Benjamin Graham thinks current S&P valuations are reasonable

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berntson
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Benjamin Graham thinks current S&P valuations are reasonable

Post by berntson » Wed Feb 26, 2014 7:37 pm

Benjamin Graham wrote:Our basic recommendation is that the stock portfolio, when acquired, should have an overall earnings/price ratio—the reverse of the P/E ratio—at least as high as the current high-grade bond rate. This would mean a P/E ratio no higher than 13.3 against an AA bond yield of 7.5%.
I recently ran across this interesting rule of thumb in chapter eleven of the The Intelligent Investor.

Two things to point out right away. First, Graham thinks that the important thing to do is to compare P/E to the interest rates on long-term bonds. This especially makes sense when one considers that Graham is interested in value, not the prediction of future price movements. Graham wants to know whether stocks are a good buy compared to bonds, not whether current P/E ratios suggest that the markets are "due" for a price correction. The second thing to point out is that Graham is here establishing a maximum P/E ratio for the purchase of stocks. Earlier in the above paragraph, he suggests that he expects investors to generally buy equities at 20% less than the maximum. He also likes to use three-year average earnings rather than annual earnings.

Now we can apply Graham's test to the current valuation of the S&P 500. The 10-year AA rate is 3.5%. Graham's test then recommends that we purchase an S&P 500 index fund only if it has an E/P of more than 3.5%. This is equivalent to having a P/E of less than 28.5. Allowing a 20% margin for error leaves us with a P/E of about 22.8.

Remember that the E for Graham is average three-year earnings. Calculated this way, the S&P 500 has a current P/E of 18.4. Not only is this well-below Graham's maximum, it leaves more than the suggested 20% cushion. So the S&P is now reasonably priced according to Graham's test.

Now let's use the test to look at the market at the end of 1999. At the end of 1999, 10-year investment grade bonds were at 7.4. This means that Graham's test sets a maximum P/E of 13.5 for the prospective buyer of the S&P 500. But the S&P had a P/E of about 31.5 (again, using average three-year earnings). So Graham's test tells the intelligent investor not to touch the S&P 500 in 1999 with a ten-foot pole and hazmat suite.

Let's also look at the end of 2007. 10-year investment grade bonds were at 5.9%. The Graham test then tells the prospective buyer of the S&P to buy the S&P only if it does not have P/E greater than 16.9. As it turns out, the S&P had a P/E of 17.85 (using average three-year earnings). So the S&P would have failed Grahams test in 2007 as well.

A question: Does anyone know of research looking at the predictive power of the ratio of S&P earnings yield to high-grade bond yield when it comes to predicting long-term price movements in the S&P? I want to figure out if this is better or worse than PE10 at predicting long-term market returns.

Conclusion: When we adjust P/E ratios for the yield on high-grade bonds, the S&P looks reasonably priced. Any argument that we should rely on non-adjusted P/E ratios (like PE10) needs to explain why interest rates on bonds are not a relevant factor to whether or not stocks are overvalued.
Last edited by berntson on Thu Feb 27, 2014 12:45 am, edited 1 time in total.

Rodc
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by Rodc » Wed Feb 26, 2014 7:50 pm

That all seems more or less reasonable to me. I expect that Mr Market looks around at his options when allocating his capital. Hard to imagine he doesn't. That said an even more reasonable approach would use a sliding scale to keep within Graham's always stay between 80/20 and 20/80 (or was it 75/25?). That said it would take a lot data to be sufficiently convincing to me.
A question: Does anyone know of research looking at the predictive power of the ratio of S&P earnings yield to high-grade bond yield when it comes to predicting long-term price movements in the S&P? I want to figure out if this is better or worse than PE10 at predicting long-term market returns.
You could do this yourself from Shiller's data freely available on the web.

It seems to me a better question given your post is too simply go month by month and say Stocks or Bonds and follow both out 10 years and see which was best (the post is not about predicting returns per se, but predicting whether stocks or bond will have the highest returns). The trick is to keep to the 20% margin and somehow factor in risk, say go forward 10 years and look at Sharpe Ratio or something. Would be interesting.
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Leesbro63
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by Leesbro63 » Wed Feb 26, 2014 7:53 pm

This assumes bond yields are not just temporarily low due to whatever reasons.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by Rodc » Wed Feb 26, 2014 8:02 pm

Leesbro63 wrote:This assumes bond yields are not just temporarily low due to whatever reasons.
Yeah, and earnings are stable.

It also ignores that E/P tends to be real as earning tend to grow with inflation and in his case bond yields were nominal. Today we could use TIPS rates.

Tons of noise so totally unclear it would work in better in practice than simply buy and hold a fixed allocation.

But, seems more reasonable to me though than the pure P/E10 schemes so many here put forth. I have always advocated that is you are going to P/E10 market time you should factor in bond yields something like this.

Would be interesting to see the data if someone wants to do. I'm too lazy tonight. :)
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by RNJ » Wed Feb 26, 2014 9:33 pm

Interesting post. What might be the appropriate benchmarks for developed ex-US markets (if there is one)? I suspect the "signal" would be green.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by nedsaid » Wed Feb 26, 2014 10:04 pm

Thanks Bernston. A good reminder why I am not selling my stocks.

It reminds me of a Warren Buffett quote that goes something like this, "The market is high, but not as high as it looks."

Thanks for the post.
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lazyday
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by lazyday » Thu Feb 27, 2014 1:18 am

When did Graham write that in relation to the gold standard / Bretton Woods 1971?

Did he write any changes to the idea before his death, 1976? Including speeches.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by swaption » Thu Feb 27, 2014 9:43 am

berntson wrote:Conclusion: When we adjust P/E ratios for the yield on high-grade bonds, the S&P looks reasonably priced. Any argument that we should rely on non-adjusted P/E ratios (like PE10) needs to explain why interest rates on bonds are not a relevant factor to whether or not stocks are overvalued.
Yeah, no doubt. But lots of luck getting the PE10 crowd to take the bait on this one. I have repeatedly brought this up on those threads, without any reasonable response. To be more spectific, the relevant metric is real interest rates, which of course in the current market really tells the same story.

