On the Drivers of Equity Returns; Diet and Slowing the Aging Process!

From: aditya rana
Date: Sat, May 7, 2016 at 2:14 PM
Subject: On the Drivers of Equity Returns; Diet and Slowing the Aging Process!


Identifying the underlying fundamental long term drivers of equity returns of the overall market is an important exercise for investors focusing on asset allocation between various asset classes, geographical regions and specific countries. The McKinsey Global Institute (MGI) came out with a much discussed report recently, suggesting that the forces leading to exceptional investment returns realized over the last 30 years are weakening, and perhaps even reversing, resulting in much lower expected returns over the next 30 years. Predicting asset class returns over the next 30 years is usually an exercise in futility, but what was most interesting in the note was their framework which decomposed equity returns over the last few decades into the underlying fundamental economic/business components which can be very helpful in making long term asset allocation decisions. To summarise this part of the report:

-Investors have often used two basic approaches to identify drivers of equity returns: 1) estimate an equity risk premium based on long-term average equity return minus a risk-free rate , or 2) a discounted cash-flow model based on GDP growth, inflation, dividend yields and P/E ratios. Both these approaches to forecast returns require assumptions to be made regarding variables which are not directly economic or business variables.

-The MGI approach builds on the discounted cash-flow model, but directly links equity returns with underlying business fundamentals, enabling investors to estimate future returns based on alternate states of the economy.

-The two basic factors underpinning equity returns are price appreciation and cash yields (i.e. cash returned to investors in the form of dividends and share repurchases). Price appreciation is determined by a company’s earnings growth (based on growth in revenue and change in profit margin) and changes in the P/E ratio. Changes in the P/E ratio in turn depend on changes in investor expectations regarding future earnings growth, return on equity, inflation and the cost of equity.

-Aggregate revenue growth of all companies in the S&P 500 index is closely tied to GDP growth, though in some periods revenues can grow faster or slower than GDP growth.

-The cash returned to investors is the company’s earnings times the payout ratio which is the portion of earnings not need to fund the company’s future growth. The amount of earnings required to fund future growth in turn depends on nominal growth and the marginal return on equity. Typically, when companies earn a higher return on equity, they do not need to invest as much to achieve a given level of growth, whereas if they grow faster they need t o invest more of their earnings implying a lower payout ratio.

-Inflation has an important impact on equity returns as it effects both payout and P/E ratios. Higher inflation increases nominal net income growth which reduces the payout ratio unless companies are able to increase their return on equity sufficiently to offset the effect of higher income growth.

-During the 1970s and early 1980s, companies were unable to increase their prices and profits enough to compensate for the higher investment required. Inflation also negatively impacts P/E ratios as investors increase their discount rates to value future cash-flows while lowering expected cash-flows due to lower payout ratios as described above.

-Changes in real interest rates can also impact equity returns, through higher interest expense and interest income (for more leveraged companies) and the higher cost of equity (i.e. the discount rate investors use to discount future cash-flows) though historical evidence shows that real rates have had little impact on the cost of equity.

-Illustrating the underlying drivers of equity returns in the chart below:

-Over the last 30 years, an increase in the P/E ratio from 10 to 14.8 (reflecting higher expectations of future real profit growth, lower inflation and higher return on equity) accounted for 2.5% out of the 3.3% increase in equity returns compared to the a longer term period of 50 years. Growth in profit margins accounted for 1.1% of the increase while slightly lower GDP returns reduced returns (see chart below).

-In summary, benign trends in the four factors – inflation, interest rates, real GDP and corporate profitability – constitute the underlying fundamental economic and business conditions which underpin equity and bond returns.

However, looking forward it’s likely that the underlying factors supporting these benign trends will begin to reverse as inflation has been in a declining trend since the 1980s; interest rates are already low or negative in most of the developed world driven by falling investment, higher savings and central bank support; the effects of favourable demographics and productivity gains fueling world GDP growth begin to wane; and the exceptional growth in corporate profits (particularly in the US and Europe) over the last 30 years driven by higher revenue growth (from increased demand in emerging markets) and lower costs (lower cost of labour in EMs) begins to normalize due to more competition from emerging market companies, technology and tech-enabled firms and from small and medium-sized companies.

-An interesting framework which highlights in the importance of key underlying economic/business factors like changes in expected real GDP growth, inflation, real rates and corporate profits/margins on equity returns. Rather than trying to predict returns based on views on these factors, it is safer to expect more headwinds from these four factors which are likely to adversely impact equity returns in the developed world going forward.

