You Can Market Time At Valuation Extremes

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Youngblood
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Re: You Can Market Time At Valuation Extremes

Post by Youngblood » Sun Jul 01, 2018 3:33 pm

Dandy wrote:
Mon Jun 18, 2018 9:58 am
The problem with market timing at valuation extremes are the "being right too early" problem that I posted about earlier and also the definition of "extreme valuations."
First I am not making any case the current markets are overvalued or extremely overvalued. Just that the topic needs to be explored in more detail than essentially being dismissed with a few words of guidance.

There is a risk for "being early" and there is a risk in being late. The stage of live, the risk tolerance you think you have, and your investment goal e.g. growth vs asset preservation, etc. come into play as to which risk -- early or late is a bigger concern. For quite some time my goal has been asset preservation thus a rather modest equity allocation of 43%. If I was in my 30's or 40's I would still have growth as a goal and not want to be "early" I'd take a risk since I would have sufficient human capital to still reach my goals.

Jack, near retirement age (and in questionable health) reduced his equity allocation by 15 or 20% e.g. from say 70% to 50%. That is a major change. It turned out to be a great call. I don't expect any more detailed research, analysis etc to be right all the time. But, as valuations rise risk likely rises also - we need better information of when that rise in risk is becoming a problem that normal rebalancing isn't necessarily enough. Agreed it will not be with a very high degree of certainty. And we need that general guidance from a trusted source based on some reasonable analysis not from some media hype/analyst.

I agree this is not an easy task and may be relatively impossible. But, Mr. Bogle blessed it in rare occasions and I think it needs more analysis/discussion. Otherwise it seems we will only recognize extreme overvaluation after the fact when many have lost a significant amount.
Such a great post, causing a slew of what ifs in my mind. Don't we all, at least, wish we knew when to fold? OTOH, what would happen if someone actually could recognize extreme overvaluation, reported it and most investors believed and acted on it?

Anyway, like you said, not easy and relatively impossible but interesting to discuss.

BTW, being a retiree like you, I did the only thing I could to protect myself by reducing my equity allocation at a time I thought the market had significant downside risk.
"I made my money by selling too soon." | Bernard M. Baruch

Random Walker
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Re: You Can Market Time At Valuation Extremes

Post by Random Walker » Sun Jul 01, 2018 3:41 pm

Can’t time a market, but I do believe one can somewhat judiciously and opportunistically time their glidepath to the retirement portfolio. This is why I somewhat disagree with Target Date Funds. They only account for our age in determining glidepath. Why not account for other variables than just age when moving towards the retirement AA. I think it’s also beneficial to account for past returns, current valuations, future expected returns, changing ability willingness need when moving to the retirement AA. This likely results in more of a stepwise transition to the retirement AA than a smooth glide. If the market has been more generous than expected, net worth greater than expected, and future expected returns less, why not take more than a measles 1-2% in a given year if approaching retirement?

Dave

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nedsaid
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Re: You Can Market Time At Valuation Extremes

Post by nedsaid » Sun Jul 01, 2018 4:46 pm

Youngblood wrote:
Sun Jul 01, 2018 3:33 pm
Dandy wrote:
Mon Jun 18, 2018 9:58 am
The problem with market timing at valuation extremes are the "being right too early" problem that I posted about earlier and also the definition of "extreme valuations."
First I am not making any case the current markets are overvalued or extremely overvalued. Just that the topic needs to be explored in more detail than essentially being dismissed with a few words of guidance.

There is a risk for "being early" and there is a risk in being late. The stage of live, the risk tolerance you think you have, and your investment goal e.g. growth vs asset preservation, etc. come into play as to which risk -- early or late is a bigger concern. For quite some time my goal has been asset preservation thus a rather modest equity allocation of 43%. If I was in my 30's or 40's I would still have growth as a goal and not want to be "early" I'd take a risk since I would have sufficient human capital to still reach my goals.

Jack, near retirement age (and in questionable health) reduced his equity allocation by 15 or 20% e.g. from say 70% to 50%. That is a major change. It turned out to be a great call. I don't expect any more detailed research, analysis etc to be right all the time. But, as valuations rise risk likely rises also - we need better information of when that rise in risk is becoming a problem that normal rebalancing isn't necessarily enough. Agreed it will not be with a very high degree of certainty. And we need that general guidance from a trusted source based on some reasonable analysis not from some media hype/analyst.

I agree this is not an easy task and may be relatively impossible. But, Mr. Bogle blessed it in rare occasions and I think it needs more analysis/discussion. Otherwise it seems we will only recognize extreme overvaluation after the fact when many have lost a significant amount.
Such a great post, causing a slew of what ifs in my mind. Don't we all, at least, wish we knew when to fold? OTOH, what would happen if someone actually could recognize extreme overvaluation, reported it and most investors believed and acted on it?

