Larry Swedroe: Capitalism Vs. Socialism

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Random Walker
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Larry Swedroe: Capitalism Vs. Socialism

Post by Random Walker » Mon Mar 18, 2019 9:30 am

https://www.etf.com/sections/index-inve ... nopaging=1

Despite the title, this article is not political: it’s all investing. Lots of valuable reminders: markets price risk not growth, value beats growth at individual stock level and at country level, information v. value added information, recency bias, prices reflect all known information. Larry reviews a study that evaluated country stock returns as a function of of a country’s commitment to free markets (freedom score); no real obvious relationship. The global equity allocation, determined by the wisdom of the crowd, is about 1/2 U.S., 3/8 Int Developed, 1/8 EM. Larry finishes by describing the current valuations of those three equity classes.

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by Vulcan » Mon Mar 18, 2019 9:39 am

The core investment philosophy should be that, in liquid and competitive markets, where capital is free to move around the globe, security prices reflect the aggregate expectations of all market participants. Among the many considerations by market participants when setting prices are political risks, information about government spending in the economy, the strength of the rule of law and the regulatory framework under which the private sector operates.

Thus, investment decisions should not be based on countries’ economic freedom—the knowledge of which is already embedded in prices. A truly global perspective offers a broader opportunity to manage idiosyncratic risks of countries.

The bottom line is that your global equity allocation should look similar to how the “wisdom of crowds” (in aggregate, all investors) allocates capital.
Which is precisely how those of us with 100% of their stock holdings in VTWAX view things.

As an added benefit of this single fund allocation one never has to worry not only about what the "appropriate" allocation to international is, but also about what the current market cap allocation is, because the current market cap allocation is the same today as it was yesterday: 100% VTWAX.
If you torture the data long enough, it will confess to anything. ~Ronald Coase

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by AtlasShrugged? » Mon Mar 18, 2019 10:17 am

One other takeaway from that article (Thanks Dave!).....Better think about increasing your emerging markets allocation. That 10-year return forecast does not look especially promising for the US and Developed countries.
“If you don't know, the thing to do is not to get scared, but to learn.”

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by DB2 » Mon Mar 18, 2019 11:20 am

Vulcan wrote:
Mon Mar 18, 2019 9:39 am
The core investment philosophy should be that, in liquid and competitive markets, where capital is free to move around the globe, security prices reflect the aggregate expectations of all market participants. Among the many considerations by market participants when setting prices are political risks, information about government spending in the economy, the strength of the rule of law and the regulatory framework under which the private sector operates.

Thus, investment decisions should not be based on countries’ economic freedom—the knowledge of which is already embedded in prices. A truly global perspective offers a broader opportunity to manage idiosyncratic risks of countries.

The bottom line is that your global equity allocation should look similar to how the “wisdom of crowds” (in aggregate, all investors) allocates capital.
Which is precisely how those of us with 100% of their stock holdings in VTWAX view things.

As an added benefit of this single fund allocation one never has to worry not only about what the "appropriate" allocation to international is, but also about what the current market cap allocation is, because the current market cap allocation is the same today as it was yesterday: 100% VTWAX.
+1

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by Random Walker » Mon Mar 18, 2019 11:21 am

AtlasShrugged? wrote:
Mon Mar 18, 2019 10:17 am
One other takeaway from that article (Thanks Dave!).....Better think about increasing your emerging markets allocation. That 10-year return forecast does not look especially promising for the US and Developed countries.
I agree. I don’t believe in market timing, but looking at valuations, I decided to move my equity allocation closer towards world market cap weighting a couple of years ago. I sort of viewed it as an opportunistic move in the direction of portfolio efficiency. Of course, that move has not paid off in the last couple years :-)

Dave

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by garlandwhizzer » Mon Mar 18, 2019 11:36 am

Interesting article, Dave, makes some good points. Thanks for posting it.

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by Day9 » Mon Mar 18, 2019 11:59 am

Remember that in a recent post Mr Swedroe let us know he has little to no control over the title of his articles he writes for this website.

At the very end he estimates future expected real returns using CAPE: "For those interested, the year-end 2018 CAPE 10 earnings yields (as good a predictor as we have for future expected real returns) was as follows: U.S., 3.6; Developed non-U.S., 5.8, and Emerging Markets, 7.3. (Data provided by AQR Capital Management.)"

