Mortgage market cleanup proceeding

[innova]

Where are those oversized gains going to come from now?

Well.. stocks are not terribly expensive now, nor real cheap either. Perhaps we're due for some more 'normal' returns after the mess. A few years of steady unimpressive growth would be just fine with me.

In the next 10 years, the SP 500 could go up 10% annualized but your diversified portfolio could underperform T-Bills. As an example, real estate, commodity, and bonds loses could be negative drags wiping out your stock gains and giving you a 0% return annualized over the next 10 years. I suppose you do not think that is possible? A diversified portfolio may be logically very well thought out, but it is not a 100% sure money maker. Every method of investing has risk.

What you are saying is certainly possible, but unlikely. A review of the Callan table of investment returns and correlations data show that scenario is very unlikely. Correlations between different types of equities vary, but generally aren't negative... I guess what I'm saying is if US stocks do well, I would expect REITS to do well also, but not always move in tandem. Bonds generally do not lose money when stocks are up. Commodities are negatively correlated to stocks, so a strong bull market may result in weak commodity returns.

For all the asset classes you mentioned, they all have a positive expected return with varying correlations to the other ones.. so I'd expect a well-contructed portfolio to continue to be the best bet going forward - bubbles or no bubbles.

One last thing.. stocks MUST underperform bonds from time to time for there to support the existence of the equity risk premium over bonds. If stocks always returned more than bonds without downside risk, they would be safer and nobody would buy bonds. So consider times like this a necessary evil.

Bear Markets A Necessary Evil - Research

 

[RockOn]

For all the asset classes you mentioned, they all have a positive expected return with varying correlations to the other ones.. so I'd expect a well-contructed portfolio to continue to be the best bet going forward - bubbles or no bubbles.

... they all have a positive expected return.....

That is an interesting concept, based upon what? Historic pricing alone?

I can see how a stock has a positive expected real return due to growth of the economy and the company.

Why would you expect bonds to have a postive expected real return?; commodities? ;the family house? ; Real Estate in general?

Other than temporary, as compared to permanent, and sometimes localized supply/demand issues, why would you expect a positive return above the inflation rate on these assets?

 

[Notmuchlonger]

My opinion....I'm leery when I see making money as a justification. Sure it was possible to make money in a very diversified portfolio, we had.....a stock bubble, a bond bubble, a real estate bubble, a commodity bubble...doubles, triples, quadruples....but the speculation seems to be unwinding. Where are those oversized gains going to come from now? Just like we all know from studies that market timing doesn't work, there are a lot of studies showing the returns of the past years in some asset classes were quite extaordinary, and there are studies showing that if you buy at high valuations it is possible to be disappointed.

Returns are likely to revert to the mean, which "could" mean your portfolio will underperform to makeup for the recent overperformance as compared to T- Bills and the SP 500. In the next 10 years, the SP 500 could go up 10% annualized but your diversified portfolio could underperform T-Bills. As an example, real estate, commodity, and bonds loses could be negative drags wiping out your stock gains and giving you a 0% return annualized over the next 10 years. I suppose you do not think that is possible? A diversified portfolio may be logically very well thought out, but it is not a 100% sure money maker. Every method of investing has risk.

Of course there might be another FED induced bubble.......

I think it has to end.

"Where are those oversized gains going to come from now?"

I cant predict the future. They why I own a well diversified portfolio. Sure it can tank and I could lose everything. I am not intelligent enough to time the market or know where the next big thing to invest is.

 

[RockOn]

"Where are those oversized gains going to come from now?"

I cant predict the future. They why I own a well diversified portfolio. Sure it can tank and I could lose everything. I am not intelligent enough to time the market or know where the next big thing to invest is.

Well said. I wish you well and cannot say I would advise you to do anything else.

This is just my opinion again, I'm interested in your comments on it.....ignoring past history as justification...... in a totally diversified non-correlated portfolio, if there are no oversized gains (I'll call them bubble markets), wouldn't the likely outcome tend to vary slightly above the inflation rate? Would you not expect a loss in one asset to cancel the gain in another?

