Investing For the Medium Run

[brewer12345]

If you are talking about the Oct 2008 to Jan 2009, than I agree the economic conditions were bad and the future looked even worse. However by March 2009, when the market hit bottom, the prospects were much improved, and the "we are doomed talk" was once again primarily from the tinfoil brigade. Here is a timeline from the NY Fed. Note that tomorrow is the 1 year anniversary of Bernake's talking about green shoots.

I remember last March with painful clarity, especially as I was in the middle of some of the things on that timeline. We are at least 70% better off than last March. More like 200%, in my estimation.

 

[clifp]

I remember last March with painful clarity, especially as I was in the middle of some of the things on that timeline. We are at least 70% better off than last March. More like 200%, in my estimation.

Fair enough, I guess we will just agree to disagree. I sincerely hope you are right and I am wrong and that market will be even higher a year from now.

 

[brewer12345]

Fair enough, I guess we will just agree to disagree. I sincerely hope you are right and I am wrong and that market will be even higher a year from now.

Heh, we will know in a year.

 

[haha]

IMO, the market on absolute basis looks fairly or slightly overvalued compared to historical levels. Stocks don't exist in a vacuum. On a relative basis compared to cash, bonds, gold, real estate, stocks look reasonably cheap. Which means that I continue to be fully invested, with less bonds and more cash than normal, but I am not happy camper. Which is why I've been whining like prima dona for the last few months...

I don't try to do overall market valuation myself. I just look at the data very generously provided by Shiller and also A. Smithers. By these metrics, we are quite overvalued, notwithstanding that we were much more overvalued at times during the past 12-15 years.

There are things to buy, but it may be be the smartest thing to go buying. Like Brewer says, we'll see.

I lightened up over the summer and early fall, and though that has hurt my performance, it is amazing how little it has cost me to be 50% or so invested, vs my more usual 75-85.

Ha

 

[Gone4Good]

The high unemployment rate may limit economic expansion, but I don't see it adversely affecting company profitability.

Audrey

To get earnings growth from here we'll have to see some follow through on the demand side, and high unemployment could be a hindrance. There is also the huge unknown of what happens when world governments start removing all of the liquidity that's sloshing around. Meanwhile we have 50 states trying to balance budgets by raising taxes and cutting spending. The Federal government isn't that far behind.

That's a lot of uncertainty in my mind. Just one year removed from The Great Recession I would have expected asset price valuations to still reflect some level of stress. I don't really see that almost anywhere.

I don't want to come across as a pessimist, because I'm not. If companies do as well this year as the Street thinks they will, then we're looking at an S&P valued at just under 15x 2010 earnings. That will look plenty cheap if the economy achieves sustainable growth. But that assumes earnings come in 37% better than 2009 and down just 15% from their all-time bubble peak. It also assumes no other major economic shoes drop. That's no easy lift.

 

[traineeinvestor]

Lot's of negative sentiment here - surely that has to be positive for future stock returns

As an aside, it is often said that stocks are a leading indicator which anticipate economic conditions 12-18 months in advance. If so, I would expect stocks to advance well before economic conditions materially improve.

To look at it slightly differently, if we had full employment, low inflation, low interest rates, government surpluses and tax cuts, then I would be worried and think it was time to sell out - things could only deteriorate from there.

 

[haha]

Lot's of negative sentiment here - surely that has to be positive for future stock returns

Absolutely correct, if you assume that we are dumb money.

Ha

 

[Mickslick]

I just don't think you have much choice but to make sure your diversification plan makes sense and stay the course. If you move everything to cash you make essentially nothing and if inflation kicks in your screwed. If the whole world collapses your screwed anyway.

On the bright side, one can argue that we are in the midst of working through the mess the world has made of our financial systems. It's painful and ugly, but it is more likely now that we have had enough of crashing and potentially dangerous scares to cause the economic and political systems to start working on working out of it. In addition some needed political turnover this November may shore up badly needed confidence - who knows this time next year we might be experiencing strong recoveries in multiple sectors and much better investment results.

But, again, the world might implode and then there wasn't really anything you could have done about it except stockpile gold and guns but even that will only buy you a few more months of suffering through the Apocalypse

 

[haha]

... and if inflation kicks in your screwed.

This turned out not to be true the last time the US had a sustained inflation, during the 70s. While gold, silver and commodities did best, short term cash equivalents were much better performers than bonds or equities.