Anyway, like you said, not easy and relatively impossible but interesting to discuss.

BTW, being a retiree like you, I did the only thing I could to protect myself by reducing my equity allocation at a time I thought the market had significant downside risk.
Dandy was quoting me. I wasn't dismissing the topic, indeed since I have started posting on this forum, I have posted on this issue many times and in detail. You have to use sort of a mental shorthand or my posts could get so lengthy that no one would read them. This last post that Dandy quoted from was a summary of my thoughts and not an extensive white paper on the subject.

My conclusion is that strategic asset allocation at valuation extremes might help you control risks and help you sleep at night but it is doubtful that doing so would boost returns.

In early 2000, I did a shift of 15% of my portfolio, shifting those funds from stocks into cash. That probably boosted returns a bit and helped with risk. In 2005, I took most of that cash and went into bonds with it. Over time, that should boost returns a bit. In 2008-2009, I did nothing but put 100% of monies for new investment into stocks for about a year. I probably hurt my returns because I didn't rebalance from bonds back into stocks. Yes, I admit that I was scared. So hard to say how these three moves affected risk and return. I did a fourth move in 2007-2008 further de-emphasizing my individual stocks, doing Small/Value tilting, and getting into International Mid/Small-Cap. My fourth move probably detracted from returns as we have been in a Large Growth market since the financial crisis.

So my experience was a mixed bag. I tried to mitigate risk a bit and (hopefully) boost returns but hard to say that I succeeded at either. Believe me, I have thought about this a whole lot.
A fool and his money are good for business.

gmaynardkrebs
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Re: You Can Market Time At Valuation Extremes

Post by gmaynardkrebs » Sun Jul 01, 2018 4:50 pm

nedsaid wrote:
Sun Jul 01, 2018 3:32 pm
gmaynardkrebs wrote:
Sun Jul 01, 2018 1:34 pm
nedsaid wrote:
Sun Jul 01, 2018 12:29 pm
...We are not in a bubble here and stock and bond valuations here are reasonable given the economic environment. My friends and family don't discuss the stock market very much if at all.
The "bubble" here is not being blown by people like you and me. This is a career risk "bubble." Put yourself in the position of a career trader or investment manager. What would you be doing now?
What bubble are you talking about? The US Stock Market has been stalled since January, trading in a range and getting close to the 10% correction. Bond prices are down in concert with interest rates ticking up. I am sure that there is a lot of churn in institutional portfolios like hedge funds but the markets haven't gone anywhere in months. No euphoria out there that I am aware of. As far as career risk of traders or managers, not sure that affects the markets themselves. They might be taking on more risk to outperform but they have always done that.
I think the S&P would be approx 1/3 lower were it not for the career risk effect. I consider 50% overvaluation to be a bubble. Of course career risk affects the market. I am surprised you would think otherwise.

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nedsaid
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Re: You Can Market Time At Valuation Extremes

Post by nedsaid » Sun Jul 01, 2018 4:53 pm

Random Walker wrote:
Sun Jul 01, 2018 3:41 pm
Can’t time a market, but I do believe one can somewhat judiciously and opportunistically time their glidepath to the retirement portfolio. This is why I somewhat disagree with Target Date Funds. They only account for our age in determining glidepath. Why not account for other variables than just age when moving towards the retirement AA. I think it’s also beneficial to account for past returns, current valuations, future expected returns, changing ability willingness need when moving to the retirement AA. This likely results in more of a stepwise transition to the retirement AA than a smooth glide. If the market has been more generous than expected, net worth greater than expected, and future expected returns less, why not take more than a measles 1-2% in a given year if approaching retirement?

Dave
You do need a plan with some thought behind it. I like what you are saying to allow flexibility in your plan as circumstances and events dictate. This is why I don't like to be too mechanical in my planning. For example, my life looks a lot different now than I thought it would look four years ago. Some things changed and this has affected my planning.

We all like to think that our tweaks to asset allocation, glide paths and the like will improve our results. Too often it is simple tinkering because of boredom. Problem is it is hard to tell the difference between tinkering and making prudent changes. We think ourselves more prudent than we really are. There is a certain vanity to all of this.
A fool and his money are good for business.

