 9.3% including reinvested dividends.

Forecast Returns The return from holding a German government bond is defined in advance. What is needed is an estimate of what the return on the EURO STOXX 50 will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the EURO STOXX 50 is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the EURO STOXX 50 over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 7.2% on the EURO STOXX 50 over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the EURO STOXX 50 as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the EURO STOXX 50 to increase by 0.2% annually. The forecasted range of annual returns is bound between -5.8% to 4.7%. Our forecast model explains 73% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 52% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The EURO STOXX 50 currently offers a dividend yield of 4.6%, implying a 5-year total return of 4.8% annually. We can compare this total return to that which the investor could earn on an 83

alternative investment, e.g., 5-year government bonds. 5-year German government bonds presently allow the investor to lock in a -0.5% annual yield. We forecast that the EURO STOXX 50 will outperform comparable bonds by December 2024 with a 91% probability.

The forecast 5-year total return of 4.8% contrasts with the current euro area inflation rate of 1.3%. If the investor made investments denominated solely in euros, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the EURO STOXX 50 will offer a real total return (including reinvested dividends) of 3.5% over the next five years. Over the coming 10-year period, we expect the EURO STOXX 50 to fall by -2.2% annually. The forecasted range of 10-year annual returns is bound between -6.6% and 1.8%. Our forecast model explains 90% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 14% probability. The EURO STOXX 50´s current dividend yield of 4.6% implies a 10-year total return of 2.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10year government bonds. 10-year German government bonds presently allow the investor to lock in a -0.2% yield. We forecast that the EURO STOXX 50 Index will outperform comparable bonds by December 84

2029 with a 90% probability.

The forecasted 10-year total return of 2.4% contrasts with the current euro area inflation rate of 1.3% to result in an estimated real total return of 1.1% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The EURO STOXX 50´s relative valuation of -0.3 standard deviations below its long-term mean is less than the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is slightly under-valued. As such, the EURO STOXX 50 is the 12th most under-valued market of the group. We forecast that the index will yield an annual real total return of 3.5% over the coming five years, and 1.1% over the coming decade. This 5-year return is about on par with the average for the 43 other countries, but slightly lower when extended out to ten years (the 4385

country average total real returns are forecast to be 3.3% and 4.5%). Consequently, the EURO STOXX 50 ranks 22nd and 33rd out of 43 markets for the 5- and 10-year total real return forecasts, in the bottom half of the pack.

EURO STOXX 50 rankings, out of 43 markets

Relative Valuation

EURO STOXX 50 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

12th

22nd

33rd

25th

34th

-0.3 +0.3

3.5 3.3

1.1 4.5

31 46

3 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is a 31% probability that the EURO STOXX 50 can achieve this return by the end of 2024 and 3% by the end of 2029, ranking the index 25th and 34th out of the 43 markets for the two probabilities, again comfortably in the bottom half of markets. On balance, it is likely that the EURO STOXX 50 will provide returns slightly lower than those of the average global market over both the coming 5- and 10-year periods.

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Euro Area MSCI EMU Index The MSCI European Economic and Monetary Union Index (MSCI EMU) captures the large and mid-cap companies located in the developed countries of the euro area and is currently composed of 244 companies based therein. The MSCI EMU is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. The index captures 85% of the total market capitalization of companies listed in euro area markets. SAP, the German technology company, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the MSCI EMU averaged 4.1% in 2019. The index is denominated in euros.

The Bottom Line The MSCI EMU finished 2019 at €185. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be €180, implying an under-valuation of -0.1 standard deviations. (The index is under-valued notwithstanding the fact it is priced higher than its fair-value level since the average situation over the preceding 30 years has been an even larger over-valuation.) The last time the index had this valuation during a rising market was in February 2017, and historically it has been more over-valued than it is today 52% of the time. 87

MSCI European Monetary Union Index (MSCI EMU) Current Price* Fair-Value Price Relative Valuation, σ Dividend Yield, %

185 180 -0.1 4.1

Government Bond Yields§, % 1-Year 5-Year 10-Year Inflation

-0.6 -0.5 -0.2 1.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % -0.6 5-Year Forecast Range, % (-4.9, 2.4) 0.69 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 45 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

3.5 77

5-Year Annual Forecast Real Total Return, %

2.2

10-Year Forecasts 10-Year Annual Forecast Price Return, % -1.5 10-Year Forecast Range, % (-4.6, 1.2) 0.87 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 22 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

2.6 92

10-Year Annual Forecast Real Total Return, %

1.3

*

Rebased in euros

§

German government bond yields, Euro area average inflation rate

Over the coming 5-year period, we expect the MSCI EMU to decrease by -0.6% annually. The forecasted range of annual returns is bound between -4.9% and 2.4%. Our forecast model explains 69% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 45% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The MSCI EMU currently offers a dividend yield of 4.1%, implying a 5-year total return of 3.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year German government bonds presently allow the investor to lock in a -0.5% annual yield. We forecast that the MSCI EMU will outperform 88

comparable bonds by December 2024 with a 77% probability. The forecast 5-year total return of 3.5% contrasts with the current euro area inflation rate of 1.3%. We forecast that the MSCI EMU will offer a real total return (including reinvested dividends) of 2.2% over the next five years. Over the coming 10-year period, we expect the MSCI EMU to fall by -1.5% annually. The forecasted range of 10-year annual returns is bound between –4.6% and 1.2%. Our forecast model explains 87% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 22% probability. The MSCI EMU´s current dividend yield of 4.1% implies a 10-year total return of 2.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year German government bonds presently allow the investor to lock in a -0.2% yield. We forecast that the MSCI EMU Index will outperform comparable bonds by December 2029 with a 92% probability. The forecasted 10-year total return of 2.6% contrasts with the current euro area inflation rate of 1.3% to result in an estimated real total return of 1.3% annually over the next decade.

Analysis The all-time monthly closing high of the MSCI EMU was €205 in March 2000, the same month the index peaked in real, or inflationadjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 4.0% annually, and a total return (including reinvested dividends) of 7.1%. Since inflation over this same period has averaged 2.0% annually in the euro area, the investor has earned an annual real total return of 5.1% Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the MSCI EMU. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the MSCI EMU is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

89

The current bull market phase of the MSCI EMU started in February 2009 at a price of €84 and a relative valuation of -1.3 standard deviations under the average of the preceding 30-year period, more under-valued than 90% of all previous months.

Since that low, the MSCI EMU has advanced to its December 2019 high of €185. At this high, the market was still under-valued with a relative valuation of -0.1. Thus, the index swung by +1.2 standard deviations since its bull market advance started. From the 2009 low until today the index has gained 7.5% annually, and 11.3% including reinvested dividends

90

Forecast Returns The return from holding a German government bond is defined in advance. What is needed is an estimate of what the return on the MSCI EMU will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the MSCI EMU is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the MSCI EMU over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 7.1% on the MSCI EMU over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the MSCI EMU as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the MSCI EMU to decrease by -0.6% annually. The forecasted range of annual returns is bound between -4.9% and 2.4%. Our forecast model explains 69% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 45% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The MSCI EMU currently offers a dividend yield of 4.1%, implying a 5-year total return of 3.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year German government bonds presently allow the investor to lock in a -0.5% annual yield. We forecast that the MSCI EMU will outperform comparable bonds by December 2024 with a 77% probability. The forecast 5-year total return of 3.5% contrasts with the current euro area inflation rate of 1.3%. If the investor made investments denominated solely in euros, this rate of inflation would not affect his 91

investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the MSCI EMU will offer a real total return (including reinvested dividends) of 2.2% over the next five years.

Over the coming 10-year period, we expect the MSCI EMU to fall by -1.5% annually. The forecasted range of 10-year annual returns is bound between –4.6% and 1.2%. Our forecast model explains 87% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 22% probability. The MSCI EMU´s current dividend yield of 4.1% implies a 10-year total return of 2.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year German government bonds presently allow the investor to lock in a -0.2% yield. We forecast that the MSCI EMU Index will outperform comparable bonds by December 2029 with a 92% probability. The forecasted 10-year total return of 2.6% contrasts with the current euro area inflation rate of 1.3% to result in an estimated real total return of 1.3% annually over the next decade.

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Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The MSCI EMU´s relative valuation of -0.1 standard deviations below its long-term mean is less than the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is approximately fairly valued. As such, the MSCI EMU is the 19th most under-valued market of the group. We forecast that the index will yield an annual real total return of 2.2% over the coming five years, and 1.3% over the coming decade, both lower than the 43-country average total real returns (3.3% and 4.5%). Consequently, the MSCI EMU ranks 24th and 31st out of 43 markets for the 5- and 10-year total real return forecasts, firmly in the bottom half of the pack. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is 93

a 42% probability that the MSCI EMU can achieve this return by the end of 2024 and 13% by the end of 2029, ranking the index 21st and 26th out of the 43 markets for the two probabilities, again comfortably in the bottom half of markets.

MSCI EMU Index rankings, out of 43 markets

Relative Valuation

MSCI EMU 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

19th

24th

31st

21st

26th

-0.1 +0.3

2.2 3.3

1.3 4.5

42 46

13 46

On balance, it is likely that the MSCI EMU will provide returns slightly lower than those of the average global market over both the coming 5- and 10-year periods.

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Finland OMX Helsinki All-Share The OMXH All-Share Index (OMXH) is the broadest stock market index of Finland. It is composed of all shares listed on the Nasdaq Helsinki exchange (formerly the Helsingin Pörssi, or Helsinki Stock Exchange). The OMXH is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Nordea Bank, the Finnish financial company, is currently the largest component of the index and industrials are the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the OMXH averaged 5.8% in 2019. The index is denominated in euros.

The Bottom Line The OMXH finished 2019 at €9,874. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be €11,885, implying an under-valuation of -0.4 standard deviations. The market has had this valuation more or less continually since November 2014, and before that the last time the index had this valuation during a rising market was in June 2010. Historically the index has been more over-valued than it is today 67% of the time. Over the coming 5-year period, we expect the OMXH to fall by 1.0% annually. The forecasted range of annual returns is quite wide, running from -9.1% to 6.0%. Our forecast model explains 76% of the variation in the index´s 5-year returns since December 1989. 95

Consequently, we forecast that the index will break-even by December 2024 with only a 45% probability. OMX Helsinki Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

9,874 11,885 -0.4 5.8

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

-0.6 -0.4 0.0 0.9

5-Year Forecasts 5-Year Annual Forecast Price Return, % -1.0 5-Year Forecast Range, % (-9.1, 6.0) 0.76 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 45 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

4.8 75

5-Year Annual Forecast Real Total Return, %

3.9

10-Year Forecasts 10-Year Annual Forecast Price Return, % 0.1 10-Year Forecast Range, % (-3.7, 3.9) 0.91 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 51 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

5.9 97

10-Year Annual Forecast Real Total Return, %

5.0

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The OMXH currently offers a dividend yield of 5.8%, implying a 5-year total return of 4.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Finnish government bonds presently allow the investor to lock in a -0.4% annual yield. We forecast that the OMXH will outperform comparable bonds by December 2024 with a 75% probability. The forecast 5-year total return of 4.8% contrasts with the current inflation rate of 0.9%. We forecast that the OMXH will offer a real total return (including reinvested dividends) of 3.9% over the next five years. 96

Over the coming 10-year period, we expect the OMXH to rise by 0.1% annually. The forecasted range of 10-year annual returns is also quite wide, running from -3.7% to 3.9%. Our forecast model explains 91% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 51% probability. The OMXH´s current dividend yield of 5.8% implies a 10-year total return of 5.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Finnish government bonds presently allow the investor to lock in a 0.0% yield. We forecast that the OMXH Index will outperform comparable bonds by December 2029 with a 97% probability. The forecasted 10-year total return of 5.0% contrasts with the current inflation rate of 0.9% to result in an estimated real total return of 5.0% annually over the next decade.

Analysis The all-time monthly closing high of the OMXH was €17,734 in April 2000, which is also the date of its real, or inflation-adjusted peak. Over the 30 years since December 1989, the index has yielded a price return of 6.4% annually.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the OMXH. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the 97

index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the OMXH is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the OMXH started in February 2009 at a price of €4,395 and a relative valuation of -0.7 standard deviations under the average of the preceding 30-year period, more under-valued than 75% of all previous months.

Since that low, the OMXH advanced to its August 2018 high of €10,301. At this high, the market was still slightly under-valued with a relative valuation of -0.3. Thus, the index swung by +0.4 standard deviations since its bull market advance started. The index´s current advance has gained 7.8% annually since the 2009 low, and 12.7% including reinvested dividends.

Forecast Returns The return from holding a Finnish government bond is defined in advance. What is needed is an estimate of what the return on the OMXH will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the OMXH is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during 98

periods of over-valuation. We have developed two models to forecast the return of the OMXH over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 6.4% on the OMXH over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the OMXH as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the OMXH to fall by 1.0% annually. The forecasted range of annual returns is quite wide, running from -9.1% to 6.0%. Our forecast model explains 76% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with only a 45% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The OMXH currently offers a dividend yield of 5.8%, implying a 5-year total return of 4.8% annually. We can compare this total return to that which the investor could earn on an alternative 99

investment, e.g., 5-year government bonds. 5-year Finnish government bonds presently allow the investor to lock in a -0.4% annual yield. We forecast that the OMXH will outperform comparable bonds by December 2024 with a 75% probability. The forecast 5-year total return of 4.8% contrasts with the current inflation rate of 0.9%. If the investor made investments denominated solely in euros, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the OMXH will offer a real total return (including reinvested dividends) of 3.9% over the next five years. Over the coming 10-year period, we expect the OMXH to rise by 0.1% annually. The forecasted range of 10-year annual returns is also quite wide, running from -3.7% to 3.9%. Our forecast model explains 91% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 51% probability.

The OMXH´s current dividend yield of 5.8% implies a 10-year total return of 5.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Finnish government bonds presently allow the investor to lock in a 0.0% yield. We forecast that the OMXH Index will outperform comparable bonds by December 2029 with a 97% probability. 100

The forecasted 10-year total return of 5.0% contrasts with the current inflation rate of 0.9% to result in an estimated real total return of 5.0% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The OMXH´s relative valuation of -0.4 standard deviations below its long-term mean is significantly less than the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is moderately under-valued. As such, the OMXH is the 9th most under-valued market of the group. We forecast that the index will yield an annual real total return of 3.9% over the coming five years, and 5.0% over the coming decade. Both returns are on par with the averages for the 43 other countries (3.3% and 4.5%). Consequently, the OMXH ranks 19th and 17th out of 43 markets for the 5- and 10-year total real return forecasts.

OMX Helsinki rankings, out of 43 markets

Relative Valuation

OMX Helsinki 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

9th

19th

17th

19th

15th

-0.4 +0.3

3.9 3.3

5.0 4.5

51 46

61 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is a 51% probability that the OMXH can achieve this return by the end of 2024 and 61% by the end of 2029, ranking the index 19th and 15th 101

out of the 43 markets for the two probabilities. On balance, it is likely that the OMXH will provide returns comparable to the average global market over both the coming 5- and 10-year periods.

102

France CAC 40 The Cotation Assistée en Continu quarante (CAC 40) is the most widely used benchmark index for the French stock market. It is composed of the 40 largest and most liquid shared listed on the Euronext Paris exchange (formerly known as the Paris Bourse). The index´s composition is rebalanced on a quarterly basis. The CAC 40 is a floatadjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares, and covers over 80% of the available market. LVMH Moët Hennessy – Louis Vuitton SE, the French luxury goods manufacturer, is currently the largest component of the index and consumer goods is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the CAC 40 averaged 4.1% in 2019. The index is denominated in euros.

The Bottom Line The CAC 40 finished 2019 at €5,978. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be €5,397, implying an over-valuation of +0.2 standard deviations. The last time the index was this over-valued during a rising market was in May 2005, and historically it has been more over-valued than it is today only 42% of the time. Over the coming 5-year period, we expect the CAC 40 to fall by 0.9% annually. The forecasted range of annual returns is bound 103

between -3.4% and 0.4%. Our forecast model explains 55% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with only a 44% probability. CAC 40 Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

5,978 5,397 +0.2 4.1

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

-0.6 -0.4 0.1 1.5

5-Year Forecasts 5-Year Average Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

-0.9 (-3.4, 0.4) 0.55 44

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

3.2 72

5-Year Annual Forecast Real Total Return, %

1.7

10-Year Forecasts 10-Year Average Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

-2.0 (-4.8, 0.6) 0.88 14

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

2.1 86

10-Year Annual Forecast Real Total Return, %

0.6

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The CAC 40 currently offers a dividend yield of 4.1%, implying a 5-year total return of 3.2% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year French government bonds presently allow the investor to lock in a -0.4% annual yield. We forecast that the CAC 40 will outperform comparable bonds by December 2024 with a 72% probability. The forecast 5-year total return of 3.2% contrasts with the current inflation rate of 1.5%. We forecast that the CAC 40 will offer a real total return (including reinvested dividends) of 1.7% over the next five 104

years. Over the coming 10-year period, we expect the CAC 40 to fall by 2.0% annually. The forecasted range of 10-year annual returns is bound between -4.8% and 0.6%. Our forecast model explains 88% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with only a 14% probability. The CAC 40´s current dividend yield of 4.1% implies a 10-year total return of 2.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year French government bonds presently allow the investor to lock in a 0.1% yield. We forecast that the CAC 40 index will outperform comparable bonds by December 2029 with an 86% probability. The forecasted 10-year total return of 2.1% contrasts with the current inflation rate of 1.5% to result in an estimated real total return of 0.6% annually over the next decade.

Analysis The all-time monthly closing high of the CAC 40 was €6,625 in December 2019. This high also represents the highest monthly close in inflation-adjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 3.7% annually, and a total return (including reinvested dividends) of 7.0%. Since inflation over this same period has averaged 1.5%, the investor has earned an annual real total return of 5.5%.

Using historical price, dividend, macroeconomic and financial data 105

dating to December 1989, we can compute the relative valuation of the CAC 40. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the CAC 40 is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the CAC 40 started in February 2009 from a relative valuation of -1.2 standard deviations under the average of the preceding 30-year period, more under-valued than 89% of all previous months. Since August 2000 the CAC 40 has undergone two-and-a-half complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market. Each bull market since 2000 has begun from a relatively undervalued position, on average -0.4 standard deviations below its longterm mean. The median duration of these bull market phases has been just over five years, with a median total gain of 108%. On an annual basis, these advances have offered a median price return of 16% (ignoring the effect of dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued 106

territory, typically completing their cycle +1.0 standard deviations overvalued relative to the long-term average. The median cycle sees its relative valuation swing by +1.5 standard deviations. CAC 40 Index: Bull and Bear Market Summary Declines Start End Start Date Date CAC 40 Aug-00 Mar-03 6,625 May-07 May-12 Jul-18

Dec-18

Advances

End Total Annual CAC 40 Change, % Change, % 2,618 -60 -30

6,104

3,017

-51

-13

5,511

4,730

-14

-31

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

Start Date

End Date

Start CAC 40

End Total Annual CAC 40 Change, % Change, %

Mar-03 May-07

2,618

6,104

133

23

May-12 Jul-18

3,017

5,511

83

10

Dec-18 Dec-19

4,730

5,978

26

26

2.6 -50.6 -30.2 1.0 -2.6

5.2 107.9 16.4 -0.4 1.5

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

The index´s most significant bull market took place between March 2003 and May 2007. During this 4-year period, the CAC 40 never suffered a decline that pushed its relative valuation into negative territory, an event necessary to mark the end of a long-term advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 133% over this period, or about 23% annually (in price terms, ignoring reinvested dividends). The 2003 low saw the index under-valued by -0.3 standard deviations, and the 4-year rally would not be completed until the CAC 40 was +1.0 standard deviations over-valued. The change in relative valuation of +1.3 standard deviations is one of the most extreme swings on record. The most significant bear market was the 60% decline in the index between August 2000 and March 2003. During this two-and-a-half-year period, the CAC 40 lost 30% of its value annually. It also lost nearly four standard deviations of valuation, starting at +3.6 standard deviations over-valued and finishing -0.3 under-valued. While 2000-03 is well-known as the most significant bear market on record, the average decline over the three bear markets has been somewhat more subdued. On balance, the median depreciating phase of the CAC 40´s valuation cycle lasted a little less than three years and shaved -51% off the value of the index, resulting in a -30% annual loss. These bear markets have started from a median valuation of +1.0 standard deviations above the long-term average and have not ended until the index was under-valued by -0.4, for a median swing of -2.6 standard deviations. Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent December 2019 high of €5,978 the index had gained 26% over the preceding year when its bull market started. Starting from the December 2018 low valuation of -0.4 standard 107

deviations the index is now +0.2 standard deviations over-valued, implying a valuation swing of +0.6 standard deviations. In terms of duration the present bull market has been quite short, and its 26% total gain is far below the index´s historical appreciations (107%). The 26% annual gain is quite strong by historical standards. The current advance started from a moderately under-valued market (0.4), and its current over-valuation of +0.2 standard deviations over the long-term average is somewhat low relative to the median valuation at the top of bull markets. The increase in valuation of +0.6 standard deviations is also low by historical precedent, and on balance it is likely that the CAC 40 still has some room to rally in its current bull-market phase.

Forecast Returns The return from holding a government bond is defined in advance. What is needed is an estimate of what the return on the CAC 40 will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the CAC 40 is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of overvaluation. We have developed two models to forecast the return of the CAC 40 over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 7.0% on the CAC 40 over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the CAC 40 as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the CAC 40 to fall by 0.9% annually. The forecasted range of annual returns is bound between -3.4% and 0.4%. Our forecast model explains 55% of the variation in the index´s 5-year returns since December 1989. 108

Consequently, we forecast that the index will break-even by December 2024 with only a 44% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The CAC 40 currently offers a dividend yield of 4.1%, implying a 5-year total return of 3.2% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year French government bonds presently allow the investor to lock in a -0.4% annual yield. We forecast that the CAC 40 will outperform comparable bonds by December 2024 with a 72% probability.

The forecast 5-year total return of 3.2% contrasts with the current inflation rate of 1.5%. If the investor made investments denominated solely in euros, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the CAC 40 will offer a real total return (including reinvested dividends) of 1.7% over the next five years. Over the coming 10-year period, we expect the CAC 40 to fall by 2.0% annually. The forecasted range of 10-year annual returns is bound between -4.8% and 0.6%. Our forecast model explains 88% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with only a 14% probability. 109

The CAC 40´s current dividend yield of 4.1% implies a 10-year total return of 2.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year French government bonds presently allow the investor to lock in a 0.1% yield. We forecast that the CAC 40 index will outperform comparable bonds by December 2029 with an 86% probability.

The forecasted 10-year total return of 2.1% contrasts with the current inflation rate of 1.5% to result in an estimated real total return of 0.6% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The CAC 40´s relative valuation of +0.2 standard deviations above its long-term mean is on par with the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the CAC 40 is the 24th most under-valued market of the group, right in the middle of the pack. 110

We forecast that the index will yield an annual real total return of 1.7% over the coming five years, and 0.6% over the coming decade. Both returns are below the averages for the 43 other countries (3.3% and 4.5%). Consequently, the CAC 40 ranks 25th and 35th out of 43 markets for both total real return forecasts.

CAC 40 rankings, out of 43 markets

Relative Valuation th

24 CAC 40 43 Country Avg.

+0.2 +0.3

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

th

25

1.7 3.3

10-Year

th

35

0.6 4.5

5-Year

10-Year

nd

32nd

22

40 46

5 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the explanatory power of our forecast models we estimate that there is a 40% probability that the CAC 40 can achieve this return by the end of 2024 and only 5% by the end of 2029, ranking the index 22nd and 32nd out of the 43 markets for both probabilities. On balance, it is highly likely that the CAC 40 will under-perform the average global market over both the coming 5- and 10-year periods.

111

112

Germany DAX The Deutscher Aktienindex (German stock index, or DAX) is the benchmark blue chip stock market index of Germany. It is composed of the 30 largest and most liquid companies listed on the Frankfurter Wertpapierbörse (Frankfurt Stock Exchange) by float-adjusted market value. The index´s composition is rebalanced on a quarterly basis. The DAX is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. SAP, the German technology company, is currently the largest component of the index and financials is the largest industry. Unlike most indexes, the DAX is commonly quoted in its total return form, including the effects of reinvested dividends in its calculation. Unless otherwise noted, we use the values of the DAX price index in the following report to make the analysis consistent with other markets. The dividend yield of the index averaged 3.9% in 2019. The index is denominated in euros.

The Bottom Line The DAX finished 2019 at €13,249. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be €13,242, implying an under-valuation of -0.1 standard deviations. The last time the index had this valuation during a rising market was in October 2014, and historically it has been more over-valued than it is today 55% of the time. Over the coming 5-year period, we expect the DAX price index to 113

increase by 2.3% annually. The forecasted range of annual returns is strictly positive, running from 0.9% to 3.4%. Our forecast model explains 73% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with a 68% probability. DAX Current Price* Fair-Value Price Relative Valuation, σ Dividend Yield, %

13,249 13,242 -0.1 3.9

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

-0.6 -0.5 -0.2 1.5

5-Year Forecasts 5-Year Average Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

2.3 (0.9, 3.4) 0.73 68

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

6.2 91

5-Year Annual Forecast Real Total Return, %

4.7

10-Year Forecasts 10-Year Average Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

3.7 (3.0, 4.1) 0.74 95

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

7.6 99

10-Year Annual Forecast Real Total Return, %

6.1

* Total return index

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The DAX currently offers a dividend yield of 3.9%, implying a 5-year total return of 6.2% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year German government bonds presently allow the investor to lock in a -0.5% annual yield. We forecast that the DAX will outperform comparable bonds by December 2024 with a 91% probability. 114

The forecast 5-year total return of 6.2% contrasts with the current inflation rate of 1.5%. We forecast that the DAX will offer a real total return (including reinvested dividends) of 4.7% over the next five years. Over the coming 10-year period, we expect the DAX price index to rise by 3.7% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from 3.0% to 4.1%. Our forecast model explains 74% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 95% probability. The DAX´s current dividend yield of 3.9% implies a 10-year total return of 7.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year German government bonds presently allow the investor to lock in a -0.2% yield. We forecast that the DAX Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 7.6% contrasts with the current inflation rate of 1.5% to result in an estimated real total return of 6.1% annually over the next decade.

Analysis The all-time monthly closing high of the DAX price index (not the normally quoted total return index) was €6,270 in October 2017. In real, or inflation-adjusted terms, the market peaked in February 2000.

Over the 30 years since December 1989, the index has yielded a price return of 4.7% annually, and a total return (including reinvested dividends) of 6.9%. Since inflation over this same period has averaged 115

1.8%, the investor has earned an annual real total return of 5.1% Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the DAX. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index.

Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the DAX is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the DAX started in February 2009 at a price of €2,419 and a relative valuation of -1.5 standard deviations under the average of the preceding 30-year period, more under-valued than 93% of all previous months. Since that low, the DAX advanced to its October 2017 high of €6,270 At this high, the market was slightly over-valued with a relative valuation of +0.3. Thus, the index swung +1.8 standard deviations over that portion of its bull market advance. From this low until today the index has gained 8.6% annually, and 12.1% including reinvested dividends.

Forecast Returns The return from holding a German government bond is defined in 116

advance. What is needed is an estimate of what the return on the DAX will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the DAX is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the DAX over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 6.9% on the DAX over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the DAX as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the DAX price index to increase by 2.3% annually. The forecasted range of annual returns is strictly positive, running from 0.9% to 3.4%. Our forecast model explains 73% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with a 68% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The DAX currently offers a dividend yield of 3.9%, implying a 5-year total return of 6.2% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year German government bonds presently allow the investor to lock in a -0.5% annual yield. We forecast that the DAX will outperform comparable bonds by December 2024 with a 91% probability. The forecast 5-year total return of 6.2% contrasts with the current inflation rate of 1.5%. If the investor made investments denominated solely in euros, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking 117

advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the DAX will offer a real total return (including reinvested dividends) of 4.7% over the next five years.

Over the coming 10-year period, we expect the DAX price index to rise by 3.7% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from 3.0% to 4.1%. Our forecast model explains 74% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 95% probability.

118

The DAX´s current dividend yield of 3.9% implies a 10-year total return of 7.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year German government bonds presently allow the investor to lock in a -0.2% yield. We forecast that the DAX Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 7.6% contrasts with the current inflation rate of 1.5% to result in an estimated real total return of 6.1% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The DAX´s relative valuation of -0.1 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is approximately fairly valued. As such, the DAX is the 19th most under-valued market of the group, just about the middle of the pack.

DAX rankings, out of 43 markets

Relative Valuation

DAX 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

19th

17th

15th

13th

10th

-0.1 +0.3

4.7 3.3

6.1 4.5

64 46

89 46

We forecast that the index will yield an annual real total return of 4.7% over the coming five years, and 6.1% over the coming decade. Both returns are slightly above the averages for the 43 other countries (3.3% and 4.5%). Consequently, the DAX ranks 17th and 15th out of 43 119

markets for the 5- and 10-year total real return forecasts, also roughly placed in the middle of the pack. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 64% probability that the DAX can achieve this return by the end of 2024 and 89% by the end of 2029, ranking the index 13th and 10th out of the 43 markets for the two probabilities, comfortably in the top half of markets. On balance, it is likely that the DAX will provide returns comparable to or slightly higher than those of the average global market over both the coming 5- and 10-year periods.

120

Global MSCI All Country World Index The MSCI All Country World Index (ACWI) is the premier index representing the performance of the global market. It is composed of large and mid-cap equities across 23 developed and 26 emerging markets, with just over half of its weighting coming from the United States, followed by Japan, China, the United Kingdom, France and the other 44 countries. The ACWI is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Apple, the American technology company, is currently the largest component of the index and technology is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the ACWI averaged 3.2% in 2019. The index is denominated in U.S. dollars.

The Bottom Line The ACWI finished 2019 at $565. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $478, implying an over-valuation of +0.9 standard deviations. The last time the index was this over-valued during a rising market was in January 2018, and historically it has been more over-valued than it is today just 17% of the time. Over the coming 5-year period, we expect the ACWI to fall by 121

1.1% annually. The forecasted range of annual returns is bound between -2.5% and 0.0%. Our forecast model explains 69% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 38% probability.

MSCI All Country World Index Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

565 478 +0.9 3.2

Government Bond Yields*, % 1-Year 5-Year 10-Year Inflation

1.6 1.7 1.9 2.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % -1.1 5-Year Forecast Range, % (-2.5, 0.0) 0.69 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 38 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

2.1 56

5-Year Annual Forecast Real Total Return, %

-0.2

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

*

1.3 (0.9, 1.7) 0.74 81

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

4.5 96

10-Year Annual Forecast Real Total Return, %

2.2

United States´s government bond yields and inflation rate

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The ACWI currently offers a dividend yield of 3.2%, implying a 5-year total return of 2.1% annually. We can compare this 122

total return to that which the investor could earn on an alternative investment, e.g., 5-year U.S. government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the ACWI will outperform comparable bonds by December 2024 with a 56% probability. The forecast 5-year total return of 2.1% contrasts with the current inflation rate of 2.3%. We forecast that the ACWI will offer a real total return (including reinvested dividends) of -0.2% over the next five years. Over the coming 10-year period, we expect the ACWI to rise by 1.3% annually. The forecasted range of 10-year annual returns is bound between 0.9% and 1.7%. Our forecast model explains 74% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with an 81% probability. The ACWI´s current dividend yield of 3.2% implies a 10-year total return of 4.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year U.S. government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the ACWI index will outperform comparable bonds by December 2029 with a 96% probability. The forecasted 10-year total return of 4.5% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 2.2% annually over the next decade.

Analysis The all-time monthly closing high of the ACWI was $565 in December 2019, the same month the market peaked in inflation-adjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 4.8% annually, or a total return (including reinvested dividends) of 7.2%. Since inflation over this same period has averaged 2.4%, the investor has earned an annual real total return of 4.8%. Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the ACWI. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the ACWI is relatively under-valued. We also use the 123

relative valuation of the index to forecast longer-term secular market declines or crashes.

The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the ACWI started in February 2016 from a relative valuation of -0.4 standard deviations under the average of the preceding 30-year period, more under-valued than 66% of all previous months.

Since that low, the ACWI has advanced to its December 2019 high 124

of $565. At this high, the market was over-valued with a relative valuation of +0.9. Thus, the index has swung by +1.3 standard deviations since its bull market advance started. The index´s current advance has gained 11.6% annually since the 2016 low, and 13.9% including reinvested dividends.

Forecast Returns The return from holding a U.S. government bond is defined in advance. What is needed is an estimate of what the return on the ACWI will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the ACWI is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of overvaluation. We have developed two models to forecast the return of the ACWI over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 7.2% on the ACWI over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the ACWI as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the ACWI to fall by 1.1% annually. The forecasted range of annual returns is bound between -2.5% and 0.0%. Our forecast model explains 69% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 38% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The ACWI currently offers a dividend yield of 3.2%, implying a 5-year total return of 2.1% annually. We can compare this total return to that which the investor could earn on an alternative 125

investment, e.g., 5-year U.S. government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the ACWI will outperform comparable bonds by December 2024 with a 56% probability.

