Do Indexers even need to pay attention to market valuation?

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Buy_N_Hold
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Do Indexers even need to pay attention to market valuation?

Post by Buy_N_Hold »

I have been kicking around this question the past few weeks. Given how difficult it is to know where we are in the market cycle, as well as what the future may bring, does it make sense to even pay attention to the overall valuation of the market? Since I started investing in 2015 I have just continued to buy and hold, and obviously it has worked out very well so far. However, I am wondering how it felt during the mania of the late 90’s, as the market zoomed higher and higher and higher. Does it make sense to try to risk off a bit when things seem toppy, and adjust your asset allocation of stocks accordingly, or is this kind of thinking essentially just trying to time the market?

For example, is there any P/E that the overall market could hit that is truly “too high”? Maybe all of this means I need to preemptively adjust my AA closer to 80/20 stocks and bonds, as right now I am 100% equities. Any thoughts or past experiences on this topic would be appreciated.
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arcticpineapplecorp.
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Re: Do Indexers even need to pay attention to market valuation?

Post by arcticpineapplecorp. »

what does your IPS tell you to do:
https://www.bogleheads.org/wiki/Investm ... _statement

If you have stocks and bonds, you just keep selling stocks as they continue to go higher and rebalance into bonds.

If you're asking if one should change their allocation due to valuations, I say no, have an allocation where you only take the amount of risk you have the need, ability and willingness to take:

https://www.cbsnews.com/news/asset-allo ... -you-take/
https://www.cbsnews.com/news/asset-allo ... tolerance/
https://www.cbsnews.com/news/asset-allo ... -you-need/
https://www.cbsnews.com/news/asset-allo ... ing-goals/

Also you might not only rebalance between stocks and bonds, you might rebalance between US stocks and International Stocks. If US has done better than international (as it has for many years) you might find yourself (as I have) continuing to buy international stocks rather than US stocks.

There's always something that's done worse (or not as good) to put new money to work in. The opposite is true in retirement. You'd have been selling US stocks over the past several years as they've been climbing higher than everything else.
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events.
Normchad
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Re: Do Indexers even need to pay attention to market valuation?

Post by Normchad »

I don’t pay attention to it.

I just keep doing what I’ve been doing for 30 years. Buy, buy, buy…….

The markets are near all time highs right now. And over the last 30 years, it’s probably been at all time highs dozens of times. In hindsight, I wish I could have bought a lot more at those other all time high levels.

I don’t know where the market will be next week, or next year. But I’m confident it will be a lot higher in 20 years than it is today.

I don’t care about valuations. Mostly because there just isn’t anything useful I can do with that information.
invest4
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Re: Do Indexers even need to pay attention to market valuation?

Post by invest4 »

It is not advisable to adjust your portfolio due to your "feeling" or "sense" of the market (nobody knows nothing). There are gobs of stories from people who have attempted it and failed...sometimes miserably. Of course, that doesn't mean that people still keep on trying (I have done so myself during my investing journey). :wink: :oops:

Depending upon your circumstances, it may make some sense to adjust your AA...for many years or permanently. If instead you think to return to 100% / other when things "seem" or "feel" less frothy, you will be in the same position again...simply market timing.
Tamalak
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Re: Do Indexers even need to pay attention to market valuation?

Post by Tamalak »

I keep track of a rolling P/E ratio of stocks to get an idea of the time value of money. I suspect it's going down, which will also reduce returns in the long run. I'm not going to use this to time the market, but rather to determine a safe indefinite withdrawal rate (right now it's 3.7%)
alex_686
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Re: Do Indexers even need to pay attention to market valuation?

Post by alex_686 »

Yes, you do.

You create a asset allocation to meet your goals. For this you need to estimate returns, risks, etc.

The expected risk, returns, and correlations are time varying. As such, when those change so should your asset allocation.

For example, consider the current high equity valuations.

Statically it does not mean the market will fall. The market does not mean revert in this fashion. Historically it is more likely to go sideways as it is to go down. We can’t tell if the market is over, under, or fairly valued.

What we can say is that long run expected returns will be lower in the future. So you should adjust your allocation according.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Trader Joe
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Re: Do Indexers even need to pay attention to market valuation?

Post by Trader Joe »

"Do Indexers even need to pay attention to market valuation?"

No, of course not. I am a decades long U.S. investor in VTSAX/VFIAX and I can tell you that I could not care less about market valuation. I never, ever pay attention to market valuation.

I can also tell you that I am very, very happy with my U.S. investment results.
Nathan Drake
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Re: Do Indexers even need to pay attention to market valuation?

Post by Nathan Drake »

If you have a highly concentrated portfolio, such as 100% US TSM stocks, then yes I think you need to pay attention quite a lot. If it's more diversified, it may be sub-optimal to ignore it but you'll likely do okay over the long term.

https://www.aqr.com/Insights/Research/W ... n-a-Little

https://mebfaber.com/2019/01/06/you-wou ... ood-thing/
Ferdinand2014
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Re: Do Indexers even need to pay attention to market valuation?

Post by Ferdinand2014 »

https://youtu.be/pFgPNVytlwA

Very Instructive.

The answer to your question is no.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett
NiceUnparticularMan
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Re: Do Indexers even need to pay attention to market valuation?

Post by NiceUnparticularMan »

So assuming a fixed savings plan (more in a moment), someone in accumulation who was wise enough to do something like just pick a low-cost Target fund from a reputable company as their savings vehicle definitely does not need to pay attention to market valuations. Or markets in general. All they need to do is put the savings in as planned. And in fact, I would suggest there is ample evidence that trying to do your own market assessments is far more likely to hurt than help you, not least if you consider yourself "sophisticated" about financial things, which is why it was so wise to choose a low-cost Target fund to begin with.

I think the tricky bit is when you get to the question of how much you should be saving. I think it is common for people here to somewhat assume away this question by de facto assuming enough work income relative to important expenditures, and high enough returns on savings, that the only sacrifice involved in saving "enough" is giving up on "luxuries" that won't contribute much to your happiness anyway.

But not all people are so fortunate, and for them it can be a real question whether they should, say, invest in their own education/training, or invest in a move, or help a family member in need, or so on, such that their savings will be materially reduced for some period.

And in theory at least, valuations might be relevant to that sort of savings decision. Like, if you reason high valuations imply lower returns on your investments, maybe you need to save more.

But even that can get tricky fast. Like, maybe it means you need to save LESS so you can invest more in increasing your future income! And so on.

I wish I had a handy rule for this savings rate issue, but I don't--I think it is a hard question to answer in present circumstances, and I think a lot of people here just basically never had to worry about it because they had enough income and enjoyed the returns boost associated with shifting to higher valuations, all of which made this look super easy.

But anyway, that savings rate issue is the only one where I see valuations maybe being something you should consider. For allocation purposes, just be wise enough to know you shouldn't be doing that sort of analysis at all.
Doc7
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Re: Do Indexers even need to pay attention to market valuation?

Post by Doc7 »

Trader Joe wrote: Sat Jul 17, 2021 9:32 pm "Do Indexers even need to pay attention to market valuation?"

