Dogs
Chasing Cars
September 25, 2017
John P. Hussman, Ph.D.
So the mindset, I think, goes something like this. Yes, market valuations are elevated, but, you know, low interest rates justify higher valuations. Besides, there’s really no alternative to stocks because you’ll get what, 1% annually in cash? Look at how the market has done in recent years. There’s no comparison. Value investors who thought stocks were overpriced in recent years have been wrong, wrong, and wrong again, and even if they’re eventually right, being early is just the same as being wrong. The best bet is just to invest in a passive index fund for the long-term, and ignore the swings. There’s really no alternative.
What’s notable about this mindset is its excruciating reliance on three ideas. The first is that low interest rates “justify” rich valuations. The second is that market returns simply emerge as a kind of providence from a higher power, perhaps magical gnomes, or the Federal Reserve if you like, and that those returns have no particular relationship to valuations even in the long-term. The third is that market returns during the recent advancing half-cycle are an accurate guide to future outcomes.DYI:
Remember
the required statement placed on all mutual fund material? Past performance is no guarantee of future
returns. The majority of the investing
public along with many of the so called professional investors become swept up
in chasing past returns no different than dogs who chase cars. The market measured by the Shiller PE10
is at the nose bleed level – as of 9-25-17 – of 30.55 along with a minuscule dividend yield for the S&P 500 at 1.89%; foretelling that future estimated
average annual returns will be dismal at best and very possibly negative over a
10 to 12 year outlook. Place your hard
earned cash into 100% invested in stocks across the board or managed and/or
index fund go to sleep like Rip Van Winkle for the next 10 years; awaken your
average annual return will be in the 0% - 1% neighborhood.
Estimated 10yr return on Stocks
*Starting dividend yield of the S&P500-**10yr estimated average annual rate of return.
In effect, stocks are viewed as good investments because they have been going up, and the evidence that stock prices will go up is that stock prices have gone up. Every additional market advance makes stocks look even better, based on past returns. Indeed, the more extreme valuations become, the more convinced investors become that extreme valuations don’t matter.
Will
the Real Valuation Driven Long Term Investor
Please
Stand Up!
The
majority of investors say they are long term investors as if this magical
potion will bring them to the promised lands of high returns. If there is no forethought to valuations then
luck will be the major reason for future returns whether dismal or dazzling.
Accumulation Phase
For
example a 30 year old is no longer in his starving 20’s has extra coinage to
invest on a dollar cost basis into his favorite mutual fund beginning in the
year 1970. Every month automatically (prearranged
dollar amount) from his checking account goes into the fund. Looking at the above chart his starting
valuation was some what high, and then a big drop off, due to the 1973 to 1974
market smash.
Our
diligent investor marches on investing a portion of his paychecks every month
with valuations now at jaw dropping bargains.
He is older earning a larger paycheck – plus the inflationary 1970’s –
he increases the monthly allotment and is repeated many times over all through
the disinflationary 1980’s, the booming 1990’s and the first half of the roller
coaster 2000’s, all the way till 2005 at age 65 when he retires. So all and all, his investing history has
been positive. The first 24 years (1970 –
1994) out of 35 - dollars were invested at reasonable or bargain prices.
Spending Phase
Our
gray haired friend has entered the spending phase instead of dollars leaving
his checking account he instructs the fund to redeem a monthly amount into his
checking account. The Mutual Fund
Association advocates 4% redemption of his market balance per year then dividing
by 12 to arrive at his monthly stipend.
This is viewed as a safe percentage all weather (valuations) percentage
with high odds of never running his account to zero. Under normal conditions – valuations at
reasonable levels [less than 0.5 standard deviation above the mean] 4% withdraw
is most definitely a safe number. However,
our gray hair – and this blogger is one of them – results will NOT be as
pleasant as his accumulation phase due to excessive valuations causing one
massive drop off with his 4% withdraw chewing up increasing amounts of his
principal. If it were not for the Fed
induced bull market quantitative easing runaway money printing high speed
bullet train of 2009 to present day he would have been shocked by a massive
drop off of principal value. So far his
experience in the spending phase has been mixed.
I’ll
Ask Again
Will
the Real Valuation Driven Long Term Investor
Please
Stand Up!
The
moral of the story is valuations. Higher
the valuations the less you want to hold or purchase stocks AND for those in
the spending phase will have to live with a lower percentage withdraw [2% at
current valuations is a safe number].
The flip side purchase or hold a much higher percentage in stocks when
valuations are low AND those in the spending phase could very easily withdraw
up to 6% per annum without undue risk to principal.
This
is where my valuation driven model portfolio of four diverse (uncorrelated) asset
allocation model comes into play. In
other words there is a bull market among at least one of the assets (almost)
all of the time. What if our soon to be
retiree in the year 2000 switch out of stocks due to insane valuation (4 standard deviations above mean) to gold that
was on the give-away-table, then in 2005 began selling off one or two coins per
month to augment his Social Security payments?
9-1-17
Updated Monthly
Secular Market Top - Since January 2000
From High to Low
+356.6% Gold
+213.0% Transports
+162.3% Utilities
+ 90.9% Dow
+ 84.5% Oil
+ 84.5% Oil
+ 68.2% S&P 500
+ 64.3% Swiss Franc's
+ 58.0% Nasdaq
+ 58.0% Nasdaq
+ 58.0% 30yr Treasury Bond
Even
with gold’s market fall off since August 2011 – our gray hair – purchased at
give-away-prices all below $300 dollars per ounce back in the year 2000. From mixed results to one happy 77 year old
camper! Or what of our new accumulator 30
year old who back then avoided stocks due to insane valuation and purchased
precious metals mining stocks purchased at give-away-prices? Reducing his exposure as this asset category’s
valuations jumped; then moving a portion of his profits from gold – into stocks
when valuations improved during the 2008 – 2009 sell off. Where are we today?
Updated Monthly
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