Recognizing an historic crash vs. correction or bear market.

[audreyh1]

I will take your word for it that the NBER 1 year lag is standard. Won't use that as a timing method . I didn't mean that the Fed announced this (my sentence positioning might have led to this impression).

When I looked it up, the Fed did start reducing short rates quite a bit in late January 2008. So maybe Bernanke was quicker then I gave him credit for. I kind of admire the guy, but I liked Greenspan until the wheels came off the economy.

So clearly Bernanke was seeing some stress in the financial system pretty early then. At that point - it's not clear what else the Fed by themselves could do.

Greenspan was to one who ignored the housing bubble. He admitted later that he didn't think companies would "shoot themselves in the foot like that" or something along those lines. In other words - that companies would take such outrageous short term risks that could result in long term disaster. but that really ignores the short term pressures in capitalism and how professional managers (who aren't necessarily company owners) respond to short-term pressures. They figure they can bail in time and let others take the long term hit.

 

[ERD50]

Doesn't what I said in that part you quoted pretty well describe this? Overvaluation metrics tell you that stocks as a group are overvalued. They will not tell you that stocks will not become more overvalued. People are unrealistic; they want everything at all times even though a little thought would demonstrate that this cannot be done.

Ha

Well, I just took your general statement and ended up looking more specifically at the 90's bull. We can measure valuation, and look at it historically, but it's tough to see how to use it - even very imperfectly.

-ERD50

 

[Lsbcal]

Well, I just took your general statement and ended up looking more specifically at the 90's bull. We can measure valuation, and look at it historically, but it's tough to see how to use it - even very imperfectly.

-ERD50

Yep, I think your are right to ask questions about market generalizations. Unless one can state emphatically the exact rules for a "trade" (or whatever one wants to call the change of investments) it is really difficult to see whether the idea will hold up.

I've had lots of ideas which appear on the surface to be plausible but when I do the data crunching, I see the reality ... almost always that picture is not a pretty one. I have found a keeper or two but they are few and far between.

 

[Running_Man]

Well, I just took your general statement and ended up looking more specifically at the 90's bull. We can measure valuation, and look at it historically, but it's tough to see how to use it - even very imperfectly.

-ERD50

I have not spent any time looking at results, but it would seem a simple model of being 75% stocks when PE10 =10 and 25% stocks when PE10 =25 and adjusting the stock percentage annually by 3.33% and replacing with a fixed income component would do very well over the long run.

 

[karluk]

I have not spent any time looking at results, but it would seem a simple model of being 75% stocks when PE10 =10 and 25% stocks when PE10 =25 and adjusting the stock percentage annually by 3.33% and replacing with a fixed income component would do very well over the long run.

Wanna bet? Your proposed strategy would require selling stocks when they are a clear-cut "buy" at PE10 in the low teens. On the high end it would also have caused you to have only a small stock holding at the beginning of 2013 and allow last year's 30% stock returns to go largely to waste, at least as far as any good it would have done you.

Sure, it will also cause you to miss the next bear market, whenever that happens, but you are incurring absolutely enormous opportunity cost in exchange for bragging rights at the next cocktail party that you "foresaw" the crash coming and reduced your stock holdings accordingly.

 

[ERD50]

I have not spent any time looking at results, but it would seem a simple model of being 75% stocks when PE10 =10 and 25% stocks when PE10 =25 and adjusting the stock percentage annually by 3.33% and replacing with a fixed income component would do very well over the long run.

Wanna bet? Your proposed strategy would require selling stocks when they are a clear-cut "buy" at PE10 in the low teens. On the high end it would also have caused you to have only a small stock holding at the beginning of 2013 and allow last year's 30% stock returns to go largely to waste, at least as far as any good it would have done you. ...

Agreed. I suspect one would have a hard time coming up with a formula that would have worked over the last few cycles. And I'll be generous with the term 'worked', and allow for lower total returns if volatility was reduced significantly below an AA with similar returns.

If there is such a formula, someone would be making some money with it I think.

It's a lot like rebalancing your AA. Sounds good, makes sense from the standpoint of having some guideposts to drive your investment decisions - but it hasn't proven to help overall.

-ERD50

 

[Running_Man]

Studies have shown that even with a 25% stock allocation that one could successfully endure 30 years of retirement. So maintaining at least 25% and increasing as PE10 declined would have to be successful as well, well I think so anyway. As luck would have it I have some time at present and so this will be an interesting study. I will report back when I have accumulated some data.

 

[haha]

Expect a lot of naysaying.

