timing markets

[NYCGuy]

As I consider the elements of a long-term investment plan, I am struck by how many asset classes appear to be priced at historical highs. The S&P has a P/E of 20 which, as we all know, is way above the historical norm of 14 or 15. So, US large caps should trend down during the next period. Commodities are high. Gold is at a 23 year peak. There's oil, of course. Bond prices are high and term and credit spreads compressed above the trend for the past twenty years, although perhaps not above trend for the past 100. There is talk of a developing bubble in emerging market stocks, including Korea and Japan, where the Nikkei closed at a five year high. REITs are high.

I am attracted to the advice of Gillette Edmunds (and others such as David Swensen) to spread out into five or so uncorellated asset classes. Edmunds (Swensen, others) strongly advise against trying to time any market. Well, I managed to call the top in the Manhattan apartment market and got out in good shape in April without being a genius. I can't get over the feeling that many or most of my target asset classes are overpriced because they have been buoyed by the same global credit bubble that drove up housing. And that as credit inevitably tightens they will go down, more or less in sync. I find that when I read well thought-out investing books, e.g. Ben Stein's "Yes, You Can be an Income Investor", they author writes from a kind of timeless present without addressing the question of whether these securities are good investments now.

I realize that I could start small and gradually increase my asset class positions over time as a way of mitigating the timing risk. The other option is to tread water in T-bills and wait for a crash in some market that unambiuously indicates a bottom. When I look back at the financial catastrophes of the past ten years (Asia in 1997, US equity bear market of 2000-2002, etc.) I realize now that these events were only problems if you were already in those markets and opportunities if you weren't. Since I am still working and not trying to live off investments, I can afford to be out of the markets for the next few years.

It may only be that I am a beginner who knows he cannot succeed at security selection, but for whom market timing still has a seductive appeal. I understand that if I could time any market effectively I wouldn't need to bother with asset allocation. And yet, how can I buy the S&P at a P/E of 20?

Are some of you thinking about this as well? Are any of you sticking strictly to asset allocation with disciplined rebalancing? For those of you who do attempt to time markets, how successful have you been at it?

 

[wildcat]

And yet, how can I buy the S&P at a P/E of 20?

Are some of you thinking about this as well? Are any of you sticking strictly to asset allocation with disciplined rebalancing? For those of you who do attempt to time markets, how successful have you been at it?

1) I think it is less than 20 and only marginally above historial levels - 18 vs 15. High asset prices - it can happen when interest rates and inflation = low.
2) No I do not think about timing. I do invest in individual stocks with some play money but I would not consider using it to time markets. DCA is for the wise.
3) A few may claim to have timed it successfully but I am sure it is incredibly biased - i.e. "I made 2 good calls over the last 2 years...I will not bother to mention what I have done over the last 10 years" DCA is passive timing if you ask me and much more productive. I think most people come out ahead as well. But good luck.

 

[Nords]

As I consider the elements of a long-term investment plan, I am struck by how many asset classes appear to be priced at historical highs. 

And yet I bet you're not interested in buying auto manufacturers or airline stocks.

If you're not comfortable with diversification then invest in assets that have historically carried a return premium-- like small-cap value or international stocks.

Your other alternative is to keep piling up cash until Warren Buffett and Tweedy, Browne start buying again too.

Market timing is possible. It requires hard work, experience, and guts. If you don't have the time to devote to all three of them-- and very few do-- then you're better off investing in diversification and indexes. There are many more out there than the S&P500, and they're not all at historical highs.

 

[kat]

I'm certainly no expert at all -- only sharing what worked for me.

I had quite a bit to invest early this year, and I was totally new to this idea of investing. But I figured out pretty fast that the year offered some very nice down days to invest a large chunk of money. I found myself checking the markets at 3:50p.m., and making a buy at Vanguard by the end of the day when it was an especially "bad" day. I guess all I'm saying is prices may be high, but some days offer good opportunities.

 

[greg]

NYCGuy: I think you're baiting me . Lke you, I've got a lot of Bills right now and see many of the same valuation problems. It doesn't feel good watching everybody make the big bucks except me. I guess patience can be considered a timing tool worth developing --maybe.