To address the comment by Leesbro63 regarding bond yields being temporarily depressed, this obviously speaks to the question of what the alternative to equities might be, given that the arguement implies that bonds would be suffering from the exact same valuation concern. Do you go to cash? Perhaps, but every year that stocks earn their current yield, it just digs a deeper and deeper hole out of which those in cash would have to climb when their day of vindication finally arrives.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by Leesbro63 » Thu Feb 27, 2014 9:55 am

swaption wrote:To address the comment by Leesbro63 regarding bond yields being temporarily depressed, this obviously speaks to the question of what the alternative to equities might be, given that the arguement implies that bonds would be suffering from the exact same valuation concern. Do you go to cash? Perhaps, but every year that stocks earn their current yield, it just digs a deeper and deeper hole out of which those in cash would have to climb when their day of vindication finally arrives.
Yes, this is the conundrum. There is no where to hide. Take risk in stocks and bonds or take risk in cash. Some might say that 50/50 with the bond side shorter rather than longer would be about as good as you can do. Even though it's still far from "safe".

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by hiddensee » Thu Feb 27, 2014 10:01 am

Thank you for this post. I have no comments, but it was informative to read.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by G-Money » Thu Feb 27, 2014 10:04 am

swaption wrote:
berntson wrote:Conclusion: When we adjust P/E ratios for the yield on high-grade bonds, the S&P looks reasonably priced. Any argument that we should rely on non-adjusted P/E ratios (like PE10) needs to explain why interest rates on bonds are not a relevant factor to whether or not stocks are overvalued.
Yeah, no doubt. But lots of luck getting the PE10 crowd to take the bait on this one. I have repeatedly brought this up on those threads, without any reasonable response. To be more spectific, the relevant metric is real interest rates, which of course in the current market really tells the same story.
I agree. Looking at P/E or PE10 in isolation doesn't provide much insight.

Back when I thought it mattered, I compared PE10 to nominal 10 year Treasury rates. Perhaps 10 year TIPS rates would have been a better metric. I scarcely bother to check anymore, and I definitely don't make any changes to my portfolio based on it.
Don't assume I know what I'm talking about.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by Methedras » Thu Feb 27, 2014 10:19 am

G-Money wrote:
swaption wrote:
berntson wrote:Conclusion: When we adjust P/E ratios for the yield on high-grade bonds, the S&P looks reasonably priced. Any argument that we should rely on non-adjusted P/E ratios (like PE10) needs to explain why interest rates on bonds are not a relevant factor to whether or not stocks are overvalued.
Yeah, no doubt. But lots of luck getting the PE10 crowd to take the bait on this one. I have repeatedly brought this up on those threads, without any reasonable response. To be more spectific, the relevant metric is real interest rates, which of course in the current market really tells the same story.
I agree. Looking at P/E or PE10 in isolation doesn't provide much insight.

Back when I thought it mattered, I compared PE10 to nominal 10 year Treasury rates. Perhaps 10 year TIPS rates would have been a better metric. I scarcely bother to check anymore, and I definitely don't make any changes to my portfolio based on it.
I thought it was a widely held belief (and strategy) to compare the E/P to current bond yields. Are there really people advocating looking at PE statistics in isolation?

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by YDNAL » Thu Feb 27, 2014 10:32 am

Methedras wrote:I thought it was a widely held belief (and strategy) to compare the E/P to current bond yields.
Me 2!.. and *hoped-for* Equity risk premium could be estimated using E/P over current 1-month Treasury rates.
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by G-Money » Thu Feb 27, 2014 10:39 am

There seems to be a somewhat vocal contingent on this forum that appears to look at PE10 as an indicator in isolation. I seem to recall several threads that focused a great deal on the fact that PE10 was >25, with many folks completely ignoring the relatively low yields (and, thus, high valuation) of alternatives such as bonds. I believe at least some of these folks simply planned to sit on the sidelines in cash, but perhaps not.
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by swaption » Thu Feb 27, 2014 10:41 am

Methedras wrote:
G-Money wrote:
swaption wrote:
berntson wrote:Conclusion: When we adjust P/E ratios for the yield on high-grade bonds, the S&P looks reasonably priced. Any argument that we should rely on non-adjusted P/E ratios (like PE10) needs to explain why interest rates on bonds are not a relevant factor to whether or not stocks are overvalued.
Yeah, no doubt. But lots of luck getting the PE10 crowd to take the bait on this one. I have repeatedly brought this up on those threads, without any reasonable response. To be more spectific, the relevant metric is real interest rates, which of course in the current market really tells the same story.
I agree. Looking at P/E or PE10 in isolation doesn't provide much insight.

Back when I thought it mattered, I compared PE10 to nominal 10 year Treasury rates. Perhaps 10 year TIPS rates would have been a better metric. I scarcely bother to check anymore, and I definitely don't make any changes to my portfolio based on it.
I thought it was a widely held belief (and strategy) to compare the E/P to current bond yields. Are there really people advocating looking at PE statistics in isolation?
That of course is the Fed model. Unfortunately, the advocates of PE10 will quickly point to the 'evidence' that PE10 is a far better predictor of future returns than the Fed model. But there are a couple of flaws in that. First of all, even if PE10 is a better predictor, that hardly means that the role of interest rates implied by the Fed model (and any basic finance literature) is irrelevant. But I think the far bigger flaw is that the Fed model was never intended to be a predictor of future returns. If anything, it is intended to be a metric of future relative returns. So maybe PE10 is telling us that expected returns are low. But this misses the important consideration of those expected returns relative to the returns elsewhere.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by kenyan » Thu Feb 27, 2014 11:29 am

Methedras wrote:
I thought it was a widely held belief (and strategy) to compare the E/P to current bond yields. Are there really people advocating looking at PE statistics in isolation?
I see many people posting or doing their analysis exactly in that manner.

