ECRI

[cute fuzzy bunny]

Anyone ever look at these indicators?

http://www.businesscycle.com/

Any comments?

 

[haha]

Anyone ever look at these indicators?

I read a book by Geoffrey Moore, the guy who founded ECRI. It was about business cycle forecasting, and to me it was a very straightforward and helpful book. It is very detail oriented, which doesn't appeal to everyone.

Mikey

 

[Marie Barton]

Yes, I do watch that site. They publish a Weekly Leading Index every Friday morning that is very good. Also, interesting commentary around the site if you dig a bit.

 

[cute fuzzy bunny]

Ok then, some others look at this. Good. When you pull up the page, click the 'view other charts' under the current leading indicator short term chart for a long term one.

Something I noted: even after formulating their primary indicators, they still demonstrably predicted both downturns and "bad times". In other words, they didnt just pull this out of their butts and worked it until the theory fit past data.

So in short, when the weekly leading indicator hits zero, it appears there is little to be gained by being fully invested in equities until the leading indicator rises back up above zero. When it fell below zero it typically stayed there for some time. When it did break above zero, it typically continued to increase. When it had a multi-week transition downward, that usually continued, albeit occasionally with some intermediate recoveries.

Also of note in the current situation: we just hit a peak in this indicator that is the second highest in 30+ years, and we've had a multiweek transition downward. Thus if one followed this indicator and believed in it, this would indicate that near term returns on equities should decline through this downward term and turn into losses once the indicator drops below zero.

Any thoughts?

 

[sgeeeee]

Also of note in the current situation: we just hit a peak in this indicator that is the second highest in 30+ years, and we've had a multiweek transition downward.  Thus if one followed this indicator and believed in it, this would indicate that near term returns on equities should decline through this downward term and turn into losses once the indicator drops below zero.

Any thoughts?

Looks like a wiggly line to me.

I can't tell where it's headed or what I should do based on it. What are you concluding is appropriate action from looking at it?

 

[unclemick]

The appropriate action (for me) is to do nothing - just stand there and let the computers in Valley Forge rebalance our balanced index funds.

Of course if we were lucky enough to get a 4-5000 pt. drop in the DOW along with 4% or more div. yield, I might buy some more 'hobby' stocks at the margin - being male with an urge to putz. The 50/50 stock/bond mix 70-80% of total stays the same.

 

[cute fuzzy bunny]

Well "appropriate action" might be to get the heck out of equities should this indicator drop below zero, and increase your holding of them when solidly above zero. If you believe the indicator is in fact a good *leading* indicator of economic malaise. It appears to at least be a good indicator of whether the economy is or *still* is in malaise...something a lot of people seemed to be struggling with over the last 3 years.

Re: the balanced non-timing. Yep, I know market timing is a bad concept for most folks around here. But tell me, if you actually had an indicator that could tell you "bad time to be in stocks" and "good time to be in stocks", and it was proven historically valid, you would ignore it entirely?

What will I do? Well, i'm going to watch the sucker for a while and see if things bear out. If it drops below zero and a while later comes back up positive, and while it was below zero equities suffer, and after it comes back positive things pick up, the next time it starts heading for zero i'm going to shift assets...

I *do* believe that good balanced index buy and hold strategies *have* worked historically. I also do believe that if i'm pounding a screw in with a hammer and someone shows me a screwdriver, that I'll consider adding to my tool set.

 

[wabmester]

I count 8 times when their line went below zero, and 4 of those times they indicate correspond to "business cycle downturns." Looks like a coin toss to me.

 

[unclemick]

3 years is a knit - try 30.

I don't really like balanced index - it by blind dumb luck was where I put 401k 'untouchable' money for years. Don't throw away the hammer.

I periodically was handed screwdriver's from 1966 on and periodically lived 'large' since I knew it would always work - new cars, boats, some penthouse living, land, rental property, vacations, etc.

Hindsight says I underran the S&P 500 by 2-3% over 30yrs.

So balanced index is the horse I rode in on and the foundation of our ER.

BUT - I still have my hobby stocks- looking for that one great stock. My current screwdriver is The Warren Buffett Way - never say die.
Probably will still be hobby stocking in the resthome - long after giving up fishing and other fun stuff.

 

[Ted]

My favorite indicator is the relationship between the projected forward earnings yield (E/P ratio) of the S&P 500, in comparison to the yield on 10 year Treasury notes.  This is tracked (together with a lot of other indicators)at:  

http://www.cm1.prusec.com/yardweb.nsf/Yardeni?readform

(See "Valuation" pages)

I regard this as an economically valid indicator of how "fairly" stocks are valued in relation to bonds.  By shifting assets between stocks and bonds according to this, it has been possible to reduce the volatility of a portfolio.  I do not believe that it has been possible to increase its long-term return, however, because of the impossibility of predicting when a divergence in the relative valuation in stocks and bonds will reverse.  

 

[unclemick]

Ted

My Lifestrategy funds are less than pure - containing 25% Asset Allocation fund - which attempts to shift between stocks/bonds/cash based on quantitative methods. Sometimes they show a positive alpha against a 'pure' 60/40 index but I don't get excited because of the less than one decade track record. Also the foreign index component (10%) muddies the water. Hand grenades not rifle bullets is ok for now.