The sentence immediately preceding this he gave us the weighting of these so I guess he left it as an exercise to the reader to calculate expected return on a global stock portfolio. That would be 0.5*3.6 + 3/8*5.8 + 1/8*7.3 = 4.8875% expected real returns going forward on a global market cap stock portfolio (compare to 3.6% for 100% US)
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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by HomerJ » Mon Mar 18, 2019 12:02 pm

Random Walker wrote:
Mon Mar 18, 2019 11:21 am
AtlasShrugged? wrote:
Mon Mar 18, 2019 10:17 am
One other takeaway from that article (Thanks Dave!).....Better think about increasing your emerging markets allocation. That 10-year return forecast does not look especially promising for the US and Developed countries.
I agree. I don’t believe in market timing, but looking at valuations, I decided to move my equity allocation closer towards world market cap weighting a couple of years ago. I sort of viewed it as an opportunistic move in the direction of portfolio efficiency. Of course, that move has not paid off in the last couple years :-)

Dave
That move hasn't paid off for close to a decade.

How many years do the experts get to be wrong before people stop listening to their predictions and thinking "Boy, I better make a change because so-and-so made a forecast!"

Note I'm not saying they are wrong. Emerging Markets may indeed take off starting today.

I'm saying they don't seem to really know. They sure ACT like they know. But they don't really know. None of us do.
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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by HomerJ » Mon Mar 18, 2019 12:05 pm

Day9 wrote:
Mon Mar 18, 2019 11:59 am
"For those interested, the year-end 2018 CAPE 10 earnings yields (as good a predictor as we have for future expected real returns)
When someone says CAPE is the best tool for predicting future returns, people need to understand that it's still a terrible tool.

It's like if all I had was a screwdriver and a saw.

I could go around for years and years saying "My screwdriver is the BEST tool I have for driving in nails", and after years and years of me saying that, you might actually start to think a screwdriver is a GOOD tool for driving in nails..

But it's not a good tool for driving in nails; even if it is indeed my BEST tool, it's still pretty terrible at it.
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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by JackoC » Mon Mar 18, 2019 12:07 pm

Random Walker wrote:
Mon Mar 18, 2019 9:30 am

Despite the title, this article is not political: it’s all investing. Lots of valuable reminders: markets price risk not growth, value beats growth at individual stock level and at country level, information v. value added information, recency bias, prices reflect all known information. Larry reviews a study that evaluated country stock returns as a function of of a country’s commitment to free markets (freedom score); no real obvious relationship.
There isn't typically an obvious relationship between known characteristics of a country or its market and returns, looking at broad samples over long periods. Same famously goes for GDP growth rate.

The question however is not only (not really at all) whether markets price in what they know, it's also how likely it is that events arise the market did not know and did not price in. And you don't even need a study to tell you what would happen if the US system became much more 'socialist' (it's already a mix of socialism and capitalism like every other rich country just not the same exact mix in each). That would hurt owners of US capital assets priced on expectation of relatively freer markets. Unfortunately we don't know whether or how much US policy will change, or exactly what the market expects (eg. the market might expect some normal 'swing of the pendulum' from where things are now).

The paper does not justify, or prove wrong, concentrating assets in one country. With or without reading it you'd already know that diversification from the particular strengths/weaknesses of the US system *in the future* (only the future will determine future returns, not the past) is available at moderate cost by investing in foreign stocks to some degree. You either embrace or pass up that diversification. This study shows nothing of what the effect would be of significant change in policy not expected by markets.

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by DB2 » Mon Mar 18, 2019 12:33 pm

Day9 wrote:
Mon Mar 18, 2019 11:59 am
Remember that in a recent post Mr Swedroe let us know he has little to no control over the title of his articles he writes for this website.

At the very end he estimates future expected real returns using CAPE: "For those interested, the year-end 2018 CAPE 10 earnings yields (as good a predictor as we have for future expected real returns) was as follows: U.S., 3.6; Developed non-U.S., 5.8, and Emerging Markets, 7.3. (Data provided by AQR Capital Management.)"