The forecast 5-year total return of 2.1% contrasts with the current inflation rate of 2.3%. If the investor made investments denominated solely in U.S. dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the ACWI will offer a real total return (including reinvested dividends) of -0.2% over the next five years. Over the coming 10-year period, we expect the ACWI to rise by 1.3% annually. The forecasted range of 10-year annual returns is bound between 0.9% and 1.7%. Our forecast model explains 74% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with an 81% probability. The ACWI´s current dividend yield of 3.2% implies a 10-year total return of 4.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year U.S. government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the ACWI index will outperform comparable bonds by December 2029 with a 96% probability. 126

The forecasted 10-year total return of 4.5% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 2.2% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The ACWI´s relative valuation of +0.9 standard deviations above its long-term mean is far above the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the ACWI is the 30th most under-valued market of the group. We forecast that the index will yield an annual real total return of – 0.2% over the coming five years, and 2.2% over the coming decade. Both returns are far below the averages for the 43 other countries (3.3% and 4.5%). Consequently, the ACWI ranks 28th and 26th out of 43 markets for both total real return forecasts. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the 127

explanatory power of our forecast models we estimate that there is a 10% probability that the ACWI can achieve this return by the end of 2024 and only 6% by the end of 2029, ranking the index 33rd and 31st out of the 43 markets for both probabilities.

MSCI ACWI rankings, out of 43 markets

Relative Valuation th

30 MSCI ACWI 43 Country Avg.

+0.9 +0.3

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

th

28

-0.2 3.3

10-Year

th

26

2.2 4.5

5-Year

rd

33

10 46

10-Year

31st 6 46

On balance, it is highly likely that the ACWI will under-perform the average global market over both the coming 5- and 10-year periods.

128

Global MSCI Emerging Markets Index The MSCI Emerging Markets Index (MSCI EM) is the premier index representing the performance of the emerging markets of the world. It is composed of large and mid-cap equities across 26 emerging markets, with 40% of its weight coming from China, followed by Taiwan, South Korea, India, Brazil and smaller allocations of the other countries. The MSCI EM is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Alibaba, the Chinese technology company specializing in e-commerce, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the MSCI EM averaged 3.5% in 2019. The index is denominated in U.S. dollars.

The Bottom Line The MSCI EM finished 2019 at $1,114. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $1,160, implying an under-valuation of -0.3 standard deviations. The last time the index was this under-valued during a declining market was in July 2015, and historically it has been more over-valued than it is today 61% of the time. Over the coming 5-year period, we expect the MSCI EM to rise by 129

5.3% annually. The forecasted range of annual returns is strictly positive and bound between 4.9% and 5.7%. Our forecast model explains 69% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with an 82% probability. MSCI Emerging Market Index (MSCI EM) Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

1,114 1,160 -0.3 3.5

Government Bond Yields*, % 1-Year 5-Year 10-Year Inflation

1.6 1.7 1.9 2.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

5.3 (4.9, 5.7) 0.69 82

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

8.8 89

5-Year Annual Forecast Real Total Return, %

6.5

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

*

6.0 (5.1, 7.2) 0.65 98

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

9.5 99

10-Year Annual Forecast Real Total Return, %

7.2

United States´s government bond yields and inflation rate

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The MSCI EM currently offers a dividend yield of 3.5%, implying a 5-year total return of 8.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year U.S. government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the MSCI EM will outperform comparable bonds by December 2024 with an 89% probability. 130

The forecast 5-year total return of 8.8% contrasts with the current U.S. inflation rate of 2.3%. We forecast that the MSCI EM will offer a real total return (including reinvested dividends) of 6.5% over the next five years. Over the coming 10-year period, we expect the MSCI EM to rise by 6.0% annually. The forecasted range of 10-year annual returns is bound between 5.1% and 7.2%. Our forecast model explains 65% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 98% probability. The MSCI EM´s current dividend yield of 3.5% implies a 10-year total return of 9.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year U.S. government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the MSCI EM will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 9.5% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 7.2% annually over the next decade.

Analysis The all-time monthly closing high of the MSCI EM was $1,337 in October 2007, the same month the market peaked in inflation-adjusted terms.

Over the 30 years since December 1989, the index has yielded a 131

price return of 5.6% annually, or a total return (including reinvested dividends) of 8.4%. Since inflation over this same period has averaged 2.4%, the investor has earned an annual real total return of 6.0%. Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the MSCI EM. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the MSCI EM is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bear market phase of the MSCI EM started in January 2018 from a high of $1,254 and a relative valuation of 0.2 standard deviations above the average of the preceding 30-year period, more under-valued than 42% of all previous months.

Since that high, the MSCI EM has declined to its October 2018 low of $955. At this low, the market was under-valued with a relative valuation of -0.7. Thus, the index lost -0.9 standard deviations of value since its bear market correction started.

132

Forecast Returns The return from holding a U.S. government bond is defined in advance. What is needed is an estimate of what the return on the MSCI EM will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the MSCI EM is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the MSCI EM over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 8.4% on the MSCI EM over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the MSCI EM as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the MSCI EM to rise by 5.3% annually. The forecasted range of annual returns is strictly positive and bound between 4.9% and 5.7%. Our forecast model explains 69% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with an 82% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The MSCI EM currently offers a dividend yield of 3.5%, implying a 5-year total return of 8.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year U.S. government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the MSCI EM will outperform comparable bonds by December 2024 with an 89% probability.

133

The forecast 5-year total return of 8.8% contrasts with the current U.S. inflation rate of 2.3%. If the investor made investments denominated solely in U.S. dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the MSCI EM will offer a real total return (including reinvested dividends) of 6.5% over the next five years.

Over the coming 10-year period, we expect the MSCI EM to rise 134

by 6.0% annually. The forecasted range of 10-year annual returns is bound between 5.1% and 7.2%. Our forecast model explains 65% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 98% probability. The MSCI EM´s current dividend yield of 3.5% implies a 10-year total return of 9.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year U.S. government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the MSCI EM will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 9.5% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 7.2% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The MSCI EM´s relative valuation of -0.3 standard deviations below its long-term mean is less than the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the MSCI EM is the 12th most under-valued market of the group. We forecast that the index will yield an annual real total return of 6.5% over the coming five years, and 7.2% over the coming decade. Both returns are far higher than the averages for the 43 other countries (3.3% and 4.5%). Consequently, the MSCI EM ranks 15th and 12th out of 43 markets for both total real return forecasts. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the explanatory power of our forecast models we estimate that there is an 64% probability that the MSCI EM can achieve this return by the end 135

of 2024 and 81% by the end of 2029, ranking the index 13th and 12th out of the 43 markets for both probabilities.

MSCI Emerging Market Index rankings, out of 43 markets

Relative Valuation

MSCI EM Index 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

12th

15th

12th

13th

12th

-0.3 +0.3

6.5 3.3

7.2 4.5

64 46

81 46

On balance, it is highly likely that the MSCI EM will out-perform the average global market over both the coming 5- and 10-year periods.

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Global MSCI World Index The MSCI World Index is the premier index representing the performance of the developed markets of the world. It is composed of large and mid-cap equities across 23 developed economies, with nearly two-thirds of its weighting coming from the United States, followed by Japan, the United Kingdom, France, Switzerland, and the other 18 countries. The World Index is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Apple, the American technology company, is currently the largest component of the index and technology is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the World Index averaged 3.2% in 2019. The index is denominated in U.S. dollars.

The Bottom Line The World Index finished 2019 at $2,358. Based on historical valuations dating to December 1989 (360 months), we estimate the fairvalue price to be $1,944, implying an over-valuation of +1.0 standard deviation. The last time the index was this over-valued during a rising market was in December 2017, and historically it has been more overvalued than it is today just 15% of the time. Over the coming 5-year period, we expect the World Index to fall by -1.8% annually. The forecasted range of annual returns is strictly 137

negative and bound between -3.2% and -0.5%. Our forecast model explains 68% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with only a 32% probability. MSCI World Index (MSCI World) Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

2,358 1,944 +1.0 3.2

Government Bond Yields*, % 1-Year 5-Year 10-Year Inflation

1.6 1.7 1.9 2.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % -1.8 5-Year Forecast Range, % (-3.2, -0.5) 0.68 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 32 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

1.4 48

5-Year Annual Forecast Real Total Return, %

-0.9

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

*

0.9 (0.3, 1.4) 0.78 73

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

4.1 93

10-Year Annual Forecast Real Total Return, %

1.8

United States´s government bond yields and inflation rate

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The World Index currently offers a dividend yield of 3.2%, implying a 5-year total return of 1.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year U.S. government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the World Index will outperform comparable bonds by December 2024 with only a 48% probability. The forecast 5-year total return of 1.4% contrasts with the current 138

inflation rate of 2.3%. We forecast that the World Index will offer a real total return (including reinvested dividends) of -0.9% over the next five years. Over the coming 10-year period, we expect the World Index to rise by 0.9% annually. The forecasted range of 10-year annual returns is bound between 0.3% and 1.4%. Our forecast model explains 78% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 73% probability. The World Index´s current dividend yield of 3.2% implies a 10-year total return of 4.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year U.S. government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the World Index will outperform comparable bonds by December 2029 with a 93% probability. The forecasted 10-year total return of 4.1% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 1.8% annually over the next decade.

Analysis The all-time monthly closing high of the World Index was $2,358 in December 2019, the same month the market peaked in inflationadjusted terms.

Over the 30 years since December 1989, the index has yielded a price return of 4.9% annually, or a total return (including reinvested 139

dividends) of 7.3%. Since inflation over this same period has averaged 2.4%, the investor has earned an annual real total return of 4.9%. Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the World Index. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the World Index is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the World Index started in February 2016 from a relative valuation of -0.3 standard deviations under the average of the preceding 30-year period, more under-valued than 62% of all previous months. Since March 2000 the World Index has undergone two complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market. Each bull market since 2000 has begun from a relatively undervalued position, on average -0.7 standard deviations below its longterm mean. The median duration of these bull market phases has been 140

a little under six years, with a median total gain of 133%. On an annual basis, these advances have offered a median price return of 16% (ignoring the effect of dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued territory, typically completing their cycle +0.3 standard deviations overvalued relative to the long-term average. The median cycle sees its relative valuation swing by +1.9 standard deviations. The median depreciating phase of the World Index´s three bear market phases of the valuation cycle lasted about a year and a half and shaved -48% off the value of the index, resulting in a -23% annual loss. These bear markets have started from a median position of +0.3 standard deviations above the long-term average and have not ended until the index was under-valued by -0.7 for a median swing of -2.8 standard deviations. MSCI World Index: Bull and Bear Market Summary Declines

Advances

Mar-00 Sep-02

Start MSCI World 1,431

End MSCI World 738

-48

-23

Oct-07 Feb-09

1,682

750

-55

-45

May-15 Feb-16

1,779

1,547

-13

-17

Start Date

End Date

Start MSCI World

End MSCI World

738

1,682

128

18

Feb-09 May-15

750

1,779

137

15

Feb-16 Dec-19

1,547

2,358

52

12

Total Annual Change, % Change, %

Start Date

End Date

Sep-02 Oct-07

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

1.3 -48.4 -23.2 0.3 -2.8

5.7 132.6 16.2 -0.7 1.9

Total Annual Change, % Change, %

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent December 2019 high of $62,358 the index had gained 52% over the four preceding years, making it the weakest and shortest bull market on record. Starting from the February 2016 low valuation of -0.3 standard deviations the index has posted127% annual gains and is now over-valued by +1.0 standard deviation, implying a valuation swing of +1.3 standard deviations. In terms of duration the present bull market has been quite short (two-thirds of the length of the median advance), and its 52% total gain is only less than half the index´s historical appreciations. The 12% annual gain is also low by historical standards. The current advance started from a mildly under-valued level (-0.3), though the current valuation of +1.0 is far above the median level that bear markets start from. The increase in valuation of +1.3 standard deviations is somewhat weak by historical precedent (a median swing of +1.9 standard deviations). If the index´s advance was completed in December 2019 it would be the shortest and weakest bull market in twenty years, though its present valuation looks like it is poised to begin 141

a new bear market.

Forecast Returns The return from holding a U.S. government bond is defined in advance. What is needed is an estimate of what the return on the World Index will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the World Index is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the World Index over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 7.3% on the World Index over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the World Index as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the World Index to fall by -1.8% annually. The forecasted range of annual returns is strictly negative and bound between -3.2% and -0.5%. Our forecast model explains 68% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with only a 32% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The World Index currently offers a dividend yield of 3.2%, implying a 5-year total return of 1.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year U.S. government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the World Index will outperform comparable bonds by December 2024 with only a 48% probability. 142

The forecast 5-year total return of 1.4% contrasts with the current inflation rate of 2.3%. If the investor made investments denominated solely in U.S. dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the World Index will offer a real total return (including reinvested dividends) of -0.9% over the next five years.

Over the coming 10-year period, we expect the World Index to rise by 0.9% annually. The forecasted range of 10-year annual returns is 143

bound between 0.3% and 1.4%. Our forecast model explains 78% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 73% probability. The World Index´s current dividend yield of 3.2% implies a 10-year total return of 4.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year U.S. government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the World Index will outperform comparable bonds by December 2029 with a 93% probability. The forecasted 10-year total return of 4.1% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 1.8% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The World Index´s relative valuation of +1.0 standard deviations above its long-term mean is far above the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the World Index is the 33rd most under-valued market of the group. We forecast that the index will yield an annual real total return of – 0.9% over the coming five years, and 1.8% over the coming decade. Both returns are far below the averages for the 43 other countries (3.3% and 4.5%). Consequently, the World Index ranks 32nd and 27th out of 43 markets for both total real return forecasts. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the explanatory power of our forecast models we estimate that there is an 8% probability that the World Index can achieve this return by the end of 2024 and only 3% by the end of 2029, ranking the index 36th and 144

34th out of the 43 markets for both probabilities.

MSCI World rankings, out of 43 markets

Relative Valuation

MSCI World 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

33rd

32nd

27th

36th

34th

+1.0 +0.3

-0.9 3.3

1.8 4.5

8 46

3 46

On balance, it is highly likely that the World Index will underperform the average global market over both the coming 5- and 10year periods.

145

146

Greece Athens General Composite The Athens General Composite Index is the benchmark stock market index of Greece. It is composed of the shares listed of the 60 largest companies covering almost 90% of the value listed on the Athens Stock Exchange. The Composite Index is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Coca-Cola Hellenic Bottling Company, the world´s third largest Coca-Cola anchor bottler, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the Composite Index averaged 2.9% in 2019. The index is denominated in euros.

The Bottom Line The Composite Index finished 2019 at €910. Based on historical valuations dating to December 1989 (360 months), we estimate the fairvalue price to be €1,577, implying an under-valuation of -0.8 standard deviations. The market has had this valuation more or less continually since August 2011, and before that the last time the index had this valuation during a rising market was in January 1993. Historically the index has been more over-valued than it is today 78% of the time. Over the coming 5-year period, we expect the Composite Index to rise by 7.2% annually. The forecasted range of annual returns is bound 147

between 5.8% and 7.8%. Our forecast model explains 40% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 70% probability. Athens General Composite Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

910 1,577 -0.8 2.9

Government Bond Yields, % 1-Year* 5-Year 10-Year Inflation

0.4 0.6 1.5 -0.2

5-Year Forecasts 5-Year Average Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

7.2 (5.8, 7.8) 0.40 70

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

10.1 75

5-Year Annual Forecast Real Total Return, %

10.3

10-Year Forecasts 10-Year Average Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

*

1.6 (1.1, 1.9) 0.73 60

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

4.5 69

10-Year Annual Forecast Real Total Return, %

4.7

6-month bond yield

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The Composite Index currently offers a dividend yield of 2.9%, implying a 5-year total return of 10.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Greek government bonds presently allow the investor to lock in a 0.6% annual yield. We forecast that the Composite Index will outperform comparable bonds by December 2024 with a 75% probability. The forecast 5-year total return of 10.1% contrasts with the current 148

inflation rate of -0.2%. We forecast that the Composite Index will offer a real total return (including reinvested dividends) of 10.3% over the next five years. Over the coming 10-year period, we expect the Composite Index to rise by 1.6% annually. The forecasted range of 10-year annual returns is tightly bound between 1.1% and 1.9%. Our forecast model explains 73% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 60% probability. The Composite Index´s current dividend yield of 2.9% implies a 10year total return of 4.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10year government bonds. 10-year Greek government bonds presently allow the investor to lock in a 1.5% yield. We forecast that the Composite Index will outperform comparable bonds by December 2029 with a 69% probability. The forecasted 10-year total return of 4.5% contrasts with the current inflation rate of -0.2% to result in an estimated real total return of 4.7% annually over the next decade.

Analysis The all-time monthly closing high of the Composite Index was €5,712 in November 1999, which is also the date of its real, or inflationadjusted peak. Over the 30 years since December 1989, the index has yielded a price return of 2.3% annually.

Using historical price, dividend, macroeconomic and financial data 149

dating to December 1989, we can compute the relative valuation of the Composite Index. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the Composite Index is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the Composite Index started in January 2016 at a price of €518 and a relative valuation of -1.1 standard deviations under the average of the preceding 30-year period, more under-valued than 85% of all previous months.

Since that low, the Composite Index advanced to its November 2019 high of €916. At this high, the market was still highly under-valued with a relative valuation of -0.8. Thus, the index swung by +0.3 standard deviations since its bull market advance started. The index´s current advance has gained 11.9% annually since the 2016 low, and 15.6% including reinvested dividends.

Forecast Returns The return from holding a Greek government bond is defined in advance. What is needed is an estimate of what the return on the Composite Index will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have 150

seen, the future return of the Composite Index is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the Composite Index over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 2.3% on the Composite Index over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the Composite Index as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the Composite Index to rise by 7.2% annually. The forecasted range of annual returns is bound between 5.8% and 7.8%. Our forecast model explains 40% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 70% probability.

151

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The Composite Index currently offers a dividend yield of 2.9%, implying a 5-year total return of 10.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Greek government bonds presently allow the investor to lock in a 0.6% annual yield. We forecast that the Composite Index will outperform comparable bonds by December 2024 with a 75% probability. The forecast 5-year total return of 10.1% contrasts with the current inflation rate of -0.2%. If the investor made investments denominated solely in euros, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the Composite Index will offer a real total return (including reinvested dividends) of 10.3% over the next five years. Over the coming 10-year period, we expect the Composite Index to rise by 1.6% annually. The forecasted range of 10-year annual returns is tightly bound between 1.1% and 1.9%. Our forecast model explains 73% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 60% probability.

The Composite Index´s current dividend yield of 2.9% implies a 10152

year total return of 4.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10year government bonds. 10-year Greek government bonds presently allow the investor to lock in a 1.5% yield. We forecast that the Composite Index will outperform comparable bonds by December 2029 with a 69% probability. The forecasted 10-year total return of 4.5% contrasts with the current inflation rate of -0.2% to result in an estimated real total return of 4.7% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The Composite Index´s relative valuation of -0.8 standard deviations below its long-term mean is far below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is highly under-valued. As such, the Composite Index is the 2nd most under-valued market of the group. We forecast that the index will yield an annual real total return of 10.3% over the coming five years, and 4.7% over the coming decade. The former return is quite high relative to the 43-country average, while the latter return is on par with their average (3.3% and 4.5%). Consequently, the Composite Index ranks 5th and 25th out of 43 markets for the 5- and 10-year total real return forecasts. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is a 63% probability that the Composite Index can achieve this return by the end of 2024 and 27% by the end of 2029, ranking the index 15th and 20th out of the 43 markets for the two probabilities.

153

Athens General Composite rankings, out of 43 markets

Relative Valuation

Athens Gen. Comp. 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

2nd

5th

25th

15th

20th

-0.8 +0.3

10.3 3.3

4.7 4.5

63 46

38 46

On balance, it is likely that the Composite Index will provide marginally above-average returns over the next five years and returns on par with the world average over the coming decade.

154

Hong Kong Hang Seng The Hang Seng Index (HSI) is the most widely quoted stock market index of Hong Kong. It is composed of the 50 largest and most liquid companies listed on the Hong Kong Stock Exchange by float-adjusted market value. These companies represent about 58% of the total market capitalization of the Hong Kong Stock Exchange. The index´s composition is rebalanced on a quarterly basis. The Hang Seng Index is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Tencent, the Chinese technology company, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the Hang Seng averaged 4.0% in 2019. The index is denominated in Hong Kong dollars.

The Bottom Line The Hang Seng finished 2019 at $28,189. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $32,072, implying an under-valuation of -0.6 standard deviations. The last time the index had this valuation during a rising market was in February 2017, and historically it has been more over-valued than it is today 71% of the time. Over the coming 5-year period, we expect the Hang Seng to 155

increase by 8.2% annually. The forecasted range of annual returns is strictly positive and tightly bound between 8.0% and 8.8%. Our forecast model explains 29% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with an 87% probability. Hang Seng Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

28,189 32,072 -0.6 4.0

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.8 1.7 1.8 3.0

5-Year Forecasts 5-Year Annual Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

8.2 (8.0, 8.8) 0.29 87

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

12.2 92

5-Year Annual Forecast Real Total Return, %

9.2

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

6.3 (5.6, 6.7) 0.35 97

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

10.3 99

10-Year Annual Forecast Real Total Return, %

7.3

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The Hang Seng currently offers a dividend yield of 4.0%, implying a 5-year total return of 12.2% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Hong Kong government bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the Hang Seng Index will outperform comparable bonds by December 2024 with a 92% probability. The forecast 5-year total return of 12.2% contrasts with the current inflation rate of 3.0%. We forecast that the Hang Seng will offer a real 156

total return (including reinvested dividends) of 9.2% over the next five years. Over the coming 10-year period, we expect the Hang Seng to rise by 6.3% annually. The forecasted range of 10-year annual returns is bound between 5.6% and 6.7%. Our forecast model explains 35% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 97% probability. The Hang Seng´s current dividend yield of 4.0% implies a 10-year total return of 10.3% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Hong Kong government bonds presently allow the investor to lock in a 1.8% yield. We forecast that the Hang Seng Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 10.3% contrasts with the current inflation rate of 3.0% to result in an estimated real total return of 7.3% annually over the next decade.

Analysis The all-time monthly closing high of the Hang Seng price was $32,887 in January 2018. In real, or inflation-adjusted terms, the market peaked in October 2007.

Over the 30 years since December 1989, the index has yielded a price return of 8.0% annually, and a total return (including reinvested dividends) of 10.8%. Since inflation over this same period has averaged 157

3.4%, the investor has earned an annual real total return of 7.4%. Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the Hang Seng. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the Hang Seng is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the Hang Seng started in February 2016 at a price of $19,111 and a relative valuation of -1.1 standard deviations under the average of the preceding 30-year period, more under-valued than 86% of all previous months.

Since that low, the Hang Seng advanced to its January 2018 high of $32,887. At this high, the market was fairly valued with a relative valuation of +0.4. Thus, the index swung by +1.5 standard deviations since its bull market advance started. From the 2016 low until today the index has gained 10.7% annually, and 15.0% including reinvested dividends.

Forecast Returns The return from holding a Hong Kong government bond is defined in advance. What is needed is an estimate of what the return on the Hang 158

Seng will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the Hang Seng is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the Hang Seng over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 10.7% on the Hang Seng over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the Hang Seng as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the Hang Seng to increase by 8.2% annually. The forecasted range of annual returns is strictly positive and tightly bound between 8.0% and 8.8%. Our forecast model explains 29% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with an 87% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The Hang Seng currently offers a dividend yield of 4.0%, implying a 5-year total return of 12.2% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Hong Kong government bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the Hang Seng Index will outperform comparable bonds by December 2024 with a 92% probability. The forecast 5-year total return of 12.2% contrasts with the current inflation rate of 3.0%. If the investor made investments denominated solely in Hong Kong dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across 159

multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the Hang Seng will offer a real total return (including reinvested dividends) of 9.2% over the next five years.

Over the coming 10-year period, we expect the Hang Seng to rise by 6.3% annually. The forecasted range of 10-year annual returns is bound between 5.6% and 6.7%. Our forecast model explains 35% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 97% probability.

The Hang Seng´s current dividend yield of 4.0% implies a 10-year 160

total return of 10.3% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Hong Kong government bonds presently allow the investor to lock in a 1.8% yield. We forecast that the Hang Seng Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 10.3% contrasts with the current inflation rate of 3.0% to result in an estimated real total return of 7.3% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The Hang Seng´s relative valuation of -0.6 standard deviations below its long-term mean is significantly below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is highly under-valued. As such, the Hang Seng is the 5th most under-valued market of the group. We forecast that the index will yield an annual real total return of 9.2% over the coming five years, and 7.3% over the coming decade. These forecasts are significantly higher than those for the 43 other countries for both periods (3.3% and 4.5%). Consequently, the Hang Seng ranks 6th and 11th out of 43 markets for the 5- and 10-year total real return forecasts. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 77% probability that the Hang Seng can achieve this return by the end of 2024 and 85% by the end of 2029, ranking the index 8th and 11th out of the 43 markets for the two probabilities, comfortably in the top half of markets.

161

Hang Seng rankings, out of 43 markets

Relative Valuation

Hang Seng 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

5th

6th

11th

8th

11th

-0.6 +0.3

9.2 3.3

7.3 4.5

77 46

85 46

On balance, it is likely that the Hang Seng will provide returns significantly higher than those of the average global market over the next 5- and 10-year periods.

162

India S&P BSE SENSEX The S&P Bombay Stock Exchange Sensitive Index (SENSEX) is India´s most tracked bellwether index. It is composed of the 30 largest and most liquid companies listed on the Bombay Stock Exchange by float-adjusted market value. The index´s composition is rebalanced on a semi-annual basis. The SENSEX is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. HDFC Bank, the Indian financial company, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the SENSEX averaged 1.5% in 2019. The index is denominated in Indian rupee.

The Bottom Line The SENSEX finished 2019 at ₹41,253. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be ₹40,152, implying an under-valuation of -0.1 standard deviations (under-valued notwithstanding the fact that the index is currently above its fair-market level since the average valuation since 1989 is even more over-valued). The last time the index had this valuation during a rising market was in September 2017, and historically it has been more overvalued than it is today 53% of the time. 163

Over the coming 5-year period, we expect the SENSEX to increase by 12.3% annually. The forecasted range of annual returns is bound between 11.7% to 12.7%. Our forecast model explains 46% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 93% probability.

S&P BSE SENSEX Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

41,253 40,152 -0.1 1.5

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

5.6 6.5 6.6 9.6

5-Year Forecasts 5-Year Annual Forecast Price Return, % 12.3 5-Year Forecast Range, % (11.7, 12.7) 0.46 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 93 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

13.8 81

5-Year Annual Forecast Real Total Return, %

4.2

10-Year Forecasts 10-Year Annual Forecast Price Return, % 11.6 10-Year Forecast Range, % (11.4, 11.9) 0.77 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 99 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

13.1 99

10-Year Annual Forecast Real Total Return, %

3.5

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The SENSEX currently offers a dividend yield of 1.5%, implying a 5-year total return of 13.8% annually. We can compare this 164

total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Indian government bonds presently allow the investor to lock in a 6.5% annual yield. We forecast that the SENSEX will outperform comparable bonds by December 2024 with an 81% probability. The forecast 5-year total return of 13.8% contrasts with the current inflation rate of 9.6%. We forecast that the SENSEX will offer a real total return (including reinvested dividends) of 4.2% over the next five years. Over the coming 10-year period, we expect the SENSEX to rise by 11.6% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from 11.4% to 11.9%. Our forecast model explains 77% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The SENSEX´s current dividend yield of 1.5% implies a 10-year total return of 13.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Indian government bonds presently allow the investor to lock in a 6.6% yield. We forecast that the SENSEX Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 13.1% contrasts with the current inflation rate of 9.6% to result in an estimated real total return of 3.5% annually over the next decade.

Analysis The all-time monthly closing high of the SENSEX was ₹41,253 in December 2019. In real, or inflation-adjusted terms, the market peaked in December 2007. Over the 30 years since December 1989, the index has yielded a price return of 14.1% annually. Since inflation over this same period has averaged 7.5%, the investor has earned an annual real total return of 6.6%. Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the SENSEX. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the SENSEX is relatively under-valued. We also use 165

the relative valuation of the index to forecast longer-term secular market declines or crashes.

The current bull market phase of the SENSEX started in February 2016 at a price of ₹23,002 and a relative valuation of -0.7 standard deviations under the average of the preceding 30-year period, more under-valued than 76% of all previous months.

Since that low, the SENSEX has advanced to its December 2019 high of ₹41,253. At this high, the market was approximately fairly valued with a relative valuation of -0.1. Thus, the index swung by +0.6 standard deviations since its bull market advance started. The index´s current advance has gained 16.5% annually since the 2016 low, and 166

18.2% including reinvested dividends.

Forecast Returns The return from holding an Indian government bond is defined in advance. What is needed is an estimate of what the return on the SENSEX will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the SENSEX is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the SENSEX over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 14.1% on the SENSEX over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the SENSEX as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the SENSEX to increase by 12.3% annually. The forecasted range of annual returns is bound between 11.7% to 12.7%. Our forecast model explains 46% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 93% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The SENSEX currently offers a dividend yield of 1.5%, implying a 5-year total return of 13.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Indian government bonds presently allow the investor to lock in a 6.5% annual yield. We forecast that the SENSEX will outperform comparable bonds by December 2024 with an 81% probability. 167

The forecast 5-year total return of 13.8% contrasts with the current inflation rate of 9.6%. If the investor made investments denominated solely in Indian rupee, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the SENSEX will offer a real total return (including reinvested dividends) of 4.2% over the next five years. Over the coming 10-year period, we expect the SENSEX to rise by 11.6% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from 11.4% to 11.9%. Our forecast model explains 77% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The SENSEX´s current dividend yield of 1.5% implies a 10-year total return of 13.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Indian government bonds presently allow the investor to lock in a 6.6% yield. We forecast that the SENSEX Index will outperform comparable bonds by December 2029 with a 99% probability.

168

The forecasted 10-year total return of 13.1% contrasts with the current inflation rate of 9.6% to result in an estimated real total return of 3.5% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The S&P BSE SENSEX´s relative valuation of -0.1 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is approximately fairly valued. As such, the SENSEX is the 19th most under-valued market of the group, just about the middle of the pack. We forecast that the index will yield an annual real total return of 4.2% over the coming five years, and 3.5% over the coming decade. Both returns are about on par with the averages for the 43 other countries (3.3% and 4.5%). Consequently, the SENSEX ranks 18th and 23rd out of 43 markets for the 5- and 10-year total real return forecasts.

169

S&P BSE SENSEX rankings, out of 43 markets

Relative Valuation

S&P BSE SENSEX 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

19th

18th

23rd

16th

14th

-0.1 +0.3

4.2 3.3

3.5 4.5

61 46

72 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 61% probability that the SENSEX can achieve this return by the end of 2024 and 72% by the end of 2029, ranking the index 16th and 14th out of the 43 markets for the two probabilities. On balance, it is highly likely that the SENSEX provide returns comparable to the average global market over both the coming 5- and 10-year periods.

170

Indonesia IDX Composite The Indeks Harga Saham Gabungan or IDX Composite Index, is the most widely quoted stock market index of Indonesia. It is composed of all companies listed on the Indonesia Stock Exchange. The IDX is a market capitalization index, meaning that each company´s contribution to the index is relative to its current market value. Bank Central Asia, the Indonesian financial company, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the IDX averaged 2.8% in 2019. The index is denominated in Indonesian rupiah.

The Bottom Line The IDX finished 2019 at Rp 6,299. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be Rp 4,135, implying an over-valuation of +0.8 standard deviations. The last time the index had this valuation during a rising market was in August 2017, and historically it has been more over-valued than it is today 21% of the time. Over the coming 5-year period, we expect the IDX to increase by 3.6% annually. The forecasted range of annual returns is strictly positive and bound between 3.1% and 4.2%. Our forecast model explains 63% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break171

even by December 2024 with a 69% probability. IDX Composite Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

6,299 4,135 +0.8 2.8

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

5.1 6.4 7.1 2.7

5-Year Forecasts 5-Year Annual Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

3.6 (3.1, 4.2) 0.63 69

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

6.4 50

5-Year Annual Forecast Real Total Return, %

3.7

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

7.5 (6.0, 9.6) 0.71 96

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

10.3 78

10-Year Annual Forecast Real Total Return, %

7.6

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The IDX currently offers a dividend yield of 2.8%, implying a 5-year total return of 6.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Indonesian government bonds presently allow the investor to lock in a 6.4% annual yield. We forecast that the IDX Index will outperform comparable bonds by December 2024 with a 50% probability. The forecast 5-year total return of 6.4% contrasts with the current inflation rate of 2.7%. We forecast that the IDX will offer a real total return (including reinvested dividends) of 3.7% over the next five years. Over the coming 10-year period, we expect the IDX to rise by 7.5% annually. The forecasted range of 10-year annual returns is bound between 3.1% and 4.2%. Our forecast model explains 71% of the 172

variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 96% probability. The IDX´s current dividend yield of 2.8% implies a 10-year total return of 10.3% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Indonesian government bonds presently allow the investor to lock in a 7.1% yield. We forecast that the IDX Index will outperform comparable bonds by December 2029 with a 96% probability. The forecasted 10-year total return of 10.3% contrasts with the current inflation rate of 2.7% to result in an estimated real total return of 7.6% annually over the next decade.