Ha

 

[karluk]

I wish you luck, Running_Man. As Erd50 points out, though, it's not enough to show that your plan makes money. You need to show that it makes more money than a simple buy and hold strategy. Just as rebalancing sounds good in theory but hasn't been shown to be better than buy and hold, we should reasonably expect the same from any PE10 based timing strategy. If you get lucky, your PE10 indicator flashes a sell signal just before a market drop. If you're unlucky, the sell signal happens right in the middle of a historic market rally, such as happened in the 1990s.

 

[Lsbcal]

Studies have shown that even with a 25% stock allocation that one could successfully endure 30 years of retirement. So maintaining at least 25% and increasing as PE10 declined would have to be successful as well, well I think so anyway. As luck would have it I have some time at present and so this will be an interesting study. I will report back when I have accumulated some data.

Wade Pfau did a study of this sort of thing, PE10 and equity weighting. He even had a paper on it as I recall. There is a long thread on Bogleheads, maybe done in 2009. Doing a search using his name there and looking around that time frame might yield the link.

 

[ERD50]

bold mine:

Studies have shown that even with a 25% stock allocation that one could successfully endure 30 years of retirement.

Well, a 75% AA had a historical 95% success rate (at 4% WR), and 25% had just 80%. So it 'endured' in fewer scenarios.

So maintaining at least 25% and increasing as PE10 declined would have to be successful as well, well I think so anyway. As luck would have it I have some time at present and so this will be an interesting study. I will report back when I have accumulated some data

.

Great, I'd be interested in the outcome as well.

-ERD50

 

[Texas Proud]

Heck, I did not see the drop in 87.... I did not see the tech bubble in 2000.. or the drop after 9/11.... and I sure did not see the one in 2008/9....


But, I also did not see all of the run ups that happened after them.... I just kept investing in the ups and the downs and have done pretty well over the years...

I don't think I will be changing any time soon....

 

[Major Tom]

My target AA is 60/35/5. The equity part was getting very close to 65 just before these few down days we've had. It may save me the trouble of rebalancing.

There's a good side to everything

 

[clifp]

Wanna bet? Your proposed strategy would require selling stocks when they are a clear-cut "buy" at PE10 in the low teens. On the high end it would also have caused you to have only a small stock holding at the beginning of 2013 and allow last year's 30% stock returns to go largely to waste, at least as far as any good it would have done you.

Sure, it will also cause you to miss the next bear market, whenever that happens, but you are incurring absolutely enormous opportunity cost in exchange for bragging rights at the next cocktail party that you "foresaw" the crash coming and reduced your stock holdings accordingly.

Just eyeballing the PE ratio with bias toward post WWII data (and higher PE/10) I think a wider range might have some validity.

How about P/E 10 or below stocks 80% P/E 40+ stocks 20% and 2% per point . So in 2013 you have entered the year with 56% stocks in Jan 2014 you go down to 49% stock (which would still involve a decent amount of selling)

In 1995 you start off with 60% stocks and get down to 20% by 1999 and also 2000,and start buying in 2002, 2003, you don't get out in 2008, but are 70% stock in 2009.

 

[karluk]

Just eyeballing the PE ratio with bias toward post WWII data (and higher PE/10) I think a wider range might have some validity.

How about P/E 10 or below stocks 80% P/E 40+ stocks 20% and 2% per point . So in 2013 you have entered the year with 56% stocks in Jan 2014 you go down to 49% stock (which would still involve a decent amount of selling)

In 1995 you start off with 60% stocks and get down to 20% by 1999 and also 2000,and start buying in 2002, 2003, you don't get out in 2008, but are 70% stock in 2009.

I agree with this, so I guess I need to backtrack a little on my previous comments. PE10 has historically had considerable validity in calling market extremes. When stocks are a screaming buy due to low valuations, PE10 shows it. When stocks are in bubble territory such as the late 1990s, PE10 also shows this.

The question is what should you do between the extremes. If you're comfortable with a 80% stock allocation at low valuations, shouldn't you also be comfortable with 80% stocks at medium valuations? PE10 predicts very generous long term returns from stocks for an extremely wide range of valuations. I would like to see a buy/sell strategy based on PE10 that clearly outperforms a 80/20 buy and hold portfolio and that generates buy or sell signals more than once or twice in a lifetime. Otherwise all this talk about PE10 is interesting and makes for a good topic for message boards like this, but it's not useful to me for real world investing.

 

[FIREd]

As I have said before, I float my AA between 30/70 and 70/30 based on market valuation in general. With this strategy, underperformance during periods of P/E expansions is to be expected. However, the inevitable reversion to the mean is also less painful. This strategy also had me doubling down on equities in 2009 when valuations reached generational lows. Honestly, I can't say whether this strategy creates value over the long term because the floating AA makes it difficult to benchmark. But I am happy with the results so far.

 

[ERD50]

Just eyeballing the PE ratio with bias toward post WWII data (and higher PE/10) I think a wider range might have some validity.