The sentence immediately preceding this he gave us the weighting of these so I guess he left it as an exercise to the reader to calculate expected return on a global stock portfolio. That would be 0.5*3.6 + 3/8*5.8 + 1/8*7.3 = 4.8875% expected real returns going forward on a global market cap stock portfolio (compare to 3.6% for 100% US)
I am probably missing something, so I apologize. I cannot get the link to open for some reason. But if these predictions come true (i.e., U.S. 3.6%, Developed non-U.S. 5.8, EM, 7.3) wouldn't that float international higher so the U.S. would be less than 50% weight, hence, a global market cap return would be higher than 4.88%? Or is it just looking at something that occurs over the period of time?

Either way, it seems to be fairly similar to what Vanguard is predicting over the next 10 years: 6-8% annual return for international and 4-5% for U.S.

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by Svensk Anga » Mon Mar 18, 2019 1:26 pm

Random Walker wrote:
Mon Mar 18, 2019 11:21 am
AtlasShrugged? wrote:
Mon Mar 18, 2019 10:17 am
One other takeaway from that article (Thanks Dave!).....Better think about increasing your emerging markets allocation. That 10-year return forecast does not look especially promising for the US and Developed countries.
I agree. I don’t believe in market timing, but looking at valuations, I decided to move my equity allocation closer towards world market cap weighting a couple of years ago. I sort of viewed it as an opportunistic move in the direction of portfolio efficiency. Of course, that move has not paid off in the last couple years :-)

Dave
EM was #1 and DM #2 on the Callan Periodic Table for 2017. Returns were 37.28% and 24.21%. These two dominated my Roth conversions that year. :D . Unfortunately, that was the last year for recharacterization of conversions and so ended the Roth horse race era. :?

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by larryswedroe » Mon Mar 18, 2019 1:47 pm

FWIW, actually the CAPE has been a pretty good, if not excellent predictor of GLOBAL returns --US was underestimated and international overestimated---random errors offsetting pretty much.

I'll post on this shortly, showing our actual forecast of global real returns and the realized returns, if we always get outcomes like this anyone would be very happy (differences in realized versus expected)
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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by HomerJ » Mon Mar 18, 2019 2:01 pm

larryswedroe wrote:
Mon Mar 18, 2019 1:47 pm
FWIW, actually the CAPE has been a pretty good, if not excellent predictor of GLOBAL returns --US was underestimated and international overestimated---random errors offsetting pretty much.
CAPE got both of them wrong is what you're saying. And by coincidence, the two errors balanced each other out. But how does that help?

The common "expert" recommendations was to put more in International, and less in U.S. (I'm not saying you recommended that, but that's the main takeaway from most people following CAPE).

Anyone who followed those recommendations has far less money today because they believed in valuation predictions for the past decade.

Putting more in the low-performing market, and less in the high-performing market does not give you results that offset each other. In fact, it's the opposite.
Last edited by HomerJ on Mon Mar 18, 2019 7:53 pm, edited 1 time in total.
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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by Random Walker » Mon Mar 18, 2019 2:08 pm

HomerJ wrote:
Mon Mar 18, 2019 12:02 pm
Random Walker wrote:
Mon Mar 18, 2019 11:21 am
AtlasShrugged? wrote:
Mon Mar 18, 2019 10:17 am
One other takeaway from that article (Thanks Dave!).....Better think about increasing your emerging markets allocation. That 10-year return forecast does not look especially promising for the US and Developed countries.
I agree. I don’t believe in market timing, but looking at valuations, I decided to move my equity allocation closer towards world market cap weighting a couple of years ago. I sort of viewed it as an opportunistic move in the direction of portfolio efficiency. Of course, that move has not paid off in the last couple years :-)

Dave
That move hasn't paid off for close to a decade.

How many years do the experts get to be wrong before people stop listening to their predictions and thinking "Boy, I better make a change because so-and-so made a forecast!"

Note I'm not saying they are wrong. Emerging Markets may indeed take off starting today.

I'm saying they don't seem to really know. They sure ACT like they know. But they don't really know. None of us do.
Just to be clear, I overwhelmingly made the move for the sake of getting closer to world market cap. Prior US returns, current valuations, future expected returns were only a catalyst for a reaction that was going to occur anyways.