I've decided on a new mantra when it comes to all of the valuation/predictions about future performance - What could happen is not a subset of what did happen.
Retirement investing is a marathon.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by berntson » Thu Feb 27, 2014 6:58 pm

Thanks everyone for your thoughts and comments!
swaption wrote: That of course is the Fed model. Unfortunately, the advocates of PE10 will quickly point to the 'evidence' that PE10 is a far better predictor of future returns than the Fed model. But there are a couple of flaws in that. First of all, even if PE10 is a better predictor, that hardly means that the role of interest rates implied by the Fed model (and any basic finance literature) is irrelevant. But I think the far bigger flaw is that the Fed model was never intended to be a predictor of future returns. If anything, it is intended to be a metric of future relative returns. So maybe PE10 is telling us that expected returns are low. But this misses the important consideration of those expected returns relative to the returns elsewhere.
As usual, it looks like I was trying to reinvent someone else's wheel. :D I hadn't heard of the fed model before this thread, so this was exactly the tip I needed. It led me to this paper by Cliff Asness. The paper is well-worth reading and persuasively argues that adding information about interest rates doesn't improve a standard PE10 model for predicting long-term returns. In other words, we shouldn't think that stocks have lower valuations just because interest rates are low.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by staythecourse » Thu Feb 27, 2014 8:01 pm

I don't understand why anyone even attempts to find some magic equation to determine asset allocation. THOUSANDS have done it through out history. These include amateurs sitting at home and professionals who have impressive degrees from around the world with every type of past data and computation abilities available and you know how many have an equation that works?? NO ONE!! And if you believe EMH even if you did find one it would be arbitraged out as everyone figured out how you did it.

Why do folks constantly think they will figure out something that no one else has when it comes to finance when ALL the information is readily available and been rehashed over and over and over and...

Good luck.
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by garlandwhizzer » Thu Feb 27, 2014 8:40 pm

High PE ratios relative to long term averages do in fact suggest lower stock returns relative to long term averages in the future. On the other hand, low bond yields relative to historical averages also suggest lower bond returns going forward with a narrower dispersion of results. Current generous PE ratios for stocks have a wider dispersion of potential future outcomes than do low bond yields which almost rule out inflation-adjusted bond gains in the next 5 - 10 years of greater than 2%. Comparing E/P ratios of stocks to the current yield of 10 year AA bonds focuses on relative, not absolute, expected future returns of these two asset classes. The point of the original post is not that stocks are expected to be pound-the-table buys at current valuations but that, based on current fundamentals, they are likely to outperform bonds going forward, assuming of course that you don't do panic selling during stock market declines. This is not exactly earth shaking news.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by swaption » Thu Feb 27, 2014 9:14 pm

berntson wrote:The paper is well-worth reading and persuasively argues that adding information about interest rates doesn't improve a standard PE10 model for predicting long-term returns. In other words, we shouldn't think that stocks have lower valuations just because interest rates are low.
Oh my goodness. First of all, nobody ever said that interest rates improve a standard PE10 model for predicting returns. Do you know why? Because the PE10 model already reflects all of the interest rate information. Perhaps one can consider an analogy. I'm sure analysis would show that the ratio of bond prices to coupons does a very good job of predicting future returns. The fact that the current level of interest doesn't improve such model's ability to predict future returns hardly constitutes an insight.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by letsgobobby » Fri Feb 28, 2014 9:22 am

We shouldn't have long to wait. Pe10 exceeded 25 last year while yields remained very low, so within 20 years we can come back and see who was right.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by kenyan » Fri Feb 28, 2014 10:57 am

As far as I can tell, those who pay lots of attention to valuations might tell us that the only thing worth buying right now is Emerging Markets. That was also the case last year, and EM has crapped the bed last year and so far this year. Since all of my investments are overvalued (cash, nominal bonds, inflation-protected bonds, domestic large blend, domestic small value, international large cap, international small cap, REIT), I suppose I wouldn't know where else to invest, so I'm glad I'm not a market timer.
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by telemark » Fri Feb 28, 2014 11:20 am

staythecourse wrote:Why do folks constantly think they will figure out something that no one else has when it comes to finance when ALL the information is readily available and been rehashed over and over and over and...
I always understand something better when I go through the work myself.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by berntson » Sat Mar 01, 2014 3:05 pm

I think Benjamin Graham has a really nice way of thinking about valuations. He stresses the importance of distinguishing between investing and speculating. Investors aim to get the most value for their investment dollars. Speculators aim to buy securities before they appreciate in price and sell securities before they depreciate in price. Investors care about value. Speculators care about price.

Graham thinks that the intelligent investor can profit from swings in market pricing. Here is a passage from chapter eight of The Intelligent Investor.
Benjamin Graham wrote:Since common stocks, even of investment grade, are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings.
This is surprising, since it sounds like Graham is advocating market timing a speculating, not intelligent investing. But Graham at least thinks that he isn't. He distinguishes market timing and pricing.
Benjamin Graham wrote: There are two possible ways by which he may try to [profit from market swings]: the way of timing and the way of pricing. By timing we mean the endeavor to anticipate the action of the stock market—to buy or hold when the future course is deemed to be upward, to sell or refrain from buying when the course is downward. By pricing we mean the endeavor to buy stocks when they are quoted below their fair value and to sell them when they rise above such value.
The distinction between the way of pricing and the way of timing is easier to see in the case of bonds. Suppose you have a portfolio of short-term government bonds yielding .1% and are considering whether to trade them for thirty-year treasuries yielding 3.5%. There are two approaches that you might take to the decision. If you are in the business of timing, you might avoid the longer-term bonds because you think that the market has misjudged the probability of large increases in interest rates. You hold onto your short-term bonds because you have certain views about how the prices of long-term bonds will evolve, and you want to take advantage of those price movements.

On the other hand, you might avoid the thirty-year bonds because you think the interest rate is just too damn low. It isn't worth taking on the term risk of long-term bonds to achieve a paltry 3.5% nominal return. You have no views about what the price of those bonds will do in the future. In particular, you have no idea whether there will by higher-yielding bonds available to purchase in the coming years. All you know is that long-term bonds presently offer too little value compared to your short-term treasuries.

Now we need to solve a puzzle. What is to stocks as yield is to bonds? For now, call this mysterious quantity "value." One idea is that long-term expected returns are to stocks and yield is to bonds. We then use PE10 or some such thing to estimate long-term returns, then say that stocks are a good value if they have sufficiently high long-term expected returns.

