What does yield curve tell us now?

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Robert T
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Post by Robert T »

.
Pete,
My point was the elementary one that outliers don't invalidate general statistical patterns.
You compared biological outcomes with financial market outcomes, for the latter outliers seem to drive the mean, while for the former they don’t (if we believe Taleb).
Per your example, a 3.35 yield spread may lead to very low returns or very high returns, but that doesn't mean there's not a probabilisitc tendency for high spreads to lead to high returns.
This is what the data says:

Image
[The above uses overlapping periods for the analysis using data from January 1959]
Similarly, per my example, very tall parents may sometimes have very short kids, but that doesn't mean there's not a probabilistic tendency for them to have taller kids.
Parental height is a MUCH stronger predictor of child height (biological/genetic outcome), than yield spreads are to subsequent one year returns (as in the above chart) – that is why I did not think your example was (too) relevant. Not a big issue... but an important distinction IMO.

Robert
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Last edited by Robert T on Sat Dec 26, 2009 3:31 pm, edited 1 time in total.
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Adrian Nenu
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Post by Adrian Nenu »

Yield curves may well be a useful tool for predicting economic activity. That isn't the issue. The question is whether it is a useful market timing tool, which is a very different question.
It's a risk timing tool, not a market timing tool. The markets may have positive returns durign recessions. Also, the inverted yield curve simply predicts recessions, it doesn't tell how bad it will get or if the market will decline, or by how much. Nobody knows any of these things. But the IYC provides the knowledge that equity risk is going up. Whatever investors decide to do based on this info is up to them, based on their risk tolerance. The IYC is just another risk management tool, that's all. You either buy into the studies and what I have presented or not. Can use my rule of thumb or not. But at the minimum, account for ~50% (+/-10%) market declines when determining your suitable asset allocations and know that stocks can have long periods of low returns.

Adrian
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peter71
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Post by peter71 »

Hi Again,

OK, it no longer seems to be on Jstor but I got it on "Business Source Complete." Scratch the above about "selling 8-months after a strong signal."

Rather, while the existing literature talks about yield spreads predicting recessions one year later, and while they thus TESTED whether yield spreads predict bear markets 1-8 months later, they ultimately found that a statistically significant tendency for yield spreads to predict bear markets only shows up 1-3 months out from a yield spread reading. So they then plug some values into their probit model to figure out what's a strong enough signal to sell one month later -- specifically, they figure out the yield spread level at which (per the probit model) there's a 30%, 40% and 50% chance of a bear market in the following month . . .

"Table 2 provides the ex ante probability estimates
from our probit model of a bear market one
month later.^ For example. Table 2 ijidicates that a
yield curve spread of 0.55 percent implies a 30 percent
chance of a bear market in the following month.
A yield spread of-0.17 percent implies a 40 percent
chance of a bear market, and a spread of -0.83
percent indicates a 50 percent probability of a bear
market in one month.^"

(Note that yield spreads are here defined as the 10-year+ minus the 3-month and are presented in percentage terms.)

And here's what they conclude based on those three analyses:

"Table 3 presents the results of the simulations
for each probability level and the results of a simple
buy-and-hold strategy of continual investment in
the S&P 500 mutual fund. Panel A shows the terminal
values of a $1 investment over the 29-year period
and the monthly and annual compound returns.
Investing $1 in a stock-only buy-and-hold strategy
would have produced $46.71 at year-end 1999 and
an armual compound retum of 14.17 percent. Every
probit market-timing strategy shown in Panel A
outperformed the buy-and-hold shategy. As the
probability screen increased from 30 to 40 to 50
percent, the profitability of the market-timmg strategy
increased. When we used a bear market probability
screen of 50 percent, the probit market-timing
strategy yielded an extra $36.31 in terminal value to
the S&P 500 mutual fimd retum and an additional
2.29 pps in annual retum. Panels B, C, and D show
that we found analogous results for the subperiods.
Considering that a tax-deferred investor (e.g.,
an individual or a pension fund manager) could
realistically replicate this simulation by costlessly
switching between a no-load S&P 500 mutual fund
and a money market fund belonging to the same
fund family (e.g., the Vanguard or Fidelity mutual
funds), the probit market-timing strategy produced
economically significant results."

So is it actionable???? I'd still say "meh." If you can figure exactly how they're measuring yield spreads in percentages, you can do exactly what they found was optimal and sell one month after you get a reading of a 50% chance of a bear market. A more practical way to think about it is that, all else equal, it appears to be optimal to sell stocks about one month after someone posts on here that, "wow, the yield curve's is REALLY inverted." :D

All best,
Pete
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Adrian Nenu
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Post by Adrian Nenu »

Yield curves may well be a useful tool for predicting economic activity. That isn't the issue. The question is whether it is a useful market timing tool, which is a very different question.
It's a risk timing tool, not a market timing tool. The markets may have positive returns durign recessions. Also, the inverted yield curve simply predicts recessions, it doesn't tell how bad it will get or if the market will decline, or by how much. Nobody knows any of these things. But the IYC provides the knowledge that equity risk is going up. Whatever investors decide to do based on this info is up to them, based on their risk tolerance. The IYC is just another risk management tool, that's all. You either buy into the studies and what I have presented or not. Can use my rule of thumb or not. But at the minimum, account for ~50% (+/-10%) market declines when determining your suitable asset allocations and know that stocks can have long periods of low returns.

Adrian
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peter71
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Post by peter71 »

VictoriaF wrote:
peter71 wrote:Hi Victoria,

It's a confusing paper to read for several reasons and I haven't read it in awhile, but while the short answer to your question is "meh, they claim it is based on selling stocks 8 months after a 'strong signal'" in terms of yield spreads, I'm also going to pull it up again on jstor (provided I can get my library acct. working remotely) and take another look and see if I can post anything more helpful.

All best,
Pete
Hi Pete,

The paper you referenced tries to combine Siegel's thesis that predicting market turning points 4 months in advance provides 4.8% increase in returns (in comparison with buy-and-hold of stocks) -- with Estrella's forecast of economic changes four quarters in advance. So if the curve sends a signal, one adds 12 months (4 quarters) to identify the beginning of the economic turn, then one subtracts 4 months (recommended by Siegel), and the result is that one should make an investment change 8 months after the signal.

