Recognizing an historic crash vs. correction or bear market.

[ERD50]

Quote:

Originally Posted by haha Many of the older members here are here because they rode that crazy market of 1995-2000 long past its clear extreme valuations. Valuation (and IMO only valuation) will keep you out of deep trouble, but it can also make you miss giant blow-offs. ...

The problem that I see with this is - I felt the market was getting pretty frothy by 1997. And looking back at PE10, it hit all time record highs by JAN 1997.

Shiller PE Ratio by Year.

But if I acted on that, when would I get back in the market? Looking at the adjusted values for SPY, its adjusted value never dropped below the 1997 start point. So other than not seeing my portfolio rise and then fall back near previous levels, what would I accomplish by getting out? It just seems really risky to me to get out, when I cannot know if there will be a good re-entry point. And even with an all time record PE-10, the re-entry points were not clear - even with 100% hindsight, you'd need to pick them almost perfectly.

This would be offset by any amount that your alternative investment exceeded the ~ 2% yield of SPY, but I don't think that drives into 'obvious territory'.

My gut wants to act on frothy valuations, but history says this would be very tricky for me to pull off. From what I see, the advantage of keeping out of deep trouble seems to be largely (and likely totally, or more) offset by missing the big blow-offs.

-ERD50

[Gatordoc50]

Quote:

Originally Posted by ducky911 When people making 15 dollars an hour were flipping houses. Should have been a pretty good hint.

+1
That was happening in 2004, well before any market indications or announcements. I actually timed the RE collapse pretty well but had no idea that it was going to affect stocks that much. I still can't believe that the banks were lending millions of dollars to people making 20 grand a year. Yikes!

[Bikerdude]

I recall talking to a long haul trucker in 1999 who told me he was day trading from the cab of his truck. I remembered the story about Joe Kennedy when he was asked how he got out of the market before the crash of 1929 and he answered "when my shoeshine boy gave me a stock tip".

[robnplunder]

Quote:

Originally Posted by Snidely Whiplash 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? I'm curious as to how others may have recognized the severity of the crash vs. the "routine" 10-30% market declines.

Nope. I thought I knew a lot about stock market hitherto. Turned out that I knew squat about mortgage derivatives, and how it was tied to global finance market, and subsequent impact to the rest of economy. More than any stock market set back, 2007-8 crash surprised me the most.

[haha]

Quote:

Originally Posted by ERD50 The problem that I see with this is - I felt the market was getting pretty frothy by 1997. And looking back at PE10, it hit all time record highs by JAN 1997. Shiller PE Ratio by Year. But if I acted on that, when would I get back in the market? Looking at the adjusted values for SPY, its adjusted value never dropped below the 1997 start point. So other than not seeing my portfolio rise and then fall back near previous levels, what would I accomplish by getting out? It just seems really risky to me to get out, when I cannot know if there will be a good re-entry point. And even with an all time record PE-10, the re-entry points were not clear - even with 100% hindsight, you'd need to pick them almost perfectly. This would be offset by any amount that your alternative investment exceeded the ~ 2% yield of SPY, but I don't think that drives into 'obvious territory'. My gut wants to act on frothy valuations, but history says this would be very tricky for me to pull off. From what I see, the advantage of keeping out of deep trouble seems to be largely (and likely totally, or more) offset by missing the big blow-offs. -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

[audreyh1]

Quote:

Originally Posted by Lsbcal 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]

Quote:

Originally Posted by haha 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]

Quote:

Originally Posted by ERD50 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]

Quote:

Originally Posted by ERD50 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]

Quote:

Originally Posted by Running_Man 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]

Quote:

Originally Posted by karluk Quote: Originally Posted by Running_Man 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]

Quote:

Originally Posted by 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.

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:

Quote:

Originally Posted by Running_Man 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.

Quote:

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]

Quote:

Originally Posted by karluk 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]

Quote:

Originally Posted by clifp 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.