Vanguard's Bogle comments

[samclem]

If one saw that the financial stocks were going to break - as the events unfolded last year - would it not be possible to at least avoid this sector, instead of suffering their decline in the S&P index? Couldn't one buy the S&P sans financial stocks and home builders stocks and various other stocks that were housing related?
. . .
As another example, most of us recognized that the housing bubble inflated to ridiculous levels. .

Okay, Casandra, you're good at spotting them in retrospect. Now, tell us what and when the next one will be.

 

[NW-Bound]

Okay, Casandra, you're good at spotting them in retrospect. Now, tell us what and when the next one will be.

Finally, someone calls me name.

As I said, it is not possible to predict what the next bubble will be. However, once one has been formed, most of us could see, but failed to do anything about it. So, right now there is no bubble that I can tell. I am in the "buy, buy, buy" mode.

In mid 2008, when I joined this forum, I posted that I advised my wife to get completely out of her financial stock in her 401k. That was not bubble predicting, only reacting to one. I did not get her out at the top, no way. However, even after recovering from the bottom, her company stock is currently still less than 50% of what we sold at. We may buy back, or we may not. I don't know yet.

No bubble predicting, only reacting to one.

 

[Gone4Good]

If one saw that the financial stocks were going to break - as the events unfolded last year - would it not be possible to at least avoid this sector, instead of suffering their decline in the S&P index? Couldn't one buy the S&P sans financial stocks and home builders stocks and various other stocks that were housing related?

Timing matters. You might see the bubble, but knowing when to get out is a really hard call. Harder still if you're going to try to short it.

You might remember Alan Greenspan's "irrational exuberance" comment . . . that was December 5, 1996.

 

[NW-Bound]

Timing matters. You might see the bubble, but knowing when to get out is a really hard call. Harder still if you're going to try to short it.

You might remember Alan Greenspan's "irrational exuberance" comment . . . that was December 5, 1996.

Yes, shorting is tough. On this forum, I have told a story of how Julian Robertson (Tiger Fund) shorted techs or dotcoms too early in 2000, and got hurt bad.

Profitting from bubbles may be tough, but I still think that avoiding one is possible. As mentioned earlier, none of us (at least no one claims to) went out and bought houses to flip. Why couldn't we apply the same logic to avoid home builders and mortgage industry near the end? Or at least why couldn't mutual fund managers, even the indexing ones? Was it greed that kept us in there, trying to get a little more?

About Greenspan's comment, he later praised the productivity provided by technology, which would imply wonderful economy growth, which would justify the higher P/Es. Then, I personally heard one of his speeches saying ARM was a good thing. I scratched my head and started to doubt his words since that speech. He was flaky!

 

[Gone4Good]

Well, it might be anathema to hard-core Bogleheads, but I think the meltdowns of 2000 and 2008 may have made some people who considered themselves "good buy-and-holders" a little more aware of market valuations with respect to their future AA.

But doing something intelligent about it is hard.

Using Shiller's data, I tried to work up an asset allocation scheme that would reduce stock allocations when P/E-10's were high and increase them when they were low. The formula I tried used a 60/40 allocation at a PE of 15x, and increased or decreased the stock allocation by 10 percentage points for every 5 turns increase or decrease in valuations. So at a 10x PE you'd have a 70% stock allocation and at a 20x PE you'd have a 50% allocation. At the peak of the 2000 bubble, you'd have almost no stock investments at all.

It seemed pretty obvious to me that this would work really well over the past 20 years. After all, you'd be reducing stocks into the first bear market, buying stocks again as they fell and then selling a bit before the next bear market . . . had to be a winner, right?

But it wasn't. Following the more complicated asset allocation model didn't leave you with any more money by May of 2008 than if you had just stuck with a 60/40 portfolio and annual rebalancing. Your portfolio wasn't as volatile, which is a plus, but you didn't achieve better total returns.

Why not?

Mostly because the formula had you selling equities early in the 90's rally (PE's broke above 20x in 1992 and never looked back) so you missed a lot of the upside. You missed the downside too, but you didn't end up with more money at the end of the day. PE's stayed high for much of the 00's so you stayed underweight equities as they rallied again. But then increased exposure a bit right before the big sell-off in October of 2008.

The moral of that long story is . . . if there was an easy way to exploit market inefficiencies, we'd all be really, really, really, rich by now.

Which brings us back to where Bogle started us off.

