abc132 wrote: ↑Wed Jul 10, 2019 10:54 pm
Always appreciate the thought and effort put into your posts. I was talking purely about what would quantify a strategy as successful moving forward, so your past results shouldn't really matter for your current decisions. A real time strategy is independent of past results, as only future results should matter to our current decision making. I was also not holding you to any standard of expertise, despite the quality of your posts. If you were to proclaim you are giving professional advice here on Bogleheads, I would then expect a different set of standards about your posts.
One thing is to look at what is working really well right now and assuming that this trend will not continue forever. So if the FAANG stocks are really, really hot right now, the prudent thing would be not to chase them. So you can at least avoid behavioral errors. Buying high and selling low is not a winning strategy but many investors do this nevertheless.
You could try to find cheaper asset classes and do what Dr. Bill Bernstein calls overbalancing, that is you would rebalance into cheaper assets to a greater degree than what you would do with normal rebalancing.
You also could try to lighten up on expensive assets, particularly if you see euphoria. So if the baggage handlers at the airport start giving you stock tips, it might be a sign to sell some of your stocks.
What I am saying here is that valuations and sentiment matter. Stocks have higher future expected returns when they are cheap than they do when they are expensive. Also low expectations are much easier to beat than high expectations. Pretty much common sense when you think it through and is also consistent with human nature and human behavior. The old thing about the cycles of greed and fear.
The whole idea of academic research is to ascertain which types of stock have the best performance over very long periods of time and to have more stocks with the characteristics that you like and fewer stocks with characteristics you don't like. This is the factor tilting we are discussing here. So pretty much, you have to decide if you buy into what the academics are telling us.
The problem with calculating real time investment results is that short term, almost anything can happen. Performance over the last three months essentially tells you nothing, particularly if market volatility up or down is due to something like massive short covering or a hedge fund manager unwinding a losing bet. Markets do really, really weird things in the shorter term and it isn't always easy to determine why.
The best you can do in measuring the effectiveness of your strategy is to look at your portfolio components and seeing if they are acting as expected. If you construct what you think is a low volatility portfolio and yet the portfolio is more volatile than your benchmarks, something is wrong with your strategy. You have to do some benchmarking.
The whole point of this thread is that Small/Value tilting has not worked over the last decade. Well, as I said, such a strategy just isn't going to beat the market when that market is led by the Large Growth stocks. If your performance is in line with a blended benchmark, that is a benchmark that includes the same percentage of Small/Value as what is in your portfolio, you haven't failed. A thoroughbred horse is just not going to win a drag race, even if he won the Triple Crown. Success is determine by relative performance compared to your benchmark. As I mentioned above, picking the appropriate benchmark is not always easy.
Problem is that there is no way to know for sure what is going to work in the future. None of us have prophetic powers. What we can do is look at the past and make reasonable guesses about what might happen in the future.
In 1999, Jack Bogle calculated the future estimated returns of stocks to be 2% for the next decade and that the returns for bonds would be 6%-7%. He was uncannily right except that stocks returned about zero from 2000-2012. His model took into account economic (business) return and speculative return. Economic return is relatively easy to calculate, pretty much earnings growth which historically is 5%-6% and adding the dividend yield which is about 2%. So that implies economic return of 7% to 8% a year. Then there is the element of speculative return which is a measure of what a market will pay for $1 of earnings. P/E ratio expansion adds to return and P/E ratio compression detracts from the returns. In normal times, P/E ratios are about 16-17 and they got up to about 32X earnings based upon future estimate earnings and 45X earnings based upon historical earnings. Bogle thought there would be a reversion of the mean back to more normal Price to Earnings ratios and he was right.
What Bogle saw was that stocks had very little future expected return with lots of risk attached. Bonds had relatively fat returns available at very little risk. Bogle said that bonds were the steal of the century. He lighted up on his stocks and he bought more bonds. A couple of versions to the story and he isn't around anymore to ask but the point was he did some calculations and acted upon what he saw. Bogle probably also was alarmed by the euphoria and all the talk about the new paradigm.
What actually happened during the 2000's was that earnings doubled during that decade, so you have about 7% earnings growth plus the 2% dividend yield. But investor enthusiasm for stocks waned, Price to Earnings ratios compressed, so returns of the S&P 500 over that decade was -1%. Fantastic earnings could not compensate for decreased investor enthusiasm. In other words, negative speculative return cancelled out the economic returns of stocks for that decade.
Of course what happened was that the market ran out of buyers in early 2000 and the markets fell. Markets need new buyers to come into the markets to push prices higher. You need pessimists who can change their mind and become optimists. When the very last pessimist throws in the towel and throws his money at the stock market, the rally is over. Everyone is optimistic, no one out there to change their mind and become a buyer and the market falls. This is an oversimplification but that is the way it works. One reason that market sentiment is a good contrary indicator.
Problem is that you might be right but just right too early. Or worse yet, right way too early.
A fool and his money are good for business.