Benjamin Graham would not approve. The problem is that estimating long-term expected returns necessarily involves estimating long-term speculative returns. Long-term returns don't just depend on the success of the underlying businesses, they depend on long-term trends in how much investors are willing to pay for that success. PE10 may predict long-term returns because it predicts long-term speculative trends. A project for the future (or for other enterprising Bogleheads): figure out whether PE10 predicts things like earnings, book value, earnings growth, sales, and so on. I conjecture that it does not.

I don't have a good answer to our puzzle. But am confident that Graham might endorse a claim like this. If you are changing your stock/bond allocation because of long-term price predictions, you are taking the way of timing and speculation. If you are changing your stock/bond allocation because you think that board-market index funds offer too little value (too little earnings, earnings growth, book value, whatever...), then you may well be an intelligent investor on the way of value.

The line between value investing and market timing is an important one, and not always easy to draw. But it can be drawn.
Last edited by berntson on Sun Mar 02, 2014 1:37 am, edited 2 times in total.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by packer16 » Sat Mar 01, 2014 4:49 pm

The Intelligent Investor breaks investors into two types, defensive or passive and enterprising or active investor. For the defensive or passive investor the index fund or the list of the type of stocks using the following criteria were suggested:

1. A portfolio of between 10 and 30 stocks (he recommends against extensive diversification greater than 30 stocks)
2. Companies should be large ($100m in 1972 dollars)
3. Companies should have current assets > 2x current liabilities and LT debt no more than 2x current assets
4. Some earnings for the past 10 years and dividends for 20 years
5. 33% earnings increase over the past 10 years
6. P/E less than 15
7. Product of P/E and P/BV not greater than 22.5

For the active or enterprising investors he suggests bargain issues or work-out types of situations. These typically require developing a valuation for each stock and buying at a discount of 33% to the estimated value. In other words if you are wired like an active investor do your own research if a passive investor then develop groups of stocks with value "tilts". He downplays funds as Bogle and others due to not performing better than a low cost index over time.

Most of the folks here are of the defensive type. What I find interesting is he recommends even for passive investors to watch valuation. His approach in either case is to "tilt" the portfolio to value and don't be too concerned about diversification as long as you can get a value "tilt".

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by lazyday » Sat Mar 01, 2014 4:52 pm

kenyan wrote:I suppose I wouldn't know where else to invest, so I'm glad I'm not a market timer.
A market timer might move some from small value to EM. And maybe increase cash or other fixed income. That is absolutely not a suggestion!

As a market timer myself, and a very high % equity person, I found 2007 much more difficult than today.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by terrabiped » Sat Mar 01, 2014 7:21 pm

berntson wrote:
Benjamin Graham wrote:Our basic recommendation is that the stock portfolio, when acquired, should have an overall earnings/price ratio—the reverse of the P/E ratio—at least as high as the current high-grade bond rate. This would mean a P/E ratio no higher than 13.3 against an AA bond yield of 7.5%.
The words "when acquired" stood out for me. I can easily see the rationale for acquiring stocks when the price is low. But should one go so far as to sell stocks one has held for a long time because the market has becomes significantly overvalued? I'm thinking of the S&P 500 around 1999, or Japan's stock market around 1990. Stay the course even in those circumstances, or reduce your exposure? I don't know. I'm asking.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by berntson » Sat Mar 01, 2014 8:31 pm

terrabiped wrote:
berntson wrote:
Benjamin Graham wrote:Our basic recommendation is that the stock portfolio, when acquired, should have an overall earnings/price ratio—the reverse of the P/E ratio—at least as high as the current high-grade bond rate. This would mean a P/E ratio no higher than 13.3 against an AA bond yield of 7.5%.
The words "when acquired" stood out for me. I can easily see the rationale for acquiring stocks when the price is low. But should one go so far as to sell stocks one has held for a long time because the market has becomes significantly overvalued? I'm thinking of the S&P 500 around 1999, or Japan's stock market around 1990. Stay the course even in those circumstances, or reduce your exposure? I don't know. I'm asking.
That's an excellent question, one that I also don't know the answer to. I suspect that it will have different answers depending on ones tax situation and capital gains? Selling stocks whose price has exceeded their value may sometime make sense before taxes, but then no longer make sense once taxes are taken into account.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by 500Kaiser » Sat Mar 01, 2014 10:15 pm

I have never read Mr. Graham's The Intelligent Investor. This thread has inspired me to finally order and do so as my next financial read. Thank you.
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by packer16 » Sat Mar 01, 2014 11:04 pm

I really like the Intelligent Investor because the issues that were issues then are issues now and the 50+ years of market experience condensed into this book provide some of the best advice about the nature of markets which never change.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by DRiP Guy » Sat Mar 01, 2014 11:44 pm

berntson wrote:I think Benjamin Graham has a really nice way of thinking about valuations. He stresses the [importance?] of distinguishing between investing and speculating. Investors aim to get the most value for their investment dollars. Speculators aim to buy securities before they appreciate in price and sell securities before they depreciate in price. Investors care about value. Speculators care about price.
[snipage]
...
The line between value investing and market timing is an important one, and not always easy to draw. But it can be drawn.
Thanks for writing my favorite post in an otherwise already excellent thread.

Well-stated and well-thought out; whether Graham would actually subscribe to it, or not.

I didn't quote it, but do also agree on the point regarding PE10 as a single metric very likely not being 'inclusive' enough, regarding other important possible value indicators, sufficient to base the buy-sell decision on alone.

In my own mind, it forever comes down to the question: "Do I want to attempt to optimize my returns, at some higher levels of both known and unknown risk; or does my plan allow me to rely on accepting whatever the broad market returns, less expenses?"

If one is willing (able) to accept market returns, then so much of the particularly difficult and particularly dangerous (imho) part of investing just falls away.