Dave

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by knpstr » Mon Mar 18, 2019 2:13 pm

All I know is that we've been told by academics that the market is pretty well efficient: so whatever CAPE says is meaningless because all of us rational/logical investors have rational/logical reasons for investing and everything we know is "priced in" rational/logically. So the market is always right where it should be. You, me, they don't know anything the market doesn't, so why bother? Go back to your activities of daily living.

P.S. It could be that these academic "predictors" are really just attempts to initiate market moves, rather than predict market moves. Academic high priests tell us the market is too high, they cause worry, which causes selling, sudden selling initiates fear causes more selling. Academics: "see we told ya so!" :twisted:
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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by Random Walker » Mon Mar 18, 2019 2:17 pm

As Larry strongly points out in the essay, the market prices risk. We tend to focus on the lower CAPE representing higher future expected returns, but we need to remember that it importantly represents perception of increased risk.

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by knpstr » Mon Mar 18, 2019 2:28 pm

Random Walker wrote:
Mon Mar 18, 2019 2:17 pm
As Larry strongly points out in the essay, the market prices risk.
Could you elaborate on this point?
I see in his article he said growth companies tend to return less than value companies so... people price risk.
That doesn't seem to be a sufficient explanation/reasoning to my stone age brain.
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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by packer16 » Mon Mar 18, 2019 2:31 pm

Although the CAPE may be the best tool it has major issues. Vanguard here states that CAPE only explains 40% of equity returns:

https://personal.vanguard.com/pdf/s338.pdf

What are the other drivers of stock returns? Innovation may be one & the timing of that is uncertain & clearly not related to valuation. So if less than 50% of stock returns can be explained by a metric one has to take predictions based upon this metric with a big grain of salt versus other more stable metrics like yield for bonds. The chief economist at Vanguard has developed a metric to try to predict innovation based upon the number of patents issued, pretty interesting research into the 60% of equity returns that are not explained by CAPE.

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by Random Walker » Mon Mar 18, 2019 4:12 pm

knpstr wrote:
Mon Mar 18, 2019 2:28 pm
Random Walker wrote:
Mon Mar 18, 2019 2:17 pm
As Larry strongly points out in the essay, the market prices risk.
Could you elaborate on this point?
I see in his article he said growth companies tend to return less than value companies so... people price risk.
That doesn't seem to be a sufficient explanation/reasoning to my stone age brain.
Not sure I understand your question or point, but I won’t let that stop me from squawking. Some people think the market should adjust prices to equilibrate returns. But the market prices risk. A riskier asset will have its price depressed to reflect that increased risk. Perceived increased risk causes lower current price and future increased expected returns. In a truly efficient market, all risky assets should have about equal risk adjusted returns. Of course that issue is somewhat complicated by different definitions and types of risk. So lower prices for more risky assets implies higher future expected returns. But sometimes the increased risk actually shows up and the expected return not realized.

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by knpstr » Mon Mar 18, 2019 8:01 pm

Random Walker wrote:
Mon Mar 18, 2019 4:12 pm
knpstr wrote:
Mon Mar 18, 2019 2:28 pm
Random Walker wrote:
Mon Mar 18, 2019 2:17 pm
As Larry strongly points out in the essay, the market prices risk.
Could you elaborate on this point?
I see in his article he said growth companies tend to return less than value companies so... people price risk.
That doesn't seem to be a sufficient explanation/reasoning to my stone age brain.
Not sure I understand your question or point, but I won’t let that stop me from squawking. Some people think the market should adjust prices to equilibrate returns. But the market prices risk. A riskier asset will have its price depressed to reflect that increased risk. Perceived increased risk causes lower current price and future increased expected returns. In a truly efficient market, all risky assets should have about equal risk adjusted returns. Of course that issue is somewhat complicated by different definitions and types of risk. So lower prices for more risky assets implies higher future expected returns. But sometimes the increased risk actually shows up and the expected return not realized.

Dave
My question was: How does a lower return for "growth companies" than "value companies" prove the market prices risk not return? Neither one of these can be accurately predicted so one doesn't know beforehand if the investment will work out as expected.

Further, I thought (perhaps incorrectly) that "risk" as traditionally referenced to in such situations is volatility. However, in your last sentence it seems like you call risk a low return, or perhaps more appropriately a lower than expected return, or perhaps a lower return versus other things available to invest in?