I did OK on the RE market. I had apartments and sold them--but a little too early. I'll live; I made money. I rode some of the early commodity bubble up too--gas and oil especially--but there too I sold early. I'll live; I made money. I'm currently riding the PM shares bubble up. I may get out too early, but it's waaay too soon to tell. I'm riding some natural gas stocks up right now; I'll probably wait 'til January or Febuary before selling. I hope I make some money. I wouldn't buy now.

What I learned do:
1) I research the trends. Sometimes I'm just a contrarian, but not much lately.
2) I look--for the most part if it's a longer-term play--for the best companies, the most durable ones, without debt (I see that as a big problem sometime in the near future. Little debt behind the stock(s) usually tells me it isn't run by wild and crazy leveragers but maybe by prudent people.
3) I usually average in in three money portions, an abreviated averaging in method that doesn't catch the bottom but oftentimes gets pretty close, especially when paying attention to other value signals and surrounding news events. I get in with the first portion which gets the stake in the game, then I watch and do extra reasearch with my new ownership perspective, then I buy the second portion post-stake, and if everything meets my expectations, I add the third. Sometimes I just get out or stop the process and wait to see what unfolds.
4) I put enough money into it to make a difference to the whole she-bang. If I put too little in I don't pay enough attention or the right kind. Putting a 'significant' amount at risk always means better research beforehand and better . . . um . . . sensitivity to the entire mess. Too much, and I can't sleep at night.
5) I rarely try to time the very top of the market or trend. On the sell side, my primary focus is "Did I make a reasonable amount of money for the risk I took?" Usually I try not to get greedy about the whole matter.


I agree with your basic attitude toward timing. If you pay any sort of attention to the market and know a decent amount about all the signals sent it should be relatively easy to time the major events. I remember in 2000 watching CNBC: They would talk up the latest tech stocks for a half an hour then show the little penguins all barreling into the water in a herd. I guess I paid too much attention to EBITA and not enough attention to the sarcasm. Hopefully next time I'll do better. Aren't they touting EBITAs again?

One option for you while waiting to deploy is look at things from a different type of diversity perspective. Instead of diversifying across asset classes with the regular slice and dice one could diversify across philosophy or manager types, finding different takes on the economic world and putting money into 3-6 different funds--each with a different money making philosophy. I might use this style if I was tentative about my own views regarding how the world and economy will go. You could spread some risk that way.

If you're braver and think things will work out your way in the end but might meander all around in between, you could find a foreign stock fund manager with your basic philosophy, a domestic manager with similar views, maybe a bond fund with a perspective you like, etc. Lots of reading and research involved though. Let them do the timing and portfolio adjustments Don't forget the macro-rebalance.

How does your ideal recession/depression play out?

 

[NYCGuy]

wildcat, I stand corrected. S&P P/E is 18.72 as of 11/30. Still seems high.

Nords, Thanks for the tip on the airline industry. Wouldn't go for auto because they will probably not recover, but the airline industry might. Will investigate further. These are the markets that I think are too highto buy into now:
US equities
US bonds
US residential real estate
gold, copper, oil
US REITS
USD
emerging markets

Which indices are cheap now, in your opinion?

Apoc, Read about some real estate baron who made a lot of money with the motto, "I always got out early." Appeals to me. I don't have the temperament to pick stocks so I will limit myself to markets, meaning index funds in most cases. Markets mean-revert, while companies don't, for one reason. You staged-entry approach has some appeal. I would consider actively-managed funds, such as Hussman, although I am loathe to pay the fees. Understand that they can do better in a bear market than during a bull run. However, picking funds by style wouldn't attract me since it would obscure the risk balancing. I think that waiting in cash is what I will do for now.

As for recession/depression, here's what the cases amount to, as far as i can determine:

recession in late 2006 or 2007:
1. FED is about to invert the yield curve. Recession follows a year later.
2. housing market declines, quickly or slowly, depriving consumers of the wealth effect which has enabled their spending in this recovery. Consumers are forced to save again and consumption reverts to 67% of GDP from current 71%.

slowdown in 2006 or 2007, but no recession
1. Declining consumer spending is matched by increasing capital expenditures from business. Jobs and wages rise at last in this recovery which also helps maintain consumption sufficiently.