:sharebeer

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by Fat-Tailed Contagion » Sun Mar 02, 2014 12:29 am

Why do you think he used a AA bond and not a 10-year Treasury ?
“The intelligent investor is a realist who sells to optimists and buys from pessimists.” | ― Benjamin Graham, The Intelligent Investor

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by mnvalue » Sun Mar 02, 2014 1:07 am

packer16 wrote:1. A portfolio of between 10 and 30 stocks (he recommends against extensive diversification greater than 30 stocks)
2. Companies should be large ($100m in 1972 dollars)
I've not yet read the book, and probably should, but how much of #1 is because it was written in 1972 when index funds weren't available and stock investing was more expensive?

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by packer16 » Sun Mar 02, 2014 6:38 am

I think what he is expressing is a real trade-off in portfolio construction. If you accept that tilting towards value makes sense, then as you add more securities in your portfolio the amount of the tilt goes down because the first securities are going to have most value tilt. So the question comes down to does the increased exposure to value outweigh the volatility of less diversification. Graham thinks that at greater than 10 securities the increased benefit of diversification does not overcome the benefit of value tilt. That is one reason I think the widely held maxim that diversification is a free lunch is not true, it may be a cheap lunch but it is not free.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by LittleD » Sun Mar 02, 2014 6:50 am

letsgobobby wrote:We shouldn't have long to wait. Pe10 exceeded 25 last year while yields remained very low, so within 20 years we can come back and see who was right.

We've had these discussions in several threads and over several years and I have no quibble with those who just stay the course and rebalance once a year. Some of us who use PE/10 to mitigate risk in our stock portfolio would rather sacrifice return when stocks are expensive and live to fight another day. My IPS mandates that at PE10 over 25, I start to move my allocation of 50/50 stocks-bonds to 40/50/10 stocks-bonds-cash. I do this because stocks are more risky than they were at PE/10 of 20. At PE/10 of 30, I would start to move my allocation to 30/50/20. I have no idea if stocks will go down tomorrow, next month or next year. I know that risk is rising and my IPS tries to fight risk. I have no quibble with those who want to use Earnings comparisons to interest rates execpt that since 2008 the FED has manipulated interest rates on both the short and long end. Since interest rates have been not allowed to float and markets to set them, I don't feel they are valid comparisons in a free market environment. Now if PE/10 was to fall to below 15 I would gladly move my allocations to something like 70/30 stocks-bonds because my risk monitor would allow it. I suspect that as the FED removes QE over the next year, interest rates may rise at a faster rate exposing stock prices to more competition and greater risk. At my age, I care more about controlling risk than making a few extra bucks. For those who still have decades to invest and are in taxable accounts, I would just follow the Boglehead creed and stay the course following their IPS and sleeping soundly at nite.

There are many roads to Dublin so good luck with yours!!!

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by terrabiped » Sun Mar 02, 2014 9:39 am

LittleD wrote:
letsgobobby wrote:We shouldn't have long to wait. Pe10 exceeded 25 last year while yields remained very low, so within 20 years we can come back and see who was right.

We've had these discussions in several threads and over several years and I have no quibble with those who just stay the course and rebalance once a year. Some of us who use PE/10 to mitigate risk in our stock portfolio would rather sacrifice return when stocks are expensive and live to fight another day. My IPS mandates that at PE10 over 25, I start to move my allocation of 50/50 stocks-bonds to 40/50/10 stocks-bonds-cash. I do this because stocks are more risky than they were at PE/10 of 20. At PE/10 of 30, I would start to move my allocation to 30/50/20. I have no idea if stocks will go down tomorrow, next month or next year. I know that risk is rising and my IPS tries to fight risk. I have no quibble with those who want to use Earnings comparisons to interest rates execpt that since 2008 the FED has manipulated interest rates on both the short and long end. Since interest rates have been not allowed to float and markets to set them, I don't feel they are valid comparisons in a free market environment. Now if PE/10 was to fall to below 15 I would gladly move my allocations to something like 70/30 stocks-bonds because my risk monitor would allow it. I suspect that as the FED removes QE over the next year, interest rates may rise at a faster rate exposing stock prices to more competition and greater risk. At my age, I care more about controlling risk than making a few extra bucks. For those who still have decades to invest and are in taxable accounts, I would just follow the Boglehead creed and stay the course following their IPS and sleeping soundly at nite.

There are many roads to Dublin so good luck with yours!!!
This seems like a reasonable strategy to me.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by William Million » Sun Mar 02, 2014 10:18 am

Very well said. But of course you'll draw the ire of the PE10 cult.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by YDNAL » Mon Mar 03, 2014 3:00 pm

LittleD wrote:My IPS mandates that at PE10 over 25, I start to move my allocation of 50/50 stocks-bonds to 40/50/10 stocks-bonds-cash. I do this because stocks are more risky than they were at PE/10 of 20. At PE/10 of 30, I would start to move my allocation to 30/50/20. I have no idea if stocks will go down tomorrow, next month or next year. I know that risk is rising and my IPS tries to fight risk..... <snip> At my age, I care more about controlling risk than making a few extra bucks.
Exactly my view.

NO ONE knows the future, but we ALL can have *opinions and guesstimates*. Mine is that a future based on the S&P 500 Price of 25x, 30x the smoothed earnings of the past 10 years can't look very bright.... can it ?
LittleD wrote:At my age, I care more about controlling risk than making a few extra bucks.
I hear you!.. all of this supposed to be driven by Ability & Need for risk. :beer
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by G-Money » Mon Mar 03, 2014 3:28 pm

Fat-Tailed Contagion wrote:Why do you think he used a AA bond and not a 10-year Treasury ?
Just a guess, maybe AA was the average credit rating of the stocks that Graham considered investing in? So perhaps he was essentially considering whether it would be better to own the company or loan the company money?
Don't assume I know what I'm talking about.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by LittleD » Mon Mar 03, 2014 3:30 pm

YDNAL wrote:
LittleD wrote:My IPS mandates that at PE10 over 25, I start to move my allocation of 50/50 stocks-bonds to 40/50/10 stocks-bonds-cash. I do this because stocks are more risky than they were at PE/10 of 20. At PE/10 of 30, I would start to move my allocation to 30/50/20. I have no idea if stocks will go down tomorrow, next month or next year. I know that risk is rising and my IPS tries to fight risk..... <snip> At my age, I care more about controlling risk than making a few extra bucks.
Exactly my view.