This is precise and actionable. However...
1. Larry Swedroe says that "the difference between long-term and short-term interest rates has borne a consistent negative relationship with subsequent real economic activity in the United States, with a lead time of about four to six quarters." And so the question is "is it four quarters or six quarters or something in between"?
2. Can we time the curve's behavior precisely? If the curve inverted for a day and then resorted to the positive slope for several weeks, did it send a signal? How large should a large positive spread be to be meaningful?
3. And the vicious circle of the logic that "if I know the precise day of making my market move, so do other investors; if, on the other hand, the information is non-specific I don't know when to act."

Thank you,
Victoria
Hi Victoria,

I thought it was eight months too based on the first page but having now re-read the whole paper I think it's one month , , ,

On the question of a short, shallow inversion, they'd definitely say "deeper is better."

On the issue of whether there's some sort of "sweet spot" in which a phenomenon can be known to smart amateur investors but not yet arbitraged away, I agree that's kind of the fundamental question. The only "hopeful" thing I can say for smart amateurs in that, contra the paper, I DON'T think many professional money managers, much less huge pension funds, can or will shift 100% into cash on a dime.

Just to clarify though I wouldn't oersonally do exactly what this paper advocates at all (i.e., look at yield spreads alone). Rather, what I personally do is look at three things -- valuations, momentum and "interest rates" more generally . . .the valuations thing helped lead me to eschew stocks from 2002 (when I started my 401k) until early last year, but the momentum thing preveented me from jumping in until mid-to-late april . . . the low short-term interest rates and the sense that the govt. has its thumb on the scale also helped me feel good about diving in (and still does have me feel good about staying in) really irrespective of the yield spreads per se . . . so if and when we do have an "inversion" I guess I'd say it'll be the third most important thing I consider when deciding whether to make a move, but that's not to say I won't consider it at all . . .

I stress that I'm by no means advocating anyone do the same or even pay attention to me . . . I just think it's helpful for Bogleheads to consider whether, even if they're always getting the average dollar return, there are certain times at which that average dollar return is systematically likely to be worse than at other times . ..

All best,
Pete
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VictoriaF
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Post by VictoriaF »

peter71 wrote:A more practical way to think about it is that, all else equal, it appears to be optimal to sell stocks about one month after someone posts on here that, "wow, the yield curve's is REALLY inverted." :D

All best,
Pete
Hi Pete,

This is a really good advice, thanks! Now, the question is 'what will the appropriate Bogleheads headline be to start buying?' ;)

Victoria
Inventor of the Bogleheads Secret Handshake | Winner of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)
peter71
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Post by peter71 »

VictoriaF wrote:
peter71 wrote:A more practical way to think about it is that, all else equal, it appears to be optimal to sell stocks about one month after someone posts on here that, "wow, the yield curve's is REALLY inverted." :D

All best,
Pete
Hi Pete,

This is a really good advice, thanks! Now, the question is 'what will the appropriate Bogleheads headline be to start buying?' ;)

Victoria
Hi Victoria,

Well, if one isn't ALREADY buying, and if one only wants one indicator, I guess just "wow, that yield curve is looking really steep again." :D

All best,
Pete

P.S. Robert, I agree that there's a huge difference in degree if not necessarily in kind between the two examples.
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VictoriaF
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Post by VictoriaF »

peter71 wrote:Hi Victoria,

On the issue of whether there's some sort of "sweet spot" in which a phenomenon can be known to smart amateur investors but not yet arbitraged away, I agree that's kind of the fundamental question. The only "hopeful" thing I can say for smart amateurs in that, contra the paper, I DON'T think many professional money managers, much less huge pension funds, can or will shift 100% into cash on a dime.
Hi Pete,

It is a good point.
peter71 wrote:Just to clarify though I wouldn't personally do exactly what this paper advocates at all (i.e., look at yield spreads alone). Rather, what I personally do is look at three things -- valuations, momentum and "interest rates" more generally . . .the valuations thing helped lead me to eschew stocks from 2002 (when I started my 401k) until early last year, but the momentum thing prevented me from jumping in until mid-to-late April . . . the low short-term interest rates and the sense that the govt. has its thumb on the scale also helped me feel good about diving in (and still does have me feel good about staying in) really irrespective of the yield spreads per se . . . so if and when we do have an "inversion" I guess I'd say it'll be the third most important thing I consider when deciding whether to make a move, but that's not to say I won't consider it at all . . .
This answers my question from a few minutes ago. Thank you.
peter71 wrote:I stress that I'm by no means advocating anyone do the same or even pay attention to me . . . I just think it's helpful for Bogleheads to consider whether, even if they're always getting the average dollar return, there are certain times at which that average dollar return is systematically likely to be worse than at other times . ..

All best,
Pete
I tend to agree that there are some market imperfections that could occasionally be arbitrated by an amateur. As you said, professional money managers, who are restricted by their declared strategies, external scrutiny, and competitive pressure, cannot always act on market signals.

Thanks again,
Victoria
Inventor of the Bogleheads Secret Handshake | Winner of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)
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Post by speedbump101 »

Another angle might be how valid is the US treasuries IYC signal to international downturns? Prior to the 2008 meltdown I'd read articles suggesting that the rest world was delinked from the US economy, which turned out to be horribly wrong... Going forward however, with the continued growth of the BRIC nations, will delinking eventually occur? If so will we see a reduction of the accuracy of the IYC to signal anything other than possible US recessions?

SB...
"Man is not a rational animal, he is a rationalizing animal" -Robert A. Heinlein
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VictoriaF
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Post by VictoriaF »

speedbump101 wrote:Another angle might be how valid is the US treasuries IYC signal to international downturns? Prior to the 2008 meltdown I'd read articles suggesting that the rest world was delinked from the US economy, which turned out to be horribly wrong... Going forward however, with the continued growth of the BRIC nations, will delinking eventually occur? If so will we see a reduction of the accuracy of the IYC to signal anything other than possible US recessions?

SB...
Hi speedbump101,

The second paper referenced by Pete (peter71) provides some answers to your question.
Market Timing of International Stock Markets using the Yield Spread (2002) wrote:There has been much interest in recent years in the ex ante equity risk premium. Empirical studies indicate that it is possible for the ex ante equity risk premium to be negative and that it is related to an inverted yield curve of government bonds. This finding holds for the U.S. marketplace and for large foreign economies. Additionally, smaller countries have negative risk premiums in periods preceded by inverted U.S. yield curves. However, it remains an empirical question whether investors can form profitable trading strategies based on the relationship between the equity risk premium and the yield curve.