Lastly, you say a "riskier asset will have it's price depressed to reflect that increased risk". So are stocks with very high P/E ratios are ultra-safe? And those with very low P/E ratios deemed extremely-risky? Naturally the inverse of what you say would be: Perceived decreased risk causes higher current prices.

It seems to me that the reason Tesla is $269/share while "making" -$5/share is because of perceived/expected return, not that it is very safe.
Or the same thing for Amazon with a 86 P/E, that it is bid that high due to perceived (rationally or irrationally) future returns, not because the market thinks it is less risky than a T-Bill.
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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by JackoC » Mon Mar 18, 2019 8:32 pm

Random Walker wrote:
Mon Mar 18, 2019 2:17 pm
As Larry strongly points out in the essay, the market prices risk. We tend to focus on the lower CAPE representing higher future expected returns, but we need to remember that it importantly represents perception of increased risk.

Dave
Increased risk or lower expected growth of earnings. Everyone accepts that PE ratio's vary according to expectations of company growth and thus by industry in given conditions. Some types of company the market expects to grow faster are a larger % of the US market's cap weight than some others. This has been explored in more detail in many articles, the 'Heard on the Street' column in the WSJ had a good summery on it some months ago. A lot, though not all, of the difference in US v foreign CAPE's is explained by the difference in CAPE by industry and difference in weighting of industries by country index.

Seems the thread detoured to the same old 'CAPE doesn't accurate predict realized outcomes'. Really not the same topic, and anyway IMO it's been beaten to death that nobody (reasonable) thinks *anything* closely predicts *future realized outcomes*. But CAPE has a fundamental relationship to *expected return* via the dividend discount model, for a given type of company or overall market composition. It's really not like correlating whether the East or West won the NBA all star game then comparing it to how stocks did that year.

However again comparisons of CAPE one place to another also involve the implicit assumption that various big markets have the same types of companies. But they don't, which while it's a reason you can't just compare CAPE's among markets to see which one has the higher risk adjusted expected return, by the same token it's all the more reason to diversify. Staying with just the US market has become more and more of a specialized bet as the world economy specializes. The higher PE's commanded by industries (and company types within broad industries) which tend to be more heavily represented in the US index is not cast in stone. Those companies might lose their favored positions (for example Apple dominating the profit of its value chain much less than it does now compared to its Far East hardware suppliers, and/or a Far East Apple taking over its position). Or not. That's not predictable, but betting 100% on the US is becoming more like betting on particular stocks (and justifying it based on past performance) as world economies and stocks market specialize.

And back to the actual topic, same with a sharp break more toward socialism in the US. The market doesn't expect it, and the whole reason would be to shift return from capital to labor, so it's absurd to claim it would not depress asset prices. Of course it would, if it were a real change. But again here nobody knows in the first place how likely it really is that US policies actually do shift sharply toward collectivism. All we can say is that all countries with significant stock markets would be unlikely to do that at the same time, so it again suggests diversification.

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by Random Walker » Mon Mar 18, 2019 8:57 pm

Knpstr,
Yes, growth companies are considered safer and value companies more risky. There’s a difference between the company and the stock of a company. There’s an old saying :”good companies make bad stocks and bad companies make good stocks”.
The returns of growth versus value do not prove that the market prices risk; didn’t intend for what I wrote to be taken that way.
Risk can have at least several different definitions: volatility, losing money, doing badly in bad times, and many others I’m sure. We mostly focus on volatility and Sharpe ratios. But there are other perceptions of risk, and that’s why I wrote that all risky assets should have about the same risk adjusted return. There are dimensions of risk not encompassed by volatility alone.
While growth stocks represent less risky companies, growth stocks entail their own kind of risk, I think of it as bubble risk. Their big P/E ratios have a lot of growth already baked into their prices. If the company fails to meet earnings projections, the stock can get creamed. I think high P/E ratios can represent a company perceived as safe, rapidly growing, optimistic investors projecting earnings growth way into the future, and a human tendency to overpay for growth.