Ha

 

[ziggy29]

This turned out not to be true the last time the US had a sustained inflation, during the 70s. While gold, silver and commodities did best, short term cash equivalents were much better performers than bonds or equities.

Which is pretty bad when you recall that the combination of tax rates and inflation were a killer on cash. Even if you got 10% on cash, that may be 5-6% after taxes (given the rates of the day) with inflation at 12-14%. Ouch.

 

[Gone4Good]

This turned out not to be true the last time the US had a sustained inflation, during the 70s. While gold, silver and commodities did best, short term cash equivalents were much better performers than bonds or equities.

Ha

I think the same could be true this time. If inflation spikes, interest rates will go up, which means bond prices come down. Equity valuations have to come down too (those future dividends are going to be discounted at those higher interest rates). So of the three (cash, bonds, or stocks) you're going to be better off owning cash before inflation accelerates than most long-duration assets.

Of course if inflation doesn't accelerate than cash may not be the best place to be.

 

[clifp]

To get earnings growth from here we'll have to see some follow through on the demand side, and high unemployment could be a hindrance. There is also the huge unknown of what happens when world governments start removing all of the liquidity that's sloshing around. Meanwhile we have 50 states trying to balance budgets by raising taxes and cutting spending. The Federal government isn't that far behind.

That's a lot of uncertainty in my mind. Just one year removed from The Great Recession I would have expected asset price valuations to still reflect some level of stress. I don't really see that almost anywhere.

Those are exactly my worries also. I don't think the economy is out of the woods yet, while there are lots of promising signs, all types of shocks could send us back into a recession. On an absolute basis, I am not sure that market has factored into the risks of a double dip. This leads to me believe that a lot of investors have gone through a similar calculation than I have.

Cash pays nothing
Bonds have low yields, little upside potential and lots of inflation/interest rate risk.
Gold is already factoring in a future inflation which may not exist.
Real Estate ugh still scary.
Ok I guess I'll put/keep my money in the market by process of elimination.

I hadn't read any of Andrew Smithers stuff before, it looks pretty compelling even if I can't say it is very cheery. HaHa is he a perma bear or pretty balanced?

I think rather than accumulate cash I'll pay off my mortgage.

 

[donheff]

I think rather than accumulate cash I'll pay off my mortgage.

Ah, positive feedback. I just paid off the mortgage on our weekend place.

 

[Amethyst]

T
Cash pays nothing

I think rather than accumulate cash I'll pay off my mortgage.

Have been feeding money to the mortgage Moloch, myself. The decreasing principal balance provides much-needed positive feedback.

(Then I read about people who walk away from their mortgages - seemingly with a sense of righteousness, and little real penalty - and feel dumb-and-dissed again).

Amethyst

 

[brewer12345]

And in yet another sign that the economy is crumbling, Bloomberg is reporting that it a new CLO deal is likely to get done for $500MM.

Wait a minute...

 

[REWahoo]

Have been feeding money to the mortgage Moloch, myself. The decreasing principal balance provides much-needed positive feedback.

(Then I read about people who walk away from their mortgages - seemingly with a sense of righteousness, and little real penalty - and feel dumb-and-dissed again).

They end up with a sense of righteousness and you'll end up with a house. I'll take your side of the deal any day.

 

[tinlizzy]

As an aside, it is often said that stocks are a leading indicator which anticipate economic conditions 12-18 months in advance. If so, I would expect stocks to advance well before economic conditions materially improve.

You are so right. I see this reflected time and again in the number and volume of deliveries at UPS.

Ah, positive feedback. I just paid off the mortgage on our weekend place.

I think rather than accumulate cash I'll pay off my mortgage.

I paid off my mortgage after 9/11 - it felt great, then I was diagnosed with SLE (Lupus) and it felt even better not having a mortgage hanging over my head.

(BTW - UPS stock has a 3% dividend yield and just increased their dividend - not a recommendation, just saying.)

 

[haha]

I hadn't read any of Andrew Smithers stuff before, it looks pretty compelling even if I can't say it is very cheery. HaHa is he a perma bear or pretty balanced?

How can he be a permabear, or even a bear? He presents data; it's up to you to decide what it means. That isn't a trivial exercise either.

Ha

 

[clifp]

How can he be a permabear, or even a bear? He presents data; it's up to you to decide what it means. That isn't a trivial exercise either.

Ha

It is interesting data and no doubt non-trivial. He seems like a pretty straight shooter. I only asked because perma bears (which I define as somebody who has been bearish more than 3/4 of the time for the last 10-20 years) can be selective in how they present data.

