Are Stocks Overvalued? A Survey of Equity Valuation Models

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Maynard F. Speer
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Re: Are Stocks Overvalued? A Survey of Equity Valuation Models

Post by Maynard F. Speer » Sun Jul 26, 2015 3:01 am

Leeraar wrote:That depends on your desired AA. I have Vanguard LifeStrategy Moderate. You can look up its four components for yourself.

Yes, I will grant that an AA that is based on the total global market may have a better risk-adjusted expected return (before expenses) but you can get there with either active or passive strategies. I think a combination of TSM and TBM get you close enough so it does not much matter if you add International or tilt to REITS, etc.

By the way, a "passive" "bond fund" may be a tautology. A friend in our local Bogleheads chapter tells of touring Vanguard in Malvern, PA. The bond department is much larger (in terms of desks) than the stock department. He said that TSM, for all its billions, is managed (monitored) by two guys each with two display monitors, in one cube.

Absolutely agree - it depends on your AA, which in turn depends on how much risk you're willing to take on

I suppose we've lost track of the discussion this sprang from, which was the criticism that changing an asset allocation based on (let's say) unusually high valuations is somehow attempting to 'beat the market' ... Which we can then claim is anti-BH thing to try and do

I don't really know what 'beat the market' means in this context .. On the one hand, there is a global market, and anyone who's ever used leverage or overweighted stocks against it could be described as trying to 'beat' it .. On the other, if your AA is really about risk management, then as risk indicators in a certain market change, it might be perfectly reasonable to adjust your exposure to that risk ... After all, our present concepts of risk and return, per asset class, are only based on past returns - so it's not like we should demand any greater certainty from valuations
"Economics is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions." - John Maynard Keynes

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Re: Are Stocks Overvalued? A Survey of Equity Valuation Models

Post by longinvest » Sun Jul 26, 2015 7:14 am

Leeraar wrote:By the way, a "passive" "bond fund" may be a tautology. A friend in our local Bogleheads chapter tells of touring Vanguard in Malvern, PA. The bond department is much larger (in terms of desks) than the stock department. He said that TSM, for all its billions, is managed (monitored) by two guys each with two display monitors, in one cube.
Of course, we all know that the proper way to measure the passiveness of a bond fund is to look at the size of its investing department, not to look at its tracking error.

Here's an interesting read: ... 1426616391
At Vanguard, his team of 15 people spends all day on the phone with Wall Street dealers acquiring or unloading bonds to make sure the fund’s holdings and returns match its selected index. Mr. Barrickman’s job is to make sure a large investor deposit or a bond downgrade doesn’t throw his fund out of whack with the index, which comprises more than 9,000 bonds.

“We control things to a point that a mistake will not hurt us,” Mr. Barrickman said.
Here's another: ... ll-me-hal/
I’m not really sure how the misconception that running a bond index fund is as simple as turning on a computer got started. Perhaps it’s just easy to think that a computer program could replicate an index of 500 stocks with predetermined weights traded with transparent pricing on exchanges.

But humans play a huge role in our stock index funds, and bonds, in many ways, are more complicated than equities. There are no central exchanges for bonds and minimal transparency into their prices. To buy and sell bonds, we often have to call the individual traders and firms that own those specific securities and negotiate prices with less-than-perfect information. It requires that Vanguard analysts and traders are constantly up-to-date on company (or country) fundamentals and trading levels so we get the best execution for our clients.

The bond market is also much bigger than the stock market. Our broad bond market index funds track the performance of the Barclays U.S. Aggregate Float Adjusted Index, which had 8,958 bonds, compared with just 502 stocks for the S&P 500 Index, both as of October 31, 2014. It would be unwieldy for our broad bond market index funds to own that many securities, so we sample the index, meaning we hold a range of securities that together capture the key risk factors of the index, with the goal of realizing indexlike performance.
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Re: Are Stocks Overvalued? A Survey of Equity Valuation Models

Post by lack_ey » Wed Jul 29, 2015 12:05 pm

longinvest wrote:
cjking wrote:
longinvest wrote: But I am not so naive as not to identify a marketing campaign behind the systematic vocabulary subversion.
While googling for global portfolio stuff, since you posted, I came across someone who thinks that the idea that passive investing exists was something dreamt up by marketing depeartments... :D ... rs-part-2/
I think the idea of “passive” investing is largely a marketing pitch sold by firms who do something that is generally a less “active” form of investing and this alternative perspective is constructed in order to draw a line in the sand thereby creating the illusion that less active forms of investing are something totally different from anything more active.
It is useful to go back to older writings, like a 1991 theorem on which our philosophy is built, to retrieve unambiguous mathematical definitions for words such as "passive", "active", and "market". Most importantly, one can see that the theorem does not assume that there exists a single market of all assets; on the contrary, it lets users of the theorem apply it to whatever market they choose.
Of course, certain definitions of the key terms are necessary. First a market must be selected -- the stocks in the S&P 500, for example, or a set of "small" stocks. Then each investor who holds securities from the market must be classified as either active or passive.

A passive investor always holds every security from the market, with each represented in the same manner as in the market. Thus if security X represents 3 per cent of the value of the securities in the market, a passive investor's portfolio will have 3 per cent of its value invested in X. Equivalently, a passive manager will hold the same percentage of the total outstanding amount of each security in the market.

An active investor is one who is not passive. His or her portfolio will differ from that of the passive managers at some or all times. Because active managers usually act on perceptions of mispricing, and because such misperceptions change relatively frequently, such managers tend to trade fairly frequently -- hence the term "active."
Using these clear and precise definitions, Vanguard's Total Bond Market Index fund is a passive fund. It invests in the market of all investment-grade nominal U.S. bonds with maturity greater than one year. That market excludes junk bonds (not investment-grade) and TIPS (not nominal). Of course, it is not 100% passive, but something like 99%, because it might use derivatives sometimes to avoid market impact and sampling when it is difficult to buy all bonds in the index.

Critics will amplify this 1% and claim that the fund is not passive; that investing in it is an active bet!

Same thing with Vanguard's Total Stock Market Index fund. You'll see it criticized for not being "properly diversified". That investing in it is a bet on "beta", the worst of factors which you should avoid at all costs.

Maybe it's not marketing, but surprisingly, we find this rhetoric in the writing of authors associated with firms that are working hard to compete with Vanguard to attract "passive" investors...
I'm very late on this, but I just realized where I'd seen something before relevant to the discussion.

We keep bringing up William Sharpe's definitions to define passive investing in certain markets while rejecting notions of weighting stocks and bonds by relative market capitalization.

This is fine, but he tends to think of global stocks and bonds as a market and recommends the global portfolio as a starting point: ... cumstances
I would like to see a very-low-cost index fund that buys proportionate shares of all the traded stocks and bonds in the world. Unfortunately, there are none at present. It would be good if there were one or more used by a great many investors as their main investment vehicle. While such a fund is not available, you can construct one from existing index funds, but then you have to monitor the current world values of the components—for example, the value of all the U.S. bonds for the U.S. bond index fund, the value of all the non-U.S. bonds for that fund and the value of all the world stocks for that fund. I’ve talked to my friends in the index fund business, and thus far nobody seems to be interested in producing that. It is a huge hole and individual investors could really use such a fund.
Obviously we think of markets in a way that suits us, and there's not particularly any reason to go by what any one person says. But if applying Sharpe's definitions and reasoning, you should at least consider this facet, lest you just pick and choose what you want to read.

Of course, the distinction between active and passive is not mentioned. He mentions human capital considerations (age) as justification for going riskier or less risky than the global market portfolio.

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