the Big One:
1. recession in 2006 or 2007 as above. Recovering Japanese economy and stock market, matched with end of BOJ's zero interest rate policy reduces Japanese apetite for US bonds causing dollar decline.
2. Chinese economy in slowdown due to reduced fixed investment and declining US consumption. Chinnese purchase of US bonds declines. Dollar declines and then collapses.
3. US housing market bubble bursts. Job losses in construction and mortfage finance. Consumption drops several percentage points in a short time causing recession. Dollar collapses. US equity market collapses. Deflation of assets conbimes with inflation for consumer items made in Asia.
4. Synchronization of global business and housing markets causes domino collapses around the world reminiscent of 1932.
5. Banking crisis caused by housing deflation since 53% of assets are residential mortgages. Derivatives market does something unexpected and bad.
6. Helicopters of money arrive from the FED causing 1970's style inflation.

I think the recession has more than a 50% chance of happening. The other scenarios seem less likely, but possible.

 

[wildcat]

7) the apes finally take over after years of planning and manipulating

 

[greg]

NYCGuy:

While posting a response to you earlier, I thought of an analogy that fits the crime—finally. (And it’s not toilet related --this time) Our country, our world, is suffering from imbalances much like a person with severe acne, a bubbling, boiling set of pustules that move about the body over the long-term but are rooted in a deeper blood imbalance below the surface. And like many sufferers, we seem to want to only cure the visible symptoms and not deal with our real underlying issues of behavior change. We see parts of the problem only--at best. We see no real systemic problem.

I discovered that before this time I had said “follow the money”: Look at the various bubbles and see what causes them (excess money) then attempt to follow the money to the source, excessive creation of M1, M2, M3. But money is a neutral element, much like Vitamin C. But too much Vitamin C in the blood can cause all sorts of imbalance and subsequent symptoms. It may build to excessive, harmful levels.

Sometime, I think in the 1970s-80s, George Soros, saw a trend in Britain (and elsewhere in other parts of the world), saw the excess creation of credit to stave off a bad economy, to inject stimulus into the system. He identified it and made a bundle shorting the British pound, catching an imbalance as it was developing and standing in its way—until ‘the natural rebalance” occurred.

The monetary and financial excesses that I see today are part and parcel of the combined increase in money supply and the creative ways of getting that money to consumers via debt. Nothing wrong with money, but at some point, about twenty-five or thirty-five years ago, began a slow but methodical expansion of the use of credit: Credit card debt grew and became easier to get, credit standards were relaxed with Fannie Mae, allowing people to borrow 95% of the purchase price of their homes. Cars were sold on monthly payments, rather than price, so was furniture and just about everything that sells for more than a few bucks. Buy a cell phone? They will roll the price into the monthly payment plan. Millions, maybe billions of examples out there. Warren Buffet said we’re becoming a nation of sharecroppers. I see that.

This new credit paradigm shift HAD to be accommodated by an expansion of the money supply or it just wouldn’t work properly. Government allowed this to happen and, in fact, reorganized the playing field to make it all work better. Why do you think financial stocks had a twenty year run? Our elected gov't took the lazy way of expanding the economy, by focusing not quite so much on improving productivity and the means of production but by encouraging the appetites of the consumer. Mmmm, chocolate cake.

So now we have a pustule covered carcass and we need to do something about it. Many are still in denial, barely recognizing the pustules, much less the underlying blood imbalances. People also don’t like to change behaviors that they somehow find very rewarding or have become habituated to. This too shall pass—I hope.

So, I see a couple of extreme pathologies for this sickness we are all a part of, although a path somewhere in between the two offered here is more likely:

One possibility I see is that the gov’t can keep the entire mess going for another ten-twenty-maybe thirty years. The only way to make this happen is for everything to go just about perfectly as we skip from one bubble-pustule to another, smearing on the Clearasil. End result: DOW 25000, 50000, or maybe even 100000. But! The only way this can fly is if at these points in the DOW the US$ drops in value accordingly. This means that if the DOW (or S&P 500 or whatever) doubles in price then the US$ needs to drop by half. If the DOW quadruples in price, then the US$ will be worth one-forth of its current value. Of course, we will pay full taxes on the false gains—otherwise the gov’t won’t be able to service their, or really our, debt. I don’t have a lot of respect for human, read gov’t, productivity numbers at this point in the game--thinking it’s mostly a chimera--created by a lieing or stupid Alan Greenspan. This is the “gluttony” scenario. This may be our future.