 

[Gone4Good]

And in yet another sign that the economy is crumbling, Bloomberg is reporting that it a new CLO deal is likely to get done for $500MM.

Wait a minute...

Yup. And I saw a blurb in Monday's WSJ that private equity was itching to do, and large lenders recently green lighted financing for, LBOs as large as $10B.

But after an extraordinary rebound in the high-yield market, buyout barons - under pressure from investors to put their cash piles to work - are thinking big again. having sized up $1 billion -to-$5 billion deals for months, they are whispering to banks about their dream of a return to $10 billion deals. We hear the biggest lenders are willing to give them a green light.

That doesn't give me a warm and fuzzy feeling. If anything it plays in to my fear that we may be swinging from excess to excess in record time.

 

[haha]

It is interesting data and no doubt non-trivial. He seems like a pretty straight shooter. I only asked because perma bears (which I define as somebody who has been bearish more than 3/4 of the time for the last 10-20 years) can be selective in how they present data.

You can read his two books, as well as many of his articles on his website. I would say that if being bearish 3/4 of the time over the last 10 years makes a permabear, he likely is one, though really it would not be fair to call him a bull or a bear. He says-"here is my data". "Here is why it is relevant". Then you as an investor or money manager or banker can decide what if anything this means to you. Most "investors" prefer a more authoritarian approach. Just give me the executive summary dammit, do I buy, sell, or hold?

All of these serious minded people who use RTM approaches are frequently criticized because they missed this or that bull phase. But that is not fair, they don't say that the market will go down, or even that it will stop going up from whatever level. They only say that according to this set of data, this has always been a risky valuation level. Smithers goes a bit farther and gives a mechanism by which the markets shoud re-create equilibrium.

Remember too, it's not like he created the Q ratio. Irving Fisher did that long ago. All the data is publically provided, with some lags. So you can just avoid anything that Smithers says, and look to the data. However I would recommend reading his 2000 book, Valuing Wall Street, to see if the thesis makes any sense to you. You may decide that it is ridiculous. Plenty people obviously have so decided, either explicitly more likely implicitly.

Any "return to the mean" hypothesis presents one basic difficulty-"Is it different this time?". Generally people decide that it is. And this is clearly literally true. Everything is always different, as we do not live in a static world.

It's just human nature to extrapolate a trend. When markets are going up, few want to hear that they will again be going down at some unspecified time in the future. What history do you include? US since WW2? US for as long as data is available? What US data will you admit? Do you look at other countries? In the case of Q, you can't because the non-price data is not available.

All sorts of reasons will always be presented as to why it is different this time, and who can say that they will prove to be irrelevant?

Ha

 

[Gone4Good]

Any "return to the mean" hypothesis presents one basic difficulty-"Is it different this time?".

That's the part I struggle with when looking at the historic data. I don't have a good argument for why valuations should be mean reverting (within a reasonable band). Whereas I can think of lots of reasons we may be willing to accept lower risk premiums today than was true 100 years ago.

And indeed, it kind of is different this time - or at least has been for 30 or so years. We've been above the "average" valuation for so long, the average itself is being pulled up. In 1980 the long-run average PE was 14.9x. Now it is 16.4x.

Here is Shiller's PE chart with a regression line inserted. Based on the regression, we're at fair value. Based on the average, we're 26% overvalued. (Neither measure shows stocks as particularly cheap).

 

[haha]

Interesting chart. This is one erason that Smither's data adds something-he argues that the Q ration is not only descriptive, but that it measures something that is at the heart of capitalism.

I tend to agree with RTM approaches, but likely as much as anything that is because I was actively investing in 72,73,74, as well as at the the bottom in 1982.

Ha

 

[clifp]

Interesting chart. Is there some correlation between interest rates and P/E ratios? Cause if their is, I sure don't see it by eyeballing the chart.

It looks like I should put Smither book on my to read list. Of course, I am still struggling to get through Ben Graham's book first

 

[drb111]

Cash pays nothing
Bonds have low yields, little upside potential and lots of inflation/interest rate risk.
Gold is already factoring in a future inflation which may not exist.
Real Estate ugh still scary.
Ok I guess I'll put/keep my money in the market by process of elimination.

I tend to agree...not sure I'll put new $$ in stocks right now, but S&P fwrd earnings are ~ $79, which puts the index at less than 15x. Not terribly expensive and Co's have more cash and more solid balance sheets than pre crisis levels. Lg Cap stalwarts with good Divi histories may be a decent place to be.