Isn't too much non-correlation and diversification actually reducing risk to the point one would expect a limited return outcome? It seems the only way to win with this type of portfolio is to pray for at least one dramatic price move upward.

 

[Notmuchlonger]

Well said. I wish you well and cannot say I would advise you to do anything else.

This is just my opinion again, I'm interested in your comments on it.....ignoring past history as justification...... in a totally diversified non-correlated portfolio, if there are no oversized gains (I'll call them bubble markets), wouldn't the likely outcome tend to vary slightly above the inflation rate? Would you not expect a loss in one asset to cancel the gain in another?

Isn't too much non-correlation and diversification actually reducing risk to the point one would expect a limited return outcome? It seems the only way to win with this type of portfolio is to pray for at least one dramatic price move upward.

I believe the world will continue growing. Some assets without a doubt will do better than others. Win? Its almost like you think the world is done growing and this is whats left. If their wasn't any growth commodities would not do well. Businesses would sell less product. People would not need as many houses. I dont need huge tremendous swings upwards. I needed to save enough money during my career to not run out in x amount of years.

I have no clue what black swan awaits. That very well may tank my retirement who knows?

 

[RockOn]

By win, I just mean get a 5-8% annualized return. Not more than that, to me that's a win. I think the world will keep growing, that's why I said I'd expect a return slightly above inflation, even if assets cancel out.

 

[Notmuchlonger]

By win, I just mean get a 5-8% annualized return. Not more than that, to me that's a win. I think the world will keep growing, that's why I said I'd expect a return slightly above inflation, even if assets cancel out.

I figure 3 to 4 % real.

 

[innova]

I figure 3 to 4 % real.

Same for me.

That is an interesting concept, based upon what? Historic pricing alone?

I'm thinking more in terms of risk and reward. If you use 28-day Tbills as the 'riskless' investment for a baseline, you can gauge the risk of an instrument by measuring what premium investors will typically place on it.

So.. if cash is expected to keep pace with inflation or not quite so, stocks had better return more - or no sane person would invest in stocks.

I can see how a stock has a positive expected real return due to growth of the economy and the company.

Why would you expect bonds to have a postive expected real return?; commodities? ;the family house? ; Real Estate in general?

Bonds have a real return for the same reason stocks do. With stocks, you are buying future earnings, with bonds, current earnings. If the economy in general grows, so should stock AND bond returns (over long periods of time, anyway).

Commodities themselves - no expected return. Commodities futures - yes. The way I've justified it is this.. Consider PCRIX, PIMCO's CCF fund. It holds TIPS as collateral on futures contracts - so the expected return is at minimum the TIPS return, plus in uncertain times commodities move opposite bonds and stocks (negative correlation to both).

Housing(personal).. I'm still not sure. In MN where I live, the oft-quoted stat was that housing values grew at 6.4% per year average from 1940-2005 without any negative years. Well, look what just happened. I think a reasonable person can do the math and say if wages inflate 3% per year and housing inflates 6% per year that is unsustainable.

REITS on the other hand.. due to their struture which has them paying out 90% of earnings as a dividend - you should expect these to have a real return. Rents have a long-term upward trajectory, and as the economy grows more buildings are constructed and leased.

This is just my opinion again, I'm interested in your comments on it.....ignoring past history as justification...... in a totally diversified non-correlated portfolio, if there are no oversized gains (I'll call them bubble markets), wouldn't the likely outcome tend to vary slightly above the inflation rate? Would you not expect a loss in one asset to cancel the gain in another?

I'm not sure you can really ignore the past - if you did you may be tempted to avoid the markets entirely in times like these. One thing you should ask yourself is why do you expect that in non-bubble times you would need to have losses in your portfolio at all? There have been many years since 1930 that all major asset classes have posted gains. I think when you consider that it is possible to 'win' over the long run.

Other thing is, its not really possible to build a completely non-correlated portfolio. All equities move together to varying degrees over rolling periods, even though the correlations may be as low as 0.4. I think the point you were making is if you held something with positive correlation and something with strong negative correlation, they would cancel out since they always move opposite each other. I don't think in the real world you could construct a combination that works like that. However - even if you could, as long as both components still EACH have a positive expected return (based on history, sorry!), the combination would also have a positive return.

