Elroy Dimson - “High Valuations Don't Necessarily Mean That We're Going to See Asset Prices Collapse" | #100

Episode Summary

Executive Summary: On the 100th episode of the Meb Faber Show, Meb interviews Elroy Dimson about his landmark long-run investing research. They cover why equities beat bonds over the long term, why economic growth and stock returns can diverge, how valuation is driven by real rates, why currency hedging is usually unnecessary for long-term investors, and what the data says about factors, housing, and collectibles.

Main Topics: Origin and scope of Triumph of the Optimists (Priority: 5/5): Dimson explains how long-term country-level return data evolved from UK index work into a multi-country historical database that became Triumph of the Optimists and its annual updates. Equities, bonds, and the long-run record (Priority: 5/5): The book’s central finding is that common stocks dramatically outperformed bonds and bills over the twentieth century, but country outcomes varied widely due to wars, regime changes, and market disappearances. Economic growth vs. stock returns (Priority: 5/5): Dimson discusses the controversial finding that high GDP growth does not predict high stock returns, arguing that growth benefits are shared broadly and that public information is already priced in. Valuation, real interest rates, and market cap weighting (Priority: 4/5): He links today’s elevated valuations to the collapse in real interest rates and defends market-cap weighting as the only aggregate-consistent method, while acknowledging historical shifts in country market shares. Inflation, real returns, and currency hedging (Priority: 5/5): The conversation emphasizes that investors should focus on real, not nominal, returns and that foreign currency exposure generally helps long-term investors because exchange rates tend to reflect inflation differentials. Factors and smart beta (Priority: 4/5): Dimson supports factor investing only when there is a sensible economic reason for the premium, warning against extrapolating short histories or assuming persistent outperformance. Housing and collectibles as investable assets (Priority: 3/5): He extends the long-run framework to housing and collectibles, concluding that housing’s financial returns are far lower than commonly believed and that fine wine has outperformed bonds but lagged equities.

Key Arguments: Long-term equity outperformance is real, but it depends on starting in an era when markets are open, institutions survive, and you can hold diversified exposure for decades. Stock returns are not tightly linked to GDP growth because economic gains are shared among workers, consumers, governments, and firms, leaving shareholders with diluted benefits. High valuations in recent decades are largely a consequence of falling real interest rates, which mechanically raise asset-price multiples under standard valuation models. Market-cap weighting is the most macro-consistent portfolio approach because investors as a group own the market as a whole; deviations require a specific risk or hedging rationale. Currency hedging is usually unnecessary for long-term investors because most currency moves reflect relative inflation differences rather than a separate source of persistent alpha. Factor premiums can exist, but they should be justified by real economic frictions or risk-sharing motives; otherwise, they may simply reflect historical noise or crowded beliefs. Housing is a consumption asset with an emotional dividend, not a high-return financial asset; after quality and maintenance adjustments, its real appreciation is modest. Collectibles such as fine wine can beat cash and bonds, but they are still generally inferior to equities as long-term wealth compounding vehicles.

Data Points: Countries in original book: 10 - Dimson says the project initially reached a century of data for 10 countries in the private Millennium Book. Markets tracked originally: 17 - Meb notes the book originally tracked 17 markets, later expanded to 26. Markets tracked later: 26 - The dataset expanded beyond the initial set as more researchers contributed historical series. Industries disappeared since 1900: about 80% - Dimson says roughly 80% of industries that existed in 1900 have disappeared. Industries that did not exist in 1900: over two-thirds - Of today’s industries, more than two-thirds did not exist in 1900. Real government bond yield in early 2000s: about 4% - He contrasts early-2000s real yields on safe inflation-linked bonds with today’s levels. Average real yield today: around -12% - Dimson says today the average inflation-linked bond yield is deeply negative in real terms. 1970s UK inflation peak: 25% to 27% - He cites mid-1970s UK inflation as an example of historically negative real-rate regimes. Government bond yield in 1970s UK: 15% to 16% - Despite extreme inflation, nominal bond yields were below inflation, creating strongly negative real returns. Country-year observations: 2,000 to 3,000 - He describes the size of the historical panel used to study interest-rate regimes and returns. Negative real interest-rate country-years: around one-third - He notes about a third of country-year observations have negative real short rates. Positive real interest-rate country-years: around two-thirds - He notes about two-thirds of the observations have positive real rates. Real equity return: about 5.5% - Meb references the global long-run real equity return cited in the book. Real bond return: about 1.7% to 2% - Meb summarizes long-run real returns for bonds from the book’s tables. Real bill return: about 1% - Meb summarizes long-run real returns for Treasury bills / short rates. Real housing capital gain: about 1% to 1.5% - Dimson says raw housing capital gains are modest before quality, maintenance, and location adjustments. Weighted real housing gain: slightly below 1% - Population-weighted house-price appreciation comes down after adjustment.

Pivotal Quotes: "the twentieth century as the one in which the optimists Triumphed" — Elroy Dimson: Explaining the book title and the central conclusion that equities outperformed safer assets over the twentieth century. "the relationship was perverse with a negative correlation" — Meb Faber: Summarizing the surprising finding that GDP growth does not reliably predict stock market performance. "Market cap weighting is, of course, the only way. Weighting scheme, which is macro-consistent." — Elroy Dimson: Discussing portfolio construction and why market-cap weighting best reflects the investable aggregate market.

Implications: For long-term investors, history argues for diversified equity exposure, real-return thinking, and skepticism toward simple GDP, valuation, or factor narratives. Currency hedging, housing, and collectibles should be treated as nuanced, horizon-dependent choices rather than automatic rules.