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nedsaid
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Re: You Can Market Time At Valuation Extremes

Post by nedsaid » Sun Jul 01, 2018 5:01 pm

gmaynardkrebs wrote:
Sun Jul 01, 2018 4:50 pm
nedsaid wrote:
Sun Jul 01, 2018 3:32 pm
gmaynardkrebs wrote:
Sun Jul 01, 2018 1:34 pm
nedsaid wrote:
Sun Jul 01, 2018 12:29 pm
...We are not in a bubble here and stock and bond valuations here are reasonable given the economic environment. My friends and family don't discuss the stock market very much if at all.
The "bubble" here is not being blown by people like you and me. This is a career risk "bubble." Put yourself in the position of a career trader or investment manager. What would you be doing now?
What bubble are you talking about? The US Stock Market has been stalled since January, trading in a range and getting close to the 10% correction. Bond prices are down in concert with interest rates ticking up. I am sure that there is a lot of churn in institutional portfolios like hedge funds but the markets haven't gone anywhere in months. No euphoria out there that I am aware of. As far as career risk of traders or managers, not sure that affects the markets themselves. They might be taking on more risk to outperform but they have always done that.
I think the S&P would be approx 1/3 lower were it not for the career risk effect. I consider 50% overvaluation to be a bubble. Of course career risk affects the market. I am surprised you would think otherwise.
You might be right but there is no way to quantify the career risk effect. My belief is that the career risk effect has always been there and hard to say if or how much this affects the market. Perhaps your premise is that the success of indexing is causing managers to take even bigger risks than before.

If you are looking at the Schiller P/E 10, the markets look pretty darned expensive. If you look at forward P/E's for the US Market, which is now 17, that doesn't look excessive. Trailing P/E's were 25 but another poster said that they are now more like 20. Again, a bit above historical averages but nowhere near bubble territory.

In early 2000, before the tech bubble burst, forward P/E's were about 32 and trailing P/E's were about 45.

Also keep in mind a lot of folks out there are shorting stocks as well. You don't short stocks if you think they are going up. Don't know how much short interest there is compared to history, perhaps you could research and report back. That is another thing to look at.
A fool and his money are good for business.

Dandy
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Re: You Can Market Time At Valuation Extremes

Post by Dandy » Sun Jul 01, 2018 5:12 pm

Dandy was quoting me. I wasn't dismissing the topic ...
Didn't mean to let my post make you look bad and unfairly characterize your post. I was probably reacting to scores of other posts that dismiss any concern about high valuations with a phrase like stay the course, that market timing etc. I feel it cuts off discussion and maybe some new ideas.

It reminds me of people saying the early bird catches the worm but never looking at the risk to the early worm. :D Investor with a need or want for asset preservation might rather risk being early to adjust equity exposure than those with decades of human capital who are shooting for growth to get their "number".

gmaynardkrebs
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Re: You Can Market Time At Valuation Extremes

Post by gmaynardkrebs » Sun Jul 01, 2018 8:36 pm

nedsaid wrote:
Sun Jul 01, 2018 5:01 pm
...Also keep in mind a lot of folks out there are shorting stocks as well. You don't short stocks if you think they are going up. Don't know how much short interest there is compared to history, perhaps you could research and report back. That is another thing to look at.
The risks of shorting are so asymmetric, I don't consider short interest to be of any real significance with regard to the assessment of the over-valuation of the market as a whole.

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nedsaid
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Re: You Can Market Time At Valuation Extremes

Post by nedsaid » Mon Jul 02, 2018 9:30 am

Dandy wrote:
Sun Jul 01, 2018 5:12 pm
Dandy was quoting me. I wasn't dismissing the topic ...
Didn't mean to let my post make you look bad and unfairly characterize your post. I was probably reacting to scores of other posts that dismiss any concern about high valuations with a phrase like stay the course, that market timing etc. I feel it cuts off discussion and maybe some new ideas.

It reminds me of people saying the early bird catches the worm but never looking at the risk to the early worm. :D Investor with a need or want for asset preservation might rather risk being early to adjust equity exposure than those with decades of human capital who are shooting for growth to get their "number".
The stock market is risky, it is good for investors, particularly older investors to err on the side of conservatism.
A fool and his money are good for business.

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HomerJ
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Re: You Can Market Time At Valuation Extremes

Post by HomerJ » Mon Jul 02, 2018 2:32 pm

Dandy wrote:
Sun Jul 01, 2018 5:12 pm
Investor with a need or want for asset preservation might rather risk being early to adjust equity exposure than those with decades of human capital who are shooting for growth to get their "number".
Investor with a need or want for asset preservation should ALREADY have changed their Asset Allocation, not waiting until valuations "get high".

The risk of a crash is never zero. If you have a need for asset preservation, then you move to preserve your assets, regardless of valuations.
The J stands for Jay

jalbert
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Re: You Can Market Time At Valuation Extremes

Post by jalbert » Mon Jul 02, 2018 2:50 pm

Park wrote:
Fri Jun 15, 2018 3:20 pm
Thanks for your comments.