This has been a good thread - made me really consider my reasons for holding some of the things I do.

 

[tryan]

Look for the hardest hit areas (FL, CA, NV) to lead the way ....

Only a handful of the properties would be selling absolute, where any bid would be accepted. The rest carried a non-disclosed reserve, or minimum bid.

"When there aren't many absolutes, it makes it hard to get things going," DeCaro said. "And this is a tough market."

The auction, which was anticipated to take four to five hours, wound up clocking in at barely two. Two-thirds of the property on the block failed to garner a single bid.

HeraldTribune.com - Real Estate - Real estate and homes news stories about Sarasota, Manatee and Charlotte counties in Florida, from the newspapers of record. - HeraldTribune.com

Once the mortgage holders realize thier reserve pricing is meaningless, everything will be sold absolute. They'll realize it is far better to get "something" than to wait for the market to improve while the asset rots on its foundation.

The absolute auctions are alot of fun. It'll take some time, but it's coming ... save your pennies!

 

[innova]

Builders have been selling their inventory 'absolute' at auctions here. Just got started recently.

 

[RockOn]

So.. if cash is expected to keep pace with inflation or not quite so, stocks had better return more - or no sane person would invest in stocks.

Bonds have a real return for the same reason stocks do. With stocks, you are buying future earnings, with bonds, current earnings. If the economy in general grows, so should stock AND bond returns (over long periods of
time, anyway).

Commodities themselves - no expected return. Commodities futures - yes. The way I've justified it is this.. Consider PCRIX, PIMCO's CCF fund. It holds TIPS as collateral on futures contracts - so the expected return is at minimum the TIPS return, plus in uncertain times commodities move opposite bonds and stocks (negative correlation to both).

Husing(personal).. I'm still not sure. In MN where I live, the oft-quoted stat was that housing values grew at 6.4% per year average from 1940-2005 without any negative years. Well, look what just happened. I think a reasonable person can do the math and say if wages inflate 3% per year and housing inflates 6% per year that is unsustainable.

REITS on the other hand.. due to their struture which has them paying out 90% of earnings as a dividend - you should expect these to have a real return. Rents have a long-term upward trajectory, and as the economy grows more buildings are constructed and leased.

I'm not sure you can really ignore the past - if you did you may be tempted to avoid the markets entirely in times like these. One thing you should ask yourself is why do you expect that in non-bubble times you would need to have losses in your portfolio at all? There have been many years since 1930 that all major asset classes have posted gains. I think when you consider that it is possible to 'win' over the long run.

Other thing is, its not really possible to build a completely non-correlated portfolio. All equities move together to varying degrees over rolling periods, even though the correlations may be as low as 0.4. I think the point you were making is if you held something with positive correlation and something with strong negative correlation, they would cancel out since they always move opposite each other. I don't think in the real world you could construct a combination that works like that. However -
even if you could, as long as both components still EACH have a positive expected return (based on history, sorry!), the combination would also have a positive return.

This has been a good thread - made me really consider my reasons for holding some of the things I do.

A few comments, IMO....I think stocks have a real return because companies grow faster than the inflation rate. That is the reason to expect a real return. Stock earnings grow at about 7% a year, if that exceeds inflation on average, you get a real return. Saying they must have a real return or nobody would invest, doesn't seem like enough for me.

Bonds...since you are locking in current rates and growth, it's hard to understand a real return. The only reason I see for exceeding inflation is that you are paid for taking default risk. As long as the premium you lock in exceeds the actual default rate you can make a real return. Default rates vary with the business cycle. It's hard to justify much of a long term real return.

Commodities....there is really no easy explanation for a real return except for supply/demand in specific situations which tends to balance out over long periods. It's hard to justify a long term real return.

A house....a house should actually depreciate as the materials it was built with age and need to be replaced. The exception would be a supply/demand situation such as waterfront property or Manhattan. It's hard to justify a real long term return overall in the US as land to build is still plentiful in most of this country.