Dave

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by LadyGeek » Mon Mar 18, 2019 10:56 pm

Random Walker wrote:
Mon Mar 18, 2019 9:30 am
https://www.etf.com/sections/index-inve ... nopaging=1

Despite the title, this article is not political: it’s all investing.
Day9 wrote:
Mon Mar 18, 2019 11:59 am
Remember that in a recent post Mr Swedroe let us know he has little to no control over the title of his articles he writes for this website.
The article is introduced as question of political policy, but the intent is on investing. As a reminder, see: Non-actionable (Trolling) Topics
If readers can't do anything with the content of a topic other than argue about it, it does not belong here. Examples include:
  • US or world economic, political, tax, health care and climate policies
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  • discussions of the crimes, shortcomings or stupidity of other people, whether they be political figures, celebrities, CEOs, Fed chairmen, subprime mortgage borrowers, lottery winners, federal "bailout" recipients, poor people, rich people, etc. Of course, you are welcome to talk about the stupid financial things you have done.
Please stay focused on the investing aspects.
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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by DeadPoets » Tue Mar 19, 2019 1:14 am

AtlasShrugged? wrote:
Mon Mar 18, 2019 10:17 am
One other takeaway from that article (Thanks Dave!).....Better think about increasing your emerging markets allocation. That 10-year return forecast does not look especially promising for the US and Developed countries.
The 10 year forecast after 08 crash was a disaster for US.

Forecasts mean nothing.

Investing on a forecast is pretty irresponsible imo

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by Random Walker » Tue Mar 19, 2019 8:22 am

HomerJ wrote:
Mon Mar 18, 2019 2:01 pm
larryswedroe wrote:
Mon Mar 18, 2019 1:47 pm
FWIW, actually the CAPE has been a pretty good, if not excellent predictor of GLOBAL returns --US was underestimated and international overestimated---random errors offsetting pretty much.
CAPE got both of them wrong is what you're saying. And by coincidence, the two errors balanced each other out. But how does that help?

The common "expert" recommendations was to put more in International, and less in U.S. (I'm not saying you recommended that, but that's the main takeaway from most people following CAPE).

Anyone who followed those recommendations has far less money today because they believed in valuation predictions for the past decade.

Putting more in the low-performing market, and less in the high-performing market does not give you results that offset each other. In fact, it's the opposite.
The fact is that valuations matter a lot. High current valuations imply lower future mean expected returns. But the expected mean represents a wide distribution of returns, and that whole potential distribution shifts left or right depending on valuations. Take a look at this article from AQR’s Cliff Asness:
https://www.aqr.com/Insights/Research/W ... Shiller-PE

Mean returns and the distribution of returns move monotonically with valuations.

Dave

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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by HomerJ » Tue Mar 19, 2019 12:31 pm

Random Walker wrote:
Tue Mar 19, 2019 8:22 am
HomerJ wrote:
Mon Mar 18, 2019 2:01 pm
larryswedroe wrote:
Mon Mar 18, 2019 1:47 pm
FWIW, actually the CAPE has been a pretty good, if not excellent predictor of GLOBAL returns --US was underestimated and international overestimated---random errors offsetting pretty much.
CAPE got both of them wrong is what you're saying. And by coincidence, the two errors balanced each other out. But how does that help?

The common "expert" recommendations was to put more in International, and less in U.S. (I'm not saying you recommended that, but that's the main takeaway from most people following CAPE).

Anyone who followed those recommendations has far less money today because they believed in valuation predictions for the past decade.

Putting more in the low-performing market, and less in the high-performing market does not give you results that offset each other. In fact, it's the opposite.
The fact is that valuations matter a lot. High current valuations imply lower future mean expected returns. But the expected mean represents a wide distribution of returns, and that whole potential distribution shifts left or right depending on valuations. Take a look at this article from AQR’s Cliff Asness:
https://www.aqr.com/Insights/Research/W ... Shiller-PE

Mean returns and the distribution of returns move monotonically with valuations.

Dave
I'm confused what point you are trying to make.

That article was written in 2012, and proves my point.
The S&P 500 Shiller P/E, a particularly useful measure of the valuation of the entire U.S. stock market, was 22.2 on September 30, 2012. While that is not close to historic excesses — it is almost exactly half of its peak value during the 1999–2000 stock market bubble and about two-thirds its height in late 1929 — it is high versus history generally. In fact, it’s higher than it has been 80% of the time since 1926.