The present study extends recent probit modeling by Estrella and Mishkin (1996, 1998) for forecasting an economic recession. Specifically, we use the yield curve spread to forecast a bear stock market (negative ex ante market risk premium) in the U.S and eight major foreign stock markets. In general, it is found that the U.S. yield spread contains more important market timing information than does the home country yield spread for profitable market timing. The findings hold from the perspective of the local currency investor and the U.S. dollar investor investing in foreign stock markets. Overall our results support the possibility of a negative ex ante risk premium.
Victoria
Inventor of the Bogleheads Secret Handshake | Winner of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)
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speedbump101
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Post by speedbump101 »

VictoriaF wrote: The second paper referenced by Pete (peter71) provides some answers to your question.

Victoria
Thanks, I hadn't read that one... All hypothetical here as my IPS is YC agnostic!

SB...
"Man is not a rational animal, he is a rationalizing animal" -Robert A. Heinlein
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Post by Valuethinker »

speedbump101 wrote:Another angle might be how valid is the US treasuries IYC signal to international downturns? Prior to the 2008 meltdown I'd read articles suggesting that the rest world was delinked from the US economy, which turned out to be horribly wrong... Going forward however, with the continued growth of the BRIC nations, will delinking eventually occur? If so will we see a reduction of the accuracy of the IYC to signal anything other than possible US recessions?

SB...
This is arguably the most synchronized world downturn we have had since the 70s, if not the 30s.

I would suggest that increased international financial linkages, plus increased trade, make it more and more difficult for nations to escape downturns in the largest economies.

The Chinese are wielding extraordinary fiscal stimulus to hold off the impact of the US downturn. Other countries just do not have that kind of fiscal firepower.

Of course some countries have not had a financial crisis to the same extent: that has been somewhat localized to the UK, Ireland, Iceland, Eastern Europe. However Spain has had a huge downturn (just not, yet, a banking crisis) and of course Canada, Australia etc. despite strong banking systems are having nasty recessions (Australia less so).

But i would hypothesize the world is much more interlinked than it was, generally. And that means hitched to the largest economy ie the US.
efmoody
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IYC

Post by efmoody »

I am the one who has pushed this a lot. I believe that investing is about risk first and foremost. If there is a flat or expanding economy, the risk overall is limited for the most part (though one can still have October 1987 etc.) One may not be able to insulate oneself from these situations.
However an inverted curve tells one that a recession is 100% foretold- though I will also submit that the future is unknown. That said, I am 1000% sure of increased risk. The average loss in a recession is 40% to 43%in equities. The exposure to an individual portfolio is determined by standard deviation and correlation (good luck) and then doing a risk of loss via a personal financial calculator. To my knowledge it is the ONLY way since there is no calculator on the web that does it.

Now does that also mean that the losses start up right away at an IYC? No, in fact the market may continue to go up as the FED tries to stop the calamity. So maybe it will be different? Look at Cleveland's graph. I sumbit the evidence says to be very very cautious because the risks are there. You have an IYC, you have a recession.

In any case, once you see more and more failed efforts by the FED, you finally realize that the risks that are there all the time may finally manifest themselves BIGTIME. It is not adequate to simply say there is A risk. It is necessary to identify THE risk. I cannot say when the recession will occur (generally 12 months) nor how long it will last nor how bad it will be. But to sit through an devastating economic situation hoping to be lucky seems the height of folly.

As an advisor and human (somewaht they say), I have to recognize this scenario and try to protect client assets. Will I be totally successful in doing so. Not a chance. But in 2000 forward I did reduce exposure by DCA down and losses were generally limiited to under 15% (some leeway given since the sold assets went into bonds or cash that actually earned yields). There were effectively no equities by mid 2001.

Did I get back in at the bottom? Nope nor will I ever. The risk is still too great around the bottom, In retrospect, the expanding yield curve is a fine predictor that things are turning around, but it does not provide clear insight was to what new correlations should be attempted. So I tend to wait.

If you look at my site, you WILL find tons of articles on the IYC. But they almost all talk about the upcoming recession and risk, not about the market. Richard indicates that it is primariuly about risk and return. I disagree in that it is when such material risk will financially impact a client. The risk of a recession is always imbedded in a portfolio. But the probability of its impact is what I am interested in.

In 2006, the curve inverted. I noted in late 2007 that maybe it was wrong this time? That said, as the economics subsequently dictated, I opted into a LOT of CDs. Did I hit the timing right? I don't even think about that. Did I adjust effectively due to risk- at least as good as I can do. I think so. Did I miss most of the mess? Yes. Perhaps more importatnly, did my clients sleep well. Yes.

Have I opted full bore into the market. No. I still see a huge economic risk that makes me cautious. So I missed some returns. So what? I am focused on the risks that a client may take and do they reflect the reality of the situation. I believe that the market has gone up too far and too fast and is unspported by potential consumer spending. Is the yield curve way up? You betcha- in fact the positive spread is the greatest it has been in decades. That is another story.

In short, my concern is about risk. Anything that has a 100% prediction of risk must be recognized and dealt with. It is only then that I start my advisory work

Errold Moody
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Robert T
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Re: IYC

Post by Robert T »

efmoody wrote:The average loss in a recession is 40% to 43% in equities.
I would be interested in seeing the reference or the data behind these numbers.

Thanks,

Robert

PS. These are the numbers I get.

=> Since 1927: 14 recessions in the US, 7 had negative equity returns, 7 had positive equity returns over the duration of the recession for a average of –2.8%. Intermediate term bonds outperformed t-bill in each recession apart from 1973-75 when the difference was 2% (the intermediate bond outperformance of t-bills was much more consistent that the equity underperformance (negative returns) over the duration of recessions).

Code: Select all

                                                                         
                                     Cumulative returns (%)
                                     ----------------------------------
Recessions (as defined by NBER)      US Stocks   5 yr T-notes   T-bills

August 1929 - March 1933              -76.4          19.4        6.6
May 1937 - June 1938                  -24.2           7.7        0.2
February - October 1945                27.7           1.4        0.3
November 1948 - October 1949            4.1           2.7        1.0
July 1953 - May 1954                   27.6           5.7        1.2
August 1957 - April 1958               -6.5          10.8        1.9
April 1960 - February 1961             18.4           7.2        2.0
December 1969 - November 1970          -3.5          14.0        6.7
November 1973 - March 1975            -17.9           8.3       10.8
January - July 1980                    16.1           8.0        6.3
July 1981 - November 1982              14.7          36.9       17.6
July 1990 - March 1991                  7.6           9.1        5.3
March - November 2001                  -7.2           6.3        2.7
Dec 2007 -…                           -20.0          11.9        2.0
			
Average                                -2.8          10.7        4.6

Source: http://www.nber.org/cycles.html , Ibbotson Yearbook 2006, iShares, and Ken French websites.