No, of course not. I am a decades long U.S. investor in VTSAX/VFIAX and I can tell you that I could not care less about market valuation. I never, ever pay attention to market valuation.

I can also tell you that I am very, very happy with my U.S. investment results.
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Re: Do Indexers even need to pay attention to market valuation?

Post by Doc7 »

Nathan Drake wrote: Sat Jul 17, 2021 9:55 pm If you have a highly concentrated portfolio, such as 100% US TSM stocks, then yes I think you need to pay attention quite a lot. If it's more diversified, it may be sub-optimal to ignore it but you'll likely do okay over the long term.

https://www.aqr.com/Insights/Research/W ... n-a-Little

https://mebfaber.com/2019/01/06/you-wou ... ood-thing/

If your AA is 100% US TSM, what benefit is there to be derived from paying attention to market valuations? It’s not like you have anything to rebalance into.
am
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Re: Do Indexers even need to pay attention to market valuation?

Post by am »

I don’t think so because high valuations don’t imply a crash is imminent, just that the chance of lower future returns is higher. But still likely higher then any alternatives. Also, valuations can always get higher or go sideways.

Now if we get to Japan 1989 valuations then maybe? :D
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nedsaid
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Re: Do Indexers even need to pay attention to market valuation?

Post by nedsaid »

Buy_N_Hold wrote: Sat Jul 17, 2021 7:17 pm I have been kicking around this question the past few weeks. Given how difficult it is to know where we are in the market cycle, as well as what the future may bring, does it make sense to even pay attention to the overall valuation of the market? Since I started investing in 2015 I have just continued to buy and hold, and obviously it has worked out very well so far. However, I am wondering how it felt during the mania of the late 90’s, as the market zoomed higher and higher and higher. Does it make sense to try to risk off a bit when things seem toppy, and adjust your asset allocation of stocks accordingly, or is this kind of thinking essentially just trying to time the market?

For example, is there any P/E that the overall market could hit that is truly “too high”? Maybe all of this means I need to preemptively adjust my AA closer to 80/20 stocks and bonds, as right now I am 100% equities. Any thoughts or past experiences on this topic would be appreciated.
Yes you should pay attention to the overall valuation of the stock market. Most of the time, there isn't really anything to do but to stay invested. If you are still working, you should keep making regular investments into the markets.

There are times when the markets get excessively optimistic and it seems that the sky is the limit for the stock market. We saw this in the late 1920's, the late 1960's, and the late 1990's. When the shoe shine boys give stock tips to Wall Street executives, that should give you pause. The current market doesn't have that feel. Current P/E ratios based upon forward estimates are about 21, earnings might still be depressed because of Covid and interest rates are still low. This looks a bit high to me but no reason to freak out either.

If you are worried that the U.S. Stock Market is too expensive there are things you can do: 1) Complement your Total Stock Market Index with a Value Index, 2) Increase your allocation to International Stocks which are cheaper than U.S., and 3) take a bit off the top and put those funds into bonds. If you haven't rebalanced your portfolio for a while, this might be a good time to do that.

Market euphoria doesn't happen very often, I have seen it just once during my investing career. It happened once before during my lifetime but I was a grade schooler during that time. Pretty hard to have an investment portfolio in first and second grade.
A fool and his money are good for business.
UpperNwGuy
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Re: Do Indexers even need to pay attention to market valuation?

Post by UpperNwGuy »

Nathan Drake wrote: Sat Jul 17, 2021 9:55 pm If you have a highly concentrated portfolio, such as 100% US TSM stocks, then yes I think you need to pay attention quite a lot. If it's more diversified, it may be sub-optimal to ignore it but you'll likely do okay over the long term.

https://www.aqr.com/Insights/Research/W ... n-a-Little

https://mebfaber.com/2019/01/06/you-wou ... ood-thing/
55% of global equities with over 3500 stocks is a highly concentrated portfolio? Give me a break.
am
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Re: Do Indexers even need to pay attention to market valuation?

Post by am »

UpperNwGuy wrote: Sun Jul 18, 2021 9:24 am
Nathan Drake wrote: Sat Jul 17, 2021 9:55 pm If you have a highly concentrated portfolio, such as 100% US TSM stocks, then yes I think you need to pay attention quite a lot. If it's more diversified, it may be sub-optimal to ignore it but you'll likely do okay over the long term.

https://www.aqr.com/Insights/Research/W ... n-a-Little

https://mebfaber.com/2019/01/06/you-wou ... ood-thing/
55% of global equities with over 3500 stocks is a highly concentrated portfolio? Give me a break.
A lot of total markets performance (and us stock market) is dependent on nasdaq and the large tech companies. It seems concentrated because us stock market is concentrated on the big tech/nasdaq companies
KlangFool
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Re: Do Indexers even need to pay attention to market valuation?

Post by KlangFool »

OP,

A) You should not be 100% stock.

B) For anyone else that are not 100% stock, they do not have to think about market valuation, By maintaining their AA in the range 70/30 to 30/70 and "buy, hold, rebalancing", they will "Buy Low and Sell High". If the stock is overvalued, they would buy the bond. And, vice versa.

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Da5id
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

UpperNwGuy wrote: Sun Jul 18, 2021 9:24 am
Nathan Drake wrote: Sat Jul 17, 2021 9:55 pm If you have a highly concentrated portfolio, such as 100% US TSM stocks, then yes I think you need to pay attention quite a lot. If it's more diversified, it may be sub-optimal to ignore it but you'll likely do okay over the long term.

https://www.aqr.com/Insights/Research/W ... n-a-Little

https://mebfaber.com/2019/01/06/you-wou ... ood-thing/
55% of global equities with over 3500 stocks is a highly concentrated portfolio? Give me a break.
Maybe referring to over 18% of TSM being in just 5 stocks?
invest2bfree
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Re: Do Indexers even need to pay attention to market valuation?

Post by invest2bfree »

Buy_N_Hold wrote: Sat Jul 17, 2021 7:17 pm I have been kicking around this question the past few weeks. Given how difficult it is to know where we are in the market cycle, as well as what the future may bring, does it make sense to even pay attention to the overall valuation of the market? Since I started investing in 2015 I have just continued to buy and hold, and obviously it has worked out very well so far. However, I am wondering how it felt during the mania of the late 90’s, as the market zoomed higher and higher and higher. Does it make sense to try to risk off a bit when things seem toppy, and adjust your asset allocation of stocks accordingly, or is this kind of thinking essentially just trying to time the market?

For example, is there any P/E that the overall market could hit that is truly “too high”? Maybe all of this means I need to preemptively adjust my AA closer to 80/20 stocks and bonds, as right now I am 100% equities. Any thoughts or past experiences on this topic would be appreciated.
There is an excellent video by Bogle on this.

https://youtu.be/k6ra5POdsYg

His idea is for all investors who are in the accumulation phase recommends 65/35. Then if you think fwd P/E is becoming like 40 then move from 65/35 to 50/50.
60% VT, 40% BND.
MarkRoulo
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Re: Do Indexers even need to pay attention to market valuation?