Based on the past, the 2012 level of Shiller P/E — the ratio of stock prices to an inflation-adjusted 10-year rolling average of corporate earnings — suggested that the average annual real stock market return over the next decade would not exceed 1%. At similar levels in the past, the worst case horrendous: –4.4%. The best case is very good — about 8.3% annually — though it is less wonderful than the much better best cases from lower starting Shiller P/E’s.
The article stated, that based on valuations, it's likely we would see a range of -4.4% to 8.3% real returns starting Nov 1, 2012. It stated the average is likely to be 1% real. That's bad. Real bad.

So far, 7 years later, we've gotten like 10% real returns annual returns (I calculate 12%+ nominal, let's say 2% for inflation). That's not just a little bit off. That's completely outside the historical range predicted in the article, and of course, far far far above the 1% likely average presented in the article.

Sure, one can explain why it happened, looking backwards. But you can't say that CAPE is a great prediction tool. You can say there are lots of other variables and that's why CAPE didn't do a good job predicting. But that's MY point too.

I don't understand how CAPE proponents can continue to say how great it is as forecasting tool when it has often been wrong in the past 20+ years. The article you linked above is one of the EXACT reasons I think CAPE is a poor prediction tool.

Sure, the CAPE model matched the first 80 years of the century. But, of course, CAPE matched the first 80 years, because that's the data that was used to create the model. That doesn't prove anything at all.

When you take 80 years of data, build a model around it, and then the following 20+ years fail to conform to that model...

You DO NOT get to say that the model is working pretty well.

I'd be okay (probably not convinced, but not outraged) with people saying "Oh, the model is showing poor results, but here's why. This reason, this reason, this reason..."

But people are actually saying "The model is working pretty well." That's outrageous. It's not working well.

There are too many variables involved in economics to make accurate predictions based on just one of the variables.
The J stands for Jay

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knpstr
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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by knpstr » Tue Mar 19, 2019 2:38 pm

Dave,
"We find the same evidence in the returns of individual stocks. For example, growth stocks, which have higher growth in earnings than value stocks, have produced lower returns. ...data to prove previous statement... To repeat, markets price for risk."
Seems to me here that since growth companies have lower returns it is being used as "proof" that market's price risk not return/earnings.

So, Amazon has an 86 P/E, and you say the safer (or perceived safer) the security the higher the P/E. A T-bill's "P/E" is roughly 42. Is Amazon perceived to be safer than a T-bill? Or Amazon has a "forward P/E" of 44 so is it as safe as a T-bill? Or is it against the rules to compare all investments against one another and we must arbitrarily group them?

It seems to me growth companies do not have high P/Es because they are deemed as safe or safer than T-bills, but people expect extremely high growth to continue and/or use poor reasoning to invest at such high levels. For example, committing a behavioral misjudgment such as social proof.
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Re: Larry Swedroe: Capitalism Vs. Socialism

Post by AtlasShrugged? » Fri Mar 22, 2019 7:02 am

I'm saying they don't seem to really know. They sure ACT like they know. But they don't really know. None of us do.
It is true, HomerJ. I think even Mr. Swedroe has said as much: Our Crystal Ball is cloudy, at best.

Investing is an imperfect science, despite our best efforts to make it precise. There is inherent unpredictability, and chaos. With that proviso, it seems to me that if we have evidence of a tendency (CAPE10 is an approximate predictor of global returns), then why would we not consider this? And by extension, consider increasing Emerging Markets exposure. That was my point: Consider the evidence and think about increasing EM exposure.

In my own case, I have two international index funds: FSPSX (401K), and FTIHX (Roth). I added FTIHX back in late 2016. I happened to read a post by Nedsaid, and looked into it further (Thanks Nedsaid!). Why did I buy it? Precisely because of the higher exposure to Emerging markets, and a higher exposure to Small Cap Value in Developed. It made sense to me. It moved my exposure to Emerging Markets from less than 1% to roughly 5%-6%. Dramatic? No. I'd call it a gentle course correction to play out for the next two decades when I eventually retire, if I am ever able to retire.
“If you don't know, the thing to do is not to get scared, but to learn.”

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