=> Since 1927: 10 periods of greater than 15% equity loss (average loss about 20%) outside of recessions.

Code: Select all

                                                                          
Periods outside of recessions         Cumulative returns (%)
With negative equity returns          ---------------------

July 1933 - October 1933              -16.8
February 1934 - October 1934          -15.2
May 1940                              -21.8
Sept 1941 - April 1942                -22.9
June 1946 - Aoril 1947                -23.0
January 1962 - July 1962              -17.8
September 1987 - November 1987        -29.7
February 1966 - Sept 1966             -15.4
July - August 1998                    -17.2
September - October 2000              -16.3
	
Average                               -19.6
Some additional data:

=> Between 1960-2007, using quarterly data from 21 OECD countries, this study finds: Median OECD country equity performance during recessions = -5.5%, and average performance to be –5.3%. [from table 1B. pg. 57 in above link]. (Compare this with the all equity declines in Table 4.A. pg. 62).

The message to me:

(1) There is no clear evidence of consistent (and large) losses over the duration of recessions and there have been many periods of equity loss outside recessions. Both suggest recessions are a poor market timing indicator.

(2) If you are concerned that risk goes up in recessions, then holding intermediate bonds (as fixed income in a stock:bond portfolio) has historically been a more consistent hedge (relative to t-bills) than avoiding equities.
.
efmoody
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Numbers

Post by efmoody »

http://www.thetrumpet.com/index.php?q=2073.913.0.0

Inverted Yield Curve—Recession Warning? 2006


According to John Mauldin, economic analyst and president of Millennium Wave Advisors, llc, “they ignored the yield curve, all finding reasons why this time it’s different” (www.321gold.com, Dec. 31, 2005).

This same tendency was also noted by above-mentioned Fed economist Estrella, who published another work documenting how “each recession since 1978 produced major academic papers telling us why ‘this time it’s different.’ … They were all wrong” (ibid.).

Mauldin does go on to say that the present yield curve inversion has not continued long enough to absolutely predict a looming recession, but as Estrella cautions, “it should definitely raise warning flags about future output growth” (Estrella, “The Yield Curve As a Leading Indicator,” October 2005). Paul Kasriel, chief economist at Northern Trust Co. in Chicago, agrees, saying, “This is a warning signal … that we are on the recession watch now” (Wall Street Journal, Dec. 28, 2005).

Although yield inversions produce several consequences, they do not cause recessions; rather, they are a symptom of a weakening economy. One consequence is, as the yield curve flattens (long-term yields approaching short-term yields), it destroys a means for banks and other money-lending institutions to make money; thus, they become more reluctant to lend it out.

This cycle can negatively affect the economy in three ways. First, it makes it harder for people and businesses to borrow, subsequently reducing investment and consumer spending. Second, as banks start looking for ways to maintain profits and cut costs, it often leads to them slashing jobs, further hurting the economy.

A third consequence to a flat or inverted yield curve is that it leads to more risk-taking by banks and hedge funds in an attempt to boost income. For example, as the difference between long-term and short-term interest rates narrows, banks can’t make the same profit margins by borrowing short-term and lending long-term. This reduces the incentive for banks to lend money, and may cause them to make riskier investments and lower the amount of reserves they hold to cover bad loans.

Only time will tell if this present yield curve is truly signaling a soon-to-arrive recession. The yield curve has missed only two predictions over the past 50 years. But each time it has been right, recession has followed four to six quarters later.

Regarding the stock market, Mauldin cautions, “When you have something as reliable as the yield curve telling you there are problems in Dodge City, it may be time to think about leaving town” (www.321gold.com, op. cit.). After all, statistics show that the stock market drops an average of 43 percent before and during a recession (ibid
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RobertH
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Re: Why is it "negative"?

Post by RobertH »

VictoriaF wrote:The Federal Reserve can influence short-term rates (but not long-term rates), ...
Victoria,
The Fed is executing a program to buy back $1.25 trillion in mortgage backed securities.

This leads me to have a couple of questions regarding buying 30-year TIPS:

1) Is the Fed's intervention depressing the the yield curve? Would the pressure be felt on the long end, or closer to the middle of the curve? What's the magnitude of the effect? What will happen when the purchase program ends?
2) To what extent are 30-year TIPS insulated from this program? Can the real interest rate for TIPS be higher than the real interest rate for MBS or other long bonds (because of Fed demand for one but not the others)? Or are there effective means for arbitraging differences in risk-free real interest rates away? In which case, should we expect the real interest rate for TIPS to rise when the MBS purchase program ends, leading to a loss on the TIPS purchase?

Robert
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magellan
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Re: Why is it "negative"?

Post by magellan »

RobertH wrote:The Fed is executing a program to buy back $1.25 trillion in mortgage backed securities.

This leads me to have a couple of questions regarding buying 30-year TIPS:

1) Is the Fed's intervention depressing the the yield curve? Would the pressure be felt on the long end, or closer to the middle of the curve? What's the magnitude of the effect? What will happen when the purchase program ends?
2) To what extent are 30-year TIPS insulated from this program? Can the real interest rate for TIPS be higher than the real interest rate for MBS or other long bonds (because of Fed demand for one but not the others)? Or are there effective means for arbitraging differences in risk-free real interest rates away? In which case, should we expect the real interest rate for TIPS to rise when the MBS purchase program ends, leading to a loss on the TIPS purchase?
IMO, this is why things really could be different this time.

The Fed's impact on short-term rates is transparent and highly signaled, but no one really knows how much (if at all) the Fed is impacting the long end of the yield curve.

Based on the size of the Fed's balance sheet and the myriad new programs that let them buy and sell many types of long-term securities, I think it's possible that the Fed could be trying to manage the shape of the yield curve. OTOH, it's tough to know what they're doing for sure. Also, most of these long-term markets are pretty deep and therefore presumably tough to manipulate.

Jim
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Robert T
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Re: Numbers

Post by Robert T »

efmoody wrote:After all, statistics show that the stock market drops an average of 43 percent before and during a recession (ibid
The 43% seems to come from John Mauldin. Which I see is now quoted in several articles (after a quick google search). His phrasing includes “before and during” a recession:

”the stock market drops an average of 43% before and during a recession” (From this article: The Yield Curve)

He also provides no reference or data sources. I would highly recommend checking the data before using this quote. I simply don't find an average 43% decline. And I tried hard to do so. The table below show the peak-to-trough returns ‘before and during’ the recessions listed in the earlier post. This is what I get:
  • => the stock market (large caps) has historically dropped an average of 26.5%, peak-to-trough, before and during the 14 recessions since 1927. The median drop is –15.8%.