Analysis The all-time monthly closing high of the IDX price was Rp 6,605 in January 2018. In real, or inflation-adjusted terms, the market peaked in April 1990. Over the 30 years since December 1989, the index has yielded a price return of 9.6% annually. Since inflation over this same period has averaged 8.9% annually, the investor has earned a real price return of 0.7% annually.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the IDX. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. 173

Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the IDX is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The current bull market phase of the IDX started in November 2008 at a price of Rp 1,241 and a relative valuation of -1.2 standard deviations under the average of the preceding 30-year period, more under-valued than 89% of all previous months. Since that low, the IDX advanced to its January 2018 high of Rp 6,605. At this high, the market was over-valued with a relative valuation of +1.2 Thus, the index swung by +2.4 standard deviations since its bull market advance started. From the 2008 low until today the index has gained 15.8% annually, and 26.9% including reinvested dividends (against an average inflation rate of 4.5%).

Forecast Returns The return from holding an Indonesian government bond is defined in advance. What is needed is an estimate of what the return on the IDX will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the IDX is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. 174

We have developed two models to forecast the return of the IDX over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 9.6% on the IDX over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the IDX as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the IDX to increase by 3.6% annually. The forecasted range of annual returns is strictly positive and bound between 3.1% and 4.2%. Our forecast model explains 63% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with a 69% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The IDX currently offers a dividend yield of 2.8%, implying a 5-year total return of 6.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Indonesian 175

government bonds presently allow the investor to lock in a 6.4% annual yield. We forecast that the IDX Index will outperform comparable bonds by December 2024 with a 50% probability. The forecast 5-year total return of 6.4% contrasts with the current inflation rate of 2.7%. If the investor made investments denominated solely in Indonesian rupiah, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the IDX will offer a real total return (including reinvested dividends) of 3.7% over the next five years.

Over the coming 10-year period, we expect the IDX to rise by 7.5% annually. The forecasted range of 10-year annual returns is bound between 3.1% and 4.2%. Our forecast model explains 71% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 96% probability. The IDX´s current dividend yield of 2.8% implies a 10-year total return of 10.3% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Indonesian government bonds presently allow the investor to lock in a 7.1% yield. We forecast that the IDX Index will outperform comparable bonds by December 2029 with a 96% probability. The forecasted 10-year total return of 10.3% contrasts with the 176

current inflation rate of 2.7% to result in an estimated real total return of 7.6% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The IDX´s relative valuation of +0.8 standard deviations above its long-term mean is significantly above the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is highly under-valued. As such, the IDX is the 29th most under-valued market of the group. We forecast that the index will yield an annual real total return of 3.7% over the coming five years, and 7.6% over the coming decade. These forecasts are on par with the 5-year forecast for the other 43 markets, and slightly higher over ten years. Consequently, the IDX ranks 20th and 6th out of 43 markets for the 5- and 10-year total real return forecasts.

IDX Composite rankings, out of 43 markets

Relative Valuation

IDX Composite 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

29th

20th

6th

27th

23rd

+0.8 +0.3

3.7 3.3

7.6 4.5

26 46

34 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 26% probability that the IDX can achieve this return by the end of 2024 and 34% by the end of 2029, ranking the index 27th and 23rd out 177

of the 43 markets for the two probabilities, near the bottom of all markets. On balance, it is likely that the IDX will provide returns significantly lower than those of the average global market over the next 5- and 10year periods.

178

Ireland ISEQ All-Share The ISEQ All-Share Index is the primary broad-based stock market index of Ireland. It is composed of the shares of all companies listed on the Euronext Dublin Stock Exchange (formerly the Irish Stock Exchange). The index´s composition is rebalanced on a semi-annual basis. The ISEQ is a market capitalization index, meaning that each company´s contribution to the index is relative to its current market value. CRH plc, the international building material company domiciled in Ireland, is currently the largest component of the index and construction and materials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the ISEQ averaged 2.5% in 2019. The index is denominated in euros.

The Bottom Line The ISEQ finished 2019 at €7,183. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be €5,810, implying an over-valuation of +0.4 standard deviations. The last time the index had this valuation during a rising market was in May 2004, and historically it has been more over-valued than it is today only 35% of the time. Over the coming 5-year period, we expect the ISEQ to increase by 2.5% annually. The forecasted range of annual returns is strictly positive, running from 2.0% to 3.3%. Our forecast model explains 49% of the variation in the index´s 5-year returns since December 1989. 179

Consequently, we forecast that the index will break-even by December 2024 with a 61% probability.

ISEQ All-Share Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

7,183 5,810 +0.4 2.5

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

-0.2 -0.3 0.1 1.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

2.5 (2.0, 3.3) 0.49 61

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

5.0 72

5-Year Annual Forecast Real Total Return, %

3.7

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

1.2 (-0.6, 3.1) 0.70 61

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

3.7 80

10-Year Annual Forecast Real Total Return, %

2.4

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The ISEQ currently offers a dividend yield of 2.5%, implying a 5-year total return of 5.0% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Irish government bonds presently allow the investor to lock in a -0.3% annual yield. We forecast that the ISEQ will outperform comparable bonds by 180

December 2024 with a 72% probability. The forecast 5-year total return of 5.0% contrasts with the current inflation rate of 1.3%. We forecast that the ISEQ will offer a real total return (including reinvested dividends) of 3.7% over the next five years. Over the coming 10-year period, we expect the ISEQ to rise by 1.2% annually. The forecasted range of 10-year annual returns is bound between -0.6% and 3.1%. Our forecast model explains 70% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 61% probability. The ISEQ´s current dividend yield of 2.5% implies a 10-year total return of 3.7% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Irish government bonds presently allow the investor to lock in a 0.1% yield. We forecast that the ISEQ Index will outperform comparable bonds by December 2029 with an 80% probability. The forecasted 10-year total return of 3.7% contrasts with the current inflation rate of 1.3% to result in an estimated real total return of 2.4% annually over the next decade.

Analysis The all-time monthly closing high of the ISEQ price was €9,854 in May 2007, the same month it made its real, or inflation-adjusted high.

Over the 30 years since December 1989, the index has yielded a 181

price return of 4.8% annually, and a total return (including reinvested dividends) of 7.4%. Since inflation over this same period has averaged 1.9%, the investor has earned an annual real total return of 5.5%. Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the ISEQ. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the ISEQ is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the ISEQ started in February 2009 at a price of €2,074 and a relative valuation of -1.7 standard deviations under the average of the preceding 30-year period, more under-valued than 95% of all previous months.

Since that low, the ISEQ advanced to its December 2019 high of €7,183. At this high, the market was more or less fairly valued with a relative valuation of +0.4. Thus, the index swung by +2.1 standard deviations since its bull market advance started. From the 2009 low until today the index has gained 12.1% annually, and 14.5% including reinvested dividends.

182

Forecast Returns The return from holding an Irish government bond is defined in advance. What is needed is an estimate of what the return on the ISEQ will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the ISEQ is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the ISEQ over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 7.4% on the ISEQ over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the ISEQ as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the ISEQ to increase by 2.5% annually. The forecasted range of annual returns is strictly positive, running from 2.0% to 3.3%. Our forecast model explains 49% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 61% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The ISEQ currently offers a dividend yield of 2.5%, implying a 5-year total return of 5.0% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Irish government bonds presently allow the investor to lock in a -0.3% annual yield. We forecast that the ISEQ will outperform comparable bonds by December 2024 with a 72% probability. The forecast 5-year total return of 5.0% contrasts with the current inflation rate of 1.3%. If the investor made investments denominated solely in euros, this rate of inflation would not affect his investment 183

decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.)

For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflationadjusted) return allows for a simple method to compare returns internationally. We forecast that the ISEQ will offer a real total return (including reinvested dividends) of 3.7% over the next five years.

Over the coming 10-year period, we expect the ISEQ to rise by 1.2% annually. The forecasted range of 10-year annual returns is bound 184

between -0.6% and 3.1%. Our forecast model explains 70% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 61% probability. The ISEQ´s current dividend yield of 2.5% implies a 10-year total return of 3.7% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Irish government bonds presently allow the investor to lock in a 0.1% yield. We forecast that the ISEQ Index will outperform comparable bonds by December 2029 with an 80% probability. The forecasted 10-year total return of 3.7% contrasts with the current inflation rate of 1.3% to result in an estimated real total return of 2.4% annually over the next decade

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The ISEQ´s relative valuation of +0.4 standard deviations above its long-term mean is on par with the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations. As such, the ISEQ is the 25th most under-valued market of the group.

ISEQ All-Share rankings, out of 43 markets

Relative Valuation th

25 ISEQ All Share 43 Country Avg.

+0.4 +0.3

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

th

20

3.7 3.3

10-Year

th

25

2.4 4.5

5-Year

th

19

51 46

10-Year

31st 37 46

We forecast that the index will yield an annual real total return of 3.7% over the coming five years, and 2.4% over the coming decade. 185

These forecasts are on par than those for the 43 other countries over five years, though somewhat lower over ten years (3.3% and 4.5%). Consequently, the ISEQ ranks 20th and 25th out of 43 markets for the 5- and 10-year total real return forecasts. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 51% probability that the ISEQ can achieve this return by the end of 2024 and 37% by the end of 2029, ranking the index 19th and 31st out of the 43 markets for the two probabilities, middling relative to the other markets. On balance, it is likely that the ISEQ will provide returns about on par with those of the average global market over the foreseeable future.

186

Japan Nikkei 225 The Nikkei 225 is the premier index of Japanese stocks. It is composed of 225 large, publicly owned companies listed on the Tokyo Stock Exchange. The index´s composition is rebalanced on an annual basis. The Nikkei is a price-weighted index, meaning that each company´s contribution to the index is relative to its current market price. Fast Retailing, the Japanese retail holding company, is currently the largest component of the index and technology is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the Nikkei averaged 2.5% in 2019. The index is denominated in Japanese yen.

The Bottom Line The Nikkei finished 2019 at ¥23,656. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be ¥14,419, implying an over-valuation of +1.3 standard deviations. The index has not been this over-valued during a rising market in the last 30 years, and historically it has been more over-valued than it is today only 9% of the time. Over the coming 5-year period, we expect the Nikkei to decrease by -10.4% annually. The forecasted range of annual returns is strictly negative, running from -12.5% to -9.1%. Our forecast model explains 59% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by 187

December 2024 with only a 4% probability.

NIKKEI 225 Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

23,656 14,419 +1.3 2.5

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

-0.1 -0.1 0.0 0.8

5-Year Forecasts 5-Year Annual Forecast Price Return, % -10.4 5-Year Forecast Range, % (-12.5, -9.1) 0.59 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 4 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

-7.9 10

5-Year Annual Forecast Real Total Return, %

-8.7

10-Year Forecasts 10-Year Annual Forecast Price Return, % -3.2 10-Year Forecast Range, % (-3.5, -2.7) 0.49 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 17 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

-0.7 42

10-Year Annual Forecast Real Total Return, %

-1.5

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The Nikkei currently offers a dividend yield of 2.5%, implying a 5-year total return of -7.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Japanese government bonds presently allow the investor to lock in a -0.1% annual yield. We forecast that the Nikkei will outperform comparable bonds by December 2024 with only a 10% probability. 188

The forecast 5-year total return of -7.9% contrasts with the current inflation rate of 0.8%. We forecast that the Nikkei will offer a real total return (including reinvested dividends) of -8.7% over the next five years. Over the coming 10-year period, we expect the Nikkei to fall by 3.2% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from -3.5% to -2.7%. Our forecast model explains 49% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 17% probability. The Nikkei ´s current dividend yield of 2.5% implies a 10-year total return of -0.7% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Japanese government bonds presently allow the investor to lock in a 0.0% yield. We forecast that the Nikkei 225 Index will outperform comparable bonds by December 2029 with a 42% probability. The forecasted 10-year total return of -0.7% contrasts with the current inflation rate of 0.8% to result in an estimated real total return of -1.5% annually over the next decade.

Analysis The all-time monthly closing high of the Nikkei was ¥38,916 in December 1989, the same month it peaked in real, or inflation-adjusted terms.

Over the 30 years since December 1989, the index has yielded a 189

price return of -1.6% annually. Since inflation over this same period has averaged 0.5% annually, the investor has earned a real price return of 2.1% annually. Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the Nikkei. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the Nikkei is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the Nikkei started in February 2009 from a relative valuation of -1.3 standard deviations under the average of the preceding 30-year period, more under-valued than 90% of all previous months. Since October 1974 the Nikkei has undergone four complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market.

Each bull market since 1974 has begun from a relatively undervalued position, on average -0.8 standard deviations below its longterm mean. The median duration of these bull market phases has been 190

1.3 years, with a median total gain of 54%. On an annual basis, these advances have offered a median price return of 31% (ignoring the effect of dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued territory, typically completing their cycle +0.3 standard deviations over-valued relative to the long-term average. The median cycle sees its relative valuation swing by +0.9 standard deviations. Nikkei 225 Index: Bull and Bear Market Summary Declines Start Date

Advances

End Date

Start Nikkei

End Nikkei

Total Annual Change, % Change, %

Dec-89 Jul-92

38,916

15,910

-59

-29

Aug-93 Jun-95

21,027

14,517

-31

-18

Jun-96 Sep-98

22,531

13,406

-40

-21

Mar-00 Feb-09

20,337

7,568

-63

-10

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

Start End Start Date Date Nikkei Oct-74 Dec-89 3,594

End Total Annual Nikkei Change, % Change, % 38,916 983 17

Jul-92 Aug-93 15,910

21,027

32

29

Jun-95 Jun-96 14,517

22,531

55

55

Sep-98 Mar-00 13,406

20,337

52

32

Feb-09 Dec-19

23,656

213

11

2.4 -49.8 -19.4 0.3 -1.2

1.3 53.5 30.7 -0.8 0.9

7,568

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

The index´s most significant bull market took place between October 1974 and December 1989. During this 15-year period, the Nikkei never suffered a decline that pushed its relative valuation into negative territory, an event necessary to mark the end of a long-term advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 983% over this period, or about 17% annually (in price terms, ignoring reinvested dividends). The 1974 low saw the index under-valued by -0.8 standard deviations, and the rally would not be completed until the Nikkei was +3.9 standard deviations over-valued. The change in relative valuation of +4.7 standard deviations is the most extreme swing on record. While the 1974-89 bull market was the largest in absolute terms, the swiftest in annual terms took place between June 1995 and June 1996. Starting from an under-valuation of -0.6 standard deviations below its long-term average, the Nikkei rallied 55% to finish its cycle +0.3 standard deviations over-valued, enough to post an annual gain of 55% (again, ignoring reinvested dividends). The most significant bear market was the 63% decline in the index between March 2000 and February 2009. During this nine-year period, the Nikkei lost 10% of its value annually. It also lost over -1.3 standard deviations of valuation, starting at fairly valued at 0.0 standard deviations and finishing -1.3 under-valued. While 2000-09 is well-known as the most significant bear market on record, the average decline over the four bear markets has been somewhat more subdued. On balance, the median depreciating phase 191

of the Nikkei´s valuation cycle lasted a little more than two-and-a-half years, and shaved 50% off the value of the index, resulting in a -19% annual loss. These bear markets have started from a median position of +0.3 standard deviations above the long-term average and have not ended until the index was under-valued by -0.8, for a median swing of -1.2 standard deviations. Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent December 2019 high of ¥23,656 the index had gained 213% over the 11 preceding years, making it the weakest (in annual terms) but longest bull market on record. Starting from the February 2009 low valuation of -1.3 standard deviations the index has posted 11% annual gains and is now over-valued at +1.3 standard deviations, implying a valuation swing of +2.6 standard deviations. In terms of duration the present bull market has been quite long (eight times the length of the median advance, and the longest since 1974-89). Its total gain of 213% is also the largest on record since the 1974-89 advance. The 11% annual gain is low by historical standards and marks the current rally as the weakest in at least 45 years. The current advance started from the most under-valued level ever (-1.3), and its current over-valuation of +1.3 is not only the most over-valued level since 1989, but also the largest relative valuation swing since the 1974-89 bull market. It is highly likely that the Nikkei is nearing the end of its bull market advance and poised for a multi-year decline.

Forecast Returns The return from holding a Japanese government bond is defined in advance. What is needed is an estimate of what the return on the Nikkei will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the Nikkei is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the Nikkei over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around -1.6% on the Nikkei over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor 192

also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the Nikkei as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the Nikkei to decrease by -10.4% annually. The forecasted range of annual returns is strictly negative, running from -12.5% to -9.1%. Our forecast model explains 59% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with only a 4% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The Nikkei currently offers a dividend yield of 2.5%, implying a 5-year total return of -7.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Japanese government bonds presently allow the investor to lock in a -0.1% annual yield. We forecast that the Nikkei will outperform comparable bonds by December 2024 with only a 10% probability.

The forecast 5-year total return of -7.9% contrasts with the current inflation rate of 0.8%. If the investor made investments denominated solely in Japanese yen, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the 193

nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the Nikkei will offer a real total return (including reinvested dividends) of -8.7% over the next five years. Over the coming 10-year period, we expect the Nikkei to fall by 3.2% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from -3.5% to -2.7%. Our forecast model explains 49% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 17% probability. The Nikkei ´s current dividend yield of 2.5% implies a 10-year total return of -0.7% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Japanese government bonds presently allow the investor to lock in a 0.0% yield. We forecast that the Nikkei 225 Index will outperform comparable bonds by December 2029 with a 42% probability.

The forecasted 10-year total return of -0.7% contrasts with the current inflation rate of 0.8% to result in an estimated real total return of -1.5% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different 194

markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The Nikkei ´s relative valuation of +1.3 standard deviations above its long-term mean is far above the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is extremely over-valued. As such, the Nikkei is the 40th most under-valued market of the group. We forecast that the index will yield an annual real total return of 8.7% over the coming five years, and -1.5% over the coming decade. Both returns are far below to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the Nikkei ranks 40th and 41st out of 43 markets for the 5- and 10-year total real return forecasts.

Nikkei 225 rankings, out of 43 markets

Relative Valuation

Nikkei 225 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

40th

40th

41st

40th

32nd

+1.3 +0.3

-8.7 3.3

-1.5 4.5

2 46

5 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is a 2% probability that the Nikkei can achieve this return by the end of 2024 and 5% by the end of 2029, ranking the index 40th and 32nd out of the 43 markets for both probabilities. On balance, it is highly likely that the Nikkei will under-perform the average global market over both the coming 5- and 10-year periods.

195

196

Malaysia FTSE Bursa Malaysia KLCI The FTSE Bursa Malaysia Kuala Lumpur Composite Index (KLCI) is the headline stock index of Malaysia. It is composed of the 30 largest companies listed on the Bursa Malaysia by market value, the composition of which is reviewed semi-annually. The KLCI is a floatadjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Public Bank Berhad, the Malaysian financial company, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the KLCI averaged 3.1% in 2019. The index is denominated in Malaysian ringgit.

The Bottom Line The KLCI finished 2019 at RM 1,588. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be RM 1,737, implying an under-valuation of -0.5 standard deviations. The last time the market had this valuation during a falling market was in August 2008, and historically it has been more overvalued than it is today 68% of the time. Over the coming 5-year period, we expect the KLCI to increase by 6.4% annually. The forecasted range of annual returns is strictly positive and tightly bound between 6.2% and 6.6%. Our forecast model explains 59% of the variation in the index´s 5-year returns since 197

December 1989. Consequently, we forecast that the index will breakeven by December 2024 with an 88% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The KLCI currently offers a dividend yield of 3.1%, implying a 5-year total return of 9.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Malaysian government bonds presently allow the investor to lock in a 3.2% annual yield. We forecast that the KLCI will outperform comparable bonds by December 2024 with an 88% probability. The forecast 5-year total return of 9.5% contrasts with the current inflation rate of 1.2%. We forecast that the KLCI will offer a real total return (including reinvested dividends) of 8.3% over the next five years. Over the coming 10-year period, we expect the KLCI to rise by 5.5% annually. The forecasted range of 10-year annual returns is bound 198

between 5.0% and 6.0%. Our forecast model explains 82% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The KLCI´s current dividend yield of 3.1% implies a 10-year total return of 8.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Malaysian government bonds presently allow the investor to lock in a 3.3% yield. We forecast that the KLCI Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 8.6% contrasts with the current inflation rate of 1.2% to result in an estimated real total return of 7.4% annually over the next decade.

Analysis The all-time monthly closing high of the KLCI was RM 1,882 in June 2014. In real, or inflation-adjusted terms, the market peaked in December 1993. Over the 30 years since December 1989, the index has yielded a price return of 3.5% annually. Since inflation over this same period has averaged 2.6%, the investor has earned an annual real price return of 0.9%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the KLCI. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the 199

index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the KLCI is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bear market phase of the KLCI started in June 2014 at a price of RM 1,882 and a relative valuation of +1.0 standard deviations above the average of the preceding 30-year period, more under-valued than only 16% of all previous months.

Since that high, the KLCI has declined to its November 2019 low of RM 1,561. At this low, the market was significantly under-valued with a relative valuation of -0.5. Thus, the index swung by -1.5 standard deviations since its bear market decline started. The index´s current correction has lost -3.0% annually since the 2017 high, and -0.1% including reinvested dividends.

Forecast Returns The return from holding a Malaysian government bond is defined in advance. What is needed is an estimate of what the return on the KLCI will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the KLCI is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of 200

over-valuation. We have developed two models to forecast the return of the KLCI over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 3.5% on the KLCI over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the KLCI as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the KLCI to increase by 6.4% annually. The forecasted range of annual returns is strictly positive and tightly bound between 6.2% and 6.6%. Our forecast model explains 59% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with an 88% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The KLCI currently offers a dividend yield of 3.1%, implying a 5-year total return of 9.5% annually. We can compare this total return to that which the investor could earn on an alternative 201

investment, e.g., 5-year government bonds. 5-year Malaysian government bonds presently allow the investor to lock in a 3.2% annual yield. We forecast that the KLCI will outperform comparable bonds by December 2024 with an 88% probability. The forecast 5-year total return of 9.5% contrasts with the current inflation rate of 1.2%. If the investor made investments denominated solely in Malaysian ringgit, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the KLCI will offer a real total return (including reinvested dividends) of 8.3% over the next five years.

Over the coming 10-year period, we expect the KLCI to rise by 5.5% annually. The forecasted range of 10-year annual returns is bound between 5.0% and 6.0%. Our forecast model explains 82% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The KLCI´s current dividend yield of 3.1% implies a 10-year total return of 8.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Malaysian government bonds presently allow the investor to lock in a 3.3% yield. We forecast that the KLCI Index will outperform comparable bonds by December 2029 with a 99% probability. 202

The forecasted 10-year total return of 8.6% contrasts with the current inflation rate of 1.2% to result in an estimated real total return of 7.4% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The KLCI´s relative valuation of -0.5 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is under-valued. As such, the KLCI is the 8th most undervalued market of the group. We forecast that the index will yield an annual real total return of 8.3% over the coming five years, and 7.4% over the coming decade. Both returns are far superior to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the KLCI ranks 9th out of 43 markets for both the 5- and 10-year total real return forecasts.

FTSE Malaysia KLCI rankings, out of 43 markets

Relative Valuation

FTSE Malaysia KLCI 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

8th

9th

9th

17th

16th

-0.5 +0.3

8.3 3.3

7.4 4.5

60 46

57 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 60% probability that the KLCI can achieve this return by the end of 2024 and 57% by the end of 2029, ranking the index 17th and 16th out 203

of the 43 markets for the two probabilities. On balance, it is highly likely that the KLCI will give comparable performance or slightly out-perform the average global market over both the coming 5- and 10-year periods.

204

Mauritius SEMDEX The SEMDEX is the benchmark stock index of Mauritius. It is composed of all rupee-denominated companies listed on the Stock Exchange of Mauritius by market value. The SEMDEX is a market capitalization index, meaning that each company´s contribution to the index is relative to its current market value. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the SEMDEX averaged 3.2% in 2019. The index is denominated in Mauritian rupee.

The Bottom Line The SEMDEX finished 2019 at Rs 2,177. Based on historical valuations dating to December 1989 (360 months), we estimate the fairvalue price to be Rs 2,517, implying an under-valuation of -0.7 standard deviations. The last time the index had this valuation during a rising market was in March 2004, and historically it has been more overvalued than it is today 74% of the time. Over the coming 5-year period, we expect the SEMDEX to increase by 11.5% annually. The forecasted range of annual returns is strictly positive and tightly bound between 11.5% and 11.6%. Our forecast model explains 58% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with a 96% probability. The total return from holding an index is composed of any price 205

appreciation or depreciation plus the forecasted dividend yield over the holding period. The SEMDEX currently offers a dividend yield of 3.2%, implying a 5-year total return of 14.7% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Mauritian government bonds presently allow the investor to lock in a 3.6% annual yield. We forecast that the SEMDEX will outperform comparable bonds by December 2024 with a 96% probability. SEMDEX Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

2,177 2,517 -0.7 3.2

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

2.5 3.6 4.3 3.0

5-Year Forecasts 5-Year Annual Forecast Price Return, % 11.5 5-Year Forecast Range, % (11.5, 11.6) 0.58 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 96 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

14.7 96

5-Year Annual Forecast Real Total Return, %

11.7

10-Year Forecasts 10-Year Annual Forecast Price Return, % 12.3 10-Year Forecast Range, % (11.4, 13.4) 0.64 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 99 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

15.5 99

10-Year Annual Forecast Real Total Return, %

12.5

The forecast 5-year total return of 14.7% contrasts with the current inflation rate of 3.0%. We forecast that the SEMDEX will offer a real total return (including reinvested dividends) of 11.7% over the next five years. Over the coming 10-year period, we expect the SEMDEX to rise by 12.3% annually. The forecasted range of 10-year annual returns is bound between 11.4% and 13.4%. Our forecast model explains 64% of the variation of the index´s 10-year returns since December 1989. 206

Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The SEMDEX´s current dividend yield of 3.2% implies a 10-year total return of 15.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Mauritian government bonds presently allow the investor to lock in a 4.3% yield. We forecast that the SEMDEX Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 15.5% contrasts with the current inflation rate of 3.0% to result in an estimated real total return of 12.5% annually over the next decade.

Analysis The all-time monthly closing high of the SEMDEX was Rs 2,292 in February 2018. In real, or inflation-adjusted terms, the market peaked in February 2008. Over the 30 years since December 1989, the index has yielded a price return of 10.2% annually, and a total return (including reinvested dividends) of 15.2%. Since inflation over this same period has averaged 6.6%, the investor has earned an annual real total return of 8.6%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the SEMDEX. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. 207

Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the SEMDEX is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the SEMDEX started in May 2016 at a price of Rs 1,746 and a relative valuation of -0.8 standard deviations under the average of the preceding 30-year period, more under-valued than 79% of all previous months.

Since that low, the SEMDEX has advanced to its February 2018 high of Rs 2,292. At this high, the market was approximately fairly valued with a relative valuation of -0.1. Thus, the index swung by +0.7 standard deviations since its bull market advance started. The index´s current advance has gained 6.3% annually since the 2016 low, and 9.8% including reinvested dividends.

Forecast Returns The return from holding a Mauritian government bond is defined in advance. What is needed is an estimate of what the return on the SEMDEX will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the SEMDEX is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of over-valuation. 208

We have developed two models to forecast the return of the SEMDEX over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 15.2% on the SEMDEX over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the SEMDEX as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the SEMDEX to increase by 11.5% annually. The forecasted range of annual returns is strictly positive and tightly bound between 11.5% and 11.6%. Our forecast model explains 58% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with a 96% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The SEMDEX currently offers a dividend yield of 3.2%, implying a 5-year total return of 14.7% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Mauritian 209

government bonds presently allow the investor to lock in a 3.6% annual yield. We forecast that the SEMDEX will outperform comparable bonds by December 2024 with a 96% probability. The forecast 5-year total return of 14.7% contrasts with the current inflation rate of 3.0%. If the investor made investments denominated solely in Mauritian rupee, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the SEMDEX will offer a real total return (including reinvested dividends) of 11.7% over the next five years.

Over the coming 10-year period, we expect the SEMDEX to rise by 12.3% annually. The forecasted range of 10-year annual returns is bound between 11.4% and 13.4%. Our forecast model explains 64% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The SEMDEX´s current dividend yield of 3.2% implies a 10-year total return of 15.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Mauritian government bonds presently allow the investor to lock in a 4.3% yield. We forecast that the SEMDEX Index will outperform comparable bonds by December 2029 with a 99% probability. 210

The forecasted 10-year total return of 15.5% contrasts with the current inflation rate of 3.0% to result in an estimated real total return of 12.5% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The SEMDEX´s relative valuation of -0.7 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is under-valued. As such, the SEMDEX is the 4th most under-valued market of the group. We forecast that the index will yield an annual real total return of 11.6% over the coming five years, and 12.3% over the coming decade. Both returns are far superior to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the SEMDEX ranks 4th and 3rd out of 43 markets for the 5- and 10-year total real return forecasts.

SEMDEX rankings, out of 43 markets

Relative Valuation

SEMDEX 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

4th

4th

3rd

5th

1st

-0.7 +0.3

11.6 3.3

12.3 4.5

83 46

99 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 83% probability that the SEMDEX can achieve this return by the end of 2024 and 99% by the end of 2029, ranking the index 5th and 1st 211

out of the 43 markets for the two probabilities. On balance, it is highly likely that the SEMDEX will out-perform the average global market over both the coming 5- and 10-year periods.

212

Mexico S&P/BMV IPC The Índice de Precios y Cotizaciones, more commonly known as the S&P/BMV IPC is the benchmark stock index of Mexico. It is currently composed of 35 large companies listed on the Bolsa Mexicana de Valores (Mexican Stock Exchange). The IPC is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. America Movil, the Mexican communication company, is currently the largest component of the index and consumer goods is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the IPC averaged 3.4% in 2019. The index is denominated in Mexican pesos.

The Bottom Line The IPC finished 2019 at $43,531. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $46,273, implying an under-valuation of -0.4 standard deviations. The last time the market had this valuation during a falling market was in November 2008, and historically it has been more over-valued than it is today 63% of the time. Over the coming 5-year period, we expect the IPC to increase by 13.4% annually. The forecasted range of annual returns is strictly positive and bound between 12.5% and 15.1%. Our forecast model explains 39% of the variation in the index´s 5-year returns since 213

December 1989. Consequently, we forecast that the index will breakeven by December 2024 with a 95% probability. S&P/BMV IPC Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

43,541 46,273 -0.4 3.4

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

7.2 6.7 6.8 2.8

5-Year Forecasts 5-Year Annual Forecast Price Return, % 13.4 5-Year Forecast Range, % (12.5, 15.1) 0.39 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 95 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

16.8 89

5-Year Annual Forecast Real Total Return, %

14.0

10-Year Forecasts 10-Year Annual Forecast Price Return, % 24.7 10-Year Forecast Range, % (22.1, 26.8) 0.63 Adjusted R2 Probability 10-Year Average Forecast Price Return > 0, % 99 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

28.1 99

10-Year Annual Forecast Real Total Return, %

25.3

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The IPC currently offers a dividend yield of 3.4%, implying a 5-year total return of 16.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Mexican government bonds presently allow the investor to lock in a 6.7% annual yield. We forecast that the IPC will outperform comparable bonds by December 2024 with an 89% probability. The forecast 5-year total return of 16.8% contrasts with the current inflation rate of 2.8%. We forecast that the IPC will offer a real total return (including reinvested dividends) of 14.0% over the next five years. Over the coming 10-year period, we expect the IPC to rise by 24.7% 214

annually. The forecasted range of 10-year annual returns is bound between 22.1% and 26.8%. Our forecast model explains 63% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The IPC´s current dividend yield of 3.4% implies a 10-year total return of 28.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Mexican government bonds presently allow the investor to lock in a 6.8% yield. We forecast that the IPC Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 28.1% contrasts with the current inflation rate of 2.8% to result in an estimated real total return of 25.3% annually over the next decade.

Analysis The all-time monthly closing high of the IPC was $51,210 in August 2017. In real, or inflation-adjusted terms, the market peaked in January 2013. Over the 30 years since December 1989, the index has yielded a price return of 16.7% annually. Since inflation over this same period has averaged 9.3%, the investor has earned an annual real price return of 7.4%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the IPC. This relative valuation is expressed in standard deviations from 215

the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the IPC is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bear market phase of the IPC started in August 2017 at a price of $51,210 and a relative valuation of +0.6 standard deviations above the average of the preceding 30-year period, more under-valued than 26% of all previous months.

Since that high, the IPC has declined to its July 2019 low of $40,863. At this low, the market was slightly under-valued with a relative valuation of -0.4. Thus, the index swung by -1.0 standard deviations since its bear market decline started. The index´s current correction has lost -6.7% annually since the 2017 high, and -4.3% including reinvested dividends.

