Are Stocks Riskier Now Than Four Years Ago?

[leo383]

With stocks at or near all-time highs, are they riskier than they were 4 years ago at their 2009 lows?

Or is it just that the expected returns are lower, and the riskiness is the same?

[Browser]

What difference does it make to your investing strategy?

[leo383]

What difference does it make to your investing strategy?

None. We are DCA'ing 80/20 all the way through.

The Airplane Melt Up thread got me thinking, that's all. The lady jumping in now that she thinks that stocks are safer than they were in 2009.

[Toons]

Wealth is created during bear markets(to those who are buying)you just don't know it at the time(07-09)

[Cut-Throat]

With stocks at or near all-time highs, are they riskier than they were 4 years ago at their 2009 lows?

Yes.

[Ranger]

Expected equity return = S&P dividend yield + 10 year treasury yield + Future inflation estimate (from philly fed estimate) + Assumed real growth in earnings + PE multiple expansion (if below shiller PE average)

In 2009
3.24% + 2.5% + 2.5% +1.7% + 0 = 7.44%
now 2013
2.22% + 1.9% + 2.48% + 1.7% + 0 = 6.4%

So expected return was higher in 2009. If you measure risk by std. deviation obviously 2009 was higher, but risk can be upside too.

[leo383]

So expected return was higher in 2009. If you measure risk by std. deviation obviously 2009 was higher, but risk can be upside too.

How is risk calculated using standard deviation? Why was the standard deviation risk higher in 2009?

[Ranger]

There are many measures of risk. Standard deviation is one of the standard measure.

There is a wiki article about standard deviation.
http://www.bogleheads.org/wiki/Standard_deviation

Regarding why was it higher?
Because there was more variance in the data at that time.

Here is the Standard deviation during that period in chart form.
http://i46.tinypic.com/3cwba.jpg

[grayfox]

With stocks at or near all-time highs, are they riskier than they were 4 years ago at their 2009 lows?

Or is it just that the expected returns are lower, and the riskiness is the same?

When you say risker now, I am guessing you mean how risky going forward. In other words, you are interested in a forecast for how risky stocks will be in the future.

One measure of risk is volatilty, and the VIX is the markets forecast for volatilty of the next 30 days. Right now, it's 13.70, which very low. I think the historical average is about 19.4

Four years ago, VIX was up around 40. So by that measure, stocks were thought to be riskier four years ago than they are today.

As far as expected return, E10/P earnings yield is about 4.3% today and was about 6.6% four years ago.

This makes sense. Four years ago stocks were perceived to be riskier, so had higher expected return than today. That's the basic principle of investing, if riskier investment, then demand a price discount -> higher expected return.

[NYBoglehead]

I think I heard today that the S&P 500 is trading at a 14:1 P/E. It was ~16:1 at the height of 2007. We need to divorce ourselves from thinking (although the media is absolutely asleep at the wheel on this one) that there is no magic number beyond which the market cannot go. This is 5+ years later, Dow 14,000+ is not something that should be feared if we get close to it. As earnings increase over the years, the market should rise by simply maintaining the P/E multiple. It'll go up and down. The drama associated with "reaching all time highs" is absurd.

[nisiprius]

In the period shown below, were stocks riskier at the end of the period, when stocks had doubled in price, than at the beginning?



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[The Wizard]

Risk is a funny word.
I think many of us look at it as a NEGATIVE concept, the risk of losing money.
Is it feasible to have risk be bidirectional: the "risk" of stocks going UP 10% in value over the next six months?

[nisiprius]

Risk is a funny word.
I think many of us look at it as a NEGATIVE concept, the risk of losing money.
Is it feasible to have risk be bidirectional: the "risk" of stocks going UP 10% in value over the next six months?

That's the usual meaning of "risk" in financial economics, and, fortunately or unfortunately, it is often what the word means in discussions of investing. Risk in this sense means unpredictability, either way.

[Toons]

An example of "Risk" to me is outliving your money due to being overly conservative in you investing strategy.

[Cut-Throat]

In the period shown below, were stocks riskier at the end of the period, when stocks had doubled in price, than at the beginning?



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Yes, much riskier........We we're entering the period of 'irrational exuberance.'.........

[Van]

I have no idea which puts me way ahead of people who do not know what they do not know!

[YDNAL]

With stocks at or near all-time highs, are they riskier than they were 4 years ago at their 2009 lows?

If you believe things like... "anticipate 50% drop in Stocks anytime:"

S&P 500 1/28/13 -- 1,503 x 50% = 751.5
S&P 500 3/9/09 -- 666 x 50% = 333

And, you were cashing-out your investments in the near future to buy that Lear Jet, your investment in the S&P 500 today has the potential to be 125% riskier (lose moolah). Anything else - other than losing moolah - is irrelevant.

[Rick Ferri]

With stocks at or near all-time highs, are they riskier than they were 4 years ago at their 2009 lows?