    => this compares to the 19.6% average decline, peak-to-trough, over the 10 periods that the stock market decline by more than 15% outside of recessions. The median decline was –17.5%.

    => the only 43% number appearing in the table is the decline in 1973-74 (not the average since 1927).

Code: Select all

Peak-to-tough returns (%) before and during US recessions

                                                      Peak-to-trough
                                                       Returns (%)
Recessions (as defined by NBER)      Peak    Trough     US Stocks

August 1929 - March 1933            Aug-29   Jun-32      -83.4
May 1937 - June 1938                Feb-37   Mar-38      -50.0
February - October 1945             Feb-45   Mar-45       -4.4
November 1948 - October 1949        Oct-48   May-49      -10.0
July 1953 - May 1954                Dec-52   Aug-53       -8.7
August 1957 - April 1958            Jul-57   Oct-58      -13.5
April 1960 - February 1961          Dec-59   Oct-61       -8.4
December 1969 - November 1970       Nov-68   Jun-70      -29.3
November 1973 - March 1975          Dec-72   Sep-74      -42.6
January - July 1980                 Feb-80   Mar-80       -9.9
July 1981 - November 1982           Nov-80   Jul-82      -16.9
July 1990 - March 1991              May-90   Oct-90      -14.7 
March - November 2001               Mar-00   Sep-01      -29.3
December 2007* - …                  Oct-07   Feb-09      -50.2
			
Average                                                  -26.5
Median                                                   -15.8

* TSM returns, the rest are large cap (S&P500 returns), due to easier data access. 

Data source: Ibbotson Yearbook 2006, Ken Fench webiste.

Robert
Last edited by Robert T on Mon Dec 28, 2009 9:00 am, edited 1 time in total.
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Numbers

Post by efmoody »

I clearly disagree with 50 year old backtesting. I do not necessarily care about returns- I DO care about risk. Coming out of the DOTCOM there was an extreme risk. That's my concern. The housing debacle was no different.

I use DCA down. If I am wrong about risk, it will show up in the economics. Maybe I will adjust. But it will be for risk, not returns.

The inability to understand and constrain risk is what caused this mess. . That is my focus. Returns are secondary and must be considered (obviously). But it is not market timing no matter what anyone says. It IS risk timing. Not perfect- it cannot be. But since risk can be currently defined and reduced, that is fine by me.

I have taught for a long time that risk predominates a client's portfolio and they must know their potential risk of loss. But without a personal calculator, it is not done.

Every investor- certainly 401ks - must know their statistical exposure to loss. Anythign else is a breach of duty.
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Post by Robert T »

.
The point of my previous two posts was simply to check (due diligence on) the numbers in the statements that:

“the average loss in a recession is 40% to 43% in equities”

and

“the stock market drops an average of 43 percent before and during a recession”

If I am reading correctly, both statements are about returns, used to signify risk. Clearly big numbers, signifying big risks. As an individual investor, I decided to check the facts (due diligence). I could find no actual return data that supports the statements (beyond 1973-1974). Just my findings as presented in the previous posts. Again, just checking the facts, nothing more.

Robert
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Re: Numbers

Post by richard »

efmoody wrote:Maybe I will adjust. But it will be for risk, not returns.
The relation between risk and expected return is about as basic and you can get. As Bill Bernstein phrases it:
One of the cornerstones of modern finance is the nexus between return and risk. These two characteristics are joined at the hip—you simply don’t get one without the other.
Managing for risk is managing for returns.

Do you disagree about the connection between risk and return? Do you think it matters that you're thinking about risk rather than thinking about return?
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Re: Numbers

Post by Roy »

efmoody wrote:I clearly disagree with 50 year old backtesting. I do not necessarily care about returns- I DO care about risk. Coming out of the DOTCOM there was an extreme risk. That's my concern. The housing debacle was no different.

...The inability to understand and constrain risk is what caused this mess. . That is my focus. Returns are secondary and must be considered (obviously).
It sounds like what you are saying is that you are concerned more about downside loss than upside gain. That is a fair opinion, perhaps shared by many, including me.

But the 43% average loss is a different question. I too would like to see the sources for that number. Also if you do not care for long backtested analyses, from what does this 43% average derive?

Roy
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Re: Numbers

Post by Valuethinker »

Robert T wrote:
  • => the stock market (large caps) has historically dropped an average of 26.5%, peak-to-trough, before and during the 14 recessions since 1927. The median drop is –15.8%.

    => this compares to the 19.6% average decline, peak-to-trough, over the 10 periods that the stock market decline by more than 15% outside of recessions. The median decline was –17.5%.

    => the only 43% number appearing in the table is the decline in 1973-74 (not the average since 1927).

Code: Select all

Peak-to-tough returns (%) before and during US recessions

                                                      Peak-to-trough
                                                       Returns (%)
Recessions (as defined by NBER)      Peak    Trough     US Stocks

August 1929 - March 1933            Aug-29   Jun-32      -83.4
May 1937 - June 1938                Feb-37   Mar-38      -50.0
February - October 1945             Feb-45   Mar-45       -4.4
November 1948 - October 1949        Oct-48   May-49      -10.0
July 1953 - May 1954                Dec-52   Aug-53       -8.7
August 1957 - April 1958            Jul-57   Oct-58      -13.5
April 1960 - February 1961          Dec-59   Oct-61       -8.4
December 1969 - November 1970       Nov-68   Jun-70      -29.3
November 1973 - March 1975          Dec-72   Sep-74      -42.6
January - July 1980                 Feb-80   Mar-80       -9.9
July 1981 - November 1982           Nov-80   Jul-82      -16.9
July 1990 - March 1991              May-90   Oct-90      -14.7 
March - November 2001               Mar-00   Sep-01      -29.3
December 2007* - …                  Oct-09   Feb-09      -50.2
			
Average                                                  -26.5
Median                                                   -15.8

* TSM returns, the rest are large cap (S&P500 returns), due to easier data access. 

Data source: Ibbotson Yearbook 2006, Ken Fench webiste.

Robert
.
Hi the Dec 2007 numbers look really wrong?

I would have said the market peak was around Jan 08 and the market bottom was March 09. The market peak was most definitely not after Lehman (15th Sept 2008)?