There are those pointing out that there are many bear markets, where market timing based on valuation extremes wouldn't have helped you.

I agree. The sensitivity of market timing based on valuation extremes isn't high.

But the specificity is high. At low valuations, the probability of high future returns is high. Conversely, at high valuations, the probability of low future returns is high.
I think it is not uncommon for the first 6-12 months and last 6-12 months of a bull market to have some of the most robust returns of the bull market run. Given the difficulty of timing the start and end of a bear market accurately, you may well give up some of the best returns of a bull market run trying to avoid a bear market even if the bear market materializes relatively near to when you predict. If it does not materialize near to when you predict, you just get hosed by the timing attempt. This creates an asymmetry where the expected return on trying to time a bear market relative to staying invested is likely negative.
Risk is not a guarantor of return.

Dandy
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Re: You Can Market Time At Valuation Extremes

Post by Dandy » Mon Jul 02, 2018 4:28 pm

Investor with a need or want for asset preservation should ALREADY have changed their Asset Allocation, not waiting until valuations "get high".
There is certainly some truth in that e.g. a good allocation and a rebalancing plan usually does the trick. Risk tolerance and the translation of that into an allocation plan and a rebalancing plan is often a lot of educated (we hope) guesses on top of other educated guesses. Risk also changes with age and the decline of human capital - which is often not fully realized.

So, sometimes extreme valuations can cause panic, worry to be sure but on occasion necessary reassessment of your ability to take risk and also your need to take it. If you recall Mr. Bogle who is a savvy investor made a significant reduction of his equity allocation just prior to the year 2000 sell off. He has said when the market is extremely overvalued you should consider taking such significant equity reduction. Why would it be ok for him to do and say that and yet be such a shock if others suggest it?

I think the real key is what measure or measures would be good indicators of extreme valuation and what would be considered extreme.

Park
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Re: You Can Market Time At Valuation Extremes

Post by Park » Wed Jul 04, 2018 7:36 am

https://www.morningstar.com/videos/3539 ... roach.html

Below is from a discussion between Frank Kinniry of Vanguard and Christine Benz of Morningstar, and is taken from the above link:

Benz: ...But the tactical umbrella has a lot of different strategies beneath it, and I'm wondering are there any strategies that make more sense to you than others within the tactical realm.

Kinniry: We've looked at it, long and hard. And actually, we have a real reason to look at this and spend a lot of time looking at it, and really the only thing we've found that has some merit is at the stock/bond mix, meaning we don't see a lot between U.S. and international or growth and value or size, but we do see some ability of tactical allocation in the extremes and really the extremes are limited periods in time where this occurs. So, 1998-1999, when you saw a valuations at unprecedented levels, one could have said the equity market was set up for potentially lower returns, and in 2009, believe it or not, at the bottom, the equity market looked about as attractive as it had in 20 to 25-plus years.

And so there is a lot of noise in the middle, but there are some small windows in time where the stock/bond mix, you may want to shade, and we would say only small shades if you were 60/40 stock/bonds, maybe it would go up 5% or 10% in your equities or down 5% or 10%, but really never making wholesale moves.

Benz: And arguably a rebalancing strategy would kind of get you there.

Kinniry: Absolutely, a rebalancing strategy is probably the best way to take advantage of some of these opportunities without making wholesale changes; that's exactly right."

In 1998-1999, PE10 was in the range of 33-44. In 2009, PE10 was in the range of 13-20. My opinion is that Frank Kinniry from Vanguard is stating that one can market time at valuation extremes, albeit quite modestly.

Park
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Re: You Can Market Time At Valuation Extremes

Post by Park » Sun Jul 08, 2018 11:11 am

I try not to bump a thread that I've started, but I'd like to make the following points, which I think would be of use to many on this board:

Larry Swedroe:

"I agree that market timing at EXTREMES is a good idea, but only if you are prepared to
a) be wrong for long time (I sold all growth in 98 and looked bad for 2 years, then looked great)
b) don't confuse strategy and outcome
c) stay disciplined (the hard part is when do you get back).

so for most, especially if have well diversified by asset classes/factors, simply rebalancing is likely to prove better.

and I've only made a few trades over the past 20 years including getting out of growth in 98 and out of REITS a few years ago. Valuations do matter, and they matter a lot."


At the end of 1989, someone who invested solely on world market cap would have had about 40% of their stock exposure in Japanese stocks.

http://www.etf.com/sections/index-inves ... nopaging=1

"through 2017, Japanese large-cap stocks would gain just 0.5% per year, producing a cumulative return of less than 15% over the 28-year period."