Or is it just that the expected returns are lower, and the riskiness is the same?

Both and neither. Prices adjust based on a required return derived from expected risk and changes in the expected growth in earnings. In the basic Gordon Growth Model, if investors believe future returns are going to be lower due to slower growth (g), or that prices are going to be more volatile and therefore they need a higher return on equity (k), then prices will fall. Today, earnings growth expectations are fairly good and price volatility is much lower, so the market is higher.

If you can predict future earnings or future volatility correctly, then you can be a successful market-timer. I honestly don't know anyone who does.

Rick Ferri

[Browser]

Down and Up respectively. We have this thing called reversion to the mean.

[peppers]

Equity was risky in 1929 and they will be risky in 2029. So......

[The Wizard]

There probably ARE metrics like Price/Earnings ratio that serve as leading indicators.
This means that they FORECAST what likely will be happening over the next three months or so.
We need someone to find a correlation analysis or two that shows that UnderValued stocks tend to go up in price and vice versa...

[Browser]

The problem is that Mr. Market doesn't care if he is overvalued or not. Crack cocaine.

[rkhusky]

With stocks at or near all-time highs, are they riskier than they were 4 years ago at their 2009 lows?

Or is it just that the expected returns are lower, and the riskiness is the same?

Is the Total Bond Market riskier now than 3 years ago?

[letsgobobby]

In the period shown below, were stocks riskier at the end of the period, when stocks had doubled in price, than at the beginning?



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price does not determine risk, but value might. In 1996, price was high but got higher, value was low and got lower. Eventually value was corrected though price never did. Of course it took 13 years. Someone who spent those 13 years waiting for better value did better (speaking only about S&P500 stocks). PE10 tactical allocation worked.

Today PE10 is about 23, almost double what it was in 2009. On that basis alone I would say stocks are much riskier now than they were in 2009.As for me, nothing actionable about PE10 23. But at PE10 25, my IPS calls for action. If that happens, I would actually be *doing* something in response to perceived risk.

[Ranger]

There probably ARE metrics like Price/Earnings ratio that serve as leading indicators.
This means that they FORECAST what likely will be happening over the next three months or so.
We need someone to find a correlation analysis or two that shows that UnderValued stocks tend to go up in price and vice versa...

Not exactly 3 month forward return, but beginning dividend yield and real long term growth has predictive power over next decade

http://i46.tinypic.com/2hn0r2q.jpg

This is from the article "Expected Return" from Research Affiliates

[Rodc]

In 2009 the economy was in free fall. Things did turn around, but they could just as easily have continued down much farther and stayed there.

My son once put his arm through a glass window and did not get hurt. Mom kind of freaked. Boy about age 6 said, "But mom, nothing bad did happen!"

Was there low risk since we know nothing did happen?

[325e]

Interesting to see the different ways people look at risk. Good stuff.

I think about it in terms of the mr market theory. That makes long term risk lowest when long term potential return is highest. It is opposite of the normal risk-return trade-off: low risk = higher returns (again, long term). Guessing when the market is going to be lowest is the hard part. So just keep putting money in regardless and we can't guess.

[Browser]

The Ancients used to say Thank the Gods for terrible markets while you're saving and investing, and for wonderful markets when you're taking it out to spend. Well, maybe they didn't say that, but they should have. 2007-2009 were good years for investors who were saving and investing, and the last four years have been good to investors taking their money out to spend it. I'm one of those hoping for more of the latter, but if you are still saving and investing you should be hoping for more of the former. Risk will be your friend if it shows up.

[Browser]

Took a look at monthly Shiller PE/10. It just crossed above 23, which it has done about 10 times previously based on monthly data:

10/1928
2/1930
10/1964
9/1965
7/1995
11/2002
4/2008
2/2011
4/2011

Obviously, when PE/10 was increasing, it was during bull market periods. After 23 was breached, it took anywhere from 1 month to 61 months before the market peaked and entered a serious bear market. The longest period was after 7/1995 when it took about 5 years before the market peaked and crashed in 2000. That also happened when 23 was breached on 11/2002 and it also took about 5 years before the market peaked and crashed in 2008. Back in 1928, it took about 2 years before the market peaked in late 1929 and crashed. So, PE/10 crossing above 23 eventually became a leading indicator of a significant bear market. But sometimes that can take a long time to materialize while the market continues to climb. PE/10 has been flirting with 23 for about 2 years now. Based on the past, we can surmise that the bear might be lurking again, but you can leave a lot of money in the casino by picking up your chips now.

[Rodc]

I have not checked the E part of P/E10 recently. And I should.

P/E10 makes most sense when E is not too wild. Smoothing across business cycles to reduce noise works best when the noise is modest and cyclic. With the huge crash and crazy loss of earnings that entailed, P/E10 may be less predictive than in the past.

Only time will tell. Lord knows a correction or worse wills surely come along at some point, always has and likely always will.