From memory, 2008 was a long bloody and slow downtrend as the reality of the credit crunch hit the market. Then, post Lehman, the final collapse of confidence down to January 09, a small bounce, then the complete collapse of hope in late Feb-early March 09.

Followed by the fastest rise in the FTSE100 in any quarter, ever recorded (the FTSE100 was invented in 1984, I think), in Q3 2009, which tells you something.
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Post by Robert T »

.
Valuethinker,

Thanks for the catch - should read Oct-07 to Feb-09, not Oct-09 to Feb-09 (will make the change to the earlier post). The -50.2% number is correct (according to Ken Fench's market data). I used monthly data (re: end Feb low), as done for all periods back to 1927. Using daily data for the full period may change the result slightly (if that data were readily available back to 1927), but don't think it will change the overall results (i.e. nowhere close to a 43% average equity decline).

Robert
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Post by Valuethinker »

Robert T wrote:.
Valuethinker,

Thanks for the catch - should read Oct-07 to Feb-09, not Oct-09 to Feb-09 (will make the change to the earlier post). The -50.2% number is correct (according to Ken Fench's market data). I used monthly data (re: end Feb low), as done for all periods back to 1927. Using daily data for the full period may change the result slightly (if that data were readily available back to 1927), but don't think it will change the overall results (i.e. nowhere close to a 43% average equity decline).

Robert
.
I suspect 'average' is almost meaningless anyways.

We'd have to regress market change (dependent variable) on GDP change (independent variable) at the very least.

It's a good rule of thumb that any equity portfolio can halve in value though. However we should be aware that in 1972-73 in the UK, it dropped 90%. 100% losses are of course possible in countries with political instability or hyperinflation.

I suspect (don't know) that one of the odd consequences of 'the great stability' has been (a la Hyman Minsky) that the risk of a big fall in equity markets has actually been increased.

Because equities are now widely understood to be long term 'safe', therefore the level of leverage against equities that is undertaken is greater (leveraged commercial property, leveraged hedge funds, complex option strategies etc.) and therefore the downside, when it comes, is greater.


Because we appear to have worked out, macroeconomically, how to iron out mild recessions, this has increased the chance of near Depressions (already we are now dubbing this one 'the Great Recession', and macroeconomic performance Sept 2008-May 2009 was pretty close to that of 1929-1930).

What I see is greater and greater global synchronisation of monetary and fiscal conditions, plus more effective transmission belts (in the 1970s, lending to Third World Countries, in the 2000s, the CDO, CDS and their ilk) which has led to bigger macro disturbances when they come.

The economy of Peoria, Illinois is now more tightly linked to the economy of China than it ever was in the past, and to the financial markets in Dubai. And in turn, the retirement savings of the average CAT employee in Peoria are more linked to the conditions in those far flung parts of the world than they ever were before.

Sitting looking at the US Yield Curve, in itself, just isn't that helpful, as it is as much a signal of currency market conditions as of US domestic financial conditions.

Or in other words, borrow short, lend long, and reap the upside. And wait for the 'snap' when the curve flattens again, and the arbitrageurs are wiped out (again).
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Risk and return

Post by efmoody »

Of course there is risk in investing. Of course returns are impacted. But the correlation of the two (taking liberty) is the same as for portfolios. They do not have to be constant. They vary all over the place. When the economy is solid, risk of loss may be muted save for scenarios like LTC in 1998, 9/11, etc. But when you have extreme risks foretold, I tend to opt out. If you look at the IYC, you will note- as after 2006- that returns may still go up. Risk and returns do not have to follow preset patterns. If I wait for returns to indicate what the risk is, it may be too late.

Look at thedotcom. Losses were 9%, 12%, 22% (rounded). The curve inverted in early 2000. Should I have waited till 2002?.

Look at 2006. There were still some nice returns before everything fell apart. Was I to wait till 2008 and then decide the risk finally was occurring?

As to the 40-43%, I opted in teaching before 2000 to focus on 1973/74 where there was a loss of 45% in a very short period of time. If you just teach risk without the corresponding human perception of money loss, you won't get to first base with anyone. they don't get it.

If I do the formal calculation of risk of loss for a standard portfolio, you will get a potential 40% to 60% loss with a one time standard deviation. But you also have to teach standard deviation. It is a lot easier to simply use numbers I have gleaned for use. I used 1973/74 for the dotcom. I used it for 2006. If you do not like the numbers, use whatever you want. Or don't use anything. Or use 50 year history (though I disagree).

If you get before an audience it is necessary to reflect specific risk of LOSS (though for individuals, you have to know their complete allocation).

If before the Dotcom you wanted to use a 15% drop for a recession or whatever, god be with you. But you would have looked like a chump afterwards. The risk was apparent. The extent of the losses were not.
Based on other factors, DCA down was appropriate. Maybe the losses were only going to be 20/30%. I will live with that and so will my clients. But I felt that risk WAS going to manifest itself far more than the 90's (once again I point to Bernstein. Risk and reward ARE tied together but NOT at the same amount nor at the same time nor.....) I chose to focus on my projected level risk without knowing if the returns will follow in like manner.

Here are comments from two of the heaviest hitters ever.

You cannot manage returns but you can manage risk

Peter Bernstein

You cannot beat the market, says the standard market doctrine. Granted. But you can sidestep its worst punches.

Benoit Mandelbrot
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Post by metalman »

To return to the original question and answer it succinctly: It probably portends an economic recovery, and all that implies.

All the talk of why it's "different now", the fed's "manipulations", the supposed "command economy", and other gibberish is meaningless speculation. The same people who are now saying its steepness predicts very high inflation are those who will be saying it predicts a recession if it becomes less steep.
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High yield curve

Post by efmoody »

The spread on the curve is the greatest it has been in decades. Far too high which portends?????????

I am still thinking but there is an inherent risk of inflation or ????. The better Christmas spending means what for next year? I jsut don't know where all the consumer money will come from to keep the economy moving.

Sure it can be different this time but the curve is too great. It can stay there for awhile but either shorts go up or long terms will have to drop.
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Post by Robert T »

.
The average loss in a recession is 40% to 43% in equities.
Truth in labeling please. Following the above posts this is a factually incorrect statement. If its 1973/74 then say that please. Implying that this is the case in all recessions is misleading (it was to me as an individual investor), and IMO seems to add a false sense of legitimacy to efforts to try to avoid these ‘average’ 40+ recession losses.