NO ONE knows the future, but we ALL can have *opinions and guesstimates*. Mine is that a future based on the S&P 500 Price of 25x, 30x the smoothed earnings of the past 10 years can't look very bright.... can it ?
LittleD wrote:At my age, I care more about controlling risk than making a few extra bucks.
I hear you!.. all of this supposed to be driven by Ability & Need for risk. :beer

As I said, I have no problem if you take a different view than mine. If you feel good about your portfolio and confident in a long, prosperous future stay the course and weather the eventual storms. If you have a long horizon then wait for those eventual crashes and buy everything you can. I weathered the inflationary 1970's, the oil shocks of the 80's, the crash of 1987, the tech bubble and the great recession. I did my share of rebalancing at bottoms and riding some bulls so I do know that in the end stocks vary and normally have more deviations than bonds. My road to Dublin is a little more crooked than yours but hey, no worries mate...

Good Luck!!!

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by LittleD » Mon Mar 03, 2014 3:49 pm

G-Money wrote:
Fat-Tailed Contagion wrote:Why do you think he used a AA bond and not a 10-year Treasury ?
Just a guess, maybe AA was the average credit rating of the stocks that Graham considered investing in? So perhaps he was essentially considering whether it would be better to own the company or loan the company money?

I suppose he preferred Company's more than Government's debt. The caveat is that your pretty sure to be repaid by the U.S. treasury even if they have to print it. Now whether that money will buy anything is an issue for another board.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by BlueEars » Mon Mar 03, 2014 4:20 pm

Coincidentally I was looking at the Fed Model a few weeks ago and noticed this is one of the few indicators that was really flashing red before the October 1987 crash. That is, PE1 yield - 10 yr Treasury = -4.6% in Sept 1987 was highly negative at that time. The current value is +2.6%. Moving some to bonds on a highly negative number seems a decent tactic but this doesn't occur often. The last time it was very negative was Jan 2000 when it was -3.6%.

Buy and holders can ignore this. No flames please. :happy

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by LittleD » Mon Mar 03, 2014 8:48 pm

BlueEars wrote:Coincidentally I was looking at the Fed Model a few weeks ago and noticed this is one of the few indicators that was really flashing red before the October 1987 crash. That is, PE1 yield - 10 yr Treasury = -4.6% in Sept 1987 was highly negative at that time. The current value is +2.6%. Moving some to bonds on a highly negative number seems a decent tactic but this doesn't occur often. The last time it was very negative was Jan 2000 when it was -3.6%.

Buy and holders can ignore this. No flames please. :happy

Just please remember that if you are doing Fed model calculations today they are hopelessly biased because of Fed manipulation of interest rates on the short & long ends of the curve since 2008. Rates you see today are still being influenced by the remainder of QE being pumped into the bond market each month. Until the Fed removes the punch bowl, I would not trust the Fed model too much to determine if stocks are still screaming buys. If interest rates start to back up as QE is removed, stocks will not seem so attractive and what goes down does so much faster than they go up.

Just sayin!!!

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by BlueEars » Mon Mar 03, 2014 9:53 pm

LittleD wrote:
BlueEars wrote:Coincidentally I was looking at the Fed Model a few weeks ago and noticed this is one of the few indicators that was really flashing red before the October 1987 crash. That is, PE1 yield - 10 yr Treasury = -4.6% in Sept 1987 was highly negative at that time. The current value is +2.6%. Moving some to bonds on a highly negative number seems a decent tactic but this doesn't occur often. The last time it was very negative was Jan 2000 when it was -3.6%.

Buy and holders can ignore this. No flames please. :happy

Just please remember that if you are doing Fed model calculations today they are hopelessly biased because of Fed manipulation of interest rates on the short & long ends of the curve since 2008. Rates you see today are still being influenced by the remainder of QE being pumped into the bond market each month. Until the Fed removes the punch bowl, I would not trust the Fed model too much to determine if stocks are still screaming buys. If interest rates start to back up as QE is removed, stocks will not seem so attractive and what goes down does so much faster than they go up.

Just sayin!!!
The point I am making is that extreme negative values for PE1_yield - 10yr_Treasury are something to be concerned about. I'm not talking about stuff "in the middle". So I'm not making any strong statements about what this sort of measurement says about today. But clearly we are nowhere near extreme negative values.

As an example of extremities, in Sept 1987 we had PE1 = 20 and 10 yr Treasuries at 9.6%. Real rates were very high then.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by cb474 » Mon Mar 03, 2014 10:15 pm

G-Money wrote:There seems to be a somewhat vocal contingent on this forum that appears to look at PE10 as an indicator in isolation. I seem to recall several threads that focused a great deal on the fact that PE10 was >25, with many folks completely ignoring the relatively low yields (and, thus, high valuation) of alternatives such as bonds. I believe at least some of these folks simply planned to sit on the sidelines in cash, but perhaps not.
It does seem like some people treat PE10 > 25 as a bubble indicator. Shiller himself uses this kind of language, so it should not be surprising that others view it this way. People then worry that they should get out, before the bubble bursts. But bernston's point about Graham is that PE is more of an indicator of future potential returns and one has to consider that relative to bond yields. You're not just getting out of equities, you're getting into something else. Getting out of equities, to avoid a possible crash (which is always possible), only to go into bonds (or worse cash) that guarantee a real loss (at the moment) doesn't make a lot of sense. As Swedroe likes to say, a strategy is only good before the fact, not in hindsight. We're always hedging out bets. Thinking in terms of future potential returns and making choices based on one's need and ability to take risk makes sense. Looking for magical bubble indicators does not.