 

[Gone4Good]

Profitting from bubbles may be tough, but I still think that avoiding one is possible. As mentioned earlier, none of us (at least no one claims to) went out and bought houses to flip. Why couldn't we apply the same logic to avoid home builders and mortgage industry near the end?

You can try. I'm inclined to think any success at doing so is more luck than skill.

Personally, I haven't had a lot of luck picking tops, or bottoms, in any markets. Sometimes I get lucky, most the times not.

I "saw" the bubble in real estate and dumped all of my REITs . . . about 3 years before the peak. And then after they corrected by 40%, but before the real meltdown happened last year, I jumped back in. Neither was a good call. I "rebalanced" my REIT position on November 21, and am up ~30% on that slice, but overall, it's been a bad run.

If I went back and modeled my total returns in REITs I almost certainly would have been better off with a buy, hold, rebalance approach.

 

[NW-Bound]

The moral of that long story is . . . if there was an easy way to exploit market inefficiencies, we'd all be really, really, really, rich by now.

Which brings us back to where Bogle started us off.

If market inefficiencies could be easily exploited, then they would cease to exist.

In "Money Game", Adam Smith (a pseudonym) described how computers were used in the 1960s to implement trading strategies. To this day, the problem with mechanical methods is that investing is a human endeavor, and the human and political market forces cannot be easily modeled nor input into a computer. Which is of course what Bogle has been saying: "Buy the whole market and call it done".

I have been a bull and like the market, but am still trying to exclude the "bad apples". My modest goal is to beat the S&P, if not a lot then a little. So far, so good. I have beaten the S&P since I have been more active managing my portfolio. My luck might just change from now on, now that I have offended the market god. But I will let you know from time to time.

 

[Gone4Good]

If market inefficiencies could be easily exploited, then they would cease to exist.

. . .

My modest goal is to beat the S&P, if not a lot then a little.

These are mutually exclusive ideas. I tend to agree more with the former than the latter, but good luck in your attempts.

 

[NW-Bound]

Well, thanks. As a very individualistic person, I always like to do my own things, though I try not do something so foolish I may not walk away from. It's what makes life interesting.

 

[cashflo2u2]

Freebird, you didn't post the title to the Bogle video- "Bogle:This Bear Market Is the Worst I Have Ever Seen" Now that is really saying something.

 

[freebird5825]

Freebird, you didn't post the title to the Bogle video- "Bogle:This Bear Market Is the Worst I Have Ever Seen" Now that is really saying something.

I left it as an "exercise for the student".

 

[NW-Bound]

I "saw" the bubble in real estate and dumped all of my REITs . . . about 3 years before the peak. And then after they corrected by 40%, but before the real meltdown happened last year, I jumped back in. Neither was a good call. I "rebalanced" my REIT position on November 21, and am up ~30% on that slice, but overall, it's been a bad run.

If I went back and modeled my total returns in REITs I almost certainly would have been better off with a buy, hold, rebalance approach.

Sorry to bring this back up, but I missed this on my first reading. I thought you only buy S&P index. But now I see that you have some extra weight in REITs.

By being proactive, selling before it's time, and buying back too soon, you did not do as well. You said you would have done better by rebalancing, but rebalancing is only reacting, per my definition.

You see, we may not be too different after all.

 

[Gone4Good]

I thought you only buy S&P index.

I'm pretty sure I never said that, because if I did, it would have been a lie.

The S&P 500 isn't the market portfolio, after all. It dose miss a lot of stuff, like international investments (about which I think Bogle is dead wrong). I also overweight small & mid cap companies, because I think I'll get higher returns for the higher risk.

But, with the exception of bailing out on REITs that one time, I try not to mess with the allocation. The market is exceedingly good at making fools of people who try to out smart her.

 

[NW-Bound]

Ah hah...

I am sorry I jumped to conclusion. So, we do agree that S&P 500 index is just something artificial, or at least just a benchmark from which one can add a bit more of the sectors that we like, or delete the stinky stuff that we hate. I thought you'd stick with the S&P as a "purist".

And back to my pet peeves about financial stocks, as I mentioned in earlier posts elsewhere, in mid-2008 I got my wife out of her financial stock, and made sure I also had none. Unfortunately, I later discovered that many of my mutual funds were loaded with financial stocks because they paid good dividends, dividends from the mortgage bubble which were not sustainable. This was the same as the growth of tech stocks that were simply not sustainable in 2000.

About financial stocks, I never heard of the book "Enough" by Bogle until I joined this thread. So, I went to Amazon and found the following review from William Berstein. In 2008, I knew that the financial sector made up a huge percentage of the S&P 500 as market caps in addition to earnings, hence my avoidance of that sector. If an individual like me knew it, why didn't these mutual funds, indexed ones included?