The other extreme pathology is depressing too: DOW drops to 2000 or 4000, and we suck A LOT of excess liquidity out of our system. This, although it doesn’t feel good while it’s going on, would partially rebalance the system. If it happens this way, we still, at some point, need to come to our senses and address the corrosive and corrupting nature of easy debt and credit.

The bubble-pustules were once good white blood cells that naturally worked correctly to make the body work properly. Now they collect in increasing frequency between layers of skin as rot, erupting and oozing all over the place.

I think a middle way, somewhere between these two extremes and which I am currently thinking about, will be the actual path. Thank you for your questions and setting me up to think differently. I believe the system is infected. It’s not just a little pimple. My specific 2-3 year outlook next.

--Greg

 

[greg]

7) the apes finally take over after years of planning and manipulating

Wildcat: The crew that wants to temper extremes rather than create them will take over some day. That's my hope, anyway.

 

[SteveR]

Wildcat:  The crew that wants to temper extremes rather than create them will take over some day.  That's my hope, anyway. 

And the moon is made of cheese and little green men live on Mars....

 

[wildcat]

No, I mean real apes as in "Planet of the Apes" - hell just thought that one was left off the list.

 

[justin]

NYCGuy,

I started my index investing 6 months ago. I'm using VG, and I'm planning on buying only one index fund at a time, dollar cost averaging until I get a $10,000 position. When I went "shopping" in June 2005, I looked around to see what was "on sale". I looked at a number of measures - Price/Earnings, Price/book, but mostly which index funds or sectors had performed the worst over the last 1-5 years or so. At the time, the growth index had done pretty bad domestically, and the VPACX (mostly Japan Stock) Pacific Index fund had done pretty bad internationally. So I bought the VPACX, because I was convinced it had been "mean reverting" for a while, and I figured 5-10 years out, Japan would recover and I'd have good returns. Unfortunately for my dollar-cost averaging, the VPACX has taken off since then.

I know what you mean about not being able to find an asset class that HASN'T gone up a lot lately.

 

[wildcat]

NYC -

To answer your question, the index methodologies can be very different - esp when it comes to ETFs. From I know and have read, Barra's (for example, the value is traditional Ben Graham P/B which has done well historically) is pretty solid but the iShares, which used to be based on Barra's, are now based on some other index. Just carefully read how each benchmark determines value or growth and go with the one that makes most sense based on your own investment theories.

 

[Nords]

Which indices are cheap now, in your opinion?

If we were in an accumulation phase, which we're not, the question would be moot. We'd be DCA'ing our butts off into small-cap value & international value.

Because I don't think any particular indices are cheap. Being in the distribution phase, we're obscenely cash-heavy right now at nearly 10%. The rest of the retirement portfolio in those bloated equities that we've all been wringing our hands about.

I'm finding more stocks to short than I am to buy-- First Fed Financial (FED), Compucredit (CCRT), Abercrombie & Fitch (ANF), Herbalife (HLF), Regal Entertainment (RGC), and Web MD (WBMD). Kudos to Brewer for helping me work up this list.

Undervalued stocks-- I'm still holding Nortel. And holding. And holding. Same for Las Vegas Sands. And Dolby. I'm beginning to think that Sun is about fairly valued but I'm happy to have them prove me wrong.

If the dollar is only temporarily recovering (I have no idea) then international investments like the PowerShares International Dividend ETF (PID) sound like a great idea. But I wish it had enough history for those guys to declare their yield.

As for all that cash, in January I'll make sure that we have a years' living expenses in the MM and another years' expenses in five-year CDs. I'll raise spouse's TSP contributions to 100% of her pay into the small-cap "S" fund. Then we'll wait for the slump (2nd spring after the inauguration) or the season (sell in May) and put the "leftover" cash back into the market.

Hunh. It just occurred to me that if all of spouse's paychecks go straight into the TSP that she'll have zero earned income for 2006. No Roth IRA contributions, right?

 

[wildcat]

http://finance.yahoo.com/columnist/article/yourlife/1789

Ben Stein column on small value - interesting and appetizing if you have a looonngg time horizon.

Nords -

Good short idea on Regal - kind of company

 

[Nords]

Good short idea on Regal -  kind of company

Gonna have to give full credit to Brewer on that one. We're just waiting for the bird flu to empty the theaters!

