John P. Hussman, Ph.D.
If I were to choose anything that investors should memorize – that will serve them well over a lifetime of investing – it would be the following two principles:
1) Valuations control long-term returns. The higher the price you pay today for each dollar you expect to receive in the future, the lower the long-term return you should expect from your investment. Don't take current earnings at face value, because profit margins are not permanent. Historically, the most reliable indicators of market valuation are driven by revenues, not earnings.
2) Risk-seeking and risk-aversion control returns over shorter portions of the market cycle. The difference between an overvalued market that becomes more overvalued, and an overvalued market that crashes, has little to do with the level of valuation and everything to do with the attitude of investors toward risk. When investors are risk-seeking, they are rarely selective about it. Historically, the most reliable way to measure risk attitudes is by the uniformity or divergence of price movements across a wide range of securities.
DYI Comments: The Dividend Yield Investor is concerned with John Hussman's point number one as the premise for this blog. My formula based asset allocation increases or decreases your exposure to stocks, bonds, or gold depending upon their current valuation. Currently today valuations for stocks are so high our formula has "kick us out of the market" for good reason. Today the best you can expect to receive for stock held or bought today and then held for the next 10 years is about 1%.
Please note: this is before fees, trading/impact costs, possible taxes, and, of course, INFLATION. Most typical 401k plans have an expense ratio of around 1% most are managed funds which will cause a further drag due to commissions plus impact costs or around 0.50% per year. For those of you who are not aware these fund managers control such large sums when they exit or enter a stock no matter how careful drive the price higher or lower reducing/increasing their return or loss. Add on the Federal Reserve which is hell bent on delivering us a 2% inflation rate and if they achieve this your returns just got clipped further.
Let's add up these additional costs for our typical 401k owner. 1% expense ratio, 0.50% trading/impact cost and a 2% inflation tax. That's -3.5% added to our 1% 10 year return estimated return and you all you receive is a negative -2.5% return for your efforts. Of course for those who have additional money outside of a pension, inside a taxable account, you can add on an additional 1 or 2 percent cost depending on your tax bracket.
Today or for the past two years has been a terrible time to acquire stocks on a whole sale basis such as your basic S&P 500 index fund or broad based managed fund. This may work out well for the clever speculator who will sell off his shares in time to a greater fool but for us "real" value based long term investors it is a rotten time to buy.
The only area of the market that is showing low valuations are your precious metals mining companies. They have gone through a massive bear market from peak to trough of around an 80% drop! This is an excellent time to dollar cost average into your favorite mining mutual fund as there will be plenty of time to build your position as these shares move through the accumulation stage that could very well last a few years before the next bull stage.
So....While everyone else is losing their head don't go around losing yours. It is time to be be very defensive as valuations have become so elevated that after any reasonable costs plus inflation you will end up with losses.
AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION - 7/1/15
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
DYI
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