My question I posed and was terribly misunderstood was this: "Why mutual fund managers, the index ones included, not do anything with this knowledge?".

As you guess it, I am not at all impressed with the performance of some "value-oriented" funds that I owned. I also do not see why one should blindly hold the financial stocks simply because they belonged in the index.

I guess I may have to read the book to see how, as Bernstein said, I could "plump up my portfolio". What is there to do, if one simply buys the index, rain or shine? But I guess this question should not be directed to you.

As Bogle states in the book's beginning, in the spring of 2007 the financial services sector--which, after all, produces nothing of substantive value--accounted for one-third of the earnings of the S&P 500. By the time you read this, this outsized influence will have shrunken drastically. Let Enough be your welcome to the brave new world; it will satisfy your curiosity, give you a sense of moral balance in this most materialistic of ages, and even plump up your investment portfolio.

--William J. Bernstein​

 

[Gone4Good]

I thought you'd stick with the S&P as a "purist".

But the S&P 500 is just one index. The REITs I owned, I owned through and index, ditto small cap stocks, international, etc.

Just because you say you believe in indexing, doesn't mean you're confined to the S&P 500.

I knew that financial sector made up a huge percentage of the S&P 500 as market caps in addition to earnings, hence my avoidance of that sector. If an individual like me knew it, why didn't these mutual funds, indexed ones included?

They did. And they valued those stocks based on the information and assumptions that prevailed at the time. Indexers went along for the ride. But if you're smarter than the market is, than you should be able to consistently find those situations where the market is mispricing securities. Bogle, supported by reams of academic research, says you can't.

As Bogle states in the book's beginning, in the spring of 2007 the financial services sector--which, after all, produces nothing of substantive value--accounted for one-third of the earnings of the S&P 500.

I guess he defines "substantive value" differently than I do. Try to start, or maintain, a business without the aid of the financial sector and then talk to me about whether they provide a service of "substantive value".

 

[NW-Bound]

But the S&P 500 is just one index. The REITs I owned, I owned through and index, ditto small cap stocks, international, etc.

Just because you say you believe in indexing, doesn't mean you're confined to the S&P 500.

Again, we may be on the same page here. You are using these indices simply as benchmarks in the sectors of interest. Nowadays, there are ETFs that allow diversification into sectors the same way.

They did. And they valued those stocks based on the information and assumptions that prevailed at the time. Indexers went along for the ride. But if you're smarter than the market is, than you should be able to consistently find those situations where the market is mispricing securities. Bogle, supported by reams of academic research, says you can't.

I suspect that many of them actually can but, being huge mutual funds, can not maneuver fast enough. While the financials were riding high, the MFs couldn't afford to miss their dividends because MFs get compared to their peers. When things went south, they couldn't dump their holdings. Who would be buying?

I guess he defines "substantive value" differently than I do. Try to start, or maintain, a business without the aid of the financial sector and then talk to me about whether they provide a service of "substantive value".

Don't get me wrong. I realize that the modern world needs banks, in constrast with some cultures that forbid loaning with interest. What irks me about the bankers I called stinky are or were the ones who sold CDOs and CDSs and made subprime loans.

 

[FUEGO]

If you completely avoided financials, then you just missed out on a 100+% return (trough to peak) from that sector in the last 3 months. Sometimes it is good to index.

 

[samclem]

If you completely avoided financials, then you just missed out on a 100+% return (trough to peak) from that sector in the last 3 months. Sometimes it is good to index.

Well, I suppose that's one way to look at it.

"If you completely avoided the voyage on the Hindenberg, you missed out on the great free lunch the fire department gave us in Lakehurst, NJ"

 

[NW-Bound]

There are so many other "innocent" stocks that were taken down in the downdraft, then rebounded even more explosively. I had been watching GT (Goodyear Tire), waiting for an entry point. I was working abroad during the March bottom and did not watch the market at all (they didn't pay me to goof around, and when I got back to the hotel was all tired). So, I missed it, but I did get something else later.

There are many other sectors that interest me more than financials. As I often said, I was hurt bad after the 2000 crash, but I recovered with other sectors, not with the telecoms and semiconductors that nearly sank me.

 

[Gone4Good]

What irks me about the bankers I called stinky are or were the ones who sold CDOs and CDSs and made subprime loans.