Post by MarkRoulo »

Buy_N_Hold wrote: Sat Jul 17, 2021 7:17 pm I have been kicking around this question the past few weeks. <u>Given how difficult it is to know where we are in the market cycle, as well as what the future may bring, does it make sense to even pay attention to the overall valuation of the market?</u> Since I started investing in 2015 I have just continued to buy and hold, and obviously it has worked out very well so far. However, I am wondering how it felt during the mania of the late 90’s, as the market zoomed higher and higher and higher. Does it make sense to try to risk off a bit when things seem toppy, and adjust your asset allocation of stocks accordingly, or is this kind of thinking essentially just trying to time the market?

For example, is there any P/E that the overall market could hit that is truly “too high”? Maybe all of this means I need to preemptively adjust my AA closer to 80/20 stocks and bonds, as right now I am 100% equities. Any thoughts or past experiences on this topic would be appreciated.
Yes, but probably not the way you are thinking about it.

If we restrict ourselves to stocks (US and international or just US), bonds and cash, we can start by looking at stock P/E valuations. Currently, we'll note that they are high compared to historical averages. The problem is that there is no obvious action to take.

You could move some of your investments from stocks to bonds, but the Vanguard Total Bond Index has a yield of about 1.3%. This is about the same as the S&P 500 and below the current inflation rate. So one option for dealing with the currently high stock prices is to lock in an expected zero or negative return with bonds. This is ... less than attractive.

Another option would be to move some of your stock investments to cash. My local credit union is paying 0.5% on saving accounts, so your expected return is even worse than bonds.

IF YOU KNEW that stocks were going to drop a lot soon, then either of these moves would be reasonable, but you don't.

So paying attention to high stock prices isn't (usually) going to help you make investment allocation decisions(*). At any given time, stocks, bonds and cash are all priced fairly sanely against each other and there is no clearly best place to invest. You CAN change the risk vs expected-return profile, but you can do this at any stock valuation.

Where paying attention to valuations has some value is in planning and managing expectations.

A number of folks on this board prefer to just look at US historical average returns (about 7% real for stocks, about 1-2% real for bonds) and assume that the future will be much like that past and that 7% stock returns is a good expectation. From this you can back out how much you need to invest each year to hit some retirement target in real money terms.

But investment returns don't work that way.

Part of the returns over the past 40 years have been bond yields dropping. The good news is that one can "take out" the return from bonds because of the drop in yield. You can then use this when planning ahead if you do NOT want to assume that bond yields will continue dropping 0.25% per year for the next 40 years. Similar things hold for stocks -- you can "take out" the P/E expansion and ask what stocks might be expected to return if P/E rations do NOT expand a lot over the next 40 years.

Both answers will probably lead to, "EXPECTED returns will be lower than the past 40 years," but this is true for every asset class so none of this tells you where to invest. You still have to decide what risk you are willing to take for what expected return. As always.

You may, however, have to plan on saving more than you would have if the past 40 years of bond yields dropping and stock P/Es rising doesn't continue for another 40 years.
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nisiprius
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Re: Do Indexers even need to pay attention to market valuation?

Post by nisiprius »

I'm not sure what you mean by "pay attention."

One interpretation of "paying attention" means to increase stock allocation when stocks seem "cheap" and reduce it when stocks seem "expensive" on the theory that this will generate higher return for the same risk than holding a static allocation. This is basically a soft form of market timing, and the name for it is "tactical asset allocation."

My opinion is that indexers do not need to perform tactical asset allocation.

There have always been people advocating this. In the 1980s and 1990s it was very popular, almost the mainstream theory, and one of the funds in my employer's 401(k) plan, Fidelity Asset Manager, was a good example of the genre. Within a year or so after inception the Vanguard LifeStrategy funds adopted tactical asset allocation, too, and continued to do it for a long time. Tactical asset allocation funds declare a "neutral" allocation for the fund, but vary the stock allocation up and down--"according to a quantitative model," Vanguard said--around the neutral point.

For a while, The Wall Street Journal almost made a contest out of this, publishing the varying allocations different managers were using and comparing their results to a static 60/40 "robot mix."

Although these funds did not perform disastrously, they consistently failed to outperform static allocations. Both Fidelity and Vanguard eventually threw in the towel and pinned their funds to fixed allocations, and the whole genre has more or less faded from the scene.

More recently, around 2010, Mebane Faber published a book entitled Global Tactical Asset Allocation which some people found convincing. He then created an ETF named GTAA to implement the strategy, with a stock/bond allocation of approximately 40/60, and got the results shown in the orange line of the chart below. The ETF was eventually liquidated.

Image

Many people cannot believe that adjusting allocations in response to valuations will not yield superior results. But when it has been tried in practice the results have been unconvincing, and fade into the usual debate areas of time periods and precise methodologies used.
Last edited by nisiprius on Sun Jul 18, 2021 12:36 pm, edited 2 times in total.
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Nathan Drake
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Re: Do Indexers even need to pay attention to market valuation?

Post by Nathan Drake »

UpperNwGuy wrote: Sun Jul 18, 2021 9:24 am
Nathan Drake wrote: Sat Jul 17, 2021 9:55 pm If you have a highly concentrated portfolio, such as 100% US TSM stocks, then yes I think you need to pay attention quite a lot. If it's more diversified, it may be sub-optimal to ignore it but you'll likely do okay over the long term.

https://www.aqr.com/Insights/Research/W ... n-a-Little

https://mebfaber.com/2019/01/06/you-wou ... ood-thing/
55% of global equities with over 3500 stocks is a highly concentrated portfolio? Give me a break.
The number of stocks in your portfolio is not a good proxy for diversification when the cap weighting skews them significantly towards a few in one sector.
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Re: Do Indexers even need to pay attention to market valuation?

Post by Nathan Drake »

MarkRoulo wrote: Sun Jul 18, 2021 10:45 am
Buy_N_Hold wrote: Sat Jul 17, 2021 7:17 pm I have been kicking around this question the past few weeks. <u>Given how difficult it is to know where we are in the market cycle, as well as what the future may bring, does it make sense to even pay attention to the overall valuation of the market?</u> Since I started investing in 2015 I have just continued to buy and hold, and obviously it has worked out very well so far. However, I am wondering how it felt during the mania of the late 90’s, as the market zoomed higher and higher and higher. Does it make sense to try to risk off a bit when things seem toppy, and adjust your asset allocation of stocks accordingly, or is this kind of thinking essentially just trying to time the market?

For example, is there any P/E that the overall market could hit that is truly “too high”? Maybe all of this means I need to preemptively adjust my AA closer to 80/20 stocks and bonds, as right now I am 100% equities. Any thoughts or past experiences on this topic would be appreciated.
Yes, but probably not the way you are thinking about it.

If we restrict ourselves to stocks (US and international or just US), bonds and cash, we can start by looking at stock P/E valuations. Currently, we'll note that they are high compared to historical averages. The problem is that there is no obvious action to take.

You could move some of your investments from stocks to bonds, but the Vanguard Total Bond Index has a yield of about 1.3%. This is about the same as the S&P 500 and below the current inflation rate. So one option for dealing with the currently high stock prices is to lock in an expected zero or negative return with bonds. This is ... less than attractive.