 

[brewer12345]

Hey Nords, care to give a brief run-down of the short case for HLF? I'm in need of some more short ideas. BTW, I sold my puts on CCRT recently for a modest profit (25%). I still think that piece of crap is going down, but I can't afford to be patient with short-dated puts. I'm still amazed at their lack of disclosure.

 

[Nords]

Hey Nords, care to give a brief run-down of the short case for HLF?  I'm in need of some more short ideas.

Multi-level marketing. Remember "Lose Weight Now, Ask Me How"?

They've been rapidly expanding overseas (cash flow is nil) and they announced a secondary offering this week. Their shares appear to be fully valued and if the dollar goes up their margins will be under pressure. If there's another weight-loss backlash, or if there's any whiff of executive misbehavior, then they'll be soundly punished. I haven't seen any of those indicators yet but I've been tracking the stock for six months waiting for the technicals to go into a dive.

BTW, I sold my puts on CCRT recently for a modest profit (25%). I still think that piece of crap is going down, but I can't afford to be patient with short-dated puts. I'm still amazed at their lack of disclosure.

I hate the time pressure of options. I stayed short on ANF for five months before everybody panicked about retailers, and I can't wait to repeat the ride. ANF has a strong jerk factor and should sell off quite briskly the week after Christmas.

I've been short FED for a couple months, too, waiting for the bad news to arrive, and I'd love to pile into CCRT too. My only problem with shorting stocks is having enough margin to do it without paying margin interest...

 

[wildcat]

they announced a secondary offering this week.

Whoop whoop warning warning - insiders tend to issue secondaries when the stock is overvalued

 

[Nords]

Whoop whoop warning warning - insiders tend to issue secondaries when the stock is overvalued

Well, you would think that, except they made the announcement at $29.25 and they're darn near $32 now.

I think that their growth strategy is sucking every available piece of cash out of the company, but I'm more patient now than I was even several years ago. They've really flattened out since Sep and the end can't be far off.

 

[greg]

NYCGuy:

Trying to look only at economic factors over the next few years, the primary issue I see is the same one you see—home price reversion difficulties and the debt underlying it. At some point mortgagees are going to start going underwater on this debt, and then some sort of panic may result where retail buying starts to slow down. And because 70% of our economy is now consumption-based, lay-offs are likely to start, especially in the service industry—our only really growing sector over the past ten-twenty years.

I think the housing sector is our current bubble-de-jour. When it starts to pop or decrease in size, the gov’t will do what they always do: lower interest rates and stimulate. And here I differ from some because I THINK that near that point the gov’t will become more obvious in their bubble blowing if things don’t quickly improve. It is likely that they will finally attempt to stimulate the demand side. This means shooting a full barrel of inflation into the economy: They’ll probably raise minimum wage across the board. (Wal-Mart recently brought the subject up.) I see it coming, especially if wages don’t rise by themselves. This currently isn’t happening due to the Asian and global wage push-down effect.

If it works, fine. But then we’ll have to face the consequences of rolling wage hikes throughout the country. If minimum wages go up 25%-50%, then everyone else will want a little additional wage increase too. Consumer prices will rise in order to support the new costs. Retirees may have their savings corroded. It’s been twenty-five years since we’ve experienced serious inflation. I see wage inflation as a looming bubble, but it’s currently just a little froth.

I’m worried about our bonds too. At some point the Chinese and Japanese who hold more than a trillion dollars worth of them, won’t want to buy more, especially if we slow down our purchases of their goods. Or if we throw up trade barriers. Or if they just want out because of the deteriorating US$. Even if they dumped $5 billion/mo., it might create havoc in our economy. (Brewer, could you speculate on this possibility?) Plus Japan and China have their own demographic problems, and at some point they may need their money back to support their aging population. At some point we could/probably will be blind-sided by dropping bond prices. This type of event could also affect bond and bond-like paper world wide.

These two ideas are only small possible factors in a larger tangled mess. I do think they will play prominent roles though. I think aggregate housing prices will tip within the next year or so--if they haven’t already.

Timing: I think it's important to remember that timing markets bears a similarity to having a car accident in that everything seems to slow down for the observer during critical moments, while waiting for the event to happen. So some mild diversification helps balance perceptions. In other words, don't make huge bets. especially with index funds .

--Greg