Is it better for an individual investor to expect large losses primarily during recessions or to expect them at any time? The historical data seems to suggest large losses can occur at any time – inside or outside of recessions. Expecting otherwise, likely gives a false sense of security IMO.

I agree that downside losses are time varying (as the historical data suggests). And its not about saying that there’s a 15% drop in recessions – its that losses can be substantial at any time (re: the commonly used 50%+ loss), prepare for it. Implying that risks only really show up significantly during recessions may tempt investors to take on high equity allocations outside of recessions and low equity allocations during recessions and then 1987 or 1998 comes along and losses could exceed tolerable levels.

How can losses be dampened?
  • (1) Peter Bernstein seems to advocate diversification as a way of managing risk. Clear and fairly easy to do.

    (2) Mandelbrot seems to think market timing can work. (re: his quote: “You cannot beat the market, says the standard market doctrine. Granted. But you can sidestep its worst punches”). Okay, but does Mandelbrot actually show us how to sidestep the worst punches (after all he says it can be done). Well – the paragraphs preceding the above quote in his book indicate that “here the work is just beginning”. The only thing he provides is early work of un-named researchers at the University of Paris and in Zurich on ex-ante identification of “financial quakes” or “storms”, with references to 1998! And no mention of inverted yield curves.
So as individual investors what are we to believe? In the absence of credible market (risk) timing schemes, I personally go for diversification … and FWIW I did not experience ‘catastrophic’ losses in 2008 (diversification worked IMO). Equity markets are risky, as Mandelbrot says “there is no puzzle to the equity premium. Real investors know better than economists. They instinctively understand the market is very, very, risky, riskier that the standard models say. So, to compensate them for taking that risk, they naturally demand and often get a higher return.” It would obviously be nice to avoid the downside risks, while still capturing the premiums the market pays for them (something I think almost everyone on Wall Street is trying to do). Personally I hope they succeed together with Mr. Moody and his clients. But they have a very high hurdle to clear IMO.

Robert
.
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Post by dumbmoney »

Robert T wrote:So as individual investors what are we to believe? In the absence of credible market (risk) timing schemes, I personally go for diversification … and FWIW I did not experience ‘catastrophic’ losses in 2008 (diversification worked IMO). Equity markets are risky, as Mandelbrot says “there is no puzzle to the equity premium. Real investors know better than economists. They instinctively understand the market is very, very, risky, riskier that the standard models say. So, to compensate them for taking that risk, they naturally demand and often get a higher return.” It would obviously be nice to avoid the downside risks, while still capturing the premiums the market pays for them (something I think almost everyone on Wall Street is trying to do). Personally I hope they succeed together with Mr. Moody and his clients. But they have a very high hurdle to clear IMO.
I agree that it's difficult to get return without risk. But it may be possible to get risk without return (U.S. 1929, Japan 1989, Nasdaq 2000, AAA bonds 2007...), and that's the scenario that would be nice to avoid if possible.
I am pleased to report that the invisible forces of destruction have been unmasked, marking a turning point chapter when the fraudulent and speculative winds are cast into the inferno of extinction.
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losses

Post by pkcrafter »

Robert,

Larry Swedroe has used the 73-74 bear as a benchmark for losses for a long time. Adrian's 2x rule is based on it and it seems to be an accepted standard. The average losses in 2000-2002 and 2008 are within the same range.

Diversification won't bail investors out in most cases because in a full blown crash investor shoot first and ask questions later. They get out--of all stocks. When everything is thrown out, correlations go to 1.

The tech wreck was a little different. In that one, diversification did help. But those all in tech lost 70+%. All the same, the tech crash was the exception. Don't count on diversification saving anything. I agree with EF Moody that allocation should be all about risk management, but it's obvious that the majority of newer investors don't give risk a second thought. And it seems to be a difficult concept to impress on new investors.


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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Post by Paladin »

richard wrote:
Adrian Nenu wrote:The inverted yield curve indicates a recession ~18 months in advance (think 2000-2002 and 2008-2009). You DCAdown you equity allocation. The recession arrives, risk increases and the markets plunge ~50%. You just avoided most of the bear market carnage and have the cash for the opportunity to buy stocks on sale if you want to.
This only works if you are the only person who knows about the predictive power of the yield curve. If not, other investors are likely to get there first.

What's the buy signal?
Adrian's Marketing Timing Newsletter? :shock:
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Post by Adrian Nenu »

Larry Swedroe has used the 73-74 bear as a benchmark for losses for a long time. Adrian's 2x rule is based on it and it seems to be an accepted standard.
E.F.Moody and I have talked about the 1973-1974 bear market/recession as a risk litmus test since 1997, after the Estrella/Mishkin paper was published in June, 1996. I first mentioned accounting for the 1973-1974 bear market loss when determining asset allocation on the old M* forum. Swedroe arrived later. He published a risk of loss chart in one of his books (2004?) after I exchanged a few e-mails with him on the 1973-1974 bear market litmus test/risk of loss. I just want to set the record straight.

Adrian
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Post by Adrian Nenu »

Adrian's Marketing Timing Newsletter?
First of all, I did not write the paper about the IYC as a recession predictor, Estrella/Mishkin did.

http://www.ny.frb.org/research/current_ ... ci2-7.html

Secondly, it is common sense that equity risk increases during recessions. You don't need studies and papers on economics to figure that one out.
This only works if you are the only person who knows about the predictive power of the yield curve. If not, other investors are likely to get there first.
Evidence suggests that investors ignored the IYC in 2006/2007 because the market went up and most of them did not bail out. There were quite a few articles on the IYC which stated that it was no longer a reliable recession forecaster.

http://money.cnn.com/2005/12/27/news/ec ... /index.htm

http://money.cnn.com/2006/05/24/news/ec ... /index.htm

https://global.vanguard.com/internation ... rtedEN.htm

Once again, just because the information is available, it doesn't mean most investors will react the same way or logically to it. Everyone knows overeating can cause obesity yet many people keep overeating. Everyone knows the bad effect of smoking yet many choose to smoke anyway. Everyone knows the odds at the Las Vegas gambling tables are against them yet they continue to play thinking they will get lucky and win the big payoff.

Adrian
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Post by Valuethinker »

Robert T wrote:.
How can losses be dampened?
  • (1) Peter Bernstein seems to advocate diversification as a way of managing risk. Clear and fairly easy to do.