Another option would be to move some of your stock investments to cash. My local credit union is paying 0.5% on saving accounts, so your expected return is even worse than bonds.

IF YOU KNEW that stocks were going to drop a lot soon, then either of these moves would be reasonable, but you don't.

So paying attention to high stock prices isn't (usually) going to help you make investment allocation decisions(*). At any given time, stocks, bonds and cash are all priced fairly sanely against each other and there is no clearly best place to invest. You CAN change the risk vs expected-return profile, but you can do this at any stock valuation.

Where paying attention to valuations has some value is in planning and managing expectations.

A number of folks on this board prefer to just look at US historical average returns (about 7% real for stocks, about 1-2% real for bonds) and assume that the future will be much like that past and that 7% stock returns is a good expectation. From this you can back out how much you need to invest each year to hit some retirement target in real money terms.

But investment returns don't work that way.

Part of the returns over the past 40 years have been bond yields dropping. The good news is that one can "take out" the return from bonds because of the drop in yield. You can then use this when planning ahead if you do NOT want to assume that bond yields will continue dropping 0.25% per year for the next 40 years. Similar things hold for stocks -- you can "take out" the P/E expansion and ask what stocks might be expected to return if P/E rations do NOT expand a lot over the next 40 years.

Both answers will probably lead to, "EXPECTED returns will be lower than the past 40 years," but this is true for every asset class so none of this tells you where to invest. You still have to decide what risk you are willing to take for what expected return. As always.

You may, however, have to plan on saving more than you would have if the past 40 years of bond yields dropping and stock P/Es rising doesn't continue for another 40 years.
Good points, although I will say that some asset classes project lower expected returns than others. US TSM looks to be quite low, but others look to have much higher expected returns. Should you aim to achieve higher expected returns, there are many options at your disposal that do come with extra risk.
rockstar
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Re: Do Indexers even need to pay attention to market valuation?

Post by rockstar »

Valuation only matters if you're going act on it.
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Buy_N_Hold
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Re: Do Indexers even need to pay attention to market valuation?

Post by Buy_N_Hold »

nisiprius wrote: Sun Jul 18, 2021 12:27 pm I'm not sure what you mean by "pay attention."

One interpretation of "paying attention" means to increase stock allocation when stocks seem "cheap" and reduce it when stocks seem "expensive" on the theory that this will generate higher return for the same risk than holding a static allocation. This is basically a soft form of market timing, and the name for it is "tactical asset allocation."

My opinion is that indexers do not need to perform tactical asset allocation.

There have always been people advocating this. In the 1980s and 1990s it was very popular, almost the mainstream theory, and one of the funds in my employer's 401(k) plan, Fidelity Asset Manager, was a good example of the genre. Within a year or so after inception the Vanguard LifeStrategy funds adopted tactical asset allocation, too, and continued to do it for a long time. Tactical asset allocation funds declare a "neutral" allocation for the fund, but vary the stock allocation up and down--"according to a quantitative model," Vanguard said--around the neutral point.

For a while, The Wall Street Journal almost made a contest out of this, publishing the varying allocations different managers were using and comparing their results to a static 60/40 "robot mix."

Although these funds did not perform disastrously, they consistently failed to outperform static allocations. Both Fidelity and Vanguard eventually threw in the towel and pinned their funds to fixed allocations, and the whole genre has more or less faded from the scene.

More recently, around 2010, Mebane Faber published a book entitled Global Tactical Asset Allocation which some people found convincing. He then created an ETF named GTAA to implement the strategy, with a stock/bond allocation of approximately 40/60, and got the results shown in the orange line of the chart below. The ETF was eventually liquidated.

Image

Many people cannot believe that adjusting allocations in response to valuations will not yield superior results. But when it has been tried in practice the results have been unconvincing, and fade into the usual debate areas of time periods and precise methodologies used.
This is exactly what I meant by “pay attention”: adjusting asset allocation based on market conditions and valuation ratios etc. interesting to hear more about the history of tactical asset allocation. Fascinating to see that folks trying to adjust their AA underperformed a static AA, although this does make perfect sense. The comments about increasing savings rates due to lower expected returns moving forward make sense to me as well. Thanks for your thoughts everyone. Very interesting stuff.
“To turn $100 into $110 is work. To turn $100 million into $110 million is inevitable.” -Edgar Bronfman
afan
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Re: Do Indexers even need to pay attention to market valuation?

Post by afan »

One might not use valuations to change asset allocation, for the reasons discussed above.

However, for long term planning you do have to assume some rates of return. One could just pick a conservative value and go forward. Or one could project lower returns and adjust expectations going forward.

This might change how much to save to hit asset targets by a certain date. Or how long one might need to work before retiring.

I share the concern that high valuations imply a risk of terrible returns from here. But I cannot think of what to do about this opinion.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
Marseille07
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Re: Do Indexers even need to pay attention to market valuation?

Post by Marseille07 »

Buy_N_Hold wrote: Sun Jul 18, 2021 1:25 pm This is exactly what I meant by “pay attention”: adjusting asset allocation based on market conditions and valuation ratios etc. interesting to hear more about the history of tactical asset allocation. Fascinating to see that folks trying to adjust their AA underperformed a static AA, although this does make perfect sense. The comments about increasing savings rates due to lower expected returns moving forward make sense to me as well. Thanks for your thoughts everyone. Very interesting stuff.
Paying attention and adjusting AA based on market conditions and valuation ratios etc is, in a nutshell, market timing. I'm not saying one can't time the market, but it is generally discouraged at BH.
HootingSloth
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Re: Do Indexers even need to pay attention to market valuation?

Post by HootingSloth »

It depends on the nature of your plan. If it has sufficiently high levels of safety built-in, then valuations can be largely or entirely irrelevant. If you are trying to spend as much as possible given your income, and don't mind bearing some increased risk of your plan failing in order to do so, then you probably want to pay at least some attention to valuations to help answer questions about how much to save or when to retire. However, I don't think valuations should be used to make market timing decisions or to change your asset allocation "tactically," regardless of your plan.
Global Market Portfolio + modest tilt towards volatility (80/20->60/40 as approach FI) + modest tilt away from exchange rate risk (80% global+20% U.S. stocks; currency-hedge bonds) + tax optimization
Nathan Drake
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Re: Do Indexers even need to pay attention to market valuation?

Post by Nathan Drake »

Doc7 wrote: Sun Jul 18, 2021 8:59 am
Nathan Drake wrote: Sat Jul 17, 2021 9:55 pm If you have a highly concentrated portfolio, such as 100% US TSM stocks, then yes I think you need to pay attention quite a lot. If it's more diversified, it may be sub-optimal to ignore it but you'll likely do okay over the long term.

https://www.aqr.com/Insights/Research/W ... n-a-Little

https://mebfaber.com/2019/01/06/you-wou ... ood-thing/

If your AA is 100% US TSM, what benefit is there to be derived from paying attention to market valuations? It’s not like you have anything to rebalance into.
Hopefully it becomes large enough to change your mind about the risks of a 100% US TSM portfolio
ScubaHogg
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Re: Do Indexers even need to pay attention to market valuation?