Forecast Returns The return from holding a Mexican government bond is defined in advance. What is needed is an estimate of what the return on the IPC will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the IPC is highly dependent on its starting valuation relative 216

to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the IPC over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 16.7% on the IPC over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the IPC as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the IPC to increase by 13.4% annually. The forecasted range of annual returns is strictly positive and bound between 12.5% and 15.1%. Our forecast model explains 39% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with a 95% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The IPC currently offers a dividend yield of 3.4%, 217

implying a 5-year total return of 16.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Mexican government bonds presently allow the investor to lock in a 6.7% annual yield. We forecast that the IPC will outperform comparable bonds by December 2024 with an 89% probability. The forecast 5-year total return of 16.8% contrasts with the current inflation rate of 2.8%. If the investor made investments denominated solely in Mexican pesos, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the IPC will offer a real total return (including reinvested dividends) of 14.0% over the next five years. Over the coming 10-year period, we expect the IPC to rise by 24.7% annually. The forecasted range of 10-year annual returns is bound between 22.1% and 26.8%. Our forecast model explains 63% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability.

The IPC´s current dividend yield of 3.4% implies a 10-year total return of 28.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Mexican government bonds presently allow the investor to lock in a 6.8% yield. We forecast that the IPC 218

Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 28.1% contrasts with the current inflation rate of 2.8% to result in an estimated real total return of 25.3% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The IPC´s relative valuation of -0.4 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is under-valued. As such, the IPC is the 9th most under-valued market of the group. We forecast that the index will yield an annual real total return of 14.0% over the coming five years, and 25.3% over the coming decade. Both returns are far superior to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the IPC ranks 1st out of 43 markets for both the 5- and 10-year total real return forecasts.

S&P/BMV IPC rankings, out of 43 markets

Relative Valuation

S&P/BMV IPC 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

9th

1st

1st

11th

4th

-0.4 +0.3

14.0 3.3

25.3 4.5

73 46

97 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is 219

an 73% probability that the IPC can achieve this return by the end of 2024 and 97% by the end of 2029, ranking the index 11th and 4th out of the 43 markets for the two probabilities. On balance, it is highly likely that the IPC will out-perform the average global market over both the coming 5- and 10-year periods.

220

Netherlands AEX The Amsterdam Exchange Index (AEX) is widely recognized as the benchmark stock index of the Netherlands. It is composed of the 25 companies with the highest trading volume listed on the Euronext Amsterdam exchange (formerly the Amsterdam Stock Exchange) by float-adjusted market value. The index´s composition is rebalanced on a quarterly basis. The AEX is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. ASML Holding, the Dutch technology company, is currently the largest component of the index and technology is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the AEX averaged 4.6% in 2019. The index is denominated in euros.

The Bottom Line The AEX finished 2019 at €604. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be €554, implying a fairly valued market with a relative valuation of 0.0 standard deviations (this occurs since the normal state of affairs for the Dutch market over the past 30 years has been an over-valuation equal to the current level). The last time the index had this valuation during a rising market was in August 2015, and historically it has been more over-valued than it is today 50% of the time. Over the coming 5-year period, we expect the AEX to decrease by 221

-3.0% annually. The forecasted range of annual returns is bound between -8.3% and 0.8%. Our forecast model explains 69% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 32% probability. AEX Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

604 554 0.0 4.6

Government Bond Yields, % 1-Year* 5-Year 10-Year Inflation

-0.6 -0.4 -0.1 2.7

5-Year Forecasts 5-Year Annual Forecast Price Return, % -3.0 5-Year Forecast Range, % (0.8, -8.3) 0.69 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 32 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

1.6 62

5-Year Annual Forecast Real Total Return, %

-1.1

10-Year Forecasts 10-Year Annual Forecast Price Return, % -3.0 10-Year Forecast Range, % (-6.3, 0.1) 0.88 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 11 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

1.6 76

10-Year Annual Forecast Real Total Return, %

-1.1

* 2-year bond

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The AEX currently offers a dividend yield of 4.6%, implying a 5-year total return of 1.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Dutch government bonds presently allow the investor to lock in a -0.4% annual yield. We forecast that the AEX will outperform comparable bonds by December 2024 with a 62% probability. 222

The forecast 5-year total return of 1.6% contrasts with the current inflation rate of 2.7%. We forecast that the AEX will offer a real total return (including reinvested dividends) of -1.1% over the next five years. Over the coming 10-year period, we expect the AEX to fall by 3.0% annually. The forecasted range of 10-year annual returns is bound between -6.3% and 0.1%. Our forecast model explains 88% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with an 11% probability. The AEX´s current dividend yield of 4.6% implies a 10-year total return of 1.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Dutch government bonds presently allow the investor to lock in a -0.1% yield. We forecast that the AEX will outperform comparable bonds by December 2029 with a 76% probability. The forecasted 10-year total return of 1.6% contrasts with the current inflation rate of 2.7% to result in an estimated real total return of -1.1% annually over the next decade.

Analysis The all-time monthly closing high of the AEX was €689 in August 2000, the same month the market peaked in real, or inflation-adjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 5.1% annually. Since inflation over this same period has averaged 2.0%, the investor has earned an annual real total return of 3.1%. Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the AEX. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the AEX is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

223

The current bull market phase of the AEX started in February 2009 at a price of €216 and a relative valuation of -1.2 standard deviations under the average of the preceding 30-year period, more under-valued than 89% of all previous months.

Since that low, the AEX has advanced to its December 2019 high of €604. At this high, the market was fairly valued with a relative valuation of 0.0. Thus, the index swung by +1.2 standard deviations since its bull market advance started. The index´s current advance has gained 9.8% annually since the 2009 low, and 13.6% including reinvested dividends.

224

Forecast Returns The return from holding a Dutch government bond is defined in advance. What is needed is an estimate of what the return on the AEX will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the AEX is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the AEX over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 5.1% on the AEX over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the AEX as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the AEX to decrease by -3.0% annually. The forecasted range of annual returns is bound between -8.3% and 0.8%. Our forecast model explains 69% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 32% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The AEX currently offers a dividend yield of 4.6%, implying a 5-year total return of 1.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Dutch government bonds presently allow the investor to lock in a -0.4% annual yield. We forecast that the AEX will outperform comparable bonds by December 2024 with a 62% probability.

225

The forecast 5-year total return of 1.6% contrasts with the current inflation rate of 2.7%. If the investor made investments denominated solely in euros, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the AEX will offer a real total return (including reinvested dividends) of -1.1% over the next five years. Over the coming 10-year period, we expect the AEX to fall by 3.0% annually. The forecasted range of 10-year annual returns is bound between -6.3% and 0.1%. Our forecast model explains 88% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with an 11% probability. The AEX´s current dividend yield of 4.6% implies a 10-year total return of 1.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Dutch government bonds presently allow the investor to lock in a -0.1% yield. We forecast that the AEX will outperform comparable bonds by December 2029 with a 76% probability.

226

The forecasted 10-year total return of 1.6% contrasts with the current inflation rate of 2.7% to result in an estimated real total return of -1.1% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The AEX´s relative valuation of 0.0 standard deviations is lower than the average of the 43 markets analyzed herein (a slight overvaluation of +0.3 standard deviations) and implies that the index is fairly valued. As such, the AEX is the 23rd most under-valued market of the group, just about the middle of the pack. We forecast that the index will yield an annual real total return of 1.1% over the both coming five and ten years. Both returns are far below to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the AEX ranks 33rd and 38th out of 43 markets for the 5- and 10-year total real return forecasts. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of 227

accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 32% probability that the AEX can achieve this return by the end of 2024 and 8% by the end of 2029, ranking the index 24th and 29th out of the 43 markets for the two probabilities.

AEX rankings, out of 43 markets

Relative Valuation rd

23 AEX 43 Country Avg.

0.0 +0.3

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

rd

33

-1.1 3.3

10-Year

th

38

-1.1 4.5

5-Year

th

24

32 46

10-Year

29th 8 46

On balance, it is highly likely that the AEX will under-perform the average global market over both the coming 5- and 10-year periods.

228

New Zealand S&P/NZX 50 The S&P/NZX 50 (NZ50) is widely recognized to be the benchmark stock index of New Zealand. It is composed of the 50 largest companies listed on the New Zealand Exchange by float-adjusted market value. The index´s composition is rebalanced on a quarterly basis. The NZ50 is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Fisher & Paykel Healthcare Corporation, the New Zealand health care company, is currently the largest component of the index and health care is the largest industry. The index covers approximately 90% of the value of the New Zealand equity market. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the NZ50 averaged 4.4% in 2019. The index is denominated in New Zealand dollars.

The Bottom Line The NZ50 finished 2019 at $4,924. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $3,069, implying an over-valuation of +3.0 standard deviations. By this measure, the market has never been this over-valued in its history. Over the coming 5-year period, we expect the NZ50 to decrease by -13.8% annually. The forecasted range of annual returns is strictly 229

negative, running from-17.7% to -10.7%. Our forecast model explains 77% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a less than 1% probability. S&P/NZX 50 Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

4,924 3,069 +3.0 4.4

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.2 1.4 1.7 2.0

5-Year Forecasts 5-Year Average Forecast Price Return, % -13.8 5-Year Forecast Range, % (-17.7, -10.7) 0.77 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 5-Year Bond, %

-9.4 0, % 12 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

-0.6 29

10-Year Annual Forecast Real Total Return, %

-2.6

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The NZ50 currently offers a dividend yield of 4.4%, implying a 5-year total return of -9.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year New Zealand government bonds presently allow the investor to lock in a 1.4% annual yield. We forecast that the NZ50 will outperform comparable bonds by December 2024 with a less than 1% probability. The forecast 5-year total return of -9.4% contrasts with the current inflation rate of 2.0%. We forecast that the NZ50 will offer a real total return (including reinvested dividends) of -11.4% over the next five 230

years. Over the coming 10-year period, we expect the NZ50 to fall by 5.0% annually. The forecasted range of 10-year annual returns is strictly negative, running from -7.4% to -4.2%. Our forecast model explains 30% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 12% probability. The NZ50´s current dividend yield of 4.4% implies a 10-year total return of -0.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year New Zealand government bonds presently allow the investor to lock in a 1.7% yield. We forecast that the NZ50 Index will outperform comparable bonds by December 2029 with a 29% probability. The forecasted 10-year total return of -0.6% contrasts with the current inflation rate of 2.0% to result in an estimated real total return of -2.6% annually over the next decade.

Analysis The all-time monthly closing high of the NZ50 was $4,924 in December 2019. In real, or inflation-adjusted terms, the market peaked in August 1989. Over the 30 years since December 1989, the index has yielded a price return of 2.3% annually, and a total return (including reinvested dividends) of 8.8%. Since inflation over this same period has averaged 2.0%, the investor has earned an annual real total return of 6.8%.

231

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the NZ50. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the NZ50 is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The current bull market phase of the NZ50 started in February 2009 at a price of $1,767 and a relative valuation of -1.9 standard deviations under the average of the preceding 30-year period, more under-valued than 97% of all previous months. Since that low, the NZ50 has advanced to its December 2019 high of $4,925. At this high, the market was over-valued with a relative valuation of +3.0. Thus, the index swung by +4.9 standard deviations since its bull market advance started. The index´s current advance has gained 9.9% annually since the 2009 low, and 15.0% including reinvested dividends.

Forecast Returns The return from holding a New Zealand government bond is defined in advance. What is needed is an estimate of what the return on the NZ50 will be over some future holding period to determine which 232

investment will prove superior: bonds or equities. As we have seen, the future return of the NZ50 is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the NZ50 over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 8.8% on the NZ50 over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the NZ50 as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the NZ50 to decrease by -13.8% annually. The forecasted range of annual returns is strictly negative, running from-17.7% to -10.7%. Our forecast model explains 77% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a less than 1% probability.

The total return from holding an index is composed of any price 233

appreciation or depreciation plus the forecasted dividend yield over the holding period. The NZ50 currently offers a dividend yield of 4.4%, implying a 5-year total return of -9.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year New Zealand government bonds presently allow the investor to lock in a 1.4% annual yield. We forecast that the NZ50 will outperform comparable bonds by December 2024 with a less than 1% probability. The forecast 5-year total return of -9.4% contrasts with the current inflation rate of 2.0%. If the investor made investments denominated solely in New Zealand dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the NZ50 will offer a real total return (including reinvested dividends) of 11.4% over the next five years. Over the coming 10-year period, we expect the NZ50 to fall by 5.0% annually. The forecasted range of 10-year annual returns is strictly negative, running from -7.4% to -4.2%. Our forecast model explains 30% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 12% probability.

The NZ50´s current dividend yield of 4.4% implies a 10-year total return of -0.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year 234

government bonds. 10-year New Zealand government bonds presently allow the investor to lock in a 1.7% yield. We forecast that the NZ50 Index will outperform comparable bonds by December 2029 with a 29% probability. The forecasted 10-year total return of -0.6% contrasts with the current inflation rate of 2.0% to result in an estimated real total return of -2.6% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The NZ50´s relative valuation of +3.0 standard deviations above its long-term mean is far greater than the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is extremely over-valued. As such, the NZ50 is the least under-valued market of the group, 43rd out of 43 markets. We forecast that the index will yield an annual real total return of 11.4% over the coming five years, and -2.6% over the coming decade. Both returns are far below to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the NZ50 ranks 40th and 39th out of 43 markets for the 5- and 10-year total real return forecasts.

S&P/NZX 50 rankings, out of 43 markets

Relative Valuation

S&P/NZX 50 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

43rd

40th

39th

40th

33rd

+3.0 +0.3

-11.4 3.3

-2.6 4.5

0, % 97 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

-

5-Year Annual Forecast Real Total Return, %

-

10-Year Forecasts 10-Year Annual Forecast Price Return, % 21.5 10-Year Forecast Range, % (21.0, 21.9) 0.62 Adjusted R2 Probability 10-Year Average Forecast Price Return > 0, % 99 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

-

10-Year Annual Forecast Real Total Return, %

-

Over the coming 10-year period, we expect the NSE to rise by 21.5% annually. The forecasted range of 10-year annual returns is tightly bound between 21.0% and 21.9%. Our forecast model explains 62% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The forecasted 10-year price return of 21.5% contrasts with the current inflation rate of 12.4% to result in an estimated real total return of 9.1% annually over the next decade.

238

Analysis The all-time monthly closing high of the NSE was ₦65,652 in February 2008, the same month as it peaked in real, or inflation-adjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 15.9% annually. Since inflation over this same period has averaged 20.5%, the investor has earned an annual real price return of -4.6%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the NSE. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the NSE is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the NSE started in March 2009 at a price of ₦19,852 and a relative valuation of -0.3 standard deviations below the average of the preceding 30-year period, more under-valued than 62% of all previous months. Since that low, the NSE has advanced to its April 2018 high of ₦41,268. At this high, the market was even further under-valued with a relative valuation of -0.6. Thus, the index swung by -0.3 standard deviations since its bull market advance started. This decline in relative valuation during a bull market typically signals that there is still 239

significant room in the advance.

The index´s current advance has gained 2.9% annually since the 2009 low, though inflation has averaged 12.5% over the period implying an annual real price return of -9.4%.

Forecast Returns The return from holding a Nigerian government bond is defined in advance. What is needed is an estimate of what the return on the NSE will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the NSE is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the NSE over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 15.9% on the NSE over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the NSE as the basis for forecasting future returns. They also look at interest rates, the yield 240

curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the NSE to increase by 29.7% annually. The forecasted range of annual returns is strictly positive and bound between 27.7% and 32.1%. Our forecast model explains 37% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with a 97% probability.

There is no information available on the total return of the index from which to calculate its dividend yield. As such no forecast of the NSE´s total return can be estimated. The forecast 5-year price return of 29.7% contrasts with the current inflation rate of 12.4%. If the investor made investments denominated solely in Nigerian naira, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the NSE will offer a real total return (including reinvested dividends) of 17.3% over the next five years. Over the coming 10-year period, we expect the NSE to rise by 21.5% annually. The forecasted range of 10-year annual returns is tightly bound between 21.0% and 21.9%. Our forecast model explains 62% of the variation of the index´s 10-year returns since December 241

1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability.

The forecasted 10-year price return of 21.5% contrasts with the current inflation rate of 12.4% to result in an estimated real total return of 9.1% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The NSE´s relative valuation of -1.3 standard deviations below its long-term mean is significantly below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is under-valued. As such, the NSE is the most under-valued market of the group.

242

NSE All Share rankings, out of 43 markets

Relative Valuation st

1

NSE All Share 43 Country Avg.

-1.3 +0.3

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

n.a.

n.a.

n.a.

n.a.

3.3

4.5

46

46

Lacking dividend data we cannot make any further forecasts concerning the future total returns of the index.

243

244

Norway OBX The OBX Index is the main stock index of Norway. It is composed of the 25 most widely traded securities listed on the Oslo Børs (Oslo Stock Exchange) by float-adjusted market value. The index´s composition is rebalanced on a semi-annual basis. The OBX is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Equinor, the Norwegian energy company formerly known as Statoil, is currently the largest component of the index and oil and gas is the largest industry. Unlike most indexes, the OBX is commonly quoted in its total return form, including the effects of reinvested dividends in its calculation. Unless otherwise noted, we use the values of the OBX price index in the following report to make the analysis consistent with other markets. The dividend yield of the index averaged 4.7% in 2019. The index is denominated in Norwegian kroner.

The Bottom Line The OBX finished 2019 at 477 kr. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be 511 kr, implying an under-valuation of -0.4 standard deviations. The last time the index had this valuation during a rising market was in July 2017, and historically it has been more over-valued than it is today 65% of the time. Over the coming 5-year period, we expect the OBX to increase by 8.9% annually. The forecasted range of annual returns is strictly positive, running from 8.2% to 9.8%. Our forecast model explains 73% 245

of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 98% probability. OBX Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

477 511 -0.4 4.7

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.3 1.4 1.6 1.4

5-Year Forecasts 5-Year Annual Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

8.9 (8.2, 9.8) 0.73 98

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

13.6 99

5-Year Annual Forecast Real Total Return, %

12.2

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

6.3 (5.3, 6.8) 0.55 99

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

11.0 99

10-Year Annual Forecast Real Total Return, %

9.6

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The OBX currently offers a dividend yield of 4.7%, implying a 5-year total return of 13.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Norwegian government bonds presently allow the investor to lock in a 1.4% annual yield. We forecast that the OBX will outperform comparable bonds by December 2024 with a 99% probability. The forecast 5-year total return of 13.6% contrasts with the current inflation rate of 1.4%. We forecast that the OBX will offer a real total return (including reinvested dividends) of 12.2% over the next five 246

years. Over the coming 10-year period, we expect the OBX to rise by 6.3% annually. The forecasted range of 10-year annual returns is bound around this level, running from 5.3% to 6.8%. Our forecast model explains 55% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 99% probability. The OBX´s current dividend yield of 4.7% implies a 10-year total return of 11.0% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Norwegian government bonds presently allow the investor to lock in a 1.6% yield. We forecast that the OBX Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 11.0% contrasts with the current inflation rate of 1.4% to result in an estimated real total return of 9.6% annually over the next decade.

Analysis The all-time monthly closing high of the OBX was 517 kr in September 2018. In real, or inflation-adjusted terms, the market peaked in October 2007. Over the 30 years since December 1989, the index has yielded a price return of 5.3% annually, and a total return (including reinvested dividends) of 9.1%. Since inflation over this same period has averaged 2.2%, the investor has earned an annual real total return of 6.9%.

Using historical price, dividend, macroeconomic and financial data 247

dating to December 1989, we can compute the relative valuation of the OBX. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the OBX is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The current bear market phase of the OBX started in September 2018 at a price of 517 kr and a relative valuation of +0.2 standard deviations above the average of the preceding 30-year period, more over-valued than 58% of all previous months. Since that high, the OBX has declined to its December 2018 low of 436 kr. At this low, the market was under-valued with a relative valuation of -0.6. Thus, the index swung by -0.8 standard deviations since its bear market decline started. The correction was relatively mild, erasing -16% off the index´s value. It´s swiftness, however, made for a 50% annualized loss.

Forecast Returns The return from holding a Norwegian government bond is defined in advance. What is needed is an estimate of what the return on the OBX will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future 248

return of the OBX is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the OBX over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 9.1% on the OBX over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the OBX as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the OBX to increase by 8.9% annually. The forecasted range of annual returns is strictly positive, running from 8.2% to 9.8%. Our forecast model explains 73% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 98% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the 249

holding period. The OBX currently offers a dividend yield of 4.7%, implying a 5-year total return of 13.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Norwegian government bonds presently allow the investor to lock in a 1.4% annual yield. We forecast that the OBX will outperform comparable bonds by December 2024 with a 99% probability. The forecast 5-year total return of 13.6% contrasts with the current inflation rate of 1.4%. If the investor made investments denominated solely in Norwegian kroner, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the OBX will offer a real total return (including reinvested dividends) of 12.2% over the next five years. Over the coming 10-year period, we expect the OBX to rise by 6.3% annually. The forecasted range of 10-year annual returns is bound around this level, running from 5.3% to 6.8%. Our forecast model explains 55% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 99% probability.

The OBX´s current dividend yield of 4.7% implies a 10-year total return of 11.0% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Norwegian government bonds presently 250

allow the investor to lock in a 1.6% yield. We forecast that the OBX Index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 11.0% contrasts with the current inflation rate of 1.4% to result in an estimated real total return of 9.6% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The OBX´s relative valuation of -0.4 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is under- valued. As such, the OBX is the 9th most undervalued market of the group. We forecast that the index will yield an annual real total return of 12.2% over the coming five years, and 9.6% over the coming decade. Both returns are far superior to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the OBX ranks 3rd and 4th out of 43 markets for the 5- and 10-year total real return forecasts.

OBX rankings, out of 43 markets

Relative Valuation

OBX 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

9th

3rd

4th

1st

3rd

-0.4 +0.3

12.2 3.3

9.6 4.5

96 46

98 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given 251

the explanatory power of our forecast models we estimate that there is a 96% probability that the OBX can achieve this return by the end of 2024 and 98% by the end of 2029, ranking the index 1st and 3rd out of the 43 markets for the two probabilities. On balance, it is highly likely that the OBX will out-perform the average global market over both the coming 5- and 10-year periods.

252

Philippines PSE Composite The PSE Composite Index (PSEi) is the headline stock index of the Philippines. It is composed of the shares of the 30 largest companies listed on the Philippine Stock Exchange by market value. The index´s composition is rebalanced on a semi-annual basis. The PSEi is a floatadjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. SM Prime Holdings, the Philippine property developer, is currently the largest component of the index and industrials is the largest industry. The index is denominated in Philippine pesos.

The Bottom Line The PSEi finished 2019 at ₱7,815. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be ₱6,006, implying an over-valuation of +0.5 standard deviations. The last time the index was this over-valued in a declining market was July 1997 and historically it has been more over-valued than it is today just 31% of the time. Over the coming 5-year period, we expect the PSEi to increase by 1.6% annually. The forecasted range of annual returns is strictly positive and bound between 0.7% and 2.1%. Our forecast model explains 52% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with a 57% probability. There is no information available on the total return of the index from which to calculate its dividend yield. As such no forecast of the 253

PSEi´s total return can be estimated.

PSEi Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

7,815 6,006 +0.5 --

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

3.5 4.0 4.4 5.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

1.6 (0.7, 2.1) 0.52 57

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

-

5-Year Annual Forecast Real Total Return, %

-

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

3.7 (3.2, 4.1) 0.83 88

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

-

10-Year Annual Forecast Real Total Return, %

-

The forecast 5-year price return of 1.6% contrasts with the current inflation rate of 5.3%. We forecast that the PSEi will offer a real price return (not including reinvested dividends) of -3.8% over the next five years. Over the coming 10-year period, we expect the PSEi to rise by 3.7% annually. The forecasted range of 10-year annual returns is bound between 3.2% and 4.1%. Our forecast model explains 83% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 254

2029 with an 88% probability. The forecasted 10-year price return of 3.7% contrasts with the current inflation rate of 5.3% to result in an estimated real price return of -1.6% annually over the next decade.

Analysis The all-time monthly closing high of the PSEi was ₱8,764 in January 2018. Its peak in real, or inflation-adjusted terms, was in December 1993. Over the 30 years since December 1989, the index has yielded a price return of 6.7% annually. Since inflation over this same period has averaged 5.7%, the investor has earned an annual real price return of 1.0%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the PSEi. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the PSEi is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the PSEi started in January 2009 at a price of ₱1,825 and a relative valuation of -1.4 standard deviations below the average of the preceding 30-year period, more under-valued 255

than 92% of all previous months.

Since that low, the PSEi has advanced to its April 2018 high of ₱8,764. At this high, the market was over-valued with a relative valuation of +1.3. Thus, the index swung by +2.7 standard deviations since its bull market advance started.

Forecast Returns The return from holding a Philippine government bond is defined in advance. What is needed is an estimate of what the return on the PSEi will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the PSEi is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the PSEi over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 6.7% on the PSEi over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the PSEi as the basis for 256

forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the PSEi to increase by 1.6% annually. The forecasted range of annual returns is strictly positive and bound between 0.7% and 2.1%. Our forecast model explains 52% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with a 57% probability. There is no information available on the total return of the index from which to calculate its dividend yield. As such no forecast of the PSEi´s total return can be estimated.

The forecast 5-year price return of 1.6% contrasts with the current inflation rate of 5.3%. If the investor made investments denominated solely in Philippine pesos, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the PSEi will offer a real price return (not including reinvested dividends) of -3.8% over the next five years. Over the coming 10-year period, we expect the PSEi to rise by 3.7% annually. The forecasted range of 10-year annual returns is bound 257

between 3.2% and 4.1%. Our forecast model explains 83% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with an 88% probability.

The forecasted 10-year price return of 3.7% contrasts with the current inflation rate of 5.3% to result in an estimated real price return of -1.6% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years.

PSEi rankings, out of 43 markets

Relative Valuation

PSEi 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

27th

n.a.

n.a.

n.a.

n.a.

+0.5 +0.3

3.3

4.5

46

46

This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the 258

closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most overvalued, or that it is expected to yield the lowest return in the future. The PSEi´s relative valuation of +0.5 standard deviations above its long-term mean is marginally higher than the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is over-valued. As such, the PSEi the 27th most under-valued market of the group. Lacking dividend data we cannot make any further forecasts concerning the future total returns of the index.

259

260

Singapore FTSE Straits Times Index The FTSE Straits Times Index (STI) is the benchmark index for Singapore. It is composed of the 30 largest and most liquid companies listed on the Singapore Exchange. The index´s composition is rebalanced on a semi-annual basis. The STI is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. DBS Bank, the Singaporean financial company, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the STI averaged 4.9% in 2019. The index is denominated in Singapore dollars.

The Bottom Line The STI finished 2019 at $3,222. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $3,311, implying an under-valuation of -0.2 standard deviations. The last time the market had this valuation during a declining market was in August 2015, and historically it has been more over-valued than it is today 59% of the time. Over the coming 5-year period, we expect the STI to increase by 4.1% annually. The forecasted range of annual returns is strictly positive and tightly bound between 4.0% to 4.3%. Our forecast model explains 45% of the variation in the index´s 5-year returns since 261

December 1989. Consequently, we forecast that the index will breakeven by December 2024 with an 80% probability. FTSE Straits Times Index (STI) Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

3,222 3,311 -0.2 4.9

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.7 0.6 1.7 0.8

5-Year Forecasts 5-Year Annual Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

4.1 (4.0, 4.3) 0.45 80

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

9.0 94

5-Year Annual Forecast Real Total Return, %

8.2

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

4.8 (4.6, 5.0) 0.64 99

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

9.7 99

10-Year Annual Forecast Real Total Return, %

8.9

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The STI currently offers a dividend yield of 4.9%, implying a 5-year total return of 9.0% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Singapore government bonds presently allow the investor to lock in a 0.6% annual yield. We forecast that the STI will outperform comparable bonds by December 2024 with a 94% probability. The forecast 5-year total return of 9.0% contrasts with the current inflation rate of 0.8%. We forecast that the STI will offer a real total return (including reinvested dividends) of 8.2% over the next five years. Over the coming 10-year period, we expect the STI to rise by 4.8% annually. The forecasted range of 10-year annual returns is tightly 262

bound around this level, running from 4.6% to 5.0%. Our forecast model explains 64% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 99% probability. The STI´s current dividend yield of 4.9% implies a 10-year total return of 9.7% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Singapore government bonds presently allow the investor to lock in a 1.7% yield. We forecast that the STI will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 9.7% contrasts with the current inflation rate of 0.8% to result in an estimated real total return of 8.9% annually over the next decade.

Analysis The all-time monthly closing high of the STI was $3,805 in October 2000, the same month the market peaked in real, or inflation-adjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 2.6% annually. Since inflation over this same period has averaged 1.6%, the investor has earned an annual real price return of 2.0%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the STI. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the 263

index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the STI is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bear market phase of the STI started in April 2018 from a relative valuation of +0.4 standard deviations above the average of the preceding 30-year period, more under-valued than 35% of all previous months. Since December 1999 the STI has undergone two complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market. Each bull market since 1999 has begun from a relatively undervalued position, on average -1.8 standard deviations below its longterm mean. The median duration of these bull market phases has been 6.7 years, with a median total gain of 153%. On an annual basis, these advances have offered a median price return of 18% (ignoring the effect of dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued territory, typically completing their cycle +0.9 standard deviations over-valued relative to the long-term average. The median cycle sees its relative valuation swing by +3.1 standard deviations. 264

The index´s most significant bull market took place between March 2003 and June 2007. During this four-year period, the STI never suffered a decline that pushed its relative valuation into negative territory, an event necessary to mark the end of a long-term advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 180% over this period, or about 27% annually (in price terms, ignoring reinvested dividends). The 2003 low saw the index under-valued by -1.2 standard deviations, and the rally would not be completed until the STI was +2.2 standard deviations over-valued. The change in relative valuation of +3.4 standard deviations is the most extreme swing on record. Straits Times Index: Bull and Bear Market Summary Declines Start End Date Date Dec-99 Mar-03

Start STI 2,479

End STI 1,267

Jun-07 Feb-09

3,548

1,594

Apr-18 Oct-18

3,613

3,018

Advances

Total Annual Change, % Change, % -49 -19 -55 -16

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

Start Date

End Date

Start STI

End STI

Total Annual Change, % Change, %

Mar-03 Jun-07

1,267

3,548

180

27

Feb-09 Apr-18

1,594

3,613

127

9

-38 -30 2.5 -52.0 -28.3 0.9 -3.3

6.7 153.3 18.4 -1.8 3.1

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

The most significant bear market was the 55% decline in the index between June 2007 and February 2009. During this 20-month period, the STI lost 38% of its value annually. It also lost over -4.5 standard deviations of valuation, starting at +2.2 standard deviations overvalued and finishing -2.3 under-valued. While 2007-09 is well-known as the most significant bear market on record, the average decline over the two bear markets has been somewhat more subdued. On balance, the median depreciating phase of the STI´ valuation cycle lasted two-and-a-half years, and shaved 52% off the value of the index, resulting in a -28% annual loss. These bear markets have started from a median position of +0.9 standard deviations above the long-term average and have not ended until the index was under-valued by -1.8, for a median swing of -3.3 standard deviations. Taking these averages into account, we can look at the current bear market and estimate how close the index is to completing the present phase. At the recent October 2018 low of $3,018 the index had lost 16% over the six preceding months, making it the weakest and shortest bear market on record. Starting from the April 2018 high valuation of +0.4 standard deviations the index has posted 30% annual losses and is now under-valued at -0.5 standard deviations, implying a valuation swing of -0.9 standard deviations. In terms of duration the present bear market has been quite short 265

(less than a fifth the length of the median decline), and its total loss of -16% is less than half the median decline. The -30% annualized loss between April and October 2018, however, is on par with the annual losses of the preceding declines. The current decline started from the least over-valued level of any bear market (+0.4), and its decline to an under-valuation of -0.5 standard deviations represents the weakest valuation swing to date.

Forecast Returns The return from holding a Singapore government bond is defined in advance. What is needed is an estimate of what the return on the STI will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the STI is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the STI over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 2.6% on the STI over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the STI as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the STI to increase by 4.1% annually. The forecasted range of annual returns is strictly positive and tightly bound between 4.0% to 4.3%. Our forecast model explains 45% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with an 80% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The STI currently offers a dividend yield of 4.9%, implying a 5-year total return of 9.0% annually. We can compare this 266

total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Singapore government bonds presently allow the investor to lock in a 0.6% annual yield. We forecast that the STI will outperform comparable bonds by December 2024 with a 94% probability. The forecast 5-year total return of 9.0% contrasts with the current inflation rate of 0.8%. If the investor made investments denominated solely in Singapore dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.)

For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflationadjusted) return allows for a simple method to compare returns internationally. We forecast that the STI will offer a real total return (including reinvested dividends) of 8.2% over the next five years. Over the coming 10-year period, we expect the STI to rise by 4.8% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from 4.6% to 5.0%. Our forecast model explains 64% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 99% probability. The STI´s current dividend yield of 4.9% implies a 10-year total return of 9.7% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Singapore government bonds presently allow the investor to lock in a 1.7% yield. We forecast that the STI will outperform comparable bonds by December 2029 with a 99% 267

probability.