I'm trying to shift my focus from general economics(the media makes it hard) to one good business at a time (hobby stocks) although clearly there is an overlap.

And pondering is - well - kinda fun,

 

[wabmester]

My favorite indicator is the relationship between the projected forward earnings yield (E/P ratio) of the S&P 500, in comparison to the yield on 10 year Treasury notes. 

This one has been touted as a successful market timing indicator by none other than a fed economist:
http://www.kc.frb.org/publicat/reswkpap/PDF/rwp02-01.pdf

 

[Ted]

This one has been touted as a successful market timing indicator by none other than a fed economist:

If it worked in the past (in retrospect) then you can bet that it won't work in the future (in the sense of increasing returns above market levels) when enough people start to practice it. However, I do believe that it can always be of benefit in reducing portfolio volatility.

 

[Bob_Smith]

My favorite indicator is the relationship between the projected forward earnings yield (E/P ratio) of the S&P 500, in comparison to the yield on 10 year Treasury notes.

Ted, at what point do you take action? Do you modify your allocation annually and use this chart to determine which way to move? And how far do you stray from your target allocation?

 

[haha]

TH, to return to ECRI- it appears that the current downturn was equaled several times during the period 1991 to 2000, but then turned around, and either stayed above 0, or only penetrated slightly. These downturns did not precede recessions. Likewise, you cite the height of the recent peak as being the second highest in 30 years. While this is true, the very highest peak in early 1982 was not followed by a recession, as the trough in mid 1983 saw us on the way to recovery from the Volker induced interest rate squeeze.

This appears to be very interesting data, but to me at least the current position of the indicator is indeterminate as to future movement in the stock market or in the economy.

Is there a chart on the website that shows the indicator overlaid with the Dow or S&P or other index?

Mikey

 

[Ted]

Bob Smith,

In an earlier edition of the "Stock Valuation Models" paper on his website, Yardeni presented a set of recommended bond/stock allocations associated with various relative valuations (based on the forward earnings yield of stocks compared to the interest rate on 10 year Treasuries). These recommendations were intended to be for a "moderately aggressive" investor. When stocks were between 10% over-valued and 10% under-valued, the ratio was 30% bonds/70% stocks. By the time that stocks became more than 30% over-valued (as they were from early 1999 to late 2000) the allocation shifted to 70% bonds/30% stocks. At the other extreme, by the time that stocks became 15% under-valued (which was reached in mid 2002) the recommended allocation became 10% bonds/90% stocks.

The practical problem with following this paradigm is that stocks often continue rising even after they are "over valued," and continue falling even after they are "under-valued." That's why it's hard to actually beat market returns. Perhaps the link referenced by Wabmester provides a solution to this (I haven't read it yet but will).

Personally, I tend to keep my asset allocation within a narrower range, where the "stock equivalent" percentage ranges from about 50% to 65%, based on the relative valuation indicator. Right now, its at about 65%, so I'll sell some stock or high yield bonds if the market goes up much more. (As I have noted before, another way for the relative valuation to "correct" itself would be for long term bond prices to fall while stocks move sideways, and to avoid this possibility I have sold all long term bonds other than TIPs.)

 

[cute fuzzy bunny]

TH, to return to ECRI- it appears that the current downturn was equaled several times during the period 1991 to 2000, but then turned around, and either stayed above 0, or only penetrated slightly. These downturns did not precede recessions. Likewise, you cite the height of the recent peak as being the second highest in 30 years. While this is true, the very highest peak in early 1982 was not followed by a recession, as the trough in mid 1983 saw us on the way to recovery from the Volker induced interest rate squeeze.

This appears to be very interesting data, but to me at least the current position of the indicator is indeterminate as to future movement in the stock market or in the economy.

Is there a chart on the website that shows the indicator overlaid with the Dow or S&P or other index?

Mikey

Agreed. As I mentioned, I might watch and see how things (s&p, bonds, etc) behave once the indicator drops below zero. It seems that once it starts heading down though, it eventually zero's, rather than dipping and then returning to a new high. Cyclical. Clearly i'm not going to base 100% of my future investment decisions on this, its simply another screwdriver of a different size. If it proves accurate over time, i'll pay more attention...but I probably wouldnt do anything special until it fell below zero and stayed there, or when it returned to positive values.

I could probably download the data from the chart and s&p 500 and overlay the two. However, I noted that the times it was below zero, by recollection (and minor scarring), these were in fact fairly crappy times to be holding equities, and the crossover back to positive also roughly coincided with better times to be in stocks.

May be an indicator as to when to shift from 60/40 stocks to 60/40 bonds. Types of stocks and bonds to be determined by other relevant conditions as Ted mentions.

So Ted, does your tweaking of the asset allocation based on indicators give you any positive results vs maintaining a 60/40 (either way) or a 50/50?

 

[Ted]

So Ted, does your tweaking of the asset allocation based on indicators give you any positive results vs maintaining a 60/40 (either way) or a 50/50?