Post by ScubaHogg »

nisiprius wrote: Sun Jul 18, 2021 12:27 pm
Many people cannot believe that adjusting allocations in response to valuations will not yield superior results. But when it has been tried in practice the results have been unconvincing, and fade into the usual debate areas of time periods and precise methodologies used.
Nisiprius, out of curiosity, is there any PE10 that would cause you to adjust your equity allocation (if you aren’t already, which I’m guessing you aren’t)? 60? 70? What if it got upwards of 100 a la Japan?
“The purpose of the margin of safety is to render the forecast unnecessary.” - Ben Graham
alex_686
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Re: Do Indexers even need to pay attention to market valuation?

Post by alex_686 »

ScubaHogg wrote: Sun Jul 18, 2021 5:22 pm
nisiprius wrote: Sun Jul 18, 2021 12:27 pm
Many people cannot believe that adjusting allocations in response to valuations will not yield superior results. But when it has been tried in practice the results have been unconvincing, and fade into the usual debate areas of time periods and precise methodologies used.
Nisiprius, out of curiosity, is there any PE10 that would cause you to adjust your equity allocation (if you aren’t already, which I’m guessing you aren’t)? 60? 70? What if it got upwards of 100 a la Japan?
I will chime in on this question - and that it is the wrong question.

P/E ratios by themselves tell you very little. They are relative measures that pack in expected growth and risk.

For a simple example, what do you invest in if not stocks? Bonds. Which is the more attractive investment, a 10 year government bond at 0.1% or stocks at a P/E ratio at 50?

This is a bit of a silly question, but kind of what we face today.

This would be a different question 25 years ago, when 10 year treasuries offered a higher expected return - a pretty decent one in the grand scheme of things.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
ScubaHogg
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Re: Do Indexers even need to pay attention to market valuation?

Post by ScubaHogg »

alex_686 wrote: Sun Jul 18, 2021 5:37 pm
ScubaHogg wrote: Sun Jul 18, 2021 5:22 pm
nisiprius wrote: Sun Jul 18, 2021 12:27 pm
Many people cannot believe that adjusting allocations in response to valuations will not yield superior results. But when it has been tried in practice the results have been unconvincing, and fade into the usual debate areas of time periods and precise methodologies used.
Nisiprius, out of curiosity, is there any PE10 that would cause you to adjust your equity allocation (if you aren’t already, which I’m guessing you aren’t)? 60? 70? What if it got upwards of 100 a la Japan?
I will chime in on this question - and that it is the wrong question.

P/E ratios by themselves tell you very little. They are relative measures that pack in expected growth and risk.

For a simple example, what do you invest in if not stocks? Bonds. Which is the more attractive investment, a 10 year government bond at 0.1% or stocks at a P/E ratio at 50?

This is a bit of a silly question, but kind of what we face today.

This would be a different question 25 years ago, when 10 year treasuries offered a higher expected return - a pretty decent one in the grand scheme of things.
Is there any PE10 that would make you think it’s the right question and that simple cash or your poorly paying 10 year bonds would be better? 100? 150? 200? What about 500?

My point is there is some logical limit to the claim that we should ignore valuations and stay the course. Maybe we will never see that limit and shouldn’t worry about it (though a Japanese investor would have been well served by worrying about it) but we should probably acknowledge it exists
“The purpose of the margin of safety is to render the forecast unnecessary.” - Ben Graham
MarkRoulo
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Re: Do Indexers even need to pay attention to market valuation?

Post by MarkRoulo »

ScubaHogg wrote: Sun Jul 18, 2021 5:57 pm
alex_686 wrote: Sun Jul 18, 2021 5:37 pm
ScubaHogg wrote: Sun Jul 18, 2021 5:22 pm
nisiprius wrote: Sun Jul 18, 2021 12:27 pm
Many people cannot believe that adjusting allocations in response to valuations will not yield superior results. But when it has been tried in practice the results have been unconvincing, and fade into the usual debate areas of time periods and precise methodologies used.
Nisiprius, out of curiosity, is there any PE10 that would cause you to adjust your equity allocation (if you aren’t already, which I’m guessing you aren’t)? 60? 70? What if it got upwards of 100 a la Japan?
I will chime in on this question - and that it is the wrong question.

P/E ratios by themselves tell you very little. They are relative measures that pack in expected growth and risk.

For a simple example, what do you invest in if not stocks? Bonds. Which is the more attractive investment, a 10 year government bond at 0.1% or stocks at a P/E ratio at 50?

This is a bit of a silly question, but kind of what we face today.

This would be a different question 25 years ago, when 10 year treasuries offered a higher expected return - a pretty decent one in the grand scheme of things.
Is there any PE10 that would make you think it’s the right question and that simple cash or your poorly paying 10 year bonds would be better? 100? 150? 200? What about 500?

My point is there is some logical limit to the claim that we should ignore valuations and stay the course. Maybe we will never see that limit and shouldn’t worry about it (though a Japanese investor would have been well served by worrying about it) but we should probably acknowledge it exists
For your question to be meaningful we must also know the alternatives to stocks. Simplifying, we need to know the interest rate for cash and bonds.

At P/E10 of 500 looks bad in isolation, but maybe isn't if the prevailing (real) interest rate is -10%.

One fundamental belief held by most indexers is that we won't have a situation where any asset is CLEARLY better than others. This is because other, active traders, will keep relative prices in line. This is much the same as expecting to find situations what a given stock or stock category is CLEARLY better than the alternatives.

So a stock P/E of 500 combined with a US govt medium term bond yielding 10% with a inflation rate of 0%? Sure, buy the bond. Except that this is considered so unlikely as to not be a realistic subject of discussion.

NOTE: A more realistic version that DID happen was us Govt TIPS yielding 3.4-3.6% *real* at the peak of the dot-com boom. I'll go out on a limb here and suggest that even many fervent indexers would have been buying the TIPS if they had (a) realized the yield, and (b) know that TIPS existed. The *real* yield corrected over the next few years (as did the insane stock P/E).
Hoongajji
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Re: Do Indexers even need to pay attention to market valuation?

Post by Hoongajji »

The p/e, p/b and p/s are fundamental.

Walk into your bank and buy $100 of rolled quarters. Or $1000 worth of quarter coins. You find one or several from 1964 that are silver and worth $10 each.

The non silver coins are returned at face value and you profit nicely from the effort on the silver coins.

Your fundamental ratio’s are better than VTI.

A mad frenzy of rolls of quarter buying hysteria might ensue.

Vanguard and other indexes are businesses selling you a service. They unwrap the quarters and redeem the silver for you for a small percentage cut.

When there is no more silver coins what happens? Lower interest rates? Inflation? A crisis?

What is the value or effort you are willing to pay for a service or product.

Pay attention to that.
alex_686
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Re: Do Indexers even need to pay attention to market valuation?