*
terrabiped wrote:
berntson wrote:
Benjamin Graham wrote:Our basic recommendation is that the stock portfolio, when acquired, should have an overall earnings/price ratio—the reverse of the P/E ratio—at least as high as the current high-grade bond rate. This would mean a P/E ratio no higher than 13.3 against an AA bond yield of 7.5%.
The words "when acquired" stood out for me. I can easily see the rationale for acquiring stocks when the price is low. But should one go so far as to sell stocks one has held for a long time because the market has becomes significantly overvalued? I'm thinking of the S&P 500 around 1999, or Japan's stock market around 1990. Stay the course even in those circumstances, or reduce your exposure? I don't know. I'm asking.
I think, as if often the case when speaking of Japan in 1990 (especially) or in this case also the S&P in 1999, this is a problem of not having a globally diversified portfolio masquerading as a concern about valuations and bubbles. If one is not expecting to ride out crashes and recoveries, then one should not be invested in equities at all. If one fears a Japan scenario, one probably has way too much domestic bias in their portfolio. (And if one fears a global equity market Japan scenario, then I think one has unfounded or misplaced fears, because twenty years of global economic deflation means we're all screwed, regardless of how our money is invested.)

*
LittleD wrote:We've had these discussions in several threads and over several years and I have no quibble with those who just stay the course and rebalance once a year. Some of us who use PE/10 to mitigate risk in our stock portfolio would rather sacrifice return when stocks are expensive and live to fight another day. My IPS mandates that at PE10 over 25, I start to move my allocation of 50/50 stocks-bonds to 40/50/10 stocks-bonds-cash. I do this because stocks are more risky than they were at PE/10 of 20. At PE/10 of 30, I would start to move my allocation to 30/50/20. I have no idea if stocks will go down tomorrow, next month or next year. I know that risk is rising and my IPS tries to fight risk. ... At my age, I care more about controlling risk than making a few extra bucks. For those who still have decades to invest and are in taxable accounts, I would just follow the Boglehead creed and stay the course following their IPS and sleeping soundly at nite.
I guess I wonder if you are mitigating risk or only sacrificing potential return.

To wit, I think this strategy really depends on how one views risk and what one thinks the PE10 means. The PE10 > 25 (or at any number above the historical mean) tells us that the expected returns for the equity market are lower than their historical average. But that does not necessarily mean that risk is higher, except the risk of less returns. But moving from securities (equities) just because of historically lower potential returns, to securities (bonds) with guaranteed even lower returns doesn't make a lot of sense.

On the other hand, if one thinks the PE10, as I note above, is a bubble indicator and the risk is a risk of a crash, then there might be some logic to this strategy. But I suppose that depends on whether or not one believes in a random walk theory of equity prices or a mean reversion theory. Where the "risk" of equities means a risk of a crash, then if one subscribes to random walk the "risk" is not greater when PE10 is 25 or 15 or whatever. But if one subscribes to mean reversion then one could believe the risk of a crash is greater at PE25.

On the other hand, as I say above, if one is not prepared to ride out a crash and recovery then one shouldn't be invested in equities at all. One should only invest as much in equities as they can stand to ride out (which of course depends on one's timeline, as well as other personal variables). So I suspect someone who has a strategy of moving their asset allocation around based on PE10 really is just taking on more equity risk than they can stomach and perhaps would be just as well off lowering their equity allocation permanently.

I also wonder, if one did simulations on historical data with buy and hold on a 50/50 asset allocation, versus an allocation based on 50/50 but shifted around depending on PE10 being above or below 25, if over any period of time the latter strategy does better or has less risk (in terms of standard of deviation). I'm skeptical. Because of course, switching around one's asset allocation runs the risk of missing out of equity returns as much as losses. Doesn't buy and hold tell us that all strategies based on shifting around asset allocations relative to market indicators do no better than random and lose out due to costs? If a PE10 over 25 strategy really delivered better risk adjusted returns in a predicatble manner than simply buy and hold with an approrpiately selected fixed income allocation, wouldn't someone already be running a fund like that?

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by LittleD » Tue Mar 04, 2014 6:59 am

I certainly understand your position and I don't really find fault with your analysis. You are right that cash pays nothing today but what will
it pay next year if QE goes away and inflation returns. If we get 3+ % GDP growth this year as many expect we will see inflation in the U.S.
Short rates will rise if the Fed removes stimulus so being in cash may not be so bad with stock prices being at 5 yr. highs. I have been
averaging over 8% real returns these past 5 years and I don't want to risk giving them back at my age. I'm just following my IPS with PE/10
boundaries and I don't mind sacrificing some potential return for less risk in my global portfolio. My Std Deviations have been below 7 these years
and my current allocation would likely only lose about 15% if we had a bubble crash which I don't expect any time soon. Like the squirrels did last
September, I'm just preparing for the cold winter that nobody sees coming.

Good fortune with your investments though!!!

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by YDNAL » Tue Mar 04, 2014 8:16 am

LittleD wrote:
YDNAL wrote:
LittleD wrote:My IPS mandates that at PE10 over 25, I start to move my allocation of 50/50 stocks-bonds to 40/50/10 stocks-bonds-cash. I do this because stocks are more risky than they were at PE/10 of 20. At PE/10 of 30, I would start to move my allocation to 30/50/20. I have no idea if stocks will go down tomorrow, next month or next year. I know that risk is rising and my IPS tries to fight risk..... <snip>
Exactly my view.

NO ONE knows the future, but we ALL can have *opinions and guesstimates*. Mine is that a future based on the S&P 500 Price of 25x, 30x the smoothed earnings of the past 10 years can't look very bright.... can it ?
LittleD wrote:At my age, I care more about controlling risk than making a few extra bucks.
I hear you!.. all of this supposed to be driven by Ability & Need for risk. :beer
As I said, I have no problem if you take a different view than mine. If you feel good about your portfolio and confident in a long, prosperous future stay the course and weather the eventual storms. If you have a long horizon then wait for those eventual crashes and buy everything you can. I weathered the inflationary 1970's, the oil shocks of the 80's, the crash of 1987, the tech bubble and the great recession. I did my share of rebalancing at bottoms and riding some bulls so I do know that in the end stocks vary and normally have more deviations than bonds. My road to Dublin is a little more crooked than yours but hey, no worries mate...

Good Luck!!!
I was largely agreeing with you, in case you didn't notice, so it is unclear why "you have no problem if you take a different view than mine."