The forecasted 10-year total return of 9.7% contrasts with the current inflation rate of 0.8% to result in an estimated real total return of 8.9% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The STI´s relative valuation of -0.2 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is somewhat under-valued, both in absolute terms and relative to the global average. As such, the STI is the 17th most undervalued market of the group, just about the middle of the pack. We forecast that the index will yield an annual real total return of 8.2% over the coming five years, and 8.9% over the coming decade. Both returns are far superior to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the STI ranks 10th and 5th out of 43 markets for the 5- and 10-year total real return forecasts. 268

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is a 70% probability that the STI can achieve this return by the end of 2024 and 93% by the end of 2029, ranking the index 12th and 8th out of the 43 markets for both probabilities.

FTSE Straits Times Index rankings, out of 43 markets

Relative Valuation

FTSE Straits Times 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

17th

10th

5th

12th

8th

-0.2 +0.3

8.2 3.3

8.9 4.5

70 46

93 46

On balance, it is highly likely that the STI will out-perform the average global market over both the coming 5- and 10-year periods.

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270

South Africa FTSE/JSE All-Share The FTSE/JSE All-Share Index (JSE) is the widely recognized as the benchmark share index for South Africa. It is composed of all companies listed on the Johannesburg Stock Exchange. The JSE is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Naspers, the multinational internet group headquartered in South Africa, is currently the largest component of the index and basic materials (mostly mining) is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the JSE averaged 5.0% in 2019. The index is denominated in South African rand.

The Bottom Line The JSE finished 2019 at R 57,084. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be R 64,979, implying an under-valuation of -0.6 standard deviations. The last time the index had this valuation during a rising market was in April 2009, and historically it has been more over-valued than it is today 73% of the time. Over the coming 5-year period, we expect the JSE to increase by 12.4% annually. The forecasted range of annual returns is strictly positive, running from 11.5% to 14.1%. Our forecast model explains 45% of the variation in the index´s 5-year returns since December 271

1989. Consequently, we forecast that the index will break-even by December 2024 with a 99% probability.

FTSE/JSE All-Share Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

57,084 64,979 -0.6 5.0

Government Bond Yields, % 1-Year* 5-Year 10-Year Inflation

6.7 7.2 8.3 4.0

5-Year Forecasts 5-Year Annual Forecast Price Return, % 12.4 5-Year Forecast Range, % (14.1, 11.5) 0.45 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 99 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

17.4 99

5-Year Annual Forecast Real Total Return, %

13.4

10-Year Forecasts 10-Year Annual Forecast Price Return, % 11.8 10-Year Forecast Range, % (11.3, 12.3) 0.67 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 99 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

16.8 99

10-Year Annual Forecast Real Total Return, %

12.8

* 2-year bond

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The JSE currently offers a dividend yield of 5.0%, implying a 5-year total return of 17.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year South African government bonds presently allow the investor to lock in a 7.2% annual 272

yield. We forecast that the JSE will outperform comparable bonds by December 2024 with a 99% probability. The forecast 5-year total return of 17.4% contrasts with the current inflation rate of 4.0%. We forecast that the JSE will offer a real total return (including reinvested dividends) of 13.4% over the next five years. Over the coming 10-year period, we expect the JSE to rise by 11.8% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from 11.3% to 12.3%. Our forecast model explains 67% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 99% probability. The JSE´s current dividend yield of 5.0% implies a 10-year total return of 16.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year South African government bonds presently allow the investor to lock in an 8.3% yield. We forecast that the JSE will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 16.8% contrasts with the current inflation rate of 4.0% to result in an estimated real total return of 12.8% annually over the next decade.

Analysis The all-time monthly closing high of the JSE was R 56,772 in November 2017. In real, or inflation-adjusted terms, the market peaked in February 2015. Over the 30 years since December 1989, the index has yielded a price return of 10.3% annually. Since inflation over this same period has averaged 4.0%, the investor has earned an annual real price return of 6.3%. Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the JSE. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the JSE is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The use of relative valuation gives us a method to divide the index´s 273

historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the JSE started in November 2018 from a relative valuation of -0.7 standard deviations under the average of the preceding 30-year period, more under-valued than 76% of all previous months.

Since March 1990 the JSE has undergone six complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market. Each bull market since 1990 has begun from a relatively undervalued position, on average -0.8 standard deviations below its longterm mean. The median duration of these bull market phases has been just over two years, with a median total gain of 69%. On an annual basis, these advances have offered a median price return of 28% (ignoring the effect of dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued territory, typically completing their cycle +0.5 standard deviations overvalued relative to the long-term average. The median cycle sees its relative valuation swing by +1.3 standard deviations. The index´s most significant bull market took place between April 2003 and November 2017. During this 14-year period, the JSE never suffered a decline that pushed its relative valuation into negative territory, an event necessary to mark the end of a long-term advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 696% over this period, or about 15% annually (in price terms, ignoring reinvested dividends). The 2003 low saw the index under-valued by -1.4 standard deviations, and the half274

decade rally would not be completed until the JSE was +1.9 standard deviations over-valued. The change in relative valuation of +.3 standard deviations is the most extreme swing on record. While the 2003-17 bull market was the largest in absolute terms, swiftest took place between December 1997 and April 1998. Starting from an under-valuation of -0.6 standard deviations below its longterm average, the JSE rallied 35% over four months to finish its cycle +0.5 standard deviations over-valued, enough to post an annualized gain of 148% (again, ignoring reinvested dividends).

The most significant bear market was the 40% decline in the index between April and August 1998. During this four-month period, the JSE lost 78% of its value at an annualized rate. It also lost over -1.9 standard deviations of valuation, starting at +0.5 standard deviations over-valued and finishing -1.4 under-valued. While the crash of 1998 is well-known as the most significant bear market on record, the average decline over the seven bear markets has been somewhat more subdued. On balance, the median depreciating phase of the JSE´s valuation cycle lasted a little more than a year and a half, and shaved 19% off the value of the index, resulting in a -35% annualized loss. These bear markets have started from a median position of +0.5 standard deviations above the long-term average and have not ended until the index was under-valued by -0.8, for a median swing of -1.2 standard deviations. Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent June 2019 high of R 58,203 the index had gained 15% over the seven preceding months, making it the weakest and 275

shortest bull market on record. FTSE/JSE All-Share Index: Bull and Bear Market Summary Declines

Advances

Start End Date Date Mar-90 Jan-91

Start JSE 3,257

End Total Annual JSE Change, % Change, % 2,555 -22 -25

Jun-92 Oct-92

3,655

3,016

-17

Jul-95

5,866

5,018

-14

-24

Jul-97

Dec-97

6,885

5,609

-19

-39

Apr-98 Aug-98

7,582

4,581

-40

-78

7,510

-33

-35

Nov-17 Nov-18 59,772 50,663

-15

-15

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

End Date

Start JSE

End JSE

Jan-91

Jun-92

Total Annual Change, % Change, %

2,555

3,655

43

29

Oct-92 Dec-94 3,016

5,866

94

36

Jul-95

6,885

37

17

-44

Dec-94

May-02 Apr-03 11,185

Start Date

Jul-97

5,018

Dec-97 Apr-98

5,609

7,582

35

148

Aug-98 May-02 4,581

11,185

144

27

Apr-03 Nov-17 7,510

59,772

696

15

Nov-18 Jun-19 50,663 58,203

15

27

0.6 -18.5 -35.2 0.5 -1.2

2.1 68.8 27.8 -0.8 1.4

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

Starting from the November 2018 low valuation of -0.7 standard deviations the index has posted 27% annualized gains and is still undervalued at -0.3 standard deviations, implying a valuation swing of +0.4 standard deviations.

Forecast Returns The return from holding a South African government bond is defined in advance. What is needed is an estimate of what the return on the JSE will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the JSE is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the JSE over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 10.3% on the JSE over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the JSE as the basis for 276

forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the JSE to increase by 12.4% annually. The forecasted range of annual returns is strictly positive, running from 11.5% to 14.1%. Our forecast model explains 45% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 99% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The JSE currently offers a dividend yield of 5.0%, implying a 5-year total return of 17.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year South African government bonds presently allow the investor to lock in a 7.2% annual yield. We forecast that the JSE will outperform comparable bonds by December 2024 with a 99% probability. The forecast 5-year total return of 17.4% contrasts with the current inflation rate of 4.0%. If the investor made investments denominated solely in South African rand, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a 277

simple method to compare returns internationally. We forecast that the JSE will offer a real total return (including reinvested dividends) of 13.4% over the next five years. Over the coming 10-year period, we expect the JSE to rise by 11.8% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from 11.3% to 12.3%. Our forecast model explains 67% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 99% probability. The JSE´s current dividend yield of 5.0% implies a 10-year total return of 16.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year South African government bonds presently allow the investor to lock in an 8.3% yield. We forecast that the JSE will outperform comparable bonds by December 2029 with a 99% probability.

The forecasted 10-year total return of 16.8% contrasts with the current inflation rate of 4.0% to result in an estimated real total return of 12.8% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them 278

against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The JSE´s relative valuation of -0.6 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is under-valued in both absolute terms, and relative to the global average. As such, the JSE is the 5th most under-valued market of the group. We forecast that the index will yield an annual real total return of 13.4% over the coming five years, and 12.8% over the coming decade. Both returns are far superior to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the JSE ranks 2nd out of 43 markets for both the 5- and 10-year total real return forecasts.

FTSE/JSE All-Share rankings, out of 43 markets

Relative Valuation th

FTSE/JSE All Share 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

nd

10-Year

nd

5

2

2

-0.6 +0.3

13.4 3.3

12.8 4.5

5-Year

nd

2

88 46

10-Year

4th 97 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 88% probability that the JSE can achieve this return by the end of 2024 and 97% by the end of 2029, ranking the index 2nd and 4th out of the 43 markets for both probabilities. On balance, it is highly likely that the JSE will out-perform the average global market over both the coming 5- and 10-year periods.

279

280

South Korea KOSPI The Korea Composite Stock Price Index (KOSPI) is widely recognized as the benchmark stock index of South Korea. It is composed of all common stocks listed on the Korea Exchange by float-adjusted market value. The KOSPI is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Samsung Electronics, the South Korean technology company, is currently the largest component of the index and technology is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the KOSPI averaged 2.5% in 2019. The index is denominated in South Korean won.

The Bottom Line The KOSPI finished 2019 at ₩2,197. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be ₩1,905, implying an over-valuation of 0.4 standard deviations. Other than during the brief rally in 2017 the index has been valued at this level since 2011, and historically it has been more over-valued than it is today only 36% of the time. Over the coming 5-year period, we expect the KOSPI to increase by 0.8% annually. The forecasted range of annual returns is bound between -0.3% and 2.6%. Our forecast model explains 54% of the variation in the index´s 5-year returns since December 1989. 281

Consequently, we forecast that the index will break-even by December 2024 with a 22% probability.

KOSPI Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

2,197 1,905 0.4 2.5

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.3 1.5 1.7 0.7

5-Year Forecasts 5-Year Annual Forecast Price Return, % 0.8 5-Year Forecast Range, % (-0.3, 2.6) 0.54 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 22 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

3.3 62

5-Year Annual Forecast Real Total Return, %

2.6

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

2.1 (1.1, 3.3) 0.79 81

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

4.6 89

10-Year Annual Forecast Real Total Return, %

3.9

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The KOSPI currently offers a dividend yield of 2.5%, implying a 5-year total return of 3.3% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year South Korean government bonds presently allow the investor to lock in a 1.5% annual yield. We forecast that the KOSPI will outperform comparable bonds 282

by December 2024 with a 62% probability. The forecast 5-year total return of 3.3% contrasts with the current inflation rate of 0.7%. We forecast that the KOSPI will offer a real total return (including reinvested dividends) of 2.6% over the next five years. Over the coming 10-year period, we expect the KOSPI to rise by 2.1% annually. The forecasted range of 10-year annual returns is bound between 1.1% and 3.3%. Our forecast model explains 79% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with an 81% probability. The KOSPI´s current dividend yield of 2.5% implies a 10-year total return of 4.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year South Korean government bonds presently allow the investor to lock in a 1.7% yield. We forecast that the KOSPI Index will outperform comparable bonds by December 2029 with an 89% probability. The forecasted 10-year total return of 4.6% contrasts with the current inflation rate of 0.7% to result in an estimated real total return of 3.9% annually over the next decade.

Analysis The all-time monthly closing high of the KOSPI was ₩2,566 in January 2018. In real, or inflation-adjusted terms, the market peaked in March 1989. Over the 30 years since December 1989, the index has yielded a price return of 3.0% annually. Since inflation over this same period has averaged 3.4%, the investor has earned an annual real price return of -0.4%.

283

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the KOSPI. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the KOSPI is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the KOSPI started in February 2009 at a price of ₩1,063 and a relative valuation of -1.1 standard deviations under the average of the preceding 30-year period, more under-valued than 87% of all previous months.

Since that low, the KOSPI has advanced to its January 2018 high of ₩2,566. At this high, the market was significantly over-valued with a relative valuation of +1.2. Thus, the index swung by +2.3 standard deviations since its bull market advance started. The index´s current advance has gained 6.9% annually since the 2009 low, and 11.5% including reinvested dividends.

Forecast Returns The return from holding a South Korean government bond is defined in advance. What is needed is an estimate of what the return on the 284

KOSPI will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the KOSPI is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the KOSPI over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 3.0% on the KOSPI over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the KOSPI as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the KOSPI to increase by 0.8% annually. The forecasted range of annual returns is bound between -0.3% and 2.6%. Our forecast model explains 54% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 22% probability.

285

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The KOSPI currently offers a dividend yield of 2.5%, implying a 5-year total return of 3.3% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year South Korean government bonds presently allow the investor to lock in a 1.5% annual yield. We forecast that the KOSPI will outperform comparable bonds by December 2024 with a 62% probability. The forecast 5-year total return of 3.3% contrasts with the current inflation rate of 0.7%. If the investor made investments denominated solely in South Korean won, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the KOSPI will offer a real total return (including reinvested dividends) of 2.6% over the next five years. Over the coming 10-year period, we expect the KOSPI to rise by 2.1% annually. The forecasted range of 10-year annual returns is bound between 1.1% and 3.3%. Our forecast model explains 79% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with an 81% probability.

The KOSPI´s current dividend yield of 2.5% implies a 10-year total return of 4.6% annually. We can compare this total return to that which 286

the investor could earn on an alternative investment, 10-year government bonds. 10-year South Korean government bonds presently allow the investor to lock in a 1.7% yield. We forecast that the KOSPI Index will outperform comparable bonds by December 2029 with an 89% probability. The forecasted 10-year total return of 4.6% contrasts with the current inflation rate of 0.7% to result in an estimated real total return of 3.9% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The KOSPI´s relative valuation of +0.4 standard deviations above its long-term mean is on par with the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is slightly over-valued in absolute terms, but by approximately the same amount as the rest of the world. As such, the KOSPI is the 25th most under-valued market of the group, just about the middle of the pack. We forecast that the index will yield an annual real total return of 2.6% over the coming five years, and 3.9% over the coming decade. Both returns are on par with the averages for the 43 other countries (3.3% and 4.5%). Consequently, the KOSPI ranks 23rd and 22nd out of 43 markets for the 5- and 10-year total real return forecasts. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is a 29% probability that the KOSPI can achieve this return by the end of 2024 and 19% by the end of 2029, ranking the index 26th and 25th out of the 43 markets for the two probabilities.

287

KOSPI rankings, out of 43 markets

Relative Valuation

KOSPI 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

25th

23rd

22nd

26th

25th

+0.4 +0.3

2.6 3.3

3.9 4.5

29 46

19 46

On balance, it is highly likely that the KOSPI will provide returns comparable to the average global market over both the coming 5- and 10-year periods.

288

Spain IBEX 35 The Índice Bursátil Español 35 (Spanish Exchange Index, or IBEX 35) is the benchmark stock market index of Spain. It is composed of the 35 largest and most liquid companies listed on the Bolsa de Madrid (Madrid Stock Exchange) by float-adjusted market value. The index´s composition is rebalanced on a semi-annual basis. The IBEX 35 is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Banco Santander, the Spanish financial company, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the IBEX 35 averaged 4.8% in 2019. The index is denominated in euros.

The Bottom Line The IBEX 35 finished 2019 at €9,549. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be €12,314, implying an under-valuation of -0.8 standard deviations. The last time the index had this valuation during a rising market was in August 2013, and historically it has been more over-valued than it is today 78% of the time. Over the coming 5-year period, we expect the IBEX 35 to increase by 4.8% annually. The forecasted range of annual returns is strictly 289

positive, running from 4.1% to 5.3%. Our forecast model explains 59% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 75% probability. IBEX 35 Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

9,549 12,314 -0.8 4.8

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

-0.5 -0.1 0.5 0.8

5-Year Forecasts 5-Year Annual Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

4.8 (4.1, 5.3) 0.59 75

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

9.6 91

5-Year Annual Forecast Real Total Return, %

8.8

10-Year Forecasts 10-Year Annual Forecast Price Return, % 0.3 10-Year Forecast Range, % (-3.1, 3.5) 0.85 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 55 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

5.1 98

10-Year Annual Forecast Real Total Return, %

4.3

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The IBEX 35 currently offers a dividend yield of 4.8%, implying a 5-year total return of 9.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Spanish government bonds presently allow the investor to lock in a -0.1% annual yield. We forecast that the IBEX 35 will outperform comparable bonds by December 2024 with a 91% probability. The forecast 5-year total return of 9.6% contrasts with the current inflation rate of 0.8%. We forecast that the IBEX 35 will offer a real total return (including reinvested dividends) of 8.8% over the next five 290

years. Over the coming 10-year period, we expect the IBEX 35 to rise by 0.3% annually. The forecasted range of 10-year annual returns is bound between -3.1% and 3.5%. Our forecast model explains 85% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 55% probability. The IBEX 35´s current dividend yield of 4.8% implies a 10-year total return of 5.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Spanish government bonds presently allow the investor to lock in a 0.5% yield. We forecast that the IBEX 35 Index will outperform comparable bonds by December 2029 with a 98% probability. The forecasted 10-year total return of 5.1% contrasts with the current inflation rate of 0.8% to result in an estimated real total return of 4.3% annually over the next decade.

Analysis The all-time monthly closing high of the IBEX 35 price was €15,890 in October 2007. In real, or inflation-adjusted terms, the market peaked in February 2000. Over the 30 years since December 1989, the index has yielded a price return of 3.9% annually.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the IBEX 35. This relative valuation is expressed in standard deviations 291

from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the IBEX 35 is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the IBEX 35 started in May 2012 at a price of €6,089 and a relative valuation of -1.4 standard deviations under the average of the preceding 30-year period, more under-valued than 93% of all previous months.

Since that low, the IBEX 35 advanced to its March 2015 high of €11,521. At this high, the market was fairly valued with a relative valuation of +0.0. Thus, the index swung by +1.4 standard deviations since its bull market advance started. From the 2012 until today the index has gained 6.1% annually, and 10.9% including reinvested dividends.

Forecast Returns The return from holding a Spanish government bond is defined in advance. What is needed is an estimate of what the return on the IBEX 35 will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the IBEX 35 is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods 292

of under-valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the IBEX 35 over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 3.9% on the IBEX 35 over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the IBEX 35 as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the IBEX 35 to increase by 4.8% annually. The forecasted range of annual returns is strictly positive, running from 4.1% to 5.3%. Our forecast model explains 59% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 75% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The IBEX 35 currently offers a dividend yield of 4.8%, implying a 5-year total return of 9.6% annually. We can compare this 293

total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Spanish government bonds presently allow the investor to lock in a -0.1% annual yield. We forecast that the IBEX 35 will outperform comparable bonds by December 2024 with a 91% probability. The forecast 5-year total return of 9.6% contrasts with the current inflation rate of 0.8%. If the investor made investments denominated solely in euros, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the IBEX 35 will offer a real total return (including reinvested dividends) of 8.8% over the next five years. Over the coming 10-year period, we expect the IBEX 35 to rise by 0.3% annually. The forecasted range of 10-year annual returns is bound between -3.1% and 3.5%. Our forecast model explains 85% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 55% probability.

The IBEX 35´s current dividend yield of 4.8% implies a 10-year total return of 5.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Spanish government bonds presently allow the investor to lock in a 0.5% yield. We forecast that the IBEX 35 Index will outperform comparable bonds by December 2029 with a 98% 294

probability. The forecasted 10-year total return of 5.1% contrasts with the current inflation rate of 0.8% to result in an estimated real total return of 4.3% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The IBEX 35´s relative valuation of -0.8 standard deviations below its long-term mean is significantly below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is highly under-valued. As such, the IBEX 35 is the 3rd most under-valued market of the group. We forecast that the index will yield an annual real total return of 8.8% over the coming five years, and 4.3% over the coming decade. These forecasts are better than those for the 43 other countries over five years, though about on par over ten years (3.3% and 4.5%). Consequently, the IBEX 35 ranks 7th and 20th out of 43 markets for the 5- and 10-year total real return forecasts.

IBEX 35 rankings, out of 43 markets

Relative Valuation

IBEX 35 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

3rd

7th

20th

10th

19th

-0.8 +0.3

8.8 3.3

4.3 4.5

74 46

43 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is 295

an 74% probability that the IBEX 35 can achieve this return by the end of 2024 and 43% by the end of 2029, ranking the index 10th and 19th out of the 43 markets for the two probabilities, comfortably in the top half of markets. On balance, it is likely that the IBEX 35 will provide returns slightly higher than those of the average global market over the next five years, and about on par with the world average for the next decade.

296

Sweden OMX Stockholm 30 The OMX Stockholm 30 Index (OMXS30) is the leading stock index of Sweden. It is composed of the 30 most actively traded stocks on the Nasdaq Stockholm exchange (formerly the Stockholmsbörsen, or Stockholm Stock Exchange). The index´s composition is rebalanced on a semi-annual basis. The OMXS30 is a capitalization index, meaning that each company´s contribution to the index is relative to its current market value. Atlas Copco, the Swedish industrial company, is currently the largest component of the index and industrials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the OMXS30 averaged 5.0% in 2019. The index is denominated in Swedish kronor.

The Bottom Line The OMXS30 finished 2019 at 1,771 kr. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be 1,908 kr, implying an under-valuation of -0.3 standard deviations. The last time the index had this valuation during a rising market was in July 2013, and historically it has been more over-valued than it is today 63% of the time. Over the coming 5-year period, we expect the OMXS30 to increase by 4.6% annually. The forecasted range of annual returns is strictly positive, running from 3.1% to 5.9%. Our forecast model explains 78% 297

of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with an 81% probability. OMX Stockholm 30 Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

1,771 1,908 -0.3 5.0

Government Bond Yields, % 1-Year* 5-Year 10-Year Inflation

-0.3 -0.2 0.2 1.8

5-Year Forecasts 5-Year Annual Forecast Price Return, % 5-Year Forecast Range, % Adjusted R2 Probability 5-Year Forecast Price Return > 0, %

4.6 (3.1, 5.9) 0.78 81

5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

9.6 97

5-Year Annual Forecast Real Total Return, %

7.8

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

*

3.9 (1.7, 5.8) 0.77 92

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

8.9 99

10-Year Annual Forecast Real Total Return, %

7.1

2-year bond yield

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The OMXS30 currently offers a dividend yield of 5.0%, implying a 5-year total return of 9.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Swedish government bonds presently allow the investor to lock in a -0.2% annual yield. We forecast that the OMXS30 will outperform comparable bonds by December 2024 with a 97% probability. The forecast 5-year total return of 9.6% contrasts with the current inflation rate of 1.8%. We forecast that the OMXS30 will offer a real 298

total return (including reinvested dividends) of 7.8% over the next five years. Over the coming 10-year period, we expect the OMXS30 to rise by 3.9% annually. The forecasted range of 10-year annual returns is bound by 1.7% to 5.8%. Our forecast model explains 77% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 92% probability. The OMXS30´s current dividend yield of 5.0% implies a 10-year total return of 8.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Swedish government bonds presently allow the investor to lock in a 0.2% yield. We forecast that the OMXS30 will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 8.9% contrasts with the current inflation rate of 1.8% to result in an estimated real total return of 7.1% annually over the next decade.

Analysis The all-time monthly closing high of the OMXS30 was 1,771 kr in December 2019. In real, or inflation-adjusted terms, the market peaked in February 2000. Over the 30 years since December 1989, the index has yielded a price return of 7.4% annually. Since inflation over this same period has averaged 1.9%, the investor has earned an annual real total return of 5.5%.

299

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the OMXS30. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the OMXS30 is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the OMXS30 started in December 2018 at a price of 1,408 kr and a relative valuation of -0.5 standard deviations under the average of the preceding 30-year period, more under-valued than 69% of all previous months.

Since that low, the OMXS30 has advanced to its December 2019 high of 1,771 kr. At this high, the market was still under-valued with a relative valuation of -0.3. Thus, the index swung by +0.2 standard deviations since its bull market advance started. The index´s current advance has gained 26% annually since the 2018 low, and 30.7% including reinvested dividends.

Forecast Returns The return from holding a Swedish government bond is defined in advance. What is needed is an estimate of what the return on the OMXS30 will be over some future holding period to determine which 300

investment will prove superior: bonds or equities. As we have seen, the future return of the OMXS30 is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the OMXS30 over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 7.4% on the OMXS30 over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the OMXS30 as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the OMXS30 to increase by 4.6% annually. The forecasted range of annual returns is strictly positive, running from 3.1% to 5.9%. Our forecast model explains 78% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with an 81% probability.

301

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The OMXS30 currently offers a dividend yield of 5.0%, implying a 5-year total return of 9.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Swedish government bonds presently allow the investor to lock in a -0.2% annual yield. We forecast that the OMXS30 will outperform comparable bonds by December 2024 with a 97% probability. The forecast 5-year total return of 9.6% contrasts with the current inflation rate of 1.8%. If the investor made investments denominated solely in Swedish kronor, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the OMXS30 will offer a real total return (including reinvested dividends) of 7.8% over the next five years.

Over the coming 10-year period, we expect the OMXS30 to rise by 3.9% annually. The forecasted range of 10-year annual returns is bound by 1.7% to 5.8%. Our forecast model explains 77% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 92% probability. The OMXS30´s current dividend yield of 5.0% implies a 10-year 302

total return of 8.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Swedish government bonds presently allow the investor to lock in a 0.2% yield. We forecast that the OMXS30 will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 8.9% contrasts with the current inflation rate of 1.8% to result in an estimated real total return of 7.1% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The OMXS30´s relative valuation of -0.2 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is approximately fairly valued. As such, the OMXS30 is the 17th most under-valued market of the group, just about the middle of the pack. We forecast that the index will yield an annual real total return of 7.8% over the coming five years, and 7.1% over the coming decade. Both returns are far superior to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the OMXS30 ranks 11th and 13th out of 43 markets for the 5- and 10-year total real return forecasts.

OMX Stockhoklm 30 rankings, out of 43 markets

Relative Valuation th

12 OMX Stockholm 30 43 Country Avg.

-0.3 +0.3

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

th

11

7.8 3.3

10-Year

th

13

7.1 4.5

5-Year

th

6

82 46

10-Year

9th 91 46

Finally, we consider the probability that the forecasted total return 303

for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 82% probability that the OMXS30 can achieve this return by the end of 2024 and 91% by the end of 2029, ranking the index near the top at estimated probabilities. On balance, it is highly likely that the OMXS30 will out-perform the average global market over both the coming 5- and 10-year periods.

304

Switzerland Swiss Market Index The Swiss Market Index (SMI) is benchmark blue chip index for Switzerland. It is composed of the 20 largest companies listed on the SIX Swiss Exchange by float-adjusted market value. The index´s composition is rebalanced on a quarterly basis. The SMI is a floatadjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Nestlé, the Swiss multinational food and drink conglomerate, is currently the largest component of the index and health care is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the SMI averaged 4.2% in 2019. The index is denominated in the Swiss franc.

The Bottom Line The SMI finished 2019 at 10,616 fr. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be 8,097 fr., implying an over-valuation of +1.0 standard deviations. The last time the index had this valuation during a rising market was in March 2007, and historically it has been more over-valued than it is today just 17% of the time. Over the coming 5-year period, we expect the SMI to decrease by 8.7% annually. The forecasted range of annual returns is strictly negative, running from -11.4% to -6.2%. Our forecast model explains 305

80% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with barely a 2% probability. SMI Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

10,616 8,097 +1.0 4.2

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

-0.6 -0.6 -0.5 0.2

5-Year Forecasts 5-Year Annual Forecast Price Return, % -8.7 5-Year Forecast Range, % (-11.4, -6.2) 0.80 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 2 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

-4.5 18

5-Year Annual Forecast Real Total Return, %

-4.7

10-Year Forecasts 10-Year Annual Forecast Price Return, % -7.3 10-Year Forecast Range, % (-7.6, -7.0) 0.76 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 10-Year Bond, %

-3.1 17

10-Year Annual Forecast Real Total Return, %

-3.3

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The SMI currently offers a dividend yield of 4.2%, implying a 5-year total return of -4.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Swiss government bonds presently allow the investor to lock in a -0.6% annual yield. We forecast that the SMI will outperform comparable bonds by December 2024 with an 18% probability. The forecast 5-year total return of -4.5% contrasts with the current inflation rate of 0.2%. We forecast that the SMI will offer a real total return (including reinvested dividends) of -4.7% over the next five years. 306

Over the coming 10-year period, we expect the SMI to fall by -7.3% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from -7.6% to -7.0%. Our forecast model explains 76% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a less than 1% probability. The SMI´s current dividend yield of 4.2% implies a 10-year total return of -3.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Swiss government bonds presently allow the investor to lock in a -0.5% yield. We forecast that the SMI Index will outperform comparable bonds by December 2029 with a 17% probability. The forecasted 10-year total return of -3.1% contrasts with the current inflation rate of 0.2% to result in an estimated real total return of -3.3% annually over the next decade.

Analysis The all-time monthly closing high of the SMI was 10,616 fr. in December 2019, the same month it peaked in real, or inflation-adjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 6.2% annually. Since inflation over this same period has averaged 1.0%, the investor has earned an annual real price return of 5.2%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the 307

SMI. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the SMI is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the SMI started in February 2009 at a price of 4,690 fr. and a relative valuation of -1.6 standard deviations under the average of the preceding 30-year period, more under-valued than 94% of all previous months.

Since that low, the SMI has advanced to its December 2019 high of 10,616 fr. At this high, the market was over-valued with a relative valuation of +1.0. Thus, the index swung by +2.6 standard deviations since its bull market advance started. The index´s current advance has gained 7.8% annually since the 2009 low, and 11.3% including reinvested dividends.

Forecast Returns The return from holding a Swiss government bond is defined in advance. What is needed is an estimate of what the return on the SMI will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the SMI is highly dependent on its starting valuation relative 308

to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the SMI over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 6.2% on the SMI over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the SMI as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the SMI to decrease by 8.7% annually. The forecasted range of annual returns is strictly negative, running from -11.4% to -6.2%. Our forecast model explains 80% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with barely a 2% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The SMI currently offers a dividend yield of 4.2%, 309

implying a 5-year total return of -4.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Swiss government bonds presently allow the investor to lock in a -0.6% annual yield. We forecast that the SMI will outperform comparable bonds by December 2024 with an 18% probability. The forecast 5-year total return of -4.5% contrasts with the current inflation rate of 0.2%. If the investor made investments denominated solely in Swiss francs, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the SMI will offer a real total return (including reinvested dividends) of 4.7% over the next five years.

Over the coming 10-year period, we expect the SMI to fall by -7.3% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from -7.6% to -7.0%. Our forecast model explains 76% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a less than 1% probability. The SMI´s current dividend yield of 4.2% implies a 10-year total return of -3.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Swiss government bonds presently allow the investor to lock in a -0.5% yield. We forecast that the SMI Index 310

will outperform comparable bonds by December 2029 with a 17% probability. The forecasted 10-year total return of -3.1% contrasts with the current inflation rate of 0.2% to result in an estimated real total return of -3.3% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The SMI´s relative valuation of +1.0 standard deviations above its long-term mean is higher than the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is over-valued both in absolute terms and relative to the global average. As such, the SMI is the 33rd most under-valued market of the group We forecast that the index will yield an annual real total return of 4.7% over the coming five years, and -3.3% over the coming decade. Both returns are far lower than the averages for the 43 other countries (3.3% and 4.5%). Consequently, the SMI ranks 39th and 40th out of 43 markets for the 5- and 10-year total real return forecast, nearly dead last for both time frames.

SMI rankings, out of 43 markets

Relative Valuation

SMI 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

33rd

39th

40th

38th

40th

+1.0 +0.3

-4.7 3.3

-3.3 4.5

2 46

0, % 19 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

1.5 19

5-Year Annual Forecast Real Total Return, %

0.9

10-Year Forecasts 10-Year Annual Forecast Price Return, % -0.1 10-Year Forecast Range, % (-0.6, 0.6) 0.43 Adjusted R2 Probability 10-Year Average Forecast Price Return > 0, % 47 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

5.5 99

10-Year Annual Forecast Real Total Return, %

4.9

* 2-year bond

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The TAIEX currently offers a dividend yield of 5.6%, implying a 5-year total return of 1.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Taiwan government bonds presently allow the investor to lock in a 0.6% annual yield. We forecast that the TAIEX will outperform comparable bonds by December 2024 with a 19% probability. The forecast 5-year total return of 1.5% contrasts with the current inflation rate of 0.6%. We forecast that the TAIEX will offer a real total return (including reinvested dividends) of 0.9% over the next five years. 314

Over the coming 10-year period, we expect the TAIEX to fall by 0.1% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from -0.6% to 0.6%. Our forecast model explains 43% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 47% probability. The TAIEX´s current dividend yield of 5.6% implies a 10-year total return of 5.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Taiwan government bonds presently allow the investor to lock in a 0.7% yield. We forecast that the TAIEX will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 5.5% contrasts with the current inflation rate of 0.6% to result in an estimated real total return of 4.9% annually over the next decade.