To be honest, I don't explicitly track what would have happened to my portfolio value if I had not reallocated assets when I did. I just know that the value was less volatile because I sell stocks when their value is rising into "over-priced" territory and sell long-term bonds when their value is entering "over-priced" territory. By doing this I am able to maintain a higher long-term allocation to stocks and high yield bonds than I would feel comfortable with if I simply rebalanced once per year to a fixed allocation. But for most people, who are not so interested in managing assets, rebalancing perhaps once per year to a fixed allocation percentage should be perfectly adequate.

 

[cute fuzzy bunny]

Hmm. Would be interesting to see if your efforts net you a benefit (positive or negative).

Every once in a while I'll log in to an old financial web site (thestreet.com, morningstar, etc) where I had entered my portfolio at some prior time years ago and later abandoned the site and updating the contents of the portfolio. Its sort of interesting to see what would have happened had I stayed with a particular asset mix or fund/stock. In general, excepting the one I found on thestreet that was tech heavy in 1999, I would have done pretty well to have hung on.

So in regards to this indicator and others, and the commentary above, I have one other influence that I keep hearing. A lot of folks are talking about prior periods of time when a certain degree of timing and buy/sell activity was necessary to maintain or add to a yearly return. They point out that the market conditions for the past 20 or so years have favored a balanced, indexed, buy and hold strategy but that the next 10-20 might not. Not to doubt anyones strategy, simply to raise the discussion, but isnt it a fairly good rule that once everyone agrees something is "the obvious choice" or "what will work", that the herd is heading that way and once the herd turns, you need to be doing something different to create real returns?

Could perhaps the next 10 year be a time when the sideways nature of the market, coupled with the expectations of higher rates and inflation, turn out to be a place where a more concentrated portfolio that bends to certain indicators might outstrip a balanced index thats bought and held?

 

[unclemick]

One in six. Not that bad odds. Bernstein in his 15 stock diversification myth article making his case for indexing estimates your odds (1989-1999) were one in six of beating the S&P 500. And if you owned say Dell - well!!!

Hindsight for asset classes would also probably produce balanced index beating results.

If you figure out how to do it going forward 10 yrs - I'm all ears - perfectly willing to let my 'hobby' stocks/funds beat my 70-80% in balanced index. Remember - you only have to be right once in a lifetime - If your right is really right.

 

[cute fuzzy bunny]

Bernsteins stuff, from what i've read, make a nice case for DFA's balanced index funds, but it looks like the generic vanguard types dont do as well. I dont do financial planners, I dont care what instruments they give me access to, so hence no DFA funds for me. Plus I come away from reading his stuff like I just enjoyed a marketmercial for DFA.

But again, his information is based on hindsight, just like much of ours. The key question is still: is the next 20 going to be like the last 20 (or more specifically, like the last 5) up/down/up/down/up/down...net: nowhere.

 

[wabmester]

OK, I'll go out on a limb here. The next 20 years will not be like the last 20.

 

[Ted]

One thing that is virtually certain is that, whatever the markets do in the future, a person who simply holds a broad index of stocks and bonds, at a low expense ratio, will do better than most other investors.
One thing that is rather remarkable about past returns -- especially on stocks -- is that a person taking this approach would have done extremely well because of the effects of compounding. (I don't expect future returns to be as high, but there is no "system" that will allow investors as a group to escape this reality.)

If a person departs from this "passive" approach, they presumably believe that they have some "system" that will allow them to "beat the market." Without counting transaction costs, roughly half of the money invested this way will "beat the market" and half won't. (After transaction costs, the fraction beating the market shrinks considerably.) But even if a person comes up with a "system" that improves their returns, say, 80% of the time, there is a pretty good chance that it involves risks that will involve big losses the other 20% of the time.

While it is impossible for there to be any system that will allow all investors (who are "the market") to "beat the market," it should be possible for all investors to (1) reduce their transaction costs by doing less trading and (2) reduce the volatility of the market by doing less trading. Item 1 implies that there would be fewer people employed in the financial services industry. Hopefully they would find employment doing something more productive. :-/

 

[cute fuzzy bunny]

Sound thinking and definitely the current "right think".

However, what if the stock market runs stagnant for 10 years. Considering its ups and downs over the last 5, the indexes are still below their highs.

Hence (and I'm not trying to be a troublemaker), if we get 5 more like this, does the buy and hold low cost index owner get anywhere?

Someone making one or two decisions per year to sell on a high or buy on a low, using one or more moderately helpful indicators might at least pick up a few more percentage points per year.

I'm constantly reminded by my Dad of the following, and I dont recall the years, but the sentiment fits: "I owned stock once. I bought it (sometime in the early 70's), the prices dropped in half and after I waited about 8 years they came back to almost what I paid for them and I got rid of them and bought bonds".

Of course, had he held those to today from that times Dow of below 1000, he'd be quite well off.

The point is, what if we get one of those 8 year stagnant periods? Even a sub-4% SWR will see your portfolio fairly well picked over to meet expenses.

 

[unclemick]

There were times in the 70's when dull but well run companies paid 6% dividends.