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You said fixed currency amount, I wasn’t sure if you were alluding to some unnecessary point about FX.
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I’m not assuming any return is constant irrespective of stock price. I’m assuming that most bear markets are driven by cyclical factors and deviations from trend. It’s a very warranted assumption applied on average across the market (question is broad based valuations) that since earnings, cash flows and equity prices all trend upwards over time underpinned fundamentally by upward trending GDP you can be sure in any non-pedantic textbook sense that on an absolute dollar basis the broader market will break prior highs on all three metrics over a long holding period. The only exceptions to this would be a regime shift in which GDP declined (population, deflation, loss of technology?). This is a view echoed by practically by Buffett and academically by the CFA materials in economics (I wrote the practice questions) in which they point out the various sources of equity returns (P/E: temporary, margin shift: temporary, GDP: long term trend). Since you’re going to regain those broadbased absolute levels of activity, you will regain those levels of return.
You wrote the questions for CFA Institute?
Cool.
BSAS Mock Exams
Gotcha.
I wrote “fixed currency amount” rather than “fixed dollar amount” because CFA Institute is trying to be more globally inclusive, or something like that. Personally, I think that it simply gives more scope for misunderstanding, as it did here.
Perhaps I’m misinterpreting the original question.
When I read “undervalued stocks”, I took it to mean stocks whose price is too low after taking into account that it’s a bear market. Of course prices are going to be lower on average in a bear market than in a bull market, but they can be appropriately lower (because investors are more risk averse and, therefore, have a higher required rate of return for assuming risk), or it can be too low. And when making that comparison, I’m not sure that “talking about price” is necessarily “talking about return”.
I see what you’re saying and that’s always the academic argument as well as a fair line of reasoning when dealing with idiosyncratic valuation drops. But in reality when you’re investing in cyclicals and broad market weakness you see this same play over and over. Mass euphoria, mass panic, mass euphoria. Take Chemours, they split off of DuPont and everyone decided TiO2 prices would never go up again, stock drops from $20 to $5 and its doom and gloom, that’s January 2016. Suddenly it’s oh wait, Trump and industrial euphoria, Ti02 jumps and the same company rallies 10X to $57 in October 2017. Now the same company with the same assets, long term earnings, dividend and strong cashflows hits $25 in December 2018. It’s the same play on re-run across cyclicals as a whole and it makes it hard for anyone rationally covering this space to believe in the gospel of CAPM or even the sanity of these quarter by quarter investment managers. Realize that for a full three quarters people happily traded this thing above $50 and 6 months later they’re half that on a basic ingredient for paints, plastics, paper.
You hear and see the same thing from WB on his investing and over time its become impossible for me to believe that anyone with patience, captive capital and the ability to sit disciplined with cash couldn’t kill the market over long holding periods and WB and Charlie Munger have made the same case. You can see the flaws of the industry, but the way it’s structured its a simple, yet seemingly impossible thing to achieve the freedom to invest long term.