That said, I do let my Ability & Need for risk guide my investment decisions and let all the noise be what it is. As such, increased Price per Earnings may be representative of lower future return. In your case, though, you take other steps and let PE10 of 25 or 30 influence your AA - like moving 20% to Cash.
LittleD wrote:My IPS mandates that at PE10 over 25, I start to move my allocation of 50/50 stocks-bonds to 40/50/10 stocks-bonds-cash. I do this because stocks are more risky than they were at PE/10 of 20. At PE/10 of 30, I would start to move my allocation to 30/50/20.
Good luck to you too!!!
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by swaption » Tue Mar 04, 2014 10:30 am

LittleD wrote:Some of us who use PE/10 to mitigate risk in our stock portfolio would rather sacrifice return when stocks are expensive and live to fight another day.
This seems to be a popular refrain, the risk mitigation vs. market timing angle. But in my mind there is that other risk that this is merely rationalization. It is entirely possible that those employing such a strategy are decreasing risk at times when it will prove to have been unwarranted. Then there is the converse scenario, where one might assume more risk at times that end up resulting in an adverse outcome.

In my opinion, we have had some relatively severe outcomes and volatility over the last 15 years. For many investors, it has been difficult to sit idly by while these cycles wreak havoc with portfolios and emotions. But I think it is a mistake to latch onto these types of approaches for some false sense of risk mitigation, when the only true form of risk mitigation should come from portfolio constrcution and asset allocation. Market timing as a tool for risk mitigation is still market timing. If the wisdom indicates that efforts to employ market timing to enhace returns are futile, then the same would be true in terms of being able to mitigate risk. The impression of safety is not necessarily safety.

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by LittleD » Tue Mar 04, 2014 2:33 pm

swaption wrote:
LittleD wrote:Some of us who use PE/10 to mitigate risk in our stock portfolio would rather sacrifice return when stocks are expensive and live to fight another day.
This seems to be a popular refrain, the risk mitigation vs. market timing angle. But in my mind there is that other risk that this is merely rationalization. It is entirely possible that those employing such a strategy are decreasing risk at times when it will prove to have been unwarranted. Then there is the converse scenario, where one might assume more risk at times that end up resulting in an adverse outcome.

In my opinion, we have had some relatively severe outcomes and volatility over the last 15 years. For many investors, it has been difficult to sit idly by while these cycles wreak havoc with portfolios and emotions. But I think it is a mistake to latch onto these types of approaches for some false sense of risk mitigation, when the only true form of risk mitigation should come from portfolio constrcution and asset allocation. Market timing as a tool for risk mitigation is still market timing. If the wisdom indicates that efforts to employ market timing to enhace returns are futile, then the same would be true in terms of being able to mitigate risk. The impression of safety is not necessarily safety.

As I said in my 1st post...My way probably will not be useful for true bogleheads who loathe any scenario that can be aligned with market timing. If you wish to equate my IPS using PE/10 blocks to adjust allocations to stocks then so be it. Anything that makes you feel better and sleep better at nite just stick to it and do it. Like I said, my IPS works for me and I have never allocated less than 30% to stocks so I'm not selling out at any point in a market cycle. If I am limiting my returns so be it. I am close to reaching my goal for my retirement years and I do not intend to upset the apple cart for 5% more return. You should not even read this thread and just stick to your IPS and stay the course especially if you have decades before retirement. I'm not really trying to sell anything to anybody except that I was commenting on using the FED model to downrate the PE/10 approach many use on this board.
The Fed has biased short and long interest rates and they are not useful for determining the attractiveness of market PE's IMVHO.

Good Luck and fortune to you, sir...

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Re: Benjamin Graham thinks current S&P valuations are reason

Post by cb474 » Tue Mar 04, 2014 6:33 pm

LittleD wrote:If I am limiting my returns so be it. ...
My point and it appears swaption was thinking something similar, is that you seem to think that you are sacrificing potential returns in exchange for mitigating your risk, when PE10 is greater than 25. But I think that my be an entirely false assumption, with no real basis in a more rational assessment of the possibilities.

I think that you may actually be increasing your risk and not protecting yourself at all from the effects of market crashes. In particular, if you believe in a random walk theory of returns, by trying to time the market you aren't protecting yourself from crashes at all. They are just as likely (as far as I understand the random walk) when PE10 is under 25 as when they are over. In addition, by market timing based on PE10, you may be doing nothing more than increasing the likelihood that you sell low and buy high, while still being subject to market crashes whenever they happen. I think that would increase the standard of deviation of your portfolio, not decrease it.

If your concern is that sometimes 50% equities is too much (when PE10 is over 25), then it seems to me your equity allocation is just too high for your needs and emotional proclivities. I also suspect that something like a 40% equities, 60% bonds buy and hold allocation might actually have less standard of deviation and better returns than your market timing scheme, thereby achieving your stated goals of mitigating risk better than your PE10 > 25 scheme. This was why I wondered above if one did monte carlo simulations with historical data based on your scheme versus a buy and hold portfolio with less than 50% equities, if the buy and hold portfolio would actually turn out to have less risk.

So I guess I just don't buy your assumption that what your scheme does it trade potential returns for less risk. It seems entirely plausible to me that your scheme actually increases your risk and decreases your returns, which seems like the worst of both worlds.

In the end, if you have all the money in the world then it doesn't matter. You can afford to increase your risk in addition to getting less returns. But if you need your portfolio to grow to continue to meet your needs, then you could be increasing your risk that you will run out of money while you still need it.

I can believe that your scheme helps you sleep better at night, but as I say it may be an illusion that it actually decreases your risk. In which case, you could just permanently decrease your equity allocation, have less risk and the same or perhaps better returns, sleep better all the time, and not have to fuss over PE10.

*

I also don't understand why you see a move into cash as a protection against unexpected inflation. If that's your concern, you should be holding TIPS. In fact, the move into cash to me seems to be one of the biggest risk increasing parts of your scheme, since it is a guaranteed real loss and since the timing of your move back into the market is far more likely to be wrong than right. I don't see the purpose of cash in a portfolio, other than for short term emergency funds.

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