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Arrow Publications
ARROW PUBLICATIONS


                        
                       

    
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THE FOLLOWING IS CHAPTER 1 TO
COVERED CALL WRITING with Qs and DIAMONDS
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CHAPTER 1
INVESTMENT RETURNS:
THE FUTURE ISN’T WHAT IT USED TO BE

When the enormous Internet, telecommunications and financial bubbles eventually burst, many of the investment “experts” people had come to trust either lost their jobs, or at the very least lost their credibility. Some were heavily fined for breaking securities laws. The dust likely won’t completely settle for years to come.
Yet through it all, we find that there are still real experts out there who can be trusted. Among them are Warren Buffett (Chairman of Berkshire Hathaway) and John Templeton, now deceased, (a pioneer in the mutual fund industry and founder of the Templeton Funds.
Many of these experts have been warning us that the generous stock market returns of the past should not be expected in the future. Warren Buffett, “The Oracle of Omaha,” is arguably the most successful investor in modern times, with average annual returns to his investors exceeding 25% annually since the late 1960s. As far back as 1999 Buffett, who had always been silent about his beliefs on the stock market, began to publicly express his concerns about the expectations that investors have for market returns in the future. He stated in Fortune that for perhaps the next decade or two, stock market returns would average about 6% per year after brokerage costs, but before taxes. Shortly thereafter the markets, particularly the NASDAQ, began their substantial fall.
He has not warmed up much to the market since that time. In one of his Berkshire Hathaway annual reports, Buffett commented:

Despite three years of falling prices, which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us. That dismal fact is testimony to the insanity of valuations reached during The Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge.

"Chairman's Letter," Berkshire Hathaway Annual Report
And, following the annual meeting of his shareholders attended by 15,000 loyal believers, Buffett had the following to say in an exclusive interview with Maria Bartiromo of CNBC in which he seems to have lengthened his time horizon for slow growth in the market:
If you own equities, over the next twenty or thirty years you'll get a reasonable return...maybe it's 6%, maybe it's 7%. People who expect 15% are doomed to disappointment.

Interview with Maria Bartiromo, CNBC TV
Looking back, although Buffett was right, he drastically underestimated the situation, because from the time he made that statement in 1999 until today, over ten years later, the major stock indexes are down 30% or more. While it is possible that Mr. Buffett could be wrong, history has certainly been on the side of those who have believed in him.
There are many other individuals with acknowledged expertise in investments as well as economists who believe that stock market returns in the future will be significantly less than they have been in the past. They offer several themes to support their conclusions:

WHY WILL THE MARKET'S GROWTH
LIKELY BE SLOWER IN THE FUTURE?

Despite market corrections in the major averages…the Dow Jones Industrial Average, the Standard & Poors® 500 Index and the NASDAQ…stocks are still selling at heftier prices now than even a historical midpoint of a range of values for these averages.

Bubbles previously created in the Internet, telecommunications and financial sectors through unprecedented access to the capital markets, resulted in unsustainable levels of borrowing and capital spending. This has been unwinding for some time as the bubbles burst and as deleveraging has occurred. Many believe that such bursting, reduced borrowing by both businesses and consumers and increased government borrowing have long-term implications that will slow future economic growth and affect other industries.

Corporate profits would have to grow at an abnormally high rate in the future as a percentage of Gross Domestic Product (national output) to support much higher stock prices. Since this is very unlikely, the relatively high level of current stock prices will increase more slowly as corporate earnings growth works to catch up and bring about more normal stock price averages in the future.

Interest rates are now at lows not seen since the Eisenhower Administration in the 1950s. Inflation is very low. Both of these factors are certainly strong supporters of relatively high stock prices. Yet to support significantly higher stock prices, both interest rates and inflation would need to decline even more. The problem is that there is no additional room for either to decline further.

These are the primary schools of thought regarding why stock prices are likely to grow at a slower pace in the future than they have in the past.
For owners of stocks and ETFs, a simple strategy unknown to the vast majority of individual investors--writing covered call options--may be the best opportunity to achieve double-digit returns in this projected future. And two of the most liquid and noteworthy ETFs available to us, the Qs and Diamonds, are as we shall see among the most attractive for writing covered calls.