REITs...if they grow as rents increases you should expect REITS to match inflation because rents are in the CPI. Supply/demand is a factor in specific situations. I wouldn't expect much of a real return.

To me the only solid case for expecting a significant real return is in the stock market. IMO speculation is the reason why prices of many assets have jumped. Are we investors or speculators?

I wonder, is a diversified, non-correlated, portfolio really the way to go? Sure it does reduce risk and smooth out returns but is also is likely to reduce returns in the long run. This is true because of reasons listed above for various asset classes, but also because with less risk should come lower returns. A better investment plan may be to just put as in much in stocks as you can stand because with stocks there is a significant exectation for a real return.

Comments?

 

[tryan]

... and with a growing population, the demand side is growing long term - pushing the return up. Seems to me, population growth is a pretty safe bet.

 

[Independent]

Rockon -

This is one way to think of bonds:

Suppose I think I have a way of generating a good return on capital in my business. I've got my own money in the business, but I want some additional capital. I could do that by selling shares or by borrowing.

People who might supply the captital understand the tradeoffs. With equity, they participate in all the upside, but they take downside risk. If they lend, their upside is fixed, but they greatly reduce the risk.

If I want to keep the upside for myself (borrow instead of selling shares), then I have to make an offer to the lenders that they percieve as a good deal vs. stock (because they could always buy stock in some other business). Since stock is likely to generate real returns, they will insist on bonds that are "as good, considering the different guarantees" as stock.

i.e. The actual yields on bonds will be whatever it takes to get a mix of equity and debt financing which appears "most attractive" to the stockholders (since they are owners), given the fact that the potential bond buyers could also buy stock somewhere.
I don't see any mechanism that would make the yields equal to the CPI (or whatever you mean by "inflation").

Historically, we see that bonds in the US really have had yields in excess of the CPI, so my theory isn't contradicted by experience.

I could also talk about "bonds" that finance consumer spending instead of business capital, but that would make for a long post.

 

[lazygood4nothinbum]

Look for the hardest hit areas (FL, CA, NV) to lead the way ....



HeraldTribune.com - Real Estate - Real estate and homes news stories about Sarasota, Manatee and Charlotte counties in Florida, from the newspapers of record. - HeraldTribune.com

Once the mortgage holders realize thier reserve pricing is meaningless, everything will be sold absolute. They'll realize it is far better to get "something" than to wait for the market to improve while the asset rots on its foundation.

The absolute auctions are alot of fun. It'll take some time, but it's coming ... save your pennies!

thanx for the post. was curious to what happened there as that is the very auction i opted out of. at first when they tried to get me to participate they said there would be a 10% commission which i thought high but what the heck. turns out the 10% is payed by the buyer (as if) so of course i would have had to factor that into the price. plus the auctioneer wanted $15k from me up front just to participate.

when i refused to pay their cost of doing business (what's up with that?), they said they'd work with me. someone would call me back. i told them to tell the person who was to call me back that i'd only consider the auction on condition that they only get their fee upon closing and not before. needless to say, i never got a return call. what a scam.

 

[CCdaCE]

What a scam, no kidding.

$15k + 10% ? If I understand correctly. Nice fee structure to have if you're the auctioneer/seller.

-CC

 

[lazygood4nothinbum]

yup, you got it. and that was just the fee at my price point, on the lower range of what was for sale there. it ran a lot higher for others. they tried convincing me that they were spending $1mm on advertising but i hardly saw any of that in local media. they insisted the advertising was international; but, um, isn't that why i'm with a pricey international realtor in the first place?

even if they did spend $1mm on advertising and adding the rental on that tent, i would not be surprised to learn that the auctioneer walked away netting about $1/2mm or more for his two-hour day.

 

[Independent]

thanx for the post. was curious to what happened there as that is the very auction i opted out of. at first when they tried to get me to participate they said there would be a 10% commission which i thought high but what the heck. turns out the 10% is payed by the buyer (as if) so of course i would have had to factor that into the price. plus the auctioneer wanted $15k from me up front just to participate.

when i refused to pay their cost of doing business (what's up with that?), they said they'd work with me. someone would call me back. i told them to tell the person who was to call me back that i'd only consider the auction on condition that they only get their fee upon closing and not before. needless to say, i never got a return call. what a scam.