Analysis The all-time monthly closing high of the TAIEX was NT$12,054 in January 1990, the same month it peaked in real, or inflation-adjusted terms.

Over the 30 years since December 1989, the index has yielded a price return of 0.7% annually. Since inflation over this same period has averaged 1.6% annually, the investor has earned an annual real price return of -0.9%. Using historical price, dividend, macroeconomic and financial data 315

dating to December 1989, we can compute the relative valuation of the TAIEX. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the TAIEX is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the TAIEX started in January 2016 from a relative valuation of -0.3 standard deviations under the average of the preceding 30-year period, more under-valued than 62% of all previous months. Since December 1999 the TAIEX has undergone two complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market.

Each bull market since 1999 has begun from a relatively undervalued position, on average -0.6 standard deviations below its longterm mean. The median duration of these bull market phases has been just over six years, with a median total gain of 149%. On an annual basis, these advances have offered a median price return of 16% (ignoring the effect of dividends). These bull markets have ended their 316

advances by pushing their starting under-valuations into over-valued territory, typically completing their cycle fairly valued relative to the long-term average. The median cycle sees its relative valuation swing by +0.7 standard deviations. The index´s most significant bull market over this 20-year period took place between August 2001 and October 2007. During these six years the TAIEX never suffered a decline that pushed its relative valuation into negative territory, an event necessary to mark the end of a long-term advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 167% over this period, or about 17% annually (in price terms, ignoring reinvested dividends). The 2001 low saw the index under-valued by -0.6 standard deviations, and the rally would not be completed until the TAIEX was fairly valued. TAIEX Index: Bull and Bear Market Summary Declines Start End Start Date Date TAIEX Dec-99 Aug-01 9,744 Oct-07 Jan-09 Apr-15 Jan-16

9,711 9,820

Advances

End Total Annual TAIEX Change, % Change, % 3,636 -63 -45 4,247 8,145

-56 -17

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

Start Date

End Date

Start TAIEX

End Total Annual TAIEX Change, % Change, %

Aug-01 Oct-07

3,636

9,711

167

17

Jan-09 Apr-15

4,247

9,820

131

14

Jan-16 Dec-19

8,145

11,997

47

10

-48 -22

1.3 -56.3 -44.6 0.0 -0.8

6.2 149.2 15.8 -0.6 0.7

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

The most significant bear market was the 63% decline in the index between December 1999 and August 2001. During this 20-month period, the TAIEX lost 45% of its value annually. It also lost over -1.4 standard deviations of valuation, starting at +0.8 standard deviations over-valued and finishing -0.8 under-valued. While the 1999-2001 decline was substantial the average decline since 1999 has been somewhat more subdued. On balance, the median depreciating phase of the TAIEX´ valuation cycle lasted a little less than a year and a half, and shaved 56% off the value of the index, resulting in a -45% annual loss. These bear markets have started from a fairly valued positions and have not ended until the index was undervalued by -0.6, for a median swing of -0.8 standard deviations. Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent November 2019 high of NT$11,997 the index had gained 47% over the previous four years, making it the weakest bull market on record and also shorter than the average. Starting from the January 2016 low valuation of -0.3 standard deviations the index has posted 10% annual gains and is now over-valued at +1.2 standard 317

deviations, implying a valuation swing of +1.5 standard deviations. The 10% annual gain is low by historical standards. The current advance started from a not significantly under-valued level (-0.3), and the increase in valuation of +1.5 standard deviations is strong by historical precedent (a median swing of +0.7 standard deviations). If the index´s advance was completed in December 2019 it would be the shortest and weakest bull market in forty years. It has also coincided, however, with the most extreme swing in valuation in two decades.

Forecast Returns The return from holding a Taiwan government bond is defined in advance. What is needed is an estimate of what the return on the TAIEX will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the TAIEX is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the TAIEX over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 0.7% on the TAIEX over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the TAIEX as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the TAIEX to decrease by -4.1% annually. The forecasted range of annual returns is strictly negative, running from -5.0% to -3.5%. Our forecast model explains 57% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 19% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the 318

holding period. The TAIEX currently offers a dividend yield of 5.6%, implying a 5-year total return of 1.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Taiwan government bonds presently allow the investor to lock in a 0.6% annual yield. We forecast that the TAIEX will outperform comparable bonds by December 2024 with a 19% probability. The forecast 5-year total return of 1.5% contrasts with the current inflation rate of 0.6%. If the investor made investments denominated solely in New Taiwan dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the TAIEX will offer a real total return (including reinvested dividends) of 0.9% over the next five years.

Over the coming 10-year period, we expect the TAIEX to fall by 0.1% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from -0.6% to 0.6%. Our forecast model explains 43% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 47% probability. The TAIEX´s current dividend yield of 5.6% implies a 10-year total return of 5.5% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Taiwan government bonds presently allow 319

the investor to lock in a 0.7% yield. We forecast that the TAIEX will outperform comparable bonds by December 2029 with a 99% probability.

The forecasted 10-year total return of 5.5% contrasts with the current inflation rate of 0.6% to result in an estimated real total return of 4.9% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The TAIEX´s relative valuation of +1.2 standard deviations above its long-term mean is significantly higher than the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is over-valued. As such, the TAIEX is the 38th most under-valued market of the group. We forecast that the index will yield an annual real total return of 0.9% over the coming five years, and 4.7% over the coming decade. Over the coming five years this performance is far below the average for the 43 other countries, and approximately on par with it over the coming decade (3.3% and 4.5%). Consequently, the TAIEX ranks 26th 320

and 18th out of 43 markets for the 5- and 10-year total real return forecasts.

TAIEX rankings, out of 43 markets

Relative Valuation

TAIEX 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

38th

26th

18th

37th

18th

+1.2 +0.3

0.9 3.3

4.7 4.5

3 46

46 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is only a 3% probability that the TAIEX can achieve this return by the end of 2024 and 46% by the end of 2029, ranking the index 37th and 18th out of the 43 markets for both probabilities. On balance, it is highly likely that the TAIEX will under-perform the average global market over both the coming 5- and 10-year periods.

321

322

Thailand Stock Exchange of Thailand The Stock Exchange of Thailand Index (SET) is widely recognized as the benchmark stock index of Thailand. It is composed of all companies listed on the Stock Exchange of Thailand by market value. The SET is a market capitalization index, meaning that each company´s contribution to the index is relative to its current market value. PTT Public Company, the Thai state-owned oil and gas company (formerly known as the Petroleum Authority of Thailand) is currently the largest component of the index and oil and gas is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the SET averaged 3.3% in 2019. The index is denominated in Thai baht.

The Bottom Line The SET finished 2019 at ฿1,579. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be ฿1,013, implying an over-valuation of +0.9 standard deviations. The last time the index had this valuation during a rising market was in April 2013, and historically it has been more over-valued than it is today just 19% of the time. Over the coming 5-year period, we expect the SET to decrease by 5.7% annually. The forecasted range of annual returns is strictly negative, running from -6.1% to -5.1%. Our forecast model explains 323

59% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with only a 26% probability. SET Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

1,579 1,013 +0.9 3.3

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.3 1.3 1.5 0.8

5-Year Forecasts 5-Year Annual Forecast Price Return, % -5.7 5-Year Forecast Range, % (-6.1, -5.1) 0.59 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 26 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

-2.4 34

5-Year Annual Forecast Real Total Return, %

-3.2

10-Year Forecasts 10-Year Annual Forecast Price Return, % -1.2 10-Year Forecast Range, % (-1.8, -0.4) 0.77 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 38 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

2.1 56

10-Year Annual Forecast Real Total Return, %

1.3

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The SET currently offers a dividend yield of 3.3%, implying a 5-year total return of -2.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Thai government bonds presently allow the investor to lock in a 1.3% annual yield. We forecast that the SET will outperform comparable bonds by December 2024 with a 34% probability. The forecast 5-year total return of -2.4% contrasts with the current inflation rate of 0.8%. We forecast that the SET will offer a real total return (including reinvested dividends) of -3.2% over the next five years. 324

Over the coming 10-year period, we expect the SET to fall by -1.2% annually. The forecasted range of 10-year annual returns is bound between -1.8% and -0.4%. Our forecast model explains 77% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 38% probability. The SET´s current dividend yield of 3.3% implies a 10-year total return of 2.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Thai government bonds presently allow the investor to lock in a 1.5% yield. We forecast that the SET Index will outperform comparable bonds by December 2029 with a 56% probability. The forecasted 10-year total return of 2.1% contrasts with the current inflation rate of 0.8% to result in an estimated real total return of 1.3% annually over the next decade.

Analysis The all-time monthly closing high of the SET was ฿1,830 in February 2018. In real, or inflation-adjusted terms, the market peaked in December 1993.

Over the 30 years since December 1989, the index has yielded a price return of 2.0% annually. Since inflation over this same period has averaged 3.0%, the investor has earned an annual real price return of 1.0%. Using historical price, dividend, macroeconomic and financial data 325

dating to December 1989, we can compute the relative valuation of the SET. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index.

Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the SET is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the SET started in July 1998 at a price of ฿214 and a relative valuation of -1.7 standard deviations under the average of the preceding 30-year period, more under-valued than 95% of all previous months. Since that low, the SET has advanced to its February 2018 high of ฿1,830. At this high, the market was over-valued with a relative valuation of +1.4. Thus, the index swung by +3.1 standard deviations since its bull market advance started. The index´s current advance has gained 8.7% annually since the 1998 low, 6.7% in real terms.

Forecast Returns The return from holding a Thai government bond is defined in advance. What is needed is an estimate of what the return on the SET will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the SET is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under326

valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the SET over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 2.0% on the SET over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the SET as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the SET to decrease by 5.7% annually. The forecasted range of annual returns is strictly negative, running from -6.1% to -5.1%. Our forecast model explains 59% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with only a 26% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The SET currently offers a dividend yield of 3.3%, 327

implying a 5-year total return of -2.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Thai government bonds presently allow the investor to lock in a 1.3% annual yield. We forecast that the SET will outperform comparable bonds by December 2024 with a 34% probability.

The forecast 5-year total return of -2.4% contrasts with the current inflation rate of 0.8%. If the investor made investments denominated solely in Thai baht, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the SET will offer a real total return (including reinvested dividends) of -3.2% over the next five years. Over the coming 10-year period, we expect the SET to fall by -1.2% annually. The forecasted range of 10-year annual returns is bound between -1.8% and -0.4%. Our forecast model explains 77% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 38% probability. The SET´s current dividend yield of 3.3% implies a 10-year total return of 2.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Thai government bonds presently allow 328

the investor to lock in a 1.5% yield. We forecast that the SET Index will outperform comparable bonds by December 2029 with a 56% probability. The forecasted 10-year total return of 2.1% contrasts with the current inflation rate of 0.8% to result in an estimated real total return of 1.3% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The SET´s relative valuation of +0.9 standard deviations above its long-term mean is higher than the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is over-valued. As such, the SET is the 30th most undervalued market of the group. We forecast that the index will yield an annual real total return of 3.1% over the coming five years, and 1.4% over the coming decade. Both returns are far below the averages for the 43 other countries (3.3% and 4.5%). Consequently, the SET ranks 37th and 30th out of 43 markets for the 5- and 10-year total real return forecasts, close to the bottom of the group.

SET rankings, out of 43 markets

Relative Valuation

SET 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

30th

37th

30th

28th

26th

+0.9 +0.3

-3.1 3.3

1.4 4.5

16 46

13 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The 329

averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 16% probability that the SET can achieve this return by the end of 2024 and 13% by the end of 2029, ranking the index 28th and 26th out of the 43 markets for the two probabilities. On balance, it is highly likely that the SET will under-perform the average global market over both the coming 5- and 10-year periods.

330

Turkey BIST 100 The Borsa İstanbul 100 (BIST 100) is widely recognized as the benchmark stock index of Turkey. It is composed of the 100 largest companies listed on the Borsa İstanbul by float-adjusted market value. The index´s composition is rebalanced on a quarterly basis. The BIST is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares. Garanti BBVA, the Turkish financial company, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the BIST averaged 4.3% in 2019. The index is denominated in Turkish lira.

The Bottom Line The BIST finished 2019 at ₺114,424. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be ₺121,642, implying an under-valuation of -0.3 standard deviations. The last time the index had this valuation during a rising market was in June 2009, and historically it has been more over-valued than it is today 63% of the time. Over the coming 5-year period, we expect the BIST to increase by 15.9% annually. The forecasted range of annual returns is strictly positive, running from 14.8% to 17.1%. Our forecast model explains 331

62% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 76% probability. BIST 100 Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

114,424 121,642 -0.3 4.3

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

11.5 11.3 12.0 11.8

5-Year Forecasts 5-Year Annual Forecast Price Return, % 15.9 5-Year Forecast Range, % (14.8, 17.1) 0.62 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 76 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

20.2 65

5-Year Annual Forecast Real Total Return, %

8.4

10-Year Forecasts 10-Year Annual Forecast Price Return, % 14.3 10-Year Forecast Range, % (13.8, 14.8) 0.43 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 77 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

18.6 64

10-Year Annual Forecast Real Total Return, %

6.8

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The BIST currently offers a dividend yield of 4.3%, implying a 5-year total return of 20.2% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Turkish government bonds presently allow the investor to lock in an 11.3% annual yield. We forecast that the BIST will outperform comparable bonds by December 2024 with a 65% probability. The forecast 5-year total return of 20.2% contrasts with the current inflation rate of 11.8%. If We forecast that the BIST will offer a real total return (including reinvested dividends) of 8.4% over the next five years. 332

Over the coming 10-year period, we expect the BIST to rise by 14.3% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from 13.8% to 14.8%. Our forecast model explains 43% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 77% probability. The BIST 100´s current dividend yield of 4.3% implies a 10-year total return of 18.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Turkish government bonds presently allow the investor to lock in a 12.0% yield. We forecast that the BIST will outperform comparable bonds by December 2029 with a 77% probability. The forecasted 10-year total return of 18.6% contrasts with the current inflation rate of 11.8% to result in an estimated real total return of 6.8% annually over the next decade.

Analysis The all-time monthly closing high of the BIST was ₺119,528 in January 2018. In real, or inflation-adjusted terms, the market peaked in April 2000.

Over the 30 years since December 1989, the index has yielded a price return of 33.0% annually. Since inflation over this same period has averaged 32.4%, the investor has earned an annual real price return of 0.6%. Using historical price, dividend, macroeconomic and financial data 333

dating to December 1989, we can compute the relative valuation of the BIST 100. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the BIST is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bear market phase of the BIST started in January 2018 at a price of ₺119,528 and a relative valuation of +0.8 standard deviations above the average of the preceding 30-year period, more under-valued than just 22% of all previous months.

Since that high, the BIST has declined to its October 2018 low of ₺90,200. At this low, the market was under-valued with a relative valuation of -0.7. Thus, the index swung by -1.5 standard deviations since its bear market advance started.

Forecast Returns The return from holding a Turkish government bond is defined in advance. What is needed is an estimate of what the return on the BIST will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the BIST is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under334

valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the BIST over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 33.0% on the BIST over his lifetime (i.e., the annual price return earned over the previous 30 years, or 0.6% in real terms). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the BIST as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the BIST to increase by 15.9% annually. The forecasted range of annual returns is strictly positive, running from 14.8% to 17.1%. Our forecast model explains 62% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 76% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The BIST currently offers a dividend yield of 4.3%, 335

implying a 5-year total return of 20.2% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Turkish government bonds presently allow the investor to lock in an 11.3% annual yield. We forecast that the BIST will outperform comparable bonds by December 2024 with a 65% probability. The forecast 5-year total return of 20.2% contrasts with the current inflation rate of 11.8%. If the investor made investments denominated solely in Turkish liras, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the BIST will offer a real total return (including reinvested dividends) of 8.4% over the next five years.

Over the coming 10-year period, we expect the BIST to rise by 14.3% annually. The forecasted range of 10-year annual returns is tightly bound around this level, running from 13.8% to 14.8%. Our forecast model explains 43% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 77% probability. The BIST 100´s current dividend yield of 4.3% implies a 10-year total return of 18.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Turkish government bonds presently allow 336

the investor to lock in a 12.0% yield. We forecast that the BIST will outperform comparable bonds by December 2029 with a 77% probability. The forecasted 10-year total return of 18.6% contrasts with the current inflation rate of 11.8% to result in an estimated real total return of 6.8% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The BIST 100´s relative valuation of -0.3 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is under-valued. As such, the BIST is the 12th most under-valued market of the group, just about the middle of the pack. We forecast that the index will yield an annual real total return of 8.4% over the coming five years, and 6.8% over the coming decade. Both returns are higher than the averages for the 43 other countries (3.3% and 4.5%). Consequently, the BIST ranks 8th and 14th out of 43 markets for the 5- and 10-year total real return forecasts.

BIST 100 rankings, out of 43 markets

Relative Valuation

BIST 100 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

12th

8th

14th

18th

17th

-0.3 +0.3

8.4 3.3

6.8 4.5

57 46

53 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given 337

the explanatory power of our forecast models we estimate that there is an 57% probability that the BIST can achieve this return by the end of 2024 and 53% by the end of 2029, roughly on par with the average, and ranking the index 18th and 17th out of the 43 markets for the two probabilities. On balance, it is likely that the BIST provide returns comparable to or slightly higher than the global market over both the coming 5- and 10-year periods.

338

United Kingdom FTSE 100 The Financial Times Stock Exchange 100 Index (FTSE 100) is widely regarded as the premier share index in the United Kingdom. It is composed of the 100 largest companies listed on the London Stock Exchange. The index´s composition is rebalanced on a quarterly basis. The FTSE 100 is a capitalization-weighted index, meaning that each company´s contribution to the index is relative to its current market value. HSBC Holdings, the British multinational financial services holding company, is currently the largest component of the index and financials is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the FTSE 100 averaged 5.0% in 2019. The index is denominated in pound sterling.

The Bottom Line The FTSE 100 finished 2019 at £7,542. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be £7,867, implying an under-valuation of -0.3 standard deviations. The last time the index had this valuation during a rising market was in November 2016, and historically it has been more over-valued than it is today 62% of the time. Over the coming 5-year period, we expect the FTSE 100 to increase by 2.2% annually. The forecasted range of annual returns is bound between -0.5% and 4.6%. Our forecast model explains 85% of the 339

variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with an 81% probability. FTSE 100 Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

7,542 7,867 -0.3 5.2

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

0.6 0.6 0.8 1.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % 2.2 5-Year Forecast Range, % (-0.5, 4.6) 0.85 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 81 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

7.4 99

5-Year Annual Forecast Real Total Return, %

6.1

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

3.6 (2.5, 4.5) 0.90 99

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

8.8 99

10-Year Annual Forecast Real Total Return, %

7.5

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. We forecast that the FTSE 100 will outperform comparable bonds by December 2024 with a 99% probability. The forecast 5-year total return of 7.4% contrasts with the current inflation rate of 1.3%. We forecast that the FTSE 100 will offer a real total return (including reinvested dividends) of 6.1% over the next five years. Over the coming 10-year period, we expect the FTSE 100 to rise by 3.6% annually. The forecasted range of 10-year annual returns is bound around this level, running from 2.5% to 4.5%. Our forecast model explains 90% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break340

even by December 2029 with a 99% probability. The FTSE 100´s current dividend yield of 5.2% implies a 10-year total return of 8.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year British government bonds presently allow the investor to lock in a 0.8% yield. We forecast that the FTSE 100 will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 8.8% contrasts with the current inflation rate of 1.3% to result in an estimated real total return of 7.5% annually over the next decade.

Analysis The all-time monthly closing high of the FTSE 100 was £7,748 in July 2018. In real, or inflation-adjusted terms, the market peaked in December 1999. Over the 30 years since December 1989, the index has yielded a price return of 3.9% annually. Since inflation over this same period has averaged 2.5%, the investor has earned an annual real total return of 1.4%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the FTSE 100. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of 341

below average returns in the future, while superior returns are found by investing when the FTSE 100 is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the FTSE 100 started in February 2009 from a relative valuation of -2.2 standard deviations under the average of the preceding 30-year period, more under-valued than 99% of all previous months.

Since December 1917 the FTSE 100 has undergone ten complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market. Each bull market since 1917 has begun from a relatively undervalued position, on average -1.3 standard deviations below its longterm mean. The median duration of these bull market phases has been five years and resulted in a total gain of 93%. On an annual basis, these advances have offered a median price return of 15% (ignoring the effect of dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued territory, typically completing their cycle +1.6 standard deviations over-valued relative to the long-term average. The median cycle sees its relative valuation swing by +2.8 standard deviations. The index´s most significant bull market took place between November 1974 and December 1999. During this 25-year period, the FTSE 100 never suffered a decline that pushed its relative valuation 342

into negative territory, an event necessary to mark the end of a longterm advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 3,348% over this period, or about 15% annually (in price terms, ignoring reinvested dividends). The 1974 low saw the index under-valued by -3.1 standard deviations, and the multi-decade rally would not be completed until the FTSE 100 was +2.5 standard deviations over-valued. The change in relative valuation of +5.6 standard deviations is one of the most extreme valuation swings on record (second only to the bull market of 1931-37 when the FTSE increased in valuation by +6.0 standard deviations.) While the 1974-99 bull market was the largest in absolute terms, the sharpest rally took place between November 1970 and April 1972. Starting from an under-valuation of -1.7 standard deviations below its long-term average, the FTSE 100 rallied 68% to finish its cycle fairly valued at 0.0, enough to post an annual gain of 44% (again, ignoring reinvested dividends). The most significant bear market was the 70% decline in the index between April 1972 and November 1974. During this two-and-a-halfyear period, the FTSE 100 lost 37% of its value annually. It also lost over -3.1 standard deviations of valuation, starting fairly valued and finishing -3.1 under-valued. FTSE 100 Index: Bull and Bear Market Summary Declines Start Date

End Date

Advances

Start FTSE

End FTSE

Total Annual Change, % Change, %

Dec-19 Dec-21

103

85

-17

-9

Dec-28 Dec-31

139

79

-43

-17

Mar-37 Aug-40

156

68

-56

-22

Oct-51 Jul-52

174

129

-26

-33

Jul-55 Mar-58

269

200

-26

-11

Sep-64 Aug-66

547

371

-32

-18

Aug-68 Nov-70

641

403

-37

-19

Apr-72 Nov-74

677

201

-70

-37

Dec-99 Jan-03

6,930

3,567

-49

-19

Oct-07 Feb-09

6,721

3,830

-43

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

Start End Date Date Dec-17 Dec-19

Start FTSE 91

End FTSE 103

Dec-21 Dec-28

85

139

Dec-31 Mar-37

79

Aug-40 Oct-51

68

Jul-52

Total Annual Change, % Change, % 13 6 64

7

156

97

14

174

156

9

Jul-55

129

269

109

28

Mar-58 Sep-64

200

547

174

17

Aug-66 Aug-68

371

641

73

31

Nov-70 Apr-72

403

677

68

44

Nov-74 Dec-99

201

6,930

3,348

15

Jan-03 Oct-07

3,567

6,721

88

14

Feb-09 Jul-18

3,830

7,748

102

8

-34

2.4 -40.1 -19.0 1.6 -3.0

5.0 92.9 14.7 -1.3 2.8

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

FTSE All-Share Index and annual data prior to 1935.

While 1972-74 is well-known as the most significant bear market on record, the average decline over the ten bear markets has been 343

somewhat more subdued. On balance, the median depreciating phase of the FTSE 100´s valuation cycle lasted a little less than 2.5 years, and shaved 40% off the value of the index, resulting in a -19% annual loss. These bear markets have started from a median position of +1.6 standard deviations above the long-term average and have not ended until the index was under-valued by -1.3, for a median swing of -3.0 standard deviations. Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent July 2018 high of £7,748 the index had gained 102% over the preceding 9.5 years making it a long bull market in duration, but average in terms of total gain. Starting from the February 2009 low valuation of -2.2 standard deviations the index has posted 8% annual gains and is still under-valued at -0.1 standard deviations, implying a valuation swing of +2.1 standard deviations. The annual gain of 8% is low by historical standards (in fact, it is the weakest rally since 1921-28). The current advance started from a quite under-valued level (-2.2), and its continued under-valuation of 0.1 standard deviations below the long-term average has never coincided with the top of any prior bull market. The increase in valuation of +2.1 standard deviations is also weak by historical precedent (a median swing of +2.8 standard deviations). Although quite long in duration, the present advance is still weak in valuation terms implying more upward room for the index to rally.

Forecast Returns The return from holding a British government bond is defined in advance. What is needed is an estimate of what the return on the FTSE 100 will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the FTSE 100 is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the FTSE 100 over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 3.9% on the FTSE 100 over his lifetime (i.e., the annual price return earned over the previous 30 years). But this 344

same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the FTSE 100 as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the FTSE 100 to increase by 2.2% annually. The forecasted range of annual returns is bound between -0.5% and 4.6%. Our forecast model explains 85% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with an 81% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The FTSE 100 currently offers a dividend yield of 5.2%, implying a 5-year total return of 7.4% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year British government bonds presently allow the investor to lock in a 0.6% annual yield. We forecast that the FTSE 100 will outperform comparable bonds by December 2024 with a 99% probability. The forecast 5-year total return of 7.4% contrasts with the current inflation rate of 1.3%. If the investor made investments denominated solely in pound sterling, this rate of inflation would not affect his investment decision concerning the allocation of funds between 345

equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the FTSE 100 will offer a real total return (including reinvested dividends) of 6.1% over the next five years. Over the coming 10-year period, we expect the FTSE 100 to rise by 3.6% annually. The forecasted range of 10-year annual returns is bound around this level, running from 2.5% to 4.5%. Our forecast model explains 90% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 99% probability. The FTSE 100´s current dividend yield of 5.2% implies a 10-year total return of 8.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year British government bonds presently allow the investor to lock in a 0.8% yield. We forecast that the FTSE 100 will outperform comparable bonds by December 2029 with a 99% probability.

The forecasted 10-year total return of 8.8% contrasts with the current inflation rate of 1.3% to result in an estimated real total return of 7.5% annually over the next decade.

346

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The FTSE 100´s relative valuation of -0.3 standard deviations below its long-term mean is below the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is marginally under-valued. As such, the FTSE 100 is the 12th most under-valued market of the group. We forecast that the index will yield an annual real total return of 6.1% over the coming five years, and 7.5% over the coming decade. Both returns are far superior to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the FTSE 100 ranks 16th and 8th out of 43 markets for the 5- and 10-year total real return forecasts.

FTSE 100 rankings, out of 43 markets

Relative Valuation th

12 FTSE 100 43 Country Avg.

-0.3 +0.3

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

th

16

6.1 3.3

10-Year

th

8

7.5 4.5

5-Year

th

9

76 46

10-Year

1st 99 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given the explanatory power of our forecast models we estimate that there is an 76% probability that the FTSE 100 can achieve this return by the end of 2024 and 99% by the end of 2029, ranking the index 9th and 1st out of the 43 markets for both probabilities. On balance, it is highly likely that the FTSE 100 will out-perform the average global market over both the coming 5- and 10-year periods.

347

348

United States Dow Jones Composite Average The Dow Jones Composite Average (DJCA) aims to represent all large and well-known companies in the United States. It is composed of all component companies included in the other three primary Dow Jones Averages: Industrial, Transportation, and Utility. The DJCA is a priceweighted index, meaning that each company´s contribution to the index is relative to its current market price. Boeing, the American multinational aerospace and defense company (as well as the country´s largest exporter), is currently the largest component of the index. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the DJCA averaged 5.0% in 2019. The index is denominated in U.S. dollars.

The Bottom Line The DJCA finished 2019 at $9,386. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $7,483, implying an over-valuation of +1.3 standard deviations. The last time the index had this valuation during a rising market was in September 1997, and historically it has been more over-valued than it is today just 10% of the time. Over the coming 5-year period, we expect the DJCA to decrease by -0.9% annually. The forecasted range of annual returns runs from 2.7% to 0.3%. Our forecast model explains 66% of the variation in the 349

index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 40% probability. Dow Jones Composite Average Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

9,386 7,483 +1.3 2.9

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.6 1.7 1.9 2.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % -0.9 5-Year Forecast Range, % (-2.7, 0.3) 0.66 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 40 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

2.0 53

5-Year Annual Forecast Real Total Return, %

-0.3

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

2.0 (1.1, 2.8) 0.82 92

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

4.9 98

10-Year Annual Forecast Real Total Return, %

2.6

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The DJCA currently offers a dividend yield of 2.9%, implying a 5-year total return of 2.0% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year U.S. government bonds presently allow the investor to lock in a 1.9% annual yield. We forecast that the DJCA will outperform comparable bonds by December 2024 with a 53% probability. The forecast 5-year total return of 2.0% contrasts with the current inflation rate of 2.3%. We forecast that the DJCA will offer a real total return (including reinvested dividends) of -0.3% over the next five years. 350

Over the coming 10-year period, we expect the DJCA to rise by 2.0% annually. The forecasted range of 10-year annual returns is bound between 1.1% and 2.8%. Our forecast model explains 82% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 92% probability. The DJCA´s current dividend yield of 2.9% implies a 10-year total return of 4.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year U.S. government bonds presently allow the investor to lock in a 1.9% yield. We forecast that the DJCA Index will outperform comparable bonds by December 2029 with a 98% probability. The forecasted 10-year total return of 4.9% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 2.6% annually over the next decade.

Analysis The all-time monthly closing high of the DJCA was $9,386 in December 2019, the same month the market peaked in real, or inflation-adjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 7.6% annually. Since inflation over this same period has averaged 2.4%, the investor has earned an annual real price return of 5.2%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the 351

DJCA. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the DJCA is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The current bull market phase of the DJCA started in February 2009 at a price of $2,434 and a relative valuation of -2.8 standard deviations under the average of the preceding 30-year period, more under-valued than 99% of all previous months.

Since that low, the DJCA has advanced to its December 2019 high of $9,386. At this high, the market was over-valued +1.3 standard deviations. Thus, the index swung by +4.1 standard deviations since its bull market advance started. The index´s current advance has gained 13.3% annually since the 2009 low, and 16.1% including reinvested dividends.

Forecast Returns The return from holding an American government bond is defined in advance. What is needed is an estimate of what the return on the DJCA will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future 352

return of the DJCA is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the DJCA over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 7.6% on the DJCA over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the DJCA as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the DJCA to decrease by -0.9% annually. The forecasted range of annual returns runs from 2.7% to 0.3%. Our forecast model explains 66% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 40% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the 353

holding period. The DJCA currently offers a dividend yield of 2.9%, implying a 5-year total return of 2.0% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year U.S. government bonds presently allow the investor to lock in a 1.9% annual yield. We forecast that the DJCA will outperform comparable bonds by December 2024 with a 53% probability. The forecast 5-year total return of 2.0% contrasts with the current inflation rate of 2.3%. If the investor made investments denominated solely in U.S. dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the DJCA will offer a real total return (including reinvested dividends) of 0.3% over the next five years.

Over the coming 10-year period, we expect the DJCA to rise by 2.0% annually. The forecasted range of 10-year annual returns is bound between 1.1% and 2.8%. Our forecast model explains 82% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 92% probability. The DJCA´s current dividend yield of 2.9% implies a 10-year total return of 4.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year U.S. government bonds presently allow the 354

investor to lock in a 1.9% yield. We forecast that the DJCA Index will outperform comparable bonds by December 2029 with a 98% probability. The forecasted 10-year total return of 4.9% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 2.6% annually over the next

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The DJCA´s relative valuation of +1.3 standard deviations above its long-term mean is significantly higher than the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations) and implies that the index is extremely over-valued. As such, the DJCA is the 40th most under-valued market of the group. We forecast that the index will yield an annual real total return of 0.3% over the coming five years, and 2.6% over the coming decade. Both returns are far below to the averages for the 43 other countries (3.3% and 4.5%). Consequently, the DJCA ranks 29th and 24th out of 43 markets for the 5- and 10-year total real return forecasts.

Dow Jones Composite Average rankings, out of 43 markets

Relative Valuation

DJ Composite Avg. 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

40th

29th

24th

33rd

30th

+1.3 +0.3

-0.3 3.3

2.6 4.5

10 46

7 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. The averages for all 43 markets give approximately even odds (46%) of accomplishing this feat over both 5- and 10-year time horizons. Given 355

the explanatory power of our forecast models we estimate that there is a 10% probability that the DJCA can achieve this return by the end of 2024 and 7% by the end of 2029, ranking the index 33rd and 30th out of the 43 markets for the two probabilities. On balance, it is highly likely that the DJCA will under-perform the average global market over both the coming 5- and 10-year periods.

