The Single Greatest Predictor of Future Stock Market Returns

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rca1824
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The Single Greatest Predictor of Future Stock Market Returns

Post by rca1824 » Tue Mar 10, 2015 8:57 am

I read a fascinating article:

The Single Greatest Predictor of Future Stock Market Returns
http://www.philosophicaleconomics.com/2 ... t-returns/

They use the current average investor's equity allocation to predict future 10-year market returns with an R^2 of 0.913. That seems like a strong predictor to me.

Any criticisms of this theory? I'm skeptical of most investing theory I read but this one seems correct to me.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB

BahamaMan
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by BahamaMan » Tue Mar 10, 2015 9:05 am

This will work good, right up to the point when it doesn't.

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Aptenodytes
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by Aptenodytes » Tue Mar 10, 2015 9:25 am

It does look interesting. But there are a lot of moving parts under the hood and you have to be skeptical of an anonymous, non-peer-reviewed piece.

Here's what the boglehead mind said about it when it first came out.

bigred77
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by bigred77 » Tue Mar 10, 2015 10:01 am

Its human nature to look for patterns in random data.

I have to think at least some of this article comes from this tendency.

Browser
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by Browser » Tue Mar 10, 2015 10:08 am

So, I'm holding my breath. What is the indicator saying future returns will be???? Of course, you know if it actually works it will not continue to work when the bozos find out about it, right?
We don't know where we are, or where we're going -- but we're making good time.

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Taylor Larimore
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by Taylor Larimore » Tue Mar 10, 2015 10:19 am

rca1824 wrote:I read a fascinating article:

The Single Greatest Predictor of Future Stock Market Returns
http://www.philosophicaleconomics.com/2 ... t-returns/

They use the current average investor's equity allocation to predict future 10-year market returns with an R^2 of 0.913. That seems like a strong predictor to me.

Any criticisms of this theory? I'm skeptical of most investing theory I read but this one seems correct to me.
rca1824:

I recall that the price of butter in Bangladesh was once a great predictor. Looking back it is easy to see what worked. Looking forward is another story.

Before adopting any market-timing strategy, it is worthwhile to listen to experts:
Alliance Bernstein Research: "In 2005 we interviewed more than 500 financial advisors. 83% of the advisors we polled felt that if investors had stuck to their original asset allocation plan prior to 2000, they could have cut their losses by more than half over the following few years."

Frank Armstrong, author and adviser: "Endless tinkering is unlikely to improve performance, and chasing last period's stellar achiever is a losing strategy."

David Babson, co-author of Investing for a Successful Future: "It must be apparent to intelligent investors--if anyone possessed the ability to do so (market time) he would become a billionaire quickly."

Baer & Ginsler authors of The Great Mutual Fund Trap: "What it really takes to improve your returns and diminish your risks is a willingness to stop focusing exclusively on the movement of the markets."

Barron's Guide to Making Investment Decisions: "If we haven't said it enough, we'll say it again: Market timing is dangerous."

Bernard Baruch, famed investor: "Only liars manage to always be "out" during bad times and "in' during good times."

Peter Bernstein, author of 10 finance books: "You have to keep reminding yourself. We don't know what's going to happen with anything, ever."

William Bernstein, author and adviser: "There are two kinds of investors, be they large or small: Those who don't know where the market is headed, and those who don't know that they don't know."

Jack Bogle: "After nearly 50 years in this business, I do not know of anybody who has done market timing successfully and consistently. I don't even know anybody who knows anybody who has done it successfully and consistently."

The Boglehead Contest began in 2001. Of 99 Diehard guesses that year, only 11 even guessed the direction of the stock market. Boglehead forecasts were worse in 2008. Only 2 out of 284 Bogleheads guessed how low the S&P 500 Index would plunge.

Jack Brennan, former Vanguard CEO and author of Straight Talk on Investing: "If you're determined to succeed at investing, make it your first priority to become a buy-and-hold investor."

Warren Buffet: "I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two."

CDA/Wiesenberger: "Market timing is an ineffective strategy for mutual fund investors."

Andrew Clarke, financial adviser: "A successful investor has a good knowledge base, a well-defined investment plan, and nerves of steel to stick with it."

Jonathan Clements, Wall Street Journal columnist: "Take my word for it. Buy-and-hold is still your best long-run strategy."

Consumer Reports: "Dalbar research has found that both stock and bond investors tend to overreact to events, moving money in and out of mutual funds with breathtakingly bad timing."

Dick Davis, publisher of Dick Davis Digest: "No one can time the market on a consistent basis."

Pat Dorsey, former Morningstar Director of Fund Analysis: "Market-timing is bunk."