At the end of 1989, Japanese stocks had a CAPE of around 90.

InvestInPasta
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Re: You Can Market Time At Valuation Extremes

Post by InvestInPasta » Mon Jul 09, 2018 3:22 am

David Jay wrote:
Wed Jun 20, 2018 8:35 am
Park wrote:
Fri Jun 15, 2018 3:20 pm
But the specificity is high. At low valuations, the probability of high future returns is high. Conversely, at high valuations, the probability of low future returns is high.
TRUE.

Now how does one monetize that information?
It's impossible, I couldn't monetize these kind of informations with Euro Bonds that always have an exact 10 years nominal return, I mean they always have an exact math nominal valuation for the next nth years.
The herd's behaviour is unpredictable!

In 2014 safe 10-15Years Euro Bonds like EIB/Bunds/OAT were yielding a yearly nominal 1.5% net (after taxes).
I said to myself: "I won't buy them at these tiny returns!"
The herd carried on buying Euro Bonds until they yielded ZERO net (+20% in bond price).
I said to myself: "People are crazy, I bet now these bonds will collapse, I'm smart, I keep staying out!"
The herd carried on buying Euro Bonfs until they yielded a NEGATIVE return. Another +10% in bond price. :shock:

How can someone monetize valuations?
When studying English I am lazier than my portfolio. Feel free to correct my english and investing mistakes.

Park
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Re: You Can Market Time At Valuation Extremes

Post by Park » Thu Oct 04, 2018 12:42 am

One justifiable criticism of valuation based market timing is that there is less reversion to the mean for stock markets.

But at extremes of valuation, you don't need reversion to mean. Expensive stock markets or cheap stock markets can do worse or better respectively, even if there is no reversion to the mean.



At extremes of valuation, the probability of reversion to mean increases, especially when a market is expensive. Historically, investors have demanded an equity risk premium. Stocks are riskier than bonds/cash; I don't think that will change, so I don't think the equity risk premium will disappear.

An individual stock can be very cheap, because earnings growth expectations are appropriately low. Similarly, an individual stock can be very expensive, because those expectations are appropriately high. But the historical real growth in earnings is 1.5% yearly in the US stock market. It can deviate from that, but not as much as at the individual stock level. And there will be a stronger tendency for reversion to mean in earnings growth for the stock market as whole, versus individual stocks.

A stock market or an individual stock could be expensive or cheap, not because of earnings growth, but due to risk. If it is riskier, it will be cheaper. If it has less risk, it will be expensive

http://www.efficientfrontier.com/ef/197/rebal197.htm

William Bernstein: "over very long time horizons there is usually relatively little difference in the returns in most national equity markets"

If you believe that markets price in risk and the level of risk is similar in most markets, then there should be little difference in returns. Once again, mean reversion in risk is likely greater at the stock market level than at the level of individual stocks. A stock can go bankrupt. A stock market can go bankrupt (Russian or Chinese markets after communism), but it is less common.

For the good majority of stock markets, there will be mean reversion in earnings growth and in risk. At extremes of valuation, this is relevant.




Another criticism of valuation based market timing is that CAPE doesn't work in the short term. But at extremes of valuation, I'm not as sure about that.

http://www.indexologyblog.com/2018/10/0 ... k-returns/

The link above has graphs showing the relationship of US CAPE to returns over the next 3, 5 7 and 10 years. If you look at the slope of the line, it increases as the time span shortens. So stock market return is more sensitive to CAPE as the time span shortens. However, dispersion increases even more as the time span shorten. The R squared increases as the time span lengthens.

But look at the dispersion at the extremes. As only American data is used, there's little data at the highest CAPEs. At the lowest CAPEs though, there is quite a bit more data. The dispersion there is noticeably less than in the middle at 3, 5 and 7 years. And what dispersion there is tends to be in positive returns. For a CAPE less than 15, the minimum return over the next 3 years is about 8%.

https://www.starcapital.de/fileadmin/us ... imling.pdf

The above link is to a study of CAPE and market returns from 17 countries.

The following is maximum drawdown in relationship to CAPE, using CAPE data from all countries.
CAPE 0-10, average maximum drawdown over the next 3 years is -5.7%, average maximum drawdown over the next 15 years is -5.2%
10-15, -8.8%, -11.1%
15-20, -12.4%, -13.6%
20-25, -18.1%, -23.1%
25-30, -22.3%, -27.5%
30+, -28.8%, -39.5%

When it comes to average maximum drawdown over the next 3 years, the relationship to CAPE isn't that bad.

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