Fascinating story. Thanks for the post.

 

[lazygood4nothinbum]

it gets even better. here ya go...

wcbstv.com - N.J. Woman Raffling Home Off On eBay For $100

 

[RockOn]

Rockon -

This is one way to think of bonds:

Suppose I think I have a way of generating a good return on capital in my business. I've got my own money in the business, but I want some additional capital. I could do that by selling shares or by borrowing.

People who might supply the captital understand the tradeoffs. With equity, they participate in all the upside, but they take downside risk. If they lend, their upside is fixed, but they greatly reduce the risk.

If I want to keep the upside for myself (borrow instead of selling shares), then I have to make an offer to the lenders that they percieve as a good deal vs. stock (because they could always buy stock in some other business). Since stock is likely to generate real returns, they will insist on bonds that are "as good, considering the different guarantees" as stock.

i.e. The actual yields on bonds will be whatever it takes to get a mix of equity and debt financing which appears "most attractive" to the stockholders (since they are owners), given the fact that the potential bond buyers could also buy stock somewhere.
I don't see any mechanism that would make the yields equal to the CPI (or whatever you mean by "inflation").

Historically, we see that bonds in the US really have had yields in excess of the CPI, so my theory isn't contradicted by experience.

I could also talk about "bonds" that finance consumer spending instead of business capital, but that would make for a long post.

I think the point you are getting at is that bonds should have a real return. I agree, just not a very high one. After all, if bonds have much lower risk as you said, they should also have a lower expected real return, correct?

Stocks historically, I don't like using that word since history is longer than the 100 years we usually tend to assume captures everything, have had a real return of 7%.

On bonds the real return is less. It has been around 3% historically, I think. Right now a top quality bond corporate pays about 5.5% or likely a 0.5% to 3.5% real return depending on what inflation does. Greenspan said to expect 5% going forward for inflation.

I will agree that I would expect some real return, I think 3% is a high expectation if buying into the bond market today, which is at very low yields due to a 28 year bond bubble. Look at TIPS, some have a negative real yield if bought today.

 

[Brat]

I think the point you are getting at is that bonds should have a real return. I agree, just not a very high one. After all, if bonds have much lower risk as you said, they should also have a lower expected real return, correct?

...
On bonds the real return is less. It has been around 3% historically, I think. Right now a top quality bond corporate pays about 5.5% or likely a 0.5% to 3.5% real return depending on what inflation does. Greenspan said to expect 5% going forward for inflation.

I will agree that I would expect some real return, I think 3% is a high expectation if buying into the bond market today, which is at very low yields due to a 28 year bond bubble. ...

IMHO bonds have very real risks, default is a big one.

 

[Independent]

I think the point you are getting at is that bonds should have a real return. I agree, just not a very high one. After all, if bonds have much lower risk as you said, they should also have a lower expected real return, correct?

Stocks historically, I don't like using that word since history is longer than the 100 years we usually tend to assume captures everything, have had a real return of 7%.

On bonds the real return is less. It has been around 3% historically, I think. Right now a top quality bond corporate pays about 5.5% or likely a 0.5% to 3.5% real return depending on what inflation does. Greenspan said to expect 5% going forward for inflation.

I will agree that I would expect some real return, I think 3% is a high expectation if buying into the bond market today, which is at very low yields due to a 28 year bond bubble. Look at TIPS, some have a negative real yield if bought today.

I apparantly mis-read your earlier post.

Yes, I intended to say that the "most likely" yield on bonds should be lower than stocks, but that doesn't mean it should be equal to inflation, or even inflation plus the most likely default losses.

Note that I was talking about corporate bonds, though gov't bonds need yields that are reasonably related to corporates.

 

[Brat]

Let me add that in addition to default, there are liquidity issues and transaction costs should you need to redeem prior to maturity.

IMHO Unless you are confident that you will hold until maturity a bond mutual fund is probably a better choice for most investors.