    (2) Mandelbrot seems to think market timing can work. (re: his quote: “You cannot beat the market, says the standard market doctrine. Granted. But you can sidestep its worst punches”). Okay, but does Mandelbrot actually show us how to sidestep the worst punches (after all he says it can be done). Well – the paragraphs preceding the above quote in his book indicate that “here the work is just beginning”. The only thing he provides is early work of un-named researchers at the University of Paris and in Zurich on ex-ante identification of “financial quakes” or “storms”, with references to 1998! And no mention of inverted yield curves.
So as individual investors what are we to believe? In the absence of credible market (risk) timing schemes, I personally go for diversification … and FWIW I did not experience ‘catastrophic’ losses in 2008 (diversification worked IMO). Equity markets are risky, as Mandelbrot says “there is no puzzle to the equity premium. Real investors know better than economists. They instinctively understand the market is very, very, risky, riskier that the standard models say. So, to compensate them for taking that risk, they naturally demand and often get a higher return.” It would obviously be nice to avoid the downside risks, while still capturing the premiums the market pays for them (something I think almost everyone on Wall Street is trying to do). Personally I hope they succeed together with Mr. Moody and his clients. But they have a very high hurdle to clear IMO.

Robert
.
Robert

I didn't read Mandelbrot that he was arguing for market timing? You have to get to Andrew Smithers to have a persuasive case for that (or Jeremy Grantham).

I read Mandelbrot (and Taleb) as basically saying you should be as diversified as you possibly can be (venture capital, small cap growth and other high risk assets), and you should position the lifetime financial plan on the basis that disaster can, and does, happen periodically (but so too extraordinary return events in the other direction).

Have I misread them?
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Post by Robert T »

.
dumbmoney wrote:I agree that it's difficult to get return without risk. But it may be possible to get risk without return (U.S. 1929, Japan 1989, Nasdaq 2000, AAA bonds 2007...), and that's the scenario that would be nice to avoid if possible.
Yes – similar to my earlier take IMO: It would obviously be nice to avoid the downside risks [US 1929, etc], while still capturing the premiums the market pays for them. According to the Ken French market data, from Jul 1926 to Oct. 2009 (1000 months) the annualized market return/annualized standard deviation was 9.7%/18.7. Missing the 5 worst months would have increased returns to 11.5% and lowered volatility to an annualized SD of 17.8, or put another way an end value 3.7 times higher with lower volatility. Missing the 10 worst months resulted in an end value almost 10 times higher. Accurately/exactly missing the worst performance, while benefiting from the best seems to be the marketing timing Holy Grail (again something I think many on Wall Street are trying to do).
pkcrafter wrote:Larry Swedroe has used the 73-74 bear as a benchmark for losses for a long time. Adrian's 2x rule is based on it and it seems to be an accepted standard. The average losses in 2000-2002 and 2008 are within the same range.
Yes, but (as I read it) Larry's message is closer to losses can occur at anytime. Not just during recessions. A big difference IMO, and a view that has more support from the historical data. Again just my take. We are all free to make our own conclusions on risk/performance inside and outside of recessions.
pkcrafter wrote:Diversification won't bail investors out in most cases because in a full blown crash investor shoot first and ask questions later. They get out--of all stocks. When everything is thrown out, correlations go to 1.

Equity (risky asset) correlations trend towards 1, not all asset classes re: high quality bonds in 2008, which I think had one of their highest negative correlations since 1927 (but are often excluded from the correlations go to 1 message). I agree, diversification doesn’t eliminate losses, and that diversification is about risk management - an important message (as Mr. Bernstein says).
Valuethinker wrote:I didn't read Mandelbrot that he was arguing for market timing?
From Mandelbrot’s book:
  • “What is an investor to do? Brokers often advise their clients to buy and hold. Focus on the average annual increases in stock prices they say. Do not try to “time the market,” seeking the golden moment to buy and sell. But this is wishful thinking. What matters is the particular, not the average. Some of the most successful investors are those who did, in fact, get the timing right. In the space of just two turbulent weeks in 1992, George Soros famously profited about $2 billion by betting against the pound. Now, very few of us are in that league, but we can in our modest way take cognizance of concentration [of gains and losses]. Suppose big news has inflated a stock price by 40 percent in a week, more than twice its normal volatility. What are the odds that, anytime soon, yet another 40 percent run will occur? Not impossible, of course, but certainly not large. A prudent investor would do as the Wall Street pros: Take a profit.”
In my reading – not worlds apart from Grantham.

Robert
.
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Post by peter71 »

Yay! This WWMD stuff (what would Mandelbrot do :D ) is if nothing else a lot fresher than our yield curve debates, and that's a weird, or at least much more "conventionalist" quote than I think you'd get from Taleb, i.e., to take a few interpretive liberties:

Mandelbrot: "Do what the pros tell you to do every day on CNBC. Buy some individual stocks and then take some profits in them after a run-up."

Taleb (2004-2008): "Realize that no one's conventional wisdom can protect you. Put most of your money in short Treasurys and the rest in lottery-ticket type options"

All best,
Pete
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Post by Valuethinker »

peter71 wrote:Yay! This WWMD stuff (what would Mandelbrot do :D ) is if nothing else a lot fresher than our yield curve debates, and that's a weird, or at least much more "conventionalist" quote than I think you'd get from Taleb, i.e., to take a few interpretive liberties:

Mandelbrot: "Do what the pros tell you to do every day on CNBC. Buy some individual stocks and then take some profits in them after a run-up."

Taleb (2004-2008): "Realize that no one's conventional wisdom can protect you. Put most of your money in short Treasurys and the rest in lottery-ticket type options"

All best,
Pete
Mandelbrot's advice is not consistent with his theory of 'the blind archer, shooting at a wall' ie returns with very fat tails?

What he is saying is if you find yourself in a bubble, take the money and run?

Problem with Taleb is you can have a year when the S&P500 goes up 20%, and none of your lottery tickets came home.

Transactions costs and taxes will decimate these proposed strategies.

I can relate to Zvi Bodie (TIPS + long call options on the index) better than either of these strategies.

I am all for high return asset classes (eg PE closed end funds) *if* you can find a way to access them cheaply enough.
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Joined: Thu Apr 12, 2007 6:27 pm

Post by Adrian Nenu »

The key is to minimize losses and only take losses which you can handle using risk management. Otherwise you will be wiped out by bear markets. You may give up some return but it is a small price to pay. Or if you don't believe risk management using the IYC is viable, then use a "buy & hold" conservative asset allocation (50% or less equity). At least you will not get killed too bad.

Adrian
anenu@tampabay.rr.com
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