-For emerging markets, improvements in GDP growth expectations from currently depressed levels, lower inflation and improving corporate margins from current low levels should provide a tailwind for higher equity returns.

How to Protect Our Telomeres with Diet:

Another great note on Dr. Greger on the importance of diet and exercise in slowing the aging process:

Dr. Greger, April 26, 2016:

-In my video, Does Meditation Affect Cellular Aging?, I discussed how stress reduction through meditation might be able to lengthen telomeres, the protective caps at the tips of our chromosomes that tend to deplete as we age.

-What about exercise? We can’t always change our situation in life, but we can always go out for a walk. London researchers studied 2,400 twins, and those who exercised more may have pumped up their telomeres along with their muscles. Apparently it doesn’t take much either. The “heavy” exercise group was only averaging about a half-hour a day.These were mostly folks in their 40’s, but does it still work in your 50’s? Yes. A study out of South Korea found that people in their 50’s who work out three hours a week had longer telomeres.

-In my video, Telomeres: Cap It All Off with Diet, you can see the telomere lengths of young healthy regular folk controls at around age 20, and then at age 50. As we’d expect, the older subjects’ telomeres were significantly shorter. What about athletes? The young athletes started out in the same boat, with nice, long, young, healthy telomeres capping all their chromosomes. The older athletes, in contrast to the controls, appeared to still have the chromosomes of 20-year-olds. But these were marathon runners, triathletes running 50 miles a week for 35 years.

-What was it about the Ornish intervention that so powerfully protected telomeres after just three months? We saw that stress management seems to help, but what about diet and exercise? Was it the plant-based diet, was it the walking 30 minutes a day,or was it just because of the weight loss? In 2013 a study was published that can help us anser just that question.

-The researchers took about 400 women and randomized them into four groups: a portion-controlled diet group, an exercise group, a portion controlled diet and exercise group, and a control group for a full year. In the video, you can see a comparison of the length of each group’s telomeres. After a year of doing nothing, there was essentially no change in the control group, which is what we’d expect. The exercise group was 45 minutes of moderate-to-vigorous exercise like jogging. After a year of that, they did no better. What about just weight loss? Nothing. The same thing for exercise and weight loss, no significant change either.

-So as long as we’re eating the same diet, it doesn’t appear to matter how small our portions are, or how much weight we lose, or how hard we exercise. After a year, the subjects saw no benefit. On the other hand, the Ornish group on the plant-based diet, who lost the same amount of weight after just three months and exercised less than half as hard, saw significant telomere protection. It wasn’t the weight loss or the exercise: it was the food.

-What aspects of a plant-based diet make it so protective? Studies have associated more vegetables and fruit, and less butter, with longer telomeres. From the latest review, foods high in fiber and vitamins are strongly related to longer telomeres. However, the key may be avoiding saturated fat. Swapping just 1% of saturated fat calories in our diet for anything else can add nearly a whole year of aging’s worth of length onto our telomeres.

-Saturated fats like palmitic acid, the primary saturated fat in salmon, and found in meat, eggs, and dairy in general, can be toxic to cells. This has been demonstrated in heart cells, bone marrow cells, pancreatic cells, and brain cells. The toxic effects on cell death rates happen right around what you’d see in the blood stream of people who eat a lot of animal products. It may not be the saturated fat itself, however, as saturated fat may just be a marker for the increased oxidative stress and inflammation associated with those foods.

-With this link to saturated fat, it’s no wonder that lifelong low cholesterol levels have been related to longer telomeres and a smaller proportion of short telomeres—in other words, markers of slower biological aging. In fact, there’s a rare congenital birth defect called progeria syndrome, where children age 8-10 times faster than normal. It seems associated with a particular inability to handle animal fats.

-The good news is that “despite past accumulated injury leading to shorter telomere lengths, current healthy behaviors might help to decrease a person’s risk of some of the potential consequences like heart disease.” Eating more fruit and vegetables and less meat, and having more support from friends and family, attenuate the association between shorter telomeres and the ravages of aging.

-To summarize: inflammation, oxidation, damage and dysfunction are constantly hacking away at our telomeres. At the same time, our antioxidant defenses, healthy diet, exercise and stress reduction are constantly rebuilding them.

Here’s to eating more vegetables and fruits at the expense of meat and dairy, and daily walking!




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