How about P/E 10 or below stocks 80% P/E 40+ stocks 20% and 2% per point . So in 2013 you have entered the year with 56% stocks in Jan 2014 you go down to 49% stock (which would still involve a decent amount of selling)

In 1995 you start off with 60% stocks and get down to 20% by 1999 and also 2000,and start buying in 2002, 2003, you don't get out in 2008, but are 70% stock in 2009.

OK, but how would that back-test over historical 30 year periods?

As I have said before, I float my AA between 30/70 and 70/30 based on market valuation in general. ... Honestly, I can't say whether this strategy creates value over the long term because the floating AA makes it difficult to benchmark. But I am happy with the results so far.

The way I would benchmark this would be to determine what AA would have provided the same total return as your variable plan. Then compare volatility.

If a variable AA based on PE10 provided less volatility with the same total return (essentially a beta measurement), then it 'wins'. But then you also need to consider if the reduced volatility was worth any reduction in total return you may have seen.

Expect a lot of naysaying.

Ha

Is it really nay-saying to want to see some objective measurement of a proposal? I look at it just the opposite - to promote an idea w/o any objective information could be seen as 'cheer-leading'.

I'm skeptical because I always thought in my gut that re-balancing was very important. But the numbers don't bear that out. Sometimes our gut isn't true to us.

-ERD50

 

[Options]

Heck, I did not see the drop in 87.... I did not see the tech bubble in 2000.. or the drop after 9/11.... and I sure did not see the one in 2008/9....


But, I also did not see all of the run ups that happened after them.... I just kept investing in the ups and the downs and have done pretty well over the years...

I don't think I will be changing any time soon....

Best post, IMHO. A book like Devil take the hindmost demonstrates how those who think they are the smartest of the smart have been misjudging bubbles, crashes, and manias to their own peril for more than a few hundred years (question: just how many bankruptcy-induced suicides does it take throughout history to convince people that they cannot outsmart the market?).

Create an ISP, set an AA you can live with in the worst of markets without panicking (single most important PF decision), manage costs and taxes (second most important), stay the course (third most important), tune out the noise and go out and have some fun.

 

[clifp]

Create an ISP, set an AA you can live with in the worst of markets without panicking (single most important PF decision), manage costs and taxes (second most important), stay the course (third most important), tune out the noise and go out and have some fun.

I mostly agree but... I don't think it is quite so cut and dry.

My opinion is you only need to make a few right calls in your lifetime to come out significantly better than just a buy and hold.

The 87 drop if you missed you were back to even in a couple of years. Rode out 9/11 (how could anybody have predicted that) 6 months.

Missed out on the bottom in 2002/2003, You had another opportunity 5 or 6 years later. Missed the 2007 top you were back to even 6 years later. Not great but not the end of the world.

On the other hand if you bought into tech stocks in 99 or early 2000 you still aren't back to even 14 years latter. I suspect the 2008 and 2009 lows won't be tested in my lifetime. You missed a double in less than 5 years.

I think it is also important to not only focus are stocks under or valued on a absolute basis but also on a relative basis.

In 2000, 10 year treasury were at 6.6% Ibonds over 3% and TIPs over 3.5%. You could justify moving from stocks to bonds not only because stocks were expensive, but because bonds provide sufficient income for a good retirements. In 2009, the S&P yield was 3.24% vs 10 year Treasury of 2.5%. Even if you didn't like stocks in many markets real estate prices had dropped 50-75% and and the cash on cash returns for real estate were well over 10%.

One of the big problems in the last few years is that while stocks have gone from fairly valued to over valued, bond have only dropped from bubble levels to over valued, while money markets are returning a negative 1.5% real return. As Ha has said it remains a particularly challenging investment environment.

So I think it makes sense to find a range of AA that you comfortable with and adjust based on my factors including P/E 10. If for some people the band is very narrow (i.e. your rebalancing band that is great.) I personally would never be comfortable having only 20% of my money in the market so for me my AA is between 50/50 and 90/10.

 

[rbmrtn]

Here's a site that has some modeling/timing tools. One of the models is a PE10 allocation model, it has a backtest simulator to play with

Market Timing Models

 

[ItDontMeanAThing]

Were there any indicators that anyone here recognized just prior to or during the 2008-2009 market crash that led them to believe that it would be as historic as it was?

Maybe. Moved to Vegas in 2005, then heard about the red hot housing market. I'd seen this before as an outsider, watching the Southern Cal. real estate bubble and crash in the 80s. To me, Vegas looked like a bubble. BUT I was clueless about prices elsewhere in the country and, more importantly, the bubble's potential effects on the economy.