But these aren't useless products. Take the much maligned "Credit Default Swap". Real industrial companies do use them to manage their counterparty credit risk. For example, ABC Company hires a contractor to build something under a contract that includes various guarantees. But the guarantees are only as good as the creditworthiness of the contractor. ABC could employ a team of credit analysts to rate the contractor's default risk and try to price that risk themselves, or they could rely on the rating agencies opinions (if the contractor is rated), or they could go to a bank and buy default protection.

The virtue of CDS, as opposed to the rating agencies or in house analysis, is that it is a free market assesment of credit risk (rather than from just a handful of guys in a conference room), it actually prices that risk (so the buyer can adjust contract terms accordingly), and provides a payment if the counterparty defaults.

Subprime lending and CDO's have constructive uses too.

 

[FUEGO]

Well, I suppose that's one way to look at it.

"If you completely avoided the voyage on the Hindenberg, you missed out on the great free lunch the fire department gave us in Lakehurst, NJ"

My point is that a 30+% rebound in the SP 500 is only 30+% if one owns the index. If one owns SP500 ex financials, then the return over the last 3 months would have been much less. As of 4/30/2009 the SP500 was around 12% financials. So missing out on 100% return on 12% of the index would take a chunk out of the 30+% return we just experienced.

Unless you used a crystal ball to pick a sector better than financials in the last 3 months. If so, I'd say keep using that crystal ball as long as it is clear!

 

[Gone4Good]

Unless you used a crystal ball to pick a sector better than financials in the last 3 months. If so, I'd say keep using that crystal ball as long as it is clear!

That is the entire argument in a nut shell.

Investing rule #1 . . . No one has a crystal ball.
Investing rule #2 . . . If you have a crystal ball, see rule #1.

 

[NW-Bound]

But these aren't useless products. ...

Subprime lending and CDO's have constructive uses too.

True. Again, another clarification on my part is needed. I am not knowledgeable in this business, but have read of many AAA-rated products later turned out to be junks because they were backed by houses that were over-appraised, bought by people who had no income, etc... There was a thread a while back about a home in AZ that, after foreclosure, was condemned by the city and had to be destroyed. The mortgage written on that shack was more than $100K as I remember.

Yes, we need these financial products. However, they were abused by some if not most of the financial institutions, and the list included more than just banks. As I could not tell who was clean or not, I would avoid them all. I learned that lesson in 2000. AT&T was clean while Worldcom was not. Until the smoke clears, the market punished them all.

 

[NW-Bound]

My point is that a 30+% rebound in the SP 500 is only 30+% if one owns the index. If one owns SP500 ex financials, then the return over the last 3 months would have been much less. As of 4/30/2009 the SP500 was around 12% financials. So missing out on 100% return on 12% of the index would take a chunk out of the 30+% return we just experienced.

Unless you used a crystal ball to pick a sector better than financials in the last 3 months. If so, I'd say keep using that crystal ball as long as it is clear!

As we come off the bottom, what you said may be true. But I wonder how the S&P 500 ex financial would do, as one measures from Oct 07 to March 09.

Anyway, there are many ways to make money, and to lose it too. It's a nice discussion, as long as we all keep cool under the collar and avoid calling names.

As long as we make money, there's no point to claim that my way is better than your way. Heck, if I can get 4% after inflation, I have more than I usually spend.

 

[FUEGO]

As we come off the bottom, what you said may be true. But I wonder how the S&P 500 ex financial would do, as one measures from Oct 07 to March 09.

I claim "no fair"! You get to pick the disfavored sector AND the time period!!!

I'm not sure how to determine SP500 ex financials, but from 10/31/09 to today, the SP500 including financials is down 39% while financials (as measured by KBE which tracks a large bank index fund) are down 61%. Obviously much worse, but still not the end of the world.

However if I can pick the time period, I'd start at July 11, 2008 when I decided to overweight financials. As of today, I am down 29% in the financials (ignoring dividends) and the SP500 is down 27% (again ignoring dividends). Nearly identical results. Surprising how financials didn't really hurt that much if you are a bottom feeder looking for deep value? So if you missed the initial drop in financials and decided to craft the SP500 index somehow into a SP500 ex financials and carved out the financials on July 11, 2008, you would be in virtually the same position today as you were then, but you couldn't easily implement this strategy with a low low cost tax efficient index fund, could you?

Many smart minds disagreed about prospects for financials through the first half of 2008 and continued to say that the worst damage was done already by mid year 2008. In hindsight, they would go on to drop another 2/3 in value before recovering to be down about 1/3 from their value in July 2008.