356

United States Dow Jones Industrial Average The Dow Jones Industrial Average (DJIA) is widely considered to be the premier index covering U.S. blue-chip equities. It is composed of 30 large industrial companies (or more correctly, companies that are neither utilities nor transports) listed in the United States. The DJIA is a price-weighted index, meaning that each company´s contribution to the index is relative to its current price, and covers over 20% of the available market. Boeing, the American multinational aerospace and defense company (as well as the country´s largest exporter), is currently the largest component of the index. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the DJIA averaged 3.0% in 2019. The index is denominated in U.S. dollars.

The Bottom Line The DJIA finished 2019 at $28,538. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $22,391, implying an over-valuation of +1.1 standard deviations. The last time the index was this over-valued during a rising market was in December 2017, and historically it has been more over-valued than it is today just 15% of the time. Over the coming 5-year period, we expect the DJIA to fall by -1.2% annually. The forecasted range of annual returns runs from -3.0% to 357

0.1%. Our forecast model explains 64% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with only a 39% probability. Dow Jones Industrial Average Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

28,538 22,392 +1.1 3.0

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.6 1.7 1.9 2.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % -1.2 5-Year Forecast Range, % (-3.0, 0.1) 0.64 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 39 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

1.8 51

5-Year Annual Forecast Real Total Return, %

-0.5

10-Year Forecasts 10-Year Annual Forecast Price Return, % 0.9 10-Year Forecast Range, % (-0.2, 1.9) 0.91 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 74 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

3.9 93

10-Year Annual Forecast Real Total Return, %

1.6

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The DJIA currently offers a dividend yield of 3.0%, implying a 5-year total return of 1.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the DJIA will outperform comparable bonds by December 2024 with a 51% probability. The forecast 5-year total return of 1.8% contrasts with the current inflation rate of 2.3%. We forecast that the DJIA will offer a real total return (including reinvested dividends) of -0.5% over the next five 358

years. Over the coming 10-year period, we expect the DJIA to rise by 0.9% annually. The forecasted range of 10-year annual returns is bound around this between -0.2% and 1.9%. Our forecast model explains 91% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 74% probability. The DJIA´s current dividend yield of 3.0% implies a 10-year total return of 2.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the DJIA index will outperform comparable bonds by December 2029 with a 93% probability. The forecasted 10-year total return of 3.9% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 1.6% annually over the next decade.

Analysis The all-time monthly closing high of the DJIA was $28,538 in December 2019, the same month the market peaked in inflationadjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 8.1% annually, and a total return (including reinvested dividends) of 10.8%. Since inflation over this same period has averaged 2.4%, the investor has earned an annual real total return of 8.4%.

359

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the DJIA. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the DJIA is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the DJIA started in August 2015 from a relative valuation of -0.3 standard deviations under the average of the preceding 30-year period, more under-valued than 62% of all previous months. Since July 1914 the DJIA has undergone seven complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market. Each bull market since 1914 has begun from a relatively undervalued position, on average -1.7 standard deviations below its longterm mean. The median duration of these bull market phases has been six years, with a total gain of 309%. On an annual basis, these advances have offered a median price return of 23% (ignoring the effect of 360

dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued territory, typically completing their cycle +1.3 standard deviations over-valued relative to the long-term average. The median cycle sees its relative valuation swing by +2.4 standard deviations. The index´s most significant bull market took place between September 1974 and October 2007. During this 33-year period, the DJIA never suffered a decline that pushed its relative valuation into negative territory, an event necessary to mark the end of a long-term advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 2,195% over this period, or about 10% annually (in price terms, ignoring reinvested dividends). The 1974 low saw the index under-valued by -2.2 standard deviations, and the 33-year rally would not be completed until the DJIA was +0.1 standard deviations over-valued for a swing of +2.3. While the 1974-2007 bull market was the largest in absolute terms and duration, swiftest bull market was the two-and-a-half-year period between July 1914 and November 1916. Starting from an undervaluation of -1.1 standard deviations below its long-term average, the DJIA rallied 110% to finish its cycle +1.3 standard deviations overvalued. The annual gain of 37% (again, ignoring reinvested dividends) is the sharpest annual gain of all ten bull markets on record. The most significant bear market was the 87% decline in the index between September 1929 and June 1932. During this three-year period, the DJIA lost 53% of its value annually. It also lost over six standard deviations of value, starting at +5.1 standard deviations over-valued and finishing -1.4 under-valued. Dow Jones Industrial Average: Bull and Bear Market Summary Declines Start Date

End Date

Advances

Start DJIA

End DJIA

Total Annual Change, % Change, %

Nov-16 Dec-17

107

70

-35

-32

Oct-19 Aug-21

113

66

-42

-25

Sep-29 Jun-32

362

46

-87

-53

Feb-37 Apr-42

188

97

-48

-12

Jan-66 Sep-74

983

607

-38

-5

Oct-07 Feb-09

13,930

7,062

-49

-40

Feb-15 Aug-15

18,132

16,528

-9

-17

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

Start End Date Date Jul-14 Nov-16

Start DJIA 51

End DJIA 107

Total Annual Change, % Change, % 110 37

Dec-17 Oct-19

70

113

61

30

Aug-21 Sep-29

66

362

448

23

Jun-32 Feb-37

46

188

309

35

Apr-42 Jan-66

97

983

913

10

Sep-74 Oct-07

607

13,930

2,195

10

Feb-09 Feb-15

7,062

18,132

157

17

Aug-15 Dec-19

16,528

28,538

73

13

1.8 -41.6 -25.4 1.3 -2.6

6.0 308.7 23.4 -1.7 2.4

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

While 1929-1932 is well-known as the most significant bear market 361

on record, the average decline over the five bear markets has been somewhat more subdued. On balance, the median depreciating phase of the DJIA´s valuation cycle lasted a little less than two years, and shaved 42% off the value of the index, resulting in a 25% annual loss. These bear markets have started from a median position of +1.3 standard deviations above the long-term average and have not ended until the index was under-valued by -1.7, for a median swing of -2.6 standard deviations. Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent December 2019 high of $28,538 the index had gained 73% over the four preceding years. Starting from the August 2015 low valuation of -0.3 standard deviations the index has posted 13% annual gains and is now +1.1 standard deviations over-valued, implying a valuation swing of +1.4 standard deviations. In terms of duration the present bull market has been quite short, and its 73% total gain is weak relative to the index´s historical appreciations. The 13% annual gain is low relative to historical rallies, though higher than both bull markets of 1942-66 and 1974-2007. The current advance started from a weakly under-valued market (-0.3), though its current over-valuation of +1.1 standard deviations over the long-term average is close to the median valuation at the top of bull markets (+1.3). The swing of +1.4 standard deviations of value is far less than the historical average of +2.6. It would also be the smallest bull market swing since 1917-19.

Forecast Returns The return from holding a U.S. government bond is defined in advance. What is needed is an estimate of what the return on the DJIA will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the DJIA is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of overvaluation. We have developed two models to forecast the return of the DJIA over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 10.8% on the DJIA over his lifetime (i.e., the annual 362

total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the DJIA as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the DJIA to fall by -1.2% annually. The forecasted range of annual returns runs from -3.0% to 0.1%. Our forecast model explains 64% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with only a 39% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The DJIA currently offers a dividend yield of 3.0%, implying a 5-year total return of 1.8% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the DJIA will outperform comparable bonds by December 2024 with a 51% probability. The forecast 5-year total return of 1.8% contrasts with the current inflation rate of 2.3%. If the investor made investments denominated solely in U.S. dollars, this rate of inflation would not affect his 363

investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the DJIA will offer a real total return (including reinvested dividends) of 0.5% over the next five years. Over the coming 10-year period, we expect the DJIA to rise by 0.9% annually. The forecasted range of 10-year annual returns is bound around this between -0.2% and 1.9%. Our forecast model explains 91% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 74% probability. The DJIA´s current dividend yield of 3.0% implies a 10-year total return of 2.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the DJIA index will outperform comparable bonds by December 2029 with a 93% probability.

The forecasted 10-year total return of 3.9% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 1.6% annually over the next

364

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The DJIA´s relative valuation of +1.1 standard deviations above its long-term mean is far above the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the DJIA is the 35th most under-valued market of the group. We forecast that the index will yield an annual real total return of 0.5% over the coming five years, and 1.6% over the coming decade. Both returns are far below the averages for the 43 other countries (3.3% and 4.5%). Consequently, the DJIA ranks 31st and 29th out of 43 markets for both total real return forecasts.

Dow Jones Industrial Average rankings, out of 43 markets

Relative Valuation th

35 DJ Industrial Avg. 43 Country Avg.

+1.1 +0.3

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

st

31

-0.5 3.3

10-Year

th

29

1.6 4.5

5-Year

th

30

13 46

10-Year

37th 1 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the explanatory power of our forecast models we estimate that there is an 13% probability that the DJIA can achieve this return by the end of 2024 and only 1% by the end of 2029, ranking the index 30th and 37th out of the 43 markets for both probabilities. On balance, it is highly likely that the DJIA will under-perform the average global market over both the coming 5- and 10-year periods.

365

366

United States Dow Jones Transportation Average The Dow Jones Transportation Average (DJTA) is a widely recognized gauge of the American transportation sector. It is composed of 20 large, publicly owned companies within the transportation industry that are listed in the United States. The DJTA is a price-weighted index, meaning that each company´s contribution to the index is relative to its current market price. Norfolk Southern, the American freight railroad, is currently the largest component of the index and transportation is the largest (and only) industry. The index is the oldest stock index still in use, first launched on 26 October 1896. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the DJTA averaged 2.0% in 2019. The index is denominated in U.S. dollars.

The Bottom Line The DJTA finished 2019 at $10,901. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $9,082, implying an over-valuation of +0.9 standard deviations. The last time the index was this over-valued during a rising market was in September 2017, and historically it has been more over-valued than it is today 18% of the time. Over the coming 5-year period, we expect the DJTA to fall by 0.1% annually. The forecasted range of annual returns is bound 367

between -1.8% and 1.4%. Our forecast model explains 72% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 49% probability. Dow Jones Transportation Average Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

10,901 9,082 +0.9 2.0

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.6 1.7 1.9 2.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % -0.1 5-Year Forecast Range, % (-1.8, 1.4) 0.72 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 49 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

1.9 52

5-Year Annual Forecast Real Total Return, %

-0.4

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

4.3 (4.0, 4.7) 0.61 99

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

6.3 99

10-Year Annual Forecast Real Total Return, %

4.0

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The DJTA currently offers a dividend yield of 2.0%, implying a 5-year total return of 1.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the DJTA will outperform comparable bonds by December 2024 with a 52% probability. The forecast 5-year total return of 1.9% contrasts with the current inflation rate of 2.3%. We forecast that the DJTA will offer a real total return (including reinvested dividends) of -0.4% over the next five 368

years. Over the coming 10-year period, we expect the DJTA to rise by 4.3% annually. The forecasted range of 10-year annual returns runs from 4.0% to 4.7%. Our forecast model explains 61% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The DJTA´s current dividend yield of 2.0% implies a 10-year total return of 6.3% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the DJTA index will outperform comparable bonds by December 2029 with a 99% probability. The forecasted 10-year total return of 6.3% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 4.0% annually over the next decade.

Analysis The all-time monthly closing high of the DJTA was $11,379 in December 2019. This high also represents the highest monthly close in inflation-adjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 7.7% annually, and a total return (including reinvested dividends) of 9.2%. Since inflation over this same period has averaged 2.4%, the investor has earned an annual real total return of 6.8%.

Using historical price, dividend, macroeconomic and financial data 369

dating to December 1989, we can compute the relative valuation of the DJTA. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the DJTA is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the DJTA started in February 2009 from a relative valuation of -2.8 standard deviations under the average of the preceding 30-year period, more under-valued than 99% of all previous months. Since August 1929 the DJTA has undergone five complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market. Each bull market since 1929 has begun from a relatively undervalued position, on average -1.6 standard deviations below its longterm mean. The median duration of these bull market phases has been just over six years, with a median total gain of 165%. On an annual basis, these advances have offered a median price return of 20% (ignoring the effect of dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued 370

territory, typically completing their cycle +1.4 standard deviations overvalued relative to the long-term average. The median cycle sees its relative valuation swing by +2.4 standard deviations. The index´s most significant bull market took place between September 1974 and April 1999. During this 25-year period, the DJTA never suffered a decline that pushed its relative valuation into negative territory, an event necessary to mark the end of a long-term advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 2,749% over this period, or about 15% annually (in price terms, ignoring reinvested dividends). The 1974 low saw the index under-valued by -2.2 standard deviations, and the 25-year rally would not be completed until the DJTA was +2.5 standard deviations over-valued. The change in relative valuation of +4.7 standard deviations is the most extreme swing on record. Dow Jones Transportation Average: Bull and Bear Market Summary Declines Start End Date Date Aug-29 Jun-32

Start DJTA 188

End DJTA 13

Apr-56 Dec-57

176

97

Jul-59

Advances Total Annual Change, % Change, % -93 -61 -45

End Date

Start DJTA

End DJTA

Total Annual Change, % Change, %

Jun-32 Apr-56

13

176

1,254

12

Dec-57 Jul-59

97

167

72

41

Sep-62 Feb-66

115

266

131

28

Sep-74 Apr-99

128

3,647

2,749

15

Feb-03 May-08

2,049

5,437

165

20

Feb-09 Sep-18

2,499

11,379

355

17

-30

Sep-62

167

115

-31

-11

Feb-66 Sep-74

266

128

-52

-8

Apr-99 Feb-03

3,647

2,049

-44

-14

May-08 Feb-09

5,437

2,499

-54

-64

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

Start Date

3.0 -48.4 -22.0 1.4 -3.3

5.2 165.3 20.4 -1.6 2.4

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

While the 1974-1999 bull market was the largest in absolute terms, it was also the longest in duration. The swiftest bull market was the year-and-a-half period between December 1957 and July 1959. Starting from an under-valuation of -0.4 standard deviations below its longterm average, the DJTA rallied 167% to finish its cycle +0.6 standard deviations over-valued. The annual gain of 41% (again, ignoring reinvested dividends) is the sharpest annual gain of all five bull markets on record. The most significant bear market was the 93% decline in the index between August 1929 and June 1932. During this three-year period, the DJTA lost 61% of its value annually. It also lost eight standard deviations of valuation, starting at +4.5 standard deviations overvalued and finishing -3.5 under-valued. While 1929-1932 is well-known as the most significant bear market on record, the average decline over the seven bear markets has been somewhat more subdued. On balance, the median depreciating phase 371

of the DJTA´s valuation cycle lasted three years, and shaved 48% off the value of the index, resulting in a -22% annual loss. These bear markets have started from a median position of +1.4 standard deviations above the long-term average and have not ended until the index was under-valued by -1.6, for a median swing of -3.3 standard deviations. Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent September 2018 high of $11,379 the index had gained 355% over the 10 preceding years. Starting from the February 2009 low valuation of -2.8 standard deviations the index has posted 17% annual gains and was at that point +1.8 standard deviations overvalued, implying a valuation swing of +4.6 standard deviations. In terms of duration the bull market was quite long, and its 355% total gain was double the index´s historical appreciations. The 17% annual gain was somewhat weak by historical standards but was the strongest rally since the 1932-56 advance. The advance started from a significantly under-valued market (-2.8), and its peak over-valuation of +1.8 standard deviations over the long-term average was high relative to the median valuation at the top of bull markets. The increase in valuation of +4.6 standard deviations was also high by historical precedent (second only to the 1974-99 bull market), and on balance it is likely that the DJTA is ended its bull market advance in 2018.

Forecast Returns The return from holding a U.S. government bond is defined in advance. What is needed is an estimate of what the return on the DJTA will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the DJTA is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of overvaluation. We have developed two models to forecast the return of the DJTA over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 9.2% on the DJTA over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same

372

investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the DJTA as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the DJTA to fall by 0.1% annually. The forecasted range of annual returns is bound between -1.8% and 1.4%. Our forecast model explains 72% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 49% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The DJTA currently offers a dividend yield of 2.0%, implying a 5-year total return of 1.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the DJTA will outperform comparable bonds by December 2024 with a 52% probability. The forecast 5-year total return of 1.9% contrasts with the current inflation rate of 2.3%. If the investor made investments denominated solely in U.S. dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between 373

equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the DJTA will offer a real total return (including reinvested dividends) of 0.4% over the next five years. Over the coming 10-year period, we expect the DJTA to rise by 4.3% annually. The forecasted range of 10-year annual returns runs from 4.0% to 4.7%. Our forecast model explains 61% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 99% probability. The DJTA´s current dividend yield of 2.0% implies a 10-year total return of 6.3% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the DJTA index will outperform comparable bonds by December 2029 with a 99% probability.

The forecasted 10-year total return of 6.3% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 4.0% annually over the next

374

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The DJTA´s relative valuation of +0.9 standard deviations above its long-term mean is far above the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the DJTA is the 30th most under-valued market of the group. We forecast that the index will yield an annual real total return of – 0.4% over the coming five years, and 4.0% over the coming decade. Both returns are less than the averages for the 43 other countries (3.3% and 4.5%). Consequently, the DJTA ranks 30th and 21st out of 43 markets for both total real return forecasts. Dow Jones Transportation Average rankings, out of 43 markets

Relative Valuation th

30 DJ Trans. Avg. 43 Country Avg.

+0.9 +0.3

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

th

30

-0.4 3.3

10-Year

st

5-Year

10-Year

th

22nd

21

35

4.0 4.5

9 46

33 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the explanatory power of our forecast models we estimate that there is an 9% probability that the DJTA can achieve this return by the end of 2024 and only 33% by the end of 2029, ranking the index 35th and 22nd out of the 43 markets for both probabilities. On balance, it is highly likely that the DJTA will under-perform the average global market over both the coming 5- and 10-year periods.

375

376

United States Dow Jones Utility Average The Dow Jones Utility Average (DJUA) is the main stock market index representing the utility sector in the United States. It is composed of 15 large, publicly owned companies based in the United States. Unlike most indexes, the DJUA is price-weighted, meaning that each company´s contribution to the index is relative to its current share price. NextEra Energy, America´s largest electric holding company, is currently the largest component of the index. Notwithstanding that the index only includes utility companies, it is concentrated specifically in the electric utility industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the DJUA averaged 4.0% in 2019. The index is denominated in U.S. dollars.

The Bottom Line The DJUA finished 2019 at $879. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $647, implying an over-valuation of +2.1 standard deviations. The last time the index was this over-valued during a rising market was in November 2000, and historically it has been more over-valued than it is today just 1% of the time. Over the coming 5-year period, we expect the DJUA to fall by 5.0% annually. The forecasted range of annual returns is strictly negative and runs from -5.3% to -4.8%. Our forecast model explains 377

66% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with only a 6% probability. Dow Jones Utility Average Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

879 647 +2.1 4.0

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.6 1.7 1.9 2.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % -5.0 5-Year Forecast Range, % (-5.3, -4.8) 0.66 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 6 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

-1.0 20

5-Year Annual Forecast Real Total Return, %

-3.3

10-Year Forecasts 10-Year Annual Forecast Price Return, % -0.7 10-Year Forecast Range, % (-0.7, -0.6) 0.62 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 34 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

3.3 81

10-Year Annual Forecast Real Total Return, %

1.0

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The DJUA currently offers a dividend yield of 4.0%, implying a 5-year total return of -1.0% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the DJUA will outperform comparable bonds by December 2024 with a 20% probability. The forecast 5-year total return of -1.0% contrasts with the current inflation rate of 2.3%. We forecast that the DJUA will offer a real total return (including reinvested dividends) of -3.3% over the next five years. 378

Over the coming 10-year period, we expect the DJUA to fall by 0.7% annually. The forecasted range of 10-year annual returns is bound around this between -0.7% and -0.6%. Our forecast model explains 62% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 34% probability. The DJUA´s current dividend yield of 4.0% implies a 10-year total return of 3.3% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the DJUA index will outperform comparable bonds by December 2029 with an 81% probability. The forecasted 10-year total return of 3.3% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 1.0% annually over the next decade.

Analysis The all-time monthly closing high of the DJUA was $879 in December 2019. The market´s peak in real, or inflation-adjusted terms, came 90 years earlier in August 1929.

Over the 30 years since December 1989, the index has yielded a price return of 4.5% annually, and a total return (including reinvested dividends) of 9.2%. Since inflation over this same period has averaged 2.4%, the investor has earned an annual real total return of 6.8%. Using historical price, dividend, macroeconomic and financial data 379

dating to December 1989, we can compute the relative valuation of the DJUA. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the DJUA is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the DJUA started in February 2009 from a relative valuation of -1.2 standard deviations under the average of the preceding 30-year period, more under-valued than 88% of all previous months. Since March 1965 the DJUA has undergone three complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market. Each bull market since 1965 has begun from a relatively undervalued position, on average -1.5 standard deviations below its longterm mean. The median duration of these bull market phases has been six-and-a-half years, with a median total gain of 171%. On an annual basis, these advances have offered a median price return of 14% (ignoring the effect of dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued 380

territory, typically completing their cycle +2.5 standard deviations overvalued relative to the long-term average. The median cycle sees its relative valuation swing by +3.9 standard deviations. The index´s most significant bull market took place between August 1974 and August 1993. During this 19-year period, the DJUA never suffered a decline that pushed its relative valuation into negative territory, an event necessary to mark the end of a long-term advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 327% over this period, or about 8% annually (in price terms, ignoring reinvested dividends). The 1974 low saw the index under-valued by -2.1 standard deviations, and the 19-year rally would not be completed until the DJUA was +1.8 standard deviations over-valued for a swing of +3.9. The most significant bear market was the 63% decline in the index between March 1965 and August 1974. During this nine-year period, the DJUA lost 10% of its value annually. It also lost over four standard deviations of value, starting at +2.2 standard deviations over-valued and finishing -2.1 under-valued. Dow Jones Utility Average: Bull and Bear Market Summary Declines Start End Date Date Mar-65 Aug-74

Start DJUA 162

End DJUA 60

Aug-93 Jun-94

256

177

Advances Total Annual Change, % Change, % -63 -10 -31

End Date

Start DJUA

End DJUA

Total Annual Change, % Change, %

Aug-74 Aug-93

60

256

327

8

Jun-94 Dec-00

177

412

133

14

Feb-03 Oct-07

197

534

171

24

Feb-09 Dec-19

323

879

172

10

-36

Dec-00 Feb-03

412

197

-52

-29

Oct-07 Feb-09

534

323

-40

-31

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

Start Date

1.8 -45.8 -30.1 2.5 -4.1

6.5 171.1 13.9 -1.5 3.9

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

While 1965-1974 is well-known as the most significant bear market on record, the average decline over the five bear markets has been somewhat more subdued. On balance, the median depreciating phase of the DJUA´s valuation cycle lasted a little less than two years and shaved -46% off the value of the index, resulting in a -30% annual loss. These bear markets have started from a median position of +2.5 standard deviations above the long-term average and have not ended until the index was under-valued by -1.5, for a median swing of -4.1 standard deviations. Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent December 2019 high of $879 the index had gained 172% over the 11 preceding years. Starting from the February 2009 low valuation of -1.2 standard deviations the index has posted 10% annual 381

gains and is now +2.1 standard deviations over-valued, implying a valuation swing of +3.3 standard deviations. In terms of duration the present bull market has been quite long, and its 172% total gain is on par with the index´s historical appreciations. The 10% annual gain is somewhat low relative to historical rallies, though higher than the bull market of 1974-93. The current advance started from an under-valued market (-1.2), and its current over-valuation of +2.1 standard deviations over the long-term average is close to the median valuation at the top of bull markets (+2.5). The swing of +3.3 standard deviations of value is also close to the historical average of +3.9- Given these facts it is highly likely that the index is close to ending its long-term bull market.

Forecast Returns The return from holding a U.S. government bond is defined in advance. What is needed is an estimate of what the return on the DJUA will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the DJUA is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of overvaluation. We have developed two models to forecast the return of the DJUA over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 9.2% on the DJUA over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the DJUA as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the DJUA to fall by 5.0% annually. The forecasted range of annual returns is strictly negative and runs from -5.3% to -4.8%. Our forecast model explains 66% of the variation in the index´s 5-year returns since December 382

1989. Consequently, we forecast that the index will break-even by December 2024 with only a 6% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The DJUA currently offers a dividend yield of 4.0%, implying a 5-year total return of -1.0% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the DJUA will outperform comparable bonds by December 2024 with a 20% probability.

The forecast 5-year total return of -1.0% contrasts with the current inflation rate of 2.3%. If the investor made investments denominated solely in U.S. dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the DJUA will offer a real total return (including reinvested dividends) of 3.3% over the next five years. Over the coming 10-year period, we expect the DJUA to fall by 0.7% annually. The forecasted range of 10-year annual returns is bound around this between -0.7% and -0.6%. Our forecast model explains 62% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 34% probability. 383

The DJUA´s current dividend yield of 4.0% implies a 10-year total return of 3.3% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the DJUA index will outperform comparable bonds by December 2029 with an 81% probability.

The forecasted 10-year total return of 3.3% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 1.0% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The DJUA´s relative valuation of +2.1 standard deviations above its long-term mean is far above the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the DJUA is the 42nd most under-valued market of the group. We forecast that the index will yield an annual real total return of 384

3.3% over the coming five years, and 1.0% over the coming decade. Both returns are far below the averages for the 43 other countries (3.3% and 4.5%). Consequently, the DJUA ranks 38th and 34th out of 43 markets for both total real return forecasts. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the explanatory power of our forecast models we estimate that there is an 1% probability that the DJUA can achieve either returns, ranking the index 39th and 37th out of the 43 markets for both probabilities.

Dow Jones Utility Average rankings, out of 43 markets

Relative Valuation

DJ Utility Avg. 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

42nd

38th

34th

39th

37th

+2.1 +0.3

-3.3 3.3

1.0 4.5

1 46

1 46

On balance, it is highly likely that the DJUA will under-perform the average global market over both the coming 5- and 10-year periods.

385

386

United States NASDAQ Composite The NASDAQ Composite Index is widely considered to be, along with the Dow Jones Industrial Average and S&P 500, one of the three most widely followed indexes covering U.S. equities. It is composed of all shares listed on the Nasdaq stock market. The NASDAQ is a capitalization-weighted index, meaning that each company´s contribution to the index is relative to its current market value. Apple, the American technology company, is currently the largest component of the index. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the NASDAQ averaged 1.5% in 2019. The index is denominated in U.S. dollars.

The Bottom Line The NASDAQ finished 2019 at $8,972. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $5,859, implying an over-valuation of +1.1 standard deviations. The last time the index was this over-valued during a rising market was in June 1998, and historically it has been more over-valued than it is today just 7% of the time. Over the coming 5-year period, we expect the NASDAQ to fall by -2.1% annually. The forecasted range of annual returns is strictly negative and runs from -4.7% to -0.6%. Our forecast model explains 55% of the variation in the index´s 5-year returns since December 387

1989. Consequently, we forecast that the index will break-even by December 2024 with a 39% probability. NASDAQ Composite Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

8,972 5,859 +1.1 1.5

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.6 1.7 1.9 2.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % -2.1 5-Year Forecast Range, % (-4.7, -0.6) 0.55 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 39 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

-0.6 38

5-Year Annual Forecast Real Total Return, %

-2.9

10-Year Forecasts 10-Year Annual Forecast Price Return, % 1.1 10-Year Forecast Range, % (-0.8, 2.6) 0.75 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 63 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

2.6 57

10-Year Annual Forecast Real Total Return, %

0.3

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The NASDAQ currently offers a dividend yield of 1.5%, implying a 5-year total return of -0.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the NASDAQ will outperform comparable bonds by December 2024 with a 38% probability. The forecast 5-year total return of -0.6% contrasts with the current inflation rate of 2.3%. We forecast that the NASDAQ will offer a real total return (including reinvested dividends) of -2.9% over the next five years. Over the coming 10-year period, we expect the NASDAQ to rise 388

by 1.1% annually. The forecasted range of 10-year annual returns is bound between -0.8% and 2.6%. Our forecast model explains 75% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 57% probability. The NASDAQ´s current dividend yield of 1.5% implies a 10-year total return of 2.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the NASDAQ index will outperform comparable bonds by December 2029 with a 57% probability. The forecasted 10-year total return of 2.6% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 0.3% annually over the next decade.

Analysis The all-time monthly closing high of the NASDAQ was $9,150 in December 2019, the same month the market peaked in inflationadjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 10.5% annually. Since inflation over this same period has averaged 2.4%, the investor has earned an annual real price return of 8.1%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the NASDAQ. This relative valuation is expressed in standard deviations 389

from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the NASDAQ is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the NASDAQ started in February 2009 from a relative valuation of -1.4 standard deviations under the average of the preceding 30-year period, more under-valued than 92% of all previous months. Since May 1969 the NASDAQ has undergone three complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market. Each bull market since 1969 has begun from a relatively undervalued position, on average -1.0 standard deviation below its long-term mean. The median duration of these bull market phases has been just over five years, with a median total gain of 144%. On an annual basis, these advances have offered a median price return of 19% (ignoring the effect of dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued territory, typically completing their cycle +1.0 standard deviations over-valued relative to the long-term average. The median cycle sees its relative valuation swing by +0.6 standard deviations.

390

The index´s most significant bull market took place between September 1974 and February 2000. During this 25-year period, the NASDAQ never suffered a decline that pushed its relative valuation into negative territory, an event necessary to mark the end of a longterm advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 8,438% over this period, or about 19% annually (in price terms, ignoring reinvested dividends). The 1974 low saw the index under-valued by -2.4 standard deviations, and the 25-year rally would not be completed until the NASDAQ was +6.0 standard deviations over-valued for a swing of +8.4. While the 1974-2000 bull market was the largest in absolute terms and duration, the swiftest bull market was the two-year period between June 1970 and December 1972. Starting from an under-valuation of 0.4 standard deviations below its long-term average, the NASDAQ rallied 133% to finish its cycle +0.2 standard deviations over-valued. The annual gain of 27% (again, ignoring reinvested dividends) is the sharpest annual gain of all three bull markets on record. The most significant bear market was the 75% decline in the index between February 2000 and September 2002. During this three-year period, the NASDAQ lost 42% of its value annually. It also lost over six standard deviations of value, starting at +6.0 standard deviations over-valued and finishing -0.5 under-valued. NASDAQ Composite Index: Bull and Bear Market Summary Declines Start Date

End Date

Advances

Start End Total Annual NASDAQ NASDAQ Change, % Change, %

May-69 Jun-70

96

73

-24

-22

Dec-72 Sep-74

133

55

-59

-40

Feb-00 Sep-02 Oct-07 Feb-09

4,696 2,859

1,172 1,377

-75 -52

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

Start Date

End Start End Total Annual Date NASDAQ NASDAQ Change, % Change, %

Jun-70 Dec-72

73

133

82

27

Sep-74 Feb-00

55

4,696

8,438

19

Sep-02 Oct-07

1,172

2,859

144

19

Feb-09 Dec-19

1,377

8,972

552

19

-42 -42

1.5 -55.2 -40.6 1.0 -2.4

5.1 143.9 19.2 -1.0 0.6

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

While 2000-02 is well-known as the most significant bear market on record, the average decline over the four bear markets has been somewhat more subdued. On balance, the median depreciating phase of the NASDAQ´s valuation cycle lasted a year and a half, and shaved 55% off the value of the index, resulting in a 41% annual loss. These bear markets have started from a median position of +1.0 standard deviations above the long-term average and have not ended until the index was under-valued by -1.0, for a median swing of -2.4 standard deviations. 391

Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent December 2019 high of $8,972 the index had gained 552% over the preceding decade. Starting from the 2009 low valuation of -1.4 standard deviations, the index posted 19% annual gains and is now +1.1 standard deviations over-valued, implying a valuation swing of +2.5 standard deviations. In terms of duration the present bull market has been quite long (double the length of the median appreciation), and its 552% total gain is high relative to the index´s historical appreciations. The 19% annual gain is on par with historical rallies. The current advance started from a somewhat strongly under-valued market (-1.4), and its current overvaluation of +1.1 standard deviations over the long-term average is close to the median valuation at the top of bull markets (+1.0). The swing of +2.5 standard deviations of value is far higher than the historical average of +1.0. All evidence points to the NASDAQ peaking and ready to commence a multi-year bear market correction.

Forecast Returns The return from holding a U.S. government bond is defined in advance. What is needed is an estimate of what the return on the NASDAQ will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the NASDAQ is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the NASDAQ over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 10.5% on the NASDAQ over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the NASDAQ as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power 392

over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the NASDAQ to fall by -2.1% annually. The forecasted range of annual returns is strictly negative and runs from -4.7% to -0.6%. Our forecast model explains 55% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 39% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The NASDAQ currently offers a dividend yield of 1.5%, implying a 5-year total return of -0.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the NASDAQ will outperform comparable bonds by December 2024 with a 38% probability.