Lucky for me, in early 2008 I moved a big chunk of monies from stocks and existing bond funds into high quality bond funds. Didn't do it because of the bubble, did it because I'd read how difficult, financially and emotionally, it is to recover from a big loss early in retirement. As planned, I retired in fall of 08. Did knowing about the bubble influence my AA and timing? Maybe.

First started studying AA after the time I realized the dot com market was a bubble. Made substantial changes to my portfolio by selling growth stocks and buying value stocks about a year before the bubble burst. Did it because I believed in AA. Did knowing about the bubble influence my timing? Maybe.

 

[ERD50]

Here's a site that has some modeling/timing tools. One of the models is a PE10 allocation model, it has a backtest simulator to play with

Market Timing Models

Hey, that looks pretty interesting.

I'll need to dig in some more, but their PE10 timing adjustment does seem to provide some significant return/risk advantage (they use the Sharpe Ratio for comparison, which compares gains to std dev).

They make big jumps in AA - 80, 60, or 20% stocks based on PE10 bands. I think it would be easier to evaluate this with something more linear, but this is a start.

From what I saw there, the rebalancing of a 60/40 portfolio really hurt using the 1950-2013 default settings. Stocks grew from $10K to $9.4M, but a 60/40 rebalance only grew to $3.3M? Heck, stocks alone should have provided $5.6M (60% of their total).

-ERD50

 

[Running_Man]

My early analysis, which is just using the very simple rule of no more than 75% stocks and no less than 25% stocks, adjusting the stock percentage on 1/1 of each year based on 25% stocks at Schiller PE25 and 75% @ PE10 and adjusting by 3.33 percent for each 1 point move in PE10 ratio , using the Barclays aggregate Bond Index for the bond component are showing some interesting results over the past 34 years. The main advantage I see, especially for anyone in withdrawal mode is the ability to avoid any years with double digit losses. The years with losses are:

2008 -6.59%
1994 -1.35%
1980 -2.20%

The overall average position in stocks from 1980 to present would have been 44%
The overall average position in stocks from Y2K to present is 31%
$100,000 invested on 1/1/1980 would have $3,047,115 on 12/31/2013 -- 10.55% annual return
$100,000 invested on 1/1/1990 would have $ 672,008 on 12/31/2013 -- 8.27% annual return
$100,000 invested on 1/1/2000 would have $ 239,584 on 12/31/2013 -- 6.40% annual return
$100,000 invested on 1/1/2007 would have $ 163,556 on 12/31/2013 -- 7.30% annual return


Returns for the recent years and % stocks are: (would have sold off about one third of the stocks owned on 1/1/14 to get to 25% net stocks)

2013 10.02%__ 35%
2012 8.70% __ 38%
2011 6.01% __ 32%
2010 9.95% __ 40%
2009 17.84%__ 58%
2008 -6.59%__ 28%
2007 6.60%__ 25%
2006 7.20%__ 25%
2005 3.05%__ 25%
2004 5.98%__ 25%
2003 11.33%__ 32%
2002 2.17%__ 25%
2001 3.35%__ 25%
2000 6.45%__ 25%
1999 4.65%__ 25%
1998 13.67%__ 25%
1997 15.57%__25%
1996 8.66% __26%
1995 26.30%__41%
1994 -1.35%__37%
1993 9.89%__ 41%
1992 7.49% __ 42%
1991 24.10% __56%
1990 2.81%__ 51%
1989 24.48%__ 58%
1988 13.30%__ 62%
1987 4.23% __ 59%
1986 17.63% __ 69%
1985 29.33% __ 75%
1984 8.49% __75%
1983 19.87% __ 75%
1982 26.28% __ 75%
1981 -2.22% __75%
1980 26.29% __75%

Where does the value of this simple model come? From avoiding the declines, and having lots of funds to invest at stock market bottoms. Look at 2009 you would be more than doubling your allocation to stocks based on this model. Data for the 1960's and 1970's will be interesting to see how this holds up.

 

[Running_Man]

What I also find interesting is that if you had a million dollars invested this way for 2013 you would have had 350K in the S&P500 at 1/1/2013 and it would have been 463K by the end of the year and rebalancing would mean taking 188K out of stocks on 1/1/2014 and into bonds. Look at the talk on the boards at the start of this year, that would be an extremely unpopular move, yet at this point it would look extremely timely.

 

[haha]

What I also find interesting is that if you had a million dollars invested this way for 2013 you would have had 350K in the S&P500 at 1/1/2013 and it would have been 463K by the end of the year and rebalancing would mean taking 188K out of stocks on 1/1/2014 and into bonds. Look at the talk on the boards at the start of this year, that would be an extremely unpopular move, yet at this point it would look extremely timely.

Internet opinions tend to be either uncorrelated or negatively correlated with what happens.

Ha