Post by alex_686 »

ScubaHogg wrote: Sun Jul 18, 2021 5:57 pm My point is there is some logical limit to the claim that we should ignore valuations and stay the course. Maybe we will never see that limit and shouldn’t worry about it (though a Japanese investor would have been well served by worrying about it) but we should probably acknowledge it exists
Well, maybe atypically as a Boglehead, I don’t advocate holding the course.

One should not panic. Trying to time the market is really hard to do. etc.

However, we always say to be calm and write up a ISP. You base your asset allocation based on your market expectations. But the market changes over time. If the market changes shouldn’t you?

MarkRoulo mentioned the 90s where expected real returns of government bonds was 3%. Compare that to now, where it is around 0%. You should come to 2 different conclusions on what your AA should be, right?
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Nathan Drake
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Re: Do Indexers even need to pay attention to market valuation?

Post by Nathan Drake »

Rob Arnott makes some interesting points around 20 mins, 25 mins, and 32 minutes into the video about taking into account Valuations.

https://youtu.be/sPwBeok5DTM?t=1207

https://youtu.be/sPwBeok5DTM?t=1507

https://youtu.be/sPwBeok5DTM?t=1911
Last edited by Nathan Drake on Sun Jul 18, 2021 8:09 pm, edited 3 times in total.
am
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Re: Do Indexers even need to pay attention to market valuation?

Post by am »

ScubaHogg wrote: Sun Jul 18, 2021 5:22 pm
nisiprius wrote: Sun Jul 18, 2021 12:27 pm
Many people cannot believe that adjusting allocations in response to valuations will not yield superior results. But when it has been tried in practice the results have been unconvincing, and fade into the usual debate areas of time periods and precise methodologies used.
Nisiprius, out of curiosity, is there any PE10 that would cause you to adjust your equity allocation (if you aren’t already, which I’m guessing you aren’t)? 60? 70? What if it got upwards of 100 a la Japan?
I guess if PE 10 gets to 100, there’d be a lot of rebalancing by then and you’d still be ok, especially if you had international as well. And if PE 10 reaches 100, a lot of us would be very wealthy, retired, and likely have more conservative allocation :D
Lee_WSP
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Re: Do Indexers even need to pay attention to market valuation?

Post by Lee_WSP »

Timing the market does require two correct or mostly correct points in time decided upon in the thick of it.

Adjusting your AA slightly to valuations may help you sleep at night, but you may be waiting a while for validation.
WyomingFIRE
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Re: Do Indexers even need to pay attention to market valuation?

Post by WyomingFIRE »

Buy_N_Hold wrote: Sat Jul 17, 2021 7:17 pm I have been kicking around this question the past few weeks. Given how difficult it is to know where we are in the market cycle, as well as what the future may bring, does it make sense to even pay attention to the overall valuation of the market? Since I started investing in 2015 I have just continued to buy and hold, and obviously it has worked out very well so far. However, I am wondering how it felt during the mania of the late 90’s, as the market zoomed higher and higher and higher. Does it make sense to try to risk off a bit when things seem toppy, and adjust your asset allocation of stocks accordingly, or is this kind of thinking essentially just trying to time the market?

For example, is there any P/E that the overall market could hit that is truly “too high”? Maybe all of this means I need to preemptively adjust my AA closer to 80/20 stocks and bonds, as right now I am 100% equities. Any thoughts or past experiences on this topic would be appreciated.
To answer your Q, from my perspective: “No”

Been in the market via indexing since circa 1986; never owned an individual stock. Never timed the market. We always were, and remain, tortoises

We have always had an AA, which we roughly track; the AA has changed over time

When circumstances dictate, we rebalance, consistent with our then-current AA

I don’t actually know or care what the market’s current valuation is

The above has gotten us to 47X by age 57; and we sleep well at night. At some level, this isn’t hard, which I think is the point and beauty of the approach
ScubaHogg
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Re: Do Indexers even need to pay attention to market valuation?

Post by ScubaHogg »

MarkRoulo wrote: Sun Jul 18, 2021 6:07 pm
For your question to be meaningful we must also know the alternatives to stocks. Simplifying, we need to know the interest rate for cash and bonds.

At P/E10 of 500 looks bad in isolation, but maybe isn't if the prevailing (real) interest rate is -10%.

One fundamental belief held by most indexers is that we won't have a situation where any asset is CLEARLY better than others. This is because other, active traders, will keep relative prices in line. This is much the same as expecting to find situations what a given stock or stock category is CLEARLY better than the alternatives.
That’s a fair question, but no one ever asks about the alternatives when “staying the course.” To be perfectly logical you should do it all the time or never.

In my head I’d first like to know what one would do if PE went extremely high while everything else (inflation, interest rates) stayed somewhere within the realms of historical norms. In particular I ask myself what I would do as a Japanese investor in the late 80s with a PE>70/80/90 (quick research can’t find an exact peak). As far as alternatives go, I think it’s safe to say a Japanese investor had alternatives that weren’t horrible (like the real interest rate of -10%).

*just to be clear, I’m not advocating that myself or anyone should get into the business of market timing. I do think it can be useful to think about extreme cases where normal heuristics maybe don’t apply*
“The purpose of the margin of safety is to render the forecast unnecessary.” - Ben Graham
reader79
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Re: Do Indexers even need to pay attention to market valuation?

Post by reader79 »

No, indexers don't need to pay attention to market valuation. We only need to pay attention to our savings rate. Beyond that, no amount of attention will increase our returns. Know thyself, and realize that we know next to nothing about future returns.

Here is what captures my attention: When people who usually don't talk about investing start to talk about how they're worried about their investments. This happened late last February when a colleague started talking with me about how worried he was that he would never be able to retire. I barely knew this guy, and suddenly he was talking with me about his financial position. I said, "That's how we know it's a great time to buy." So, I spent the next month buying as I possibly could and got on with my life. It worked well, as it did during 2008's Category 5 financial hurricane.
VTI: 48.75%, QQQM: 28.75%, QQQJ: 9%, VB: 9%, BTC: 2.5%, ETH: 2%
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nedsaid
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Re: Do Indexers even need to pay attention to market valuation?

Post by nedsaid »

alex_686 wrote: Sun Jul 18, 2021 5:37 pm
ScubaHogg wrote: Sun Jul 18, 2021 5:22 pm
nisiprius wrote: Sun Jul 18, 2021 12:27 pm
Many people cannot believe that adjusting allocations in response to valuations will not yield superior results. But when it has been tried in practice the results have been unconvincing, and fade into the usual debate areas of time periods and precise methodologies used.
Nisiprius, out of curiosity, is there any PE10 that would cause you to adjust your equity allocation (if you aren’t already, which I’m guessing you aren’t)? 60? 70? What if it got upwards of 100 a la Japan?
I will chime in on this question - and that it is the wrong question.

P/E ratios by themselves tell you very little. They are relative measures that pack in expected growth and risk.

For a simple example, what do you invest in if not stocks? Bonds. Which is the more attractive investment, a 10 year government bond at 0.1% or stocks at a P/E ratio at 50?

This is a bit of a silly question, but kind of what we face today.