The forecast 5-year total return of -0.6% contrasts with the current inflation rate of 2.3%. If the investor made investments denominated solely in U.S. dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the NASDAQ will offer a real total return (including reinvested dividends) of -2.9% over the next five years. Over the coming 10-year period, we expect the NASDAQ to rise 393

by 1.1% annually. The forecasted range of 10-year annual returns is bound between -0.8% and 2.6%. Our forecast model explains 75% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 57% probability. The NASDAQ´s current dividend yield of 1.5% implies a 10-year total return of 2.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the NASDAQ index will outperform comparable bonds by December 2029 with a 57% probability.

The forecasted 10-year total return of 2.6% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 0.3% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. 394

The NASDAQ´s relative valuation of +1.1 standard deviations above its long-term mean is far above the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the NASDAQ is the 35th most under-valued market of the group. We forecast that the index will yield an annual real total return of 2.9% over the coming five years, and 0.3% over the coming decade. Both returns are far below the averages for the 43 other countries (3.3% and 4.5%). Consequently, the NASDAQ ranks 36th and 37th out of 43 markets for both total real return forecasts.

NASDAQ Composite rankings, out of 43 markets

Relative Valuation

NASDAQ Comp. 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

35th

36th

37th

28th

28th

+1.1 +0.3

-2.9 3.3

0.3 4.5

16 46

9 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the explanatory power of our forecast models we estimate that there is an 16% probability that the NASDAQ can achieve this return by the end of 2024 and only 9% by the end of 2029, ranking the index 28th out of the 43 markets for both probabilities. On balance, it is highly likely that the NASDAQ will under-perform the average global market over both the coming 5- and 10-year periods.

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396

United States NASDAQ-100 The NASDAQ-100 Index (NASDAQ-100) is widely considered to be the premier index covering U.S. technology equities. It is composed of the 100 largest companies listed on the Nasdaq stock market, excluding financial companies. The NASDAQ-100 is a capitalization-weighted index, meaning that each company´s contribution to the index is relative to its current market value. It is rebalanced on an annual basis. Apple, the American technology company, is currently the largest component of the index. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the NASDAQ-100 averaged 1.5% in 2019. The index is denominated in U.S. dollars.

The Bottom Line The NASDAQ-100 finished 2019 at $8,733. Based on historical valuations dating to December 1989 (360 months), we estimate the fairvalue price to be $5,707, implying an over-valuation of +0.7 standard deviations. The last time the index was this over-valued during a rising market was in March 1998, and historically it has been more overvalued than it is today only 26% of the time. Over the coming 5-year period, we expect the NASDAQ-100 to rise by 0.7% annually. The forecasted range of annual returns is bound between -2.0% and 2.4%. Our forecast model explains 50% of the variation in the index´s 5-year returns since December 1989. 397

Consequently, we forecast that the index will break-even by December 2024 with a 53% probability. NASDAQ-100 Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

8,733 5,707 +0.7 1.5

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.6 1.7 1.9 2.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % 0.7 5-Year Forecast Range, % (-2.0, 2.4) 0.50 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 53 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

2.2 52

5-Year Annual Forecast Real Total Return, %

-0.1

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

2.6 (0.2, 4.5) 0.72 72

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

4.1 69

10-Year Annual Forecast Real Total Return, %

1.8

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The NASDAQ-100 currently offers a dividend yield of 1.5%, implying a 5-year total return of 2.2% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the NASDAQ-100 will outperform comparable bonds by December 2024 with a 52% probability. The forecast 5-year total return of 2.2% contrasts with the current inflation rate of 2.3%. We forecast that the NASDAQ-100 will offer a real total return (including reinvested dividends) of -0.1% over the next five years. Over the coming 10-year period, we expect the NASDAQ-100 to 398

rise by 2.6% annually. The forecasted range of 10-year annual returns is bound between 0.2% and 4.5%. Our forecast model explains 72% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 72% probability. The NASDAQ-100´s current dividend yield of 1.5% implies a 10year total return of 4.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the NASDAQ-100 index will outperform comparable bonds by December 2029 with a 69% probability. The forecasted 10-year total return of 4.1% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 1.8% annually over the next decade.

Analysis The all-time monthly closing high of the NASDAQ-100 was $8,733 in December 2019, the same month the market peaked in inflationadjusted terms. Over the 30 years since December 1989, the index has yielded a price return of 13.0% annually. Since inflation over this same period has averaged 2.4%, the investor has earned an annual real price return of 10.6%.

Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the NASDAQ-100. This relative valuation is expressed in standard 399

deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the NASDAQ-100 is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes. The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the NASDAQ-100 started in February 2009 from a relative valuation of -1.0 standard deviations under the average of the preceding 30-year period, more under-valued than 84% of all previous months.

Since that low, the NASDAQ-100 has advanced to its December 2019 high of $8,733. At this high, the market was over-valued with a relative valuation of +0.7. Thus, the index swung by +1.7 standard deviations since its bull market advance started. The index´s current advance has gained 20.9% annually since the 2009 low, and 22.3% including reinvested dividends.

Forecast Returns The return from holding a U.S. government bond is defined in advance. What is needed is an estimate of what the return on the NASDAQ-100 400

will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the NASDAQ-100 is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the NASDAQ-100 over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual price return of around 13.0% on the NASDAQ-100 over his lifetime (i.e., the annual price return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the NASDAQ-100 as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the NASDAQ-100 to rise by 0.7% annually. The forecasted range of annual returns is bound between -2.0% and 2.4%. Our forecast model explains 50% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 53% probability.

401

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The NASDAQ-100 currently offers a dividend yield of 1.5%, implying a 5-year total return of 2.2% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the NASDAQ-100 will outperform comparable bonds by December 2024 with a 52% probability. The forecast 5-year total return of 2.2% contrasts with the current inflation rate of 2.3%. If the investor made investments denominated solely in U.S. dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the NASDAQ-100 will offer a real total return (including reinvested dividends) of -0.1% over the next five years. Over the coming 10-year period, we expect the NASDAQ-100 to rise by 2.6% annually. The forecasted range of 10-year annual returns is bound between 0.2% and 4.5%. Our forecast model explains 72% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 72% probability.

402

The NASDAQ-100´s current dividend yield of 1.5% implies a 10year total return of 4.1% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the NASDAQ-100 index will outperform comparable bonds by December 2029 with a 69% probability. The forecasted 10-year total return of 4.1% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 1.8% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The NASDAQ-100´s relative valuation of +0.7 standard deviations above its long-term mean is far above the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the NASDAQ-100 is the 28th most under-valued market of the group. We forecast that the index will yield an annual real total return of 0.1% over the coming five years, and 1.8% over the coming decade. Both returns are far below the averages for the 43 other countries (3.3% and 4.5%). Consequently, the NASDAQ-100 ranks 27th out of 43 markets for both total real return forecasts.

NASDAQ-100 rankings, out of 43 markets

Relative Valuation

NASDAQ-100 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

28th

27th

27th

23rd

24th

+0.7 +0.3

-0.1 3.3

1.8 4.5

33 46

26 46

Finally, we consider the probability that the forecasted total return 403

for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the explanatory power of our forecast models we estimate that there is an 33% probability that the NASDAQ-100 can achieve this return by the end of 2024 and only 26% by the end of 2029, ranking the index 23rd and 24th out of the 43 markets for both probabilities. On balance, it is highly likely that the NASDAQ-100 will underperform the average global market over both the coming 5- and 10year periods.

404

United States S&P 500 The S&P 500 is widely considered to be the best gauge of large-cap U.S. equities. It is composed of 500 large, publicly owned companies listed in the United States. The index´s composition is rebalanced on a quarterly basis. The S&P 500 is a float-adjusted market capitalization index, meaning that each company´s contribution to the index is relative to the value of its publicly traded shares, and covers over 80% of the available market. Microsoft, the American technology company, is currently the largest component of the index and technology is the largest industry. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the S&P 500 averaged 2.6% in 2019. The index is denominated in U.S. dollars.

The Bottom Line The S&P 500 finished 2019 at $3,230. Based on historical valuations dating to December 1989 (360 months), we estimate the fair-value price to be $2,412, implying an over-valuation of +1.2 standard deviations. The last time the index was this over-valued during a rising market was in September 1998, and historically it has been more over-valued than it is today only 12% of the time. Over the coming 5-year period, we expect the S&P 500 to fall by 2.3% annually. The forecasted range of annual returns is strictly negative, running from -4.4% to -1.0%. Our forecast model explains 405

62% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 32% probability.

S&P 500 Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

3,230 2,412 +1.2 2.6

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.6 1.7 1.9 2.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % -2.3 5-Year Forecast Range, % (-4.4, -1.0) 0.62 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 32 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

0.3 39

5-Year Annual Forecast Real Total Return, %

-2.0

10-Year Forecasts 10-Year Annual Forecast Price Return, % 10-Year Forecast Range, % Adjusted R2 Probability 10-Year Forecast Price Return > 0, %

0.3 (-1.0, 1.6) 0.90 59

10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

2.9 75

10-Year Annual Forecast Real Total Return, %

0.6

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The S&P 500 currently offers a dividend yield of 2.6%, implying a 5-year total return of 0.3% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast 406

that the S&P 500 will outperform comparable bonds by December 2024 with a 39% probability. The forecast 5-year total return of 0.3% contrasts with the current inflation rate of 2.3%. We forecast that the S&P 500 will offer a real total return (including reinvested dividends) of -2.0% over the next five years. Over the coming 10-year period, we expect the S&P 500 to rise by 0.3% annually. The forecasted range of 10-year annual returns is bound around this break-even level, running from -1.0% to 1.6%. Our forecast model explains 90% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 59% probability. The S&P 500´s current dividend yield of 2.6% implies a 10-year total return of 2.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the S&P 500 index will outperform comparable bonds by December 2029 with a 75% probability. The forecasted 10-year total return of 2.9% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 0.6% annually over the next decade.

Analysis The all-time monthly closing high of the S&P 500 was $3,230 in December 2019. This high also represents the highest monthly close in inflation-adjusted terms.

407

Over the 30 years since December 1989, the index has yielded a price return of 7.7% annually, and a total return (including reinvested dividends) of 9.9%. Since inflation over this same period has averaged 2.4%, the investor has earned an annual real total return of 7.5%. Using historical price, dividend, macroeconomic and financial data dating to December 1989, we can compute the relative valuation of the S&P 500. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the S&P 500 is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the S&P 500 started in February 2009 from a relative valuation of -2.2 standard deviations under the average of the preceding 30-year period, more under-valued than 99% of all previous months. Since December 1909 the S&P 500 has undergone six complete valuation cycles. Each cycle includes on appreciating bull market, and one depreciating bear market. 408

Each bull market since 1909 has begun from a relatively undervalued position, on average -1.5 standard deviations below its longterm mean. The median duration of these bull market phases has been six-and-a-half years, with a median total gain of 333%. On an annual basis, these advances have offered a median price return of 17% (ignoring the effect of dividends). These bull markets have ended their advances by pushing their starting under-valuations into over-valued territory, typically completing their cycle +1.6 standard deviations overvalued relative to the long-term average. The median cycle sees its relative valuation swing by +2.7 standard deviations. S&P 500 Index: Bull and Bear Market Summary Declines

Advances

Start End Start End S&P Total Annual Date Date S&P 500 500 Change, % Change, % Dec-09 Aug-21 10 6 -37 -4 Sep-29 Jun-32

31

5

-85

-50

Feb-37 Apr-42

18

8

-57

-15

May-46 Jun-49

19

14

-25

107

64

-40

-9

Aug-00 Aug-02

1,518

916

-40

-22

1,549

735

-53

Median Duration, years Median Decline, % Median Annual Decline, % Median Starting Relative Valuation Median Change in Relative Valuation

End Date

Start End Total Annual S&P 500 S&P 500 Change, % Change, %

Aug-21 Sep-29

6

31

385

22

Jun-32 Feb-37

5

18

280

33

Apr-42 May-46

8

19

139

24

Jun-49 Dec-68

14

107

662

11

-9

Dec-68 Sep-74

Oct-07 Feb-09

Start Date

Sep-74 Aug-00

64

1,518

2,289

13

Aug-02 Oct-07

916

1,549

69

11

Feb-09 Dec-19

735

3,231

340

15

-43

3.1 -40.3 -15.0 1.6 -2.7

6.6 332.5 17.3 -1.5 2.7

Median Duration, years Median Advance, % Median Annual Advance, % Median Starting Relative Valuation Median Change in Relative Valuation

The index´s most significant bull market took place between September 1974 and August 2000. During this 26-year period, the S&P 500 never suffered a decline that pushed its relative valuation into negative territory, an event necessary to mark the end of a long-term advance. (Any under-valuations during this period did not coincide with a market decline.) The index gained 2,289% over this period, or about 13% annually (in price terms, ignoring reinvested dividends). The 1974 low saw the index under-valued by -2.3 standard deviations, and the 26-year rally would not be completed until the S&P 500 was +2.8 standard deviations over-valued. The change in relative valuation of +5.1 standard deviations is one of the most extreme swings on record (surpassed only by the bull market of 1921-29). While the 1974-2000 bull market was the largest in absolute terms, it was also the longest in duration. The swiftest bull market was the four-and-a-half-year period between June 1932 and February 1937. Starting from an under-valuation of -1.5 standard deviations below its long-term average, the S&P 500 rallied 280% to finish its cycle +1.8 standard deviations over-valued. The annual gain of 33% (again, ignoring reinvested dividends) is the sharpest annual gain of all seven 409

bull markets on record. The most significant bear market was the 85% decline in the index between September 1929 and June 1932. During this three-year period, the S&P 500 lost 50% of its value annually. It also lost over seven standard deviations of valuation, starting at +5.5 standard deviations over-valued and finishing -1.5 under-valued. While 1929-1932 is well-known as the most significant bear market on record, the average decline over the seven bear markets has been somewhat more subdued. On balance, the median depreciating phase of the S&P 500´s valuation cycle lasted a little more than three years, and shaved 40% off the value of the index, resulting in a 15% annual loss. These bear markets have started from a median position of +1.6 standard deviations above the long-term average and have not ended until the index was under-valued by -1.5, for a median swing of -2.7 standard deviations. Taking these averages into account, we can look at the current bull market and estimate how close the index is to completing the present phase. At the recent December 2019 high of $3,231 the index had gained 340% over the ten preceding years. Starting from the February 2009 low valuation of -2.2 standard deviations the index has posted 15% annual gains and is now +1.2 standard deviations over-valued, implying a valuation swing of +3.4 standard deviations. In terms of duration the present bull market has been quite long, and its 340% total gain is on par with the index´s historical appreciations. The 15% annual gain is somewhat weak by historical standards but is the strongest rally since the 1942-1946 advance. The current advance started from a significantly under-valued market (-2.2), and its current over-valuation of +1.2 standard deviations over the long-term average is somewhat low relative to the median valuation at the top of bull markets. This fact notwithstanding, the increase in valuation of +3.4 standard deviations is high by historical precedent, and on balance it is likely that the S&P 500 is nearing the end of its current bull-market phase.

Forecast Returns The return from holding a U.S. government bond is defined in advance. What is needed is an estimate of what the return on the S&P 500 will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the S&P 500 is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of under-valuation deliver far superior returns to those made during periods of over410

valuation. We have developed two models to forecast the return of the S&P 500 over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 9.9% on the S&P 500 over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the S&P 500 as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the S&P 500 to fall by 2.3% annually. The forecasted range of annual returns is strictly negative, running from -4.4% to -1.0%. Our forecast model explains 62% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will break-even by December 2024 with a 32% probability.

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The S&P 500 currently offers a dividend yield of 2.6%, implying a 5-year total return of 0.3% annually. We can compare this total return to that which the investor could earn on an alternative 411

investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the S&P 500 will outperform comparable bonds by December 2024 with a 39% probability. The forecast 5-year total return of 0.3% contrasts with the current inflation rate of 2.3%. If the investor made investments denominated solely in U.S. dollars, this rate of inflation would not affect his investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the S&P 500 will offer a real total return (including reinvested dividends) of -2.0% over the next five years. Over the coming 10-year period, we expect the S&P 500 to rise by 0.3% annually. The forecasted range of 10-year annual returns is bound around this break-even level, running from -1.0% to 1.6%. Our forecast model explains 90% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will breakeven by December 2029 with a 59% probability.

The S&P 500´s current dividend yield of 2.6% implies a 10-year total return of 2.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10-year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the S&P 500 index will outperform comparable bonds by December 2029 with a 75% probability. 412

The forecasted 10-year total return of 2.9% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 0.6% annually over the next decade.

Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The S&P 500´s relative valuation of +1.2 standard deviations above its long-term mean is far above the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the S&P 500 is the 38th most under-valued market of the group. We forecast that the index will yield an annual real total return of 2.0% over the coming five years, and 0.6% over the coming decade. Both returns are far below the averages for the 43 other countries (3.3% and 4.5%). Consequently, the S&P 500 ranks 35th out of 43 markets for both total real return forecasts.

S&P 500 rankings, out of 43 markets

Relative Valuation

S&P 500 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

38th

35th

35th

31st

37th

+1.2 +0.3

-2.0 3.3

0.6 4.5

11 46

1 46

Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the explanatory power of our forecast models we estimate that there is an 11% probability that the S&P 500 can achieve this return by the end of 2024 and only 1% by the end of 2029, ranking the index 31st and 37th out of the 43 markets for both probabilities. 413

On balance, it is highly likely that the S&P 500 will under-perform the average global market over both the coming 5- and 10-year periods.

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United States Wilshire 5000 The Wilshire 5000 Total Market Index (Wilshire 5000) is widely regarded as the best single measure of the full U.S. equity market. It is composed of all U.S. equities with readily available prices, including most common stocks and REITS traded on the New York Stock Exchange, NASDAQ and the American Stock Exchange. The Wilshire 5000 is a capitalization-weighted index, meaning that each company´s contribution to the index is relative to its current market value. It is rebalanced on a monthly basis. Apple, the American technology company, is currently the largest component of the index. Like most indexes it represents only price appreciation of the underlying stocks, thus ignoring reinvested dividends in its calculation. Notwithstanding the fact that it is a price index, the dividend yield of the Wilshire 5000 averaged 2.5% in 2019. The index is denominated in U.S. dollars.

The Bottom Line The Wilshire 5000 finished 2019 at $32,886. Based on historical valuations dating to December 1989 (360 months), we estimate the fairvalue price to be $25,265, implying an over-valuation of +1.1 standard deviations. The last time the index was this over-valued during a rising market was in August 1998, and historically it has been more overvalued than it is today only 13% of the time. Over the coming 5-year period, we expect the Wilshire 5000 to fall by -1.6% annually. The forecasted range of annual returns is strictly negative and bound between -3.5% and -0.2%. Our forecast model 415

explains 63% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with only a 37% probability. Wilshire 5000 Current Price Fair-Value Price Relative Valuation, σ Dividend Yield, %

32,886 25,265 +1.1 2.5

Government Bond Yields, % 1-Year 5-Year 10-Year Inflation

1.6 1.7 1.9 2.3

5-Year Forecasts 5-Year Annual Forecast Price Return, % -1.6 5-Year Forecast Range, % (-3.5, -0.2) 0.63 Adjusted R2 Probability 5-Year Forecast Price Return > 0, % 37 5-Year Annual Forecast Total Return, % Probability 5-Year Forecast Total Return > 5-Year Bond, %

0.9 44

5-Year Annual Forecast Real Total Return, %

-1.4

10-Year Forecasts 10-Year Annual Forecast Price Return, % 1.1 10-Year Forecast Range, % (-0.1, 2.3) 0.88 Adjusted R2 Probability 10-Year Forecast Price Return > 0, % 77 10-Year Annual Forecast Total Return, % Probability 10-Year Forecast Total Return > 10-Year Bond, %

3.6 88

10-Year Annual Forecast Real Total Return, %

1.3

The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The Wilshire 5000 currently offers a dividend yield of 2.5%, implying a 5-year total return of 0.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the Wilshire 5000 will outperform comparable bonds by December 2024 with a 44% probability. The forecast 5-year total return of 1.1% contrasts with the current inflation rate of 2.3%. We forecast that the Wilshire 5000 will offer a real total return (including reinvested dividends) of -1.4% over the next five years. 416

Over the coming 10-year period, we expect the Wilshire 5000 to rise by 1.1% annually. The forecasted range of 10-year annual returns is bound between -0.1% and 2.3%. Our forecast model explains 88% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 77% probability. The Wilshire 5000´s current dividend yield of 2.5% implies a 10year total return of 3.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the Wilshire 5000 index will outperform comparable bonds by December 2029 with an 88% probability. The forecasted 10-year total return of 3.6% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 1.3% annually over the next decade.

Analysis The all-time monthly closing high of the Wilshire 5000 was $32,886 in December 2019, the same month the market peaked in inflationadjusted terms.

Over the 30 years since December 1989, the index has yielded a price return of 7.8% annually, and a total return (including reinvested dividends) of 10.0%. Since inflation over this same period has averaged 2.4%, the investor has earned an annual real price return of 7.6%. Using historical price, dividend, macroeconomic and financial data 417

dating to December 1989, we can compute the relative valuation of the Wilshire 5000. This relative valuation is expressed in standard deviations from the mean, with the mean representing the fair-market value of the index. Relative valuation is used to signal periods of market over- and under-valuation. Periods of over-valuation increase the probability of below average returns in the future, while superior returns are found by investing when the Wilshire 5000 is relatively under-valued. We also use the relative valuation of the index to forecast longer-term secular market declines or crashes.

The use of relative valuation gives us a method to divide the index´s historical returns into periods of appreciation (bull markets) and depreciation (bear markets). All bull markets have started from a position of relative under-valuation and have ended at a relatively overvalued valuation. The current bull market phase of the Wilshire 5000 started in February 2009 from a relative valuation of -2.3 standard deviations under the average of the preceding 30-year period, more under-valued than 99% of all previous months. Since that low, the Wilshire 5000 has advanced to its December 2019 high of $32,886. At this high, the market was over-valued with a relative valuation of +1.1. Thus, the index swung by +3.4 standard deviations since its bull market advance started. The index´s current advance has gained 14.7% annually since the 2009 low, and 16.9% including reinvested dividends.

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Forecast Returns The return from holding a U.S. government bond is defined in advance. What is needed is an estimate of what the return on the Wilshire 5000 will be over some future holding period to determine which investment will prove superior: bonds or equities. As we have seen, the future return of the Wilshire 5000 is highly dependent on its starting valuation relative to its longer-term mean. Investments made in periods of undervaluation deliver far superior returns to those made during periods of over-valuation. We have developed two models to forecast the return of the Wilshire 5000 over two different time periods – five years and ten years. In general, the 10-year forecast model is more robust and accurate than the 5-year model. This accords with common sense as the long-term volatility of the equity market is much lower than in the short run. To put it another way, the average investor probably expects to earn an annual total return of around 10.0% on the Wilshire 5000 over his lifetime (i.e., the annual total return earned over the previous 30 years). But this same investor also expects that in any 1-year period he will either gain or lose significantly. Both models use the relative valuation of the Wilshire 5000 as the basis for forecasting future returns. They also look at interest rates, the yield curve, current macroeconomic conditions (e.g., unemployment, inflation, etc.) and financial indicators. All models are tested statistically at the 95% confidence level, and we also list their explanatory power over past data, as well as their expected ability to estimate future values. Over the coming 5-year period, we expect the Wilshire 5000 to fall by -1.6% annually. The forecasted range of annual returns is strictly negative and bound between -3.5% and -0.2%. Our forecast model explains 63% of the variation in the index´s 5-year returns since December 1989. Consequently, we forecast that the index will breakeven by December 2024 with only a 37% probability. The total return from holding an index is composed of any price appreciation or depreciation plus the forecasted dividend yield over the holding period. The Wilshire 5000 currently offers a dividend yield of 2.5%, implying a 5-year total return of 0.9% annually. We can compare this total return to that which the investor could earn on an alternative investment, e.g., 5-year government bonds. 5-year Treasury bonds presently allow the investor to lock in a 1.7% annual yield. We forecast that the Wilshire 5000 will outperform comparable bonds by December 2024 with a 44% probability. The forecast 5-year total return of 1.1% contrasts with the current inflation rate of 2.3%. If the investor made investments denominated solely in U.S. dollars, this rate of inflation would not affect his 419

investment decision concerning the allocation of funds between equities and bonds. (Since inflation negatively impacts both the nominal returns of equities and bonds by the same amount.) For those investors taking advantage of a geographical diversification across multiple currencies, the real (or inflation-adjusted) return allows for a simple method to compare returns internationally. We forecast that the Wilshire 5000 will offer a real total return (including reinvested dividends) of -1.4% over the next five years.

Over the coming 10-year period, we expect the Wilshire 5000 to rise by 1.1% annually. The forecasted range of 10-year annual returns is bound between -0.1% and 2.3%. Our forecast model explains 88% of the variation of the index´s 10-year returns since December 1989. Consequently, we estimate that the index will break-even by December 2029 with a 77% probability. The Wilshire 5000´s current dividend yield of 2.5% implies a 10year total return of 3.6% annually. We can compare this total return to that which the investor could earn on an alternative investment, 10year government bonds. 10-year Treasury bonds presently allow the investor to lock in a 1.9% yield. We forecast that the Wilshire 5000 index will outperform comparable bonds by December 2029 with an 88% probability. The forecasted 10-year total return of 3.6% contrasts with the current inflation rate of 2.3% to result in an estimated real total return of 1.3% annually over the next decade.

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Conclusion This investment report assesses the forecasted returns of 43 different markets from 32 different countries and regions around the world. Each market is assessed on its own merits, resulting in quantitative forecasts for the next five and ten years. This concluding analysis, however, takes a qualitative look at these forecasts by ranking them against the other 42 markets. In general, the closer to 1st the ranking is, the more likely it is to outperform the other markets. A ranking of 43rd signifies that the market is the most over-valued, or that it is expected to yield the lowest return in the future. The Wilshire 5000´s relative valuation of +1.1 standard deviations above its long-term mean is far above the average of the 43 markets analyzed herein (a slight over-valuation of +0.3 standard deviations). As such, the Wilshire 5000 is the 35th most under-valued market of the group. We forecast that the index will yield an annual real total return of 1.4% over the coming five years, and 1.3% over the coming decade. Both returns are far below the averages for the 43 other countries (3.3% and 4.5%). Consequently, the Wilshire 5000 ranks 34th and 31st out of 43 markets for both total real return forecasts. Finally, we consider the probability that the forecasted total return for the index will exceed its comparable bond yield by at least 5%. Over both 5- and 10-year time horizons, the average for all 43 markets gives approximately even odds (46%) of accomplishing this feat. Given the explanatory power of our forecast models we estimate that there is an 11% probability that the Wilshire 5000 can achieve this return by the end of 2024 and only 2% by the end of 2029, ranking the index 31st and 421

32nd out of the 43 markets for both probabilities.

Wilshire 5000 rankings, out of 43 markets

Relative Valuation

Wilshire 5000 43 Country Avg.

Probability that total return exceeds gov´t bond plus 5%

Forecast total real returns 5-Year

10-Year

5-Year

10-Year

35th

34th

31st

31st

32nd

+1.1 +0.3

-1.4 3.3

1.3 4.5

11 46

2 46

On balance, it is highly likely that the Wilshire 5000 will underperform the average global market over both the coming 5- and 10year periods.

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Conclusion We forecast that the S&P 500 will drop -2.3% annually until 2024 and rise by 0.3% annually through to 2029. Another way to state this conclusion is that we think the index will trade at $2,871 on December 2024, and that it will round out 2029 at $3,283. Despite the smoothness that this forecast provides, if history shows anything it’s that the months between will be a choppy ride.

These forecasts can also be interpreted as the market dipping over the coming five years, amounting to an 11% decline. Then over the next five years the S&P 500 should rise 14% to finish with an aggregate gain of a little under 2% in total. Focusing on the end points skews one to think that the easiest path to get there is direct. More likely there will be some significant volatility along the way. Consider that between December 1999 and December 2007 the 423

S&P 500 hardly moved at all, taken in the aggregate. It stared the 7-year period at $1,469 and ended at $1,418. Along the way it went through one whole bust boom cycle where the index lost 40% of its value, and then gained 69%. The investor had some significant headaches to contend with along the way. The more likely scenario is that the S&P 500 will yield some very high and very low (and negative) returns over the next decade, especially on an annual basis. S&P 500, historical returns

Number Standard Dev. Minimum Date Maximum Date Average Probability Return > 15% that: Return > 15% *

Investment Horizon 5-Year 10-Year 1,728 1,768 8.0 5.0 -22.3 -9.1 Sep-29 Aug-29 27.6 16.8 Sep-24 Aug-90 4.7 4.6 0.10 0.02 0.01 0.00

1-Year 1,777 18.5 -65.6 Jun-31 124.2 Jul-32 6.1 0.32 0.13

Continuous* 1,500 1.3 4.5 Apr-72 § 9.5 Jul-82 6.5 0.00 0.00

Only periods prior to December 1995. §April 1872.

Since January 1871 there have been 1,777 1-year investment periods. The average yearly return for the S&P 500 has been a hair over 6%. This shines in contrast to the minimum 1-year return of -65% that came from investing in June 1931. Likewise, an investor who bought the index just one year later, in July 1932, would have been able to realize an annual return of 124%. Not only are those figures miles away from the average but it should impress the reader that the best and worst 1-year returns over a nearly 150-year period were spaced out by only one year. Timing apparently matters in taking advantage of these situations. Statistically we can describe the spread of the 1-year returns by referring to the standard deviation. Two-thirds of the returns will come within one standard deviation of the mean. Since the mean yearly return is 6.1% and the standard deviation is 18.5, two-thirds of the 1-year returns to the S&P 500 have been between -12.4% and 24.6%, a fairly wide spread. One-third (32%) of the these 1-year returns have seen the S&P 500 increase by more than 15%. This sounds pretty good until the investor realizes that 13% of the years have resulted in a loss of more than 15%. There is even a 1% chance that the annual return will be worse that 40%, which doesn´t seem to be so often until you realize that this means it happens once every eight years. By the way, the last 1-year 424

period to see a -40% loss in the S&P 500 was March 2008, almost 12 years ago.

All investors expect the short-term volatility of the market to be high. Over longer periods we also expect things to smooth out. Since January 1871 there have been 1,728 5-year investment periods for the S&P 500. The average of these 5-year returns is just under 5%, and their range is much more tightly bound than the 1-year returns. The worst 5-year return the investor could have earned came from buying at the September 1929 high. The -22% annual loss resulted in the investor´s principal falling by 72% by September 1934. Of course, if he had of made his investment just five years earlier, in September 1924, he could have more than tripled his money with a 28% annual gain.

425

So much for nightmares and dreams. The 5-year return standard deviation of 8.0 implies that about two-thirds of the 5-year returns fell between -3.3% and 12.7%, which is much easier for the investor to stomach. And as the accompanying histogram shows, nearly all 5-year returns fell between a loss of -5% and a gain of 15%. Still, while the average return is positive and its spread is likely to be tightly bound around this average, over 10% of the monthly periods resulted in a gain of more than 15%, which is more than once a year. Since the mean is positive and less dispersed than the 1-year returns, it´s much less likely that any 5-year period will lose the investor more than 15%, but it happens. More than 1% of the time (once every eight years) the investor has lost more than 15% over the next 5-years. (Thankfully, this hasn’t happened since May 1930 and most of the cases were confined to the Great Depression.) The story dulls further when we extend our time horizon to ten years. The average return is about the same as for 5-year periods, but the spread narrows. For the 1,668 10-year investment periods since January 1871, two-thirds returned between -0.4% and 9.6%.

The worst 10-year period followed the August 1929 high. A -9% annual loss spread over a decade means the investor watched his capital evaporate by 62%. Of course, those investors lucky (or prescient) enough to buy the S&P 500 in August 1990 would have realized a 17% annual gain over the following decade, enough to be enrichened nearly five-fold. To give a standardized view of these returns with the other periods, there was never a chance the investor lost more than 15% annually over any 10-year period, and he could have gained more than 15% annually over the coming decade only 2% of the time (about once every four years). 426

Finally, we can consider the results on a continuous basis. If the investor made an investment on any date and held it until December 2019, what would be the return? Since the annualized return for very recent investments is very high and biased by the recent boom, we´ve limited this analysis to only those investments made more than 25 years ago. One can consider this analysis relevant for the long-term oriented investor. This approach means that we are averaging the returns of 1,500 different investment time frames. The longest, resulting from an investment made in January 1871, is 149 years long. The shortest, made in December 1994 is only 25 years long. The average long-term return of the S&P 500 has been 6.5% and with a very narrow spread. Twothirds of all the returns came between gains of 5.2% and 7.8%. The worst an investor could do was to buy the S&P 500 in April 1872. The 4.5% annual return might not seem like much, but compounded over 149 years the investor still saw, or at least his greatgreat-grandchildren did, each dollar of initial investment grow to over $700. The best he could have done was to buy the index in July 1982 in order to get a 9.5% annual return.

This conclusion serves as a warning and to temper the investor´s expectations. There are no guaranteed results in the investment world, and even the highly probable outcomes are subject to large amounts of variance. The variability of the equity markets is especially high over short periods. The preceding discussion illustrates just how volatile we can expect the future to be based on the past. (Keep in mind that our use of the S&P 500, the most broad-based index of the world´s largest economy, probably understates the actual volatility that smaller or more focused markets are subject to.) Caveat creditor. 427