This would be a different question 25 years ago, when 10 year treasuries offered a higher expected return - a pretty decent one in the grand scheme of things.
I always say that you need to look underneath the hood and not just take numbers at face value. For example, Price/Earnings ratios can be high because there is lots of speculation in the markets OR can be high because corporate earnings are depressed and the markets expect earnings to recover.

Economically sensitive stocks or cyclicals are often counterintuitive. There is the old saying that you buy when P/E ratios are high and you sell when P/E ratios are low. What happens here is that recessions hit earnings hard but P/E's are high because the market expects both the economy and earnings to rebound, in other words the drop in earnings is temporary and better days are ahead. When the economy is roaring and earnings are high, P/E ratios can be low because the market expects an economic downturn and that earnings will fall. This is a way of saying that markets anticipate the future rather than just focus on today's news. The cyclicals include such things as Autos, the Homebuilders, Natural Resources.

I would also focus on P/E ratios based upon future expected earnings. We all know that earnings estimates made by stock analysts are flawed and sometimes too optimistic but that is what we have.

All other things being equal, lower interest rates tend towards higher P/E ratios and higher interest rates tend towards lower P/E ratios. Cash on the balance sheet is another factor, more cash on the balance sheet also tends towards higher P/E ratios. We are in the situation where interest rates are low and corporate America's balance sheets are flush with cash. No surprise why P/E's are high.

P/E ratios are also a measure of investor enthusiasm for a particular stock and for the stock market in general. Euphoria and speculation can drive P/E ratios to insane levels, this rarely happens but we saw this during the latter parts of the roaring twenties, the Go-Go sixties with the Nifty Fifty stocks, and the late 1990's with the High Tech and Internet boom.
A fool and his money are good for business.
MarkRoulo
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Re: Do Indexers even need to pay attention to market valuation?

Post by MarkRoulo »

ScubaHogg wrote: Sun Jul 18, 2021 11:14 pm
MarkRoulo wrote: Sun Jul 18, 2021 6:07 pm
For your question to be meaningful we must also know the alternatives to stocks. Simplifying, we need to know the interest rate for cash and bonds.

At P/E10 of 500 looks bad in isolation, but maybe isn't if the prevailing (real) interest rate is -10%.

One fundamental belief held by most indexers is that we won't have a situation where any asset is CLEARLY better than others. This is because other, active traders, will keep relative prices in line. This is much the same as expecting to find situations what a given stock or stock category is CLEARLY better than the alternatives.
That’s a fair question, but no one ever asks about the alternatives when “staying the course.” To be perfectly logical you should do it all the time or never.

In my head I’d first like to know what one would do if PE went extremely high while everything else (inflation, interest rates) stayed somewhere within the realms of historical norms. In particular I ask myself what I would do as a Japanese investor in the late 80s with a PE>70/80/90 (quick research can’t find an exact peak). As far as alternatives go, I think it’s safe to say a Japanese investor had alternatives that weren’t horrible (like the real interest rate of -10%).

*just to be clear, I’m not advocating that myself or anyone should get into the business of market timing. I do think it can be useful to think about extreme cases where normal heuristics maybe don’t apply*
As nearly as I can tell, the Japanese stock market P/E was around 60 in 1989. The Japanese government bonds were yielding around 5% nominal. Japanese inflation (maybe not including Tokyo real estate?) was about 2%.

The "problem" was that the Japanese stock market had been going up, basically, "forever." Few Japanese investors thought that the Japanese stock market could go down for long. So if you are trying to figure out what you would do as a Japanese investor, you need to account for this. Why would you believe anything different than everyone around you? And why would things be different now?

Consider Nikkei pricing (roughly):
1950: ~90
1960: ~1,000
1970: ~2,300 (a "bad" decade)
1980: ~6,500
1990: ~32,000

Eyeballing it, I'm pretty sure that a Japanese investor in 1989/1990 could say the following:
1) I'm saving for retirement. I won't need the money for a long time.
2) The Japanese stock market hasn't been down for ten years "ever" ("ever" being "since the Americans nuked us").
3) Japanese companies *dominate* the world economy. We have Sony, Honda, Toyota, Fuji Film, Komatsu, ...
4) Our stock market is 43% of the world stock market
5) If I'd gotten out of the market in 1987/8 I would have missed the last 50% increase (from 20,000 to 30,000)

At 5% yield, a bond takes 14 years to double. Even a "bad" decade for Japanese stocks will double faster than that.

I think you would be more likely to (at least partially) bail on the US stock market in 1999/2000:

*) P/E of almost 40 (not PE10, just for the year 2000)
*) Bond yields of 6% (I don't know the length), TIPS of 3.4-3.6%
*) Inflation of 3.4% (so the real bond yields are in line with 3% TIPS)
*) S&P 500 dividend yield of about 1.2% (and the total market would be lower ... maybe 1%)

But *would* you really? The S&P had gone up 20% per year for five years running!!!!

1995: 34%
1996: 20%
1997: 31%
1998: 27%
1999: 19%

Are you really going to trade this for a bond yielding 6%??????

If you had bailed on the stock market after Alan Greenspan's "Irrational Exuberance" speech in late 1996 you would have
missed yearly returns of 31%, 27% and 19% ... which cummulate to almost a double. If you had gotten out of the stock
market and into bonds when the federal reserve chairman had noted that stocks were unreasonably priced you would
now, three years later, have missed a doubling of your stock investments.


Which leads to the (not horrible) simplification of: Stay the course.

It is hard to know when an irrational market has peaked and when an irrational market still has another double to go!

[Which doesn't mean that some of us don't try :-)]
esteen
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Re: Do Indexers even need to pay attention to market valuation?

Post by esteen »

nisiprius wrote: Sun Jul 18, 2021 12:27 pm I'm not sure what you mean by "pay attention."

One interpretation of "paying attention" means to increase stock allocation when stocks seem "cheap" and reduce it when stocks seem "expensive" on the theory that this will generate higher return for the same risk than holding a static allocation. This is basically a soft form of market timing, and the name for it is "tactical asset allocation."

My opinion is that indexers do not need to perform tactical asset allocation.

There have always been people advocating this. In the 1980s and 1990s it was very popular, almost the mainstream theory, and one of the funds in my employer's 401(k) plan, Fidelity Asset Manager, was a good example of the genre. Within a year or so after inception the Vanguard LifeStrategy funds adopted tactical asset allocation, too, and continued to do it for a long time. Tactical asset allocation funds declare a "neutral" allocation for the fund, but vary the stock allocation up and down--"according to a quantitative model," Vanguard said--around the neutral point.

For a while, The Wall Street Journal almost made a contest out of this, publishing the varying allocations different managers were using and comparing their results to a static 60/40 "robot mix."

Although these funds did not perform disastrously, they consistently failed to outperform static allocations. Both Fidelity and Vanguard eventually threw in the towel and pinned their funds to fixed allocations, and the whole genre has more or less faded from the scene.

More recently, around 2010, Mebane Faber published a book entitled Global Tactical Asset Allocation which some people found convincing. He then created an ETF named GTAA to implement the strategy, with a stock/bond allocation of approximately 40/60, and got the results shown in the orange line of the chart below. The ETF was eventually liquidated.

Image

Many people cannot believe that adjusting allocations in response to valuations will not yield superior results. But when it has been tried in practice the results have been unconvincing, and fade into the usual debate areas of time periods and precise methodologies used.
A+ post. Thank you for all the time and effort you put into these responses.
LiterallyIronic
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Re: Do Indexers even need to pay attention to market valuation?

Post by LiterallyIronic »

Buy_N_Hold wrote: Sat Jul 17, 2021 7:17 pm does it make sense to even pay attention to the overall valuation of the market?
Not only do I not do that, I don't even know what you're talking about. Valuation? P/E? I don't even have a written investment plan because the plan is always just status quo. 401k automatically goes into my 100% large cap index fund. IRA automatically goes into Target Retirement Fund 2045. Never sell, never rebalance, never do anything but watch the money get automatically sucked into those accounts. Doesn't matter what the market did, is doing, or will do - it's none of my concern.
ScubaHogg
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Re: Do Indexers even need to pay attention to market valuation?

Post by ScubaHogg »

MarkRoulo wrote: Mon Jul 19, 2021 10:15 am Why would you believe anything different than everyone around you? And why would things be different now?

…..
Which leads to the (not horrible) simplification of: Stay the course.

It is hard to know when an irrational market has peaked and when an irrational market still has another double to go!

[Which doesn't mean that some of us don't try :-)]
That’s kinda the point. At some extreme PE you are probably well served by stepping back some. You are just paying so much for a dollar of earnings it would be pretty irrational to expect previous growth to continue. And no, I am not talking about about levels the US saw in the mid to late 90s. I’m talking much higher.

(I’ve seen some charts showing Japan touched some PEs around 90, which seems insane)
“The purpose of the margin of safety is to render the forecast unnecessary.” - Ben Graham
Nathan Drake
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Re: Do Indexers even need to pay attention to market valuation?

Post by Nathan Drake »

ScubaHogg wrote: Tue Jul 20, 2021 12:10 pm
MarkRoulo wrote: Mon Jul 19, 2021 10:15 am Why would you believe anything different than everyone around you? And why would things be different now?

…..
Which leads to the (not horrible) simplification of: Stay the course.

It is hard to know when an irrational market has peaked and when an irrational market still has another double to go!

[Which doesn't mean that some of us don't try :-)]
That’s kinda the point. At some extreme PE you are probably well served by stepping back some. You are just paying so much for a dollar of earnings it would be pretty irrational to expect previous growth to continue. And no, I am not talking about about levels the US saw in the mid to late 90s. I’m talking much higher.

(I’ve seen some charts showing Japan touched some PEs around 90, which seems insane)
If a 90 PE results in 30 years of bad returns

A 40 PE could mean 15 years of bad returns
Hoongajji
Posts: 38
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Re: Do Indexers even need to pay attention to market valuation?

Post by Hoongajji »

Some p/e

TSLA 662
MRNA 178
ZM 133
CMG 111
NVDA 95
AMZN 71

Compare p/e against previous 5 years in rev growth.

Compare rev growth against market cap growth valuations in same period.

I did the math.

Alarm bells

Marks Nikkei 1990 analogy is spot on!

The boglehead method is great for a quiet accumulation and appreciation.

Venture away from that allocation and theory becomes a hornets nest.

Regular Synthetic high mileage motor oil changes - or a new car lease?

Enjoy your passion. We are in it together.
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HomerJ
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Joined: Fri Jun 06, 2008 12:50 pm

Re: Do Indexers even need to pay attention to market valuation?

Post by HomerJ »

Valuations today do not tell you anything about "long run" expected returns. They MIGHT tell you something about "short run" expected returns.

I completely ignore valuations and expected returns. I pick an Asset Allocation based purely on risk management. I'm close to retirement, so I have a good chunk in bond/cash so I have safer money for the short-term, and keep the rest of my money in stocks for the long-term.

I get what I get, and I adjust to ACTUAL returns. Don't make plans around "expected" returns.

I consider it foolish to make large adjustments to one's Asset Allocation based on weak predictions with huge error bars.

The market has always moved in cycles. Bad years are followed by good years are followed by bad years are followed by good years.. Will this continue? No guarantees, but probably.

The long-term 10% nominal historical annual return of the stock market INCLUDES all the high valuations years and the crashes and bad decades.

Read that again.

So far, just buying and holding, through the good times and the bad times, still made you rich, because the average return was good even including those bad years.

People talk about 1999-2000, when valuations were the highest in U.S. history... A terrible time to invest, right? No, it turned out fine.

One still made 7.5% a year on money invested at the very top of the dot-com bubble over the past 21 years. And of course, every OTHER year has made even more. When the WORST CASE, in recent years, is 7.5% a year over 21 years, that's pretty good.

Sure short-term, people who invested in 2000 lost money, then gained some, then lost again over the 2000-2010 year period. Long periods of bad years do happen.

But even including those 10 bad years, someone who ignored valuations in 2000, has still made a ton of money investing over the past 21 years.

Another crash or a long sideways market will happen. Maybe even starting tomorrow. But bad years, so far, are followed by good years, and the average will likely still be good enough to make you rich.

Sure, it would be great to be out of the marke during the bad years, and only in the market during the good years, but that's hard... Valuations alone don't tell you that. I talked about 2000. But anyone following valuations would have gotten out of the market in 1996, not 2000. But the market more than doubled from 1996-2000. And even at the bottom of the dot-com crash, in 2003, the market never was as low as it was in 1996.

Buying and holding in 1996, even with valuations at heights no one had seen since right before the Great Depression.... turned out to be a great time to buy.

Valuations predictive power has been terrible since it was discovered in 1988. Ignore them.

Pick an Asset Allocation that you can hold through the long-run even if the market crashes tomorrow, and then you don't have to worry about crashes anymore. We invest for the long run.
A Goldman Sachs associate provided a variety of detailed explanations, but then offered a caveat, “If I’m being dead-### honest, though, nobody knows what’s really going on.”
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HomerJ
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Re: Do Indexers even need to pay attention to market valuation?

Post by HomerJ »

ScubaHogg wrote: Tue Jul 20, 2021 12:10 pmThat’s kinda the point. At some extreme PE you are probably well served by stepping back some. You are just paying so much for a dollar of earnings it would be pretty irrational to expect previous growth to continue. And no, I am not talking about about levels the US saw in the mid to late 90s. I’m talking much higher.

(I’ve seen some charts showing Japan touched some PEs around 90, which seems insane)
But the problem is that the definition of "extreme" PE keeps changing.

mid to late 90s absolutely was considered "extreme" PE at the time. Shiller himself said in 1996 that the 10-year expected real return was 0%. And based on his data, he was right to do so.

CAPE hit 25 in 1996, and it had never been that high before except in 1929. That was a pretty insane extreme number at the time.

And now you yawn at 25... Heck, you're yawning at 35 or even 40.

"Extreme" is subjective, and if it keeps changing, it's not actionable.
A Goldman Sachs associate provided a variety of detailed explanations, but then offered a caveat, “If I’m being dead-### honest, though, nobody knows what’s really going on.”
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