David Dreman, author of Contrarian Investment Strategies: "The performance of 185 tactical asset allocation mutual funds was compared with buy-and-hold strategies and equity mutual funds over the years 1985-97. Over this period the S&P 500 Index increased 734%, average equity funds increased 598%, and tactical asset allocation funds increased 384%."

Charles Ellis, author of The Loser's Game: "Market timing is a wicked idea. Don't try it-ever."

Paul Farrell, CBS MarketWatch: "Forget market timing in any form."

Rick Ferri, adviser and co-author of seven books including The Bogleheads' Guide to Retirement Planning: "The best practice for investors is to design a long-term globally diversified asset allocation plan based on present and future financial needs. Then follow that plan religiously, through all markets good and bad."

Forbes: "Benjamin Graham spent much of his career trying to devise a good formula for when to get into--and out of--the stock market. All formulas, he concluded, failed."

Fortune Investor's Guide: "Buy and hold. Diversify. But your money in index funds. Pay attention to to the one thing you can control--costs."

Norman Fosback, author, researcher: "Don't sell out of fear or buy out of greed. Just keep making investments, and let the market take its course over the long-term."

John Kenneth Galbraith, economist: "The only function of economic forecasting is to make astrology look respectful."

Elaine Garzarelli, Wall Street's best known strategist until fired by Lehman Brothers: "I've learned that market timing can ruin you."

Good & Hermansen, authors of Index Your Way to Investment Success: "Staying on course may be just as difficult in bull markets as in bear markets."

Carol Gould, author & New York Times columnist: "For most investors the odds favor a buy-and-hold strategy."

Graham/Campbell Study: "From June 1980 through December 1992, 94.5% of 237 market timing investment newsletters had gone of business."

Graham & Zweig, authors of The Intelligent Investor: "Your very refusal to be active, and your renunciation of any pretended ability to predict the future, can become your most powerful weapon."

Chuck Hill, Director of Research at FirstCall/Thomson Financial: "At the peak of the bull market in March of 2000 only 0.7% of all recommendations on stocks issued by Wall Street brokerages and investment banks were to sell."

Mark Hulbert, Editor of The Hulbert Financial Digest: "Among the 160 or so newsletters the HFD monitors, the market timing recommendations of only 10 have beaten the stock market over the last decade on a risk-adjusted basis."

Daniel Kahneman, Nobel Laureate: "After receiving the Nobel Prize, Daniel Kahneman, was asked by a CNBC anchorman what investment tips he had for viewers. His answer: "Buy and hold.""

Michael Leboeuf, author of The Millionaire in You : "Timing the market is for losers. Time IN the market will get you to the winner's circle, and you'll sleep better at night."

Arthur Levitt, former SEC Chairman: "No one is smart enough to time the market's ups and downs."

Jessie Livermore, famous investor: "It never was my thinking that made the big money for me. It always was my sitting."

Peter Lynch: "Nobody can predict interest rates, the future direction of the economy or the stock market."

Burton Malkiel, author of the classic Random Walk Down Wall Street: "Buying-and-holding a broad-based market index fund is still the only game in town."

John Markese, PhD, President, American Association of Independent Investors: "Nobody, but nobody, has consistently guessed the direction of the bond or stock market over any meaningful length of time."

Moshe Milevsky, author & researcher: "If you can't handle the short term, if the uncertainty is stressful and the headlines are unbearable, then the markets are too hot for you: get out of the kitchen."

Morningstar Course 106: "We're not keen on market-timing. It just doesn't work."

Motley Fools: "We've yet to find anyone who can accurately and consistently predict the market's short-term moves."

"Odean and Barber tested over 66,400 investors between 1991 and 1997. Their findings: "The most active traders earned 7% less annually than buy-and-hold investors."

Gerald Perritt, financial author: "Forget trying to time the market and do something productive instead."

Don Phillips, Managing Director of Morningstar: "I can't point to any mutual fund anywhere in the world that's produced a superior long-term record using market timing as its main investment criteria."

Jane Bryant Quinn author and syndicated columnist: "The market timer's Hall of Fame is an empty room."

Mary Roland, author of Best Practices for Financial Advisors: "Countless studies have proved that no one is able to time the market effectively."

Ron Ross, author of The Unbeatable Market: "Trading is based on the rather arrogant belief that the trader knows more than the buyers and sellers with whom he is trading."

Louis Rukeyser, famous (deceased) TV host: "In the long run it doesn't matter much whether your timing is great or lousy. What matters is that you stay invested."

Richard Russell, editor of Dow Theory Letters: "There are no geniuses on Wall Street, only geniuses for a while."

Paul Samuelson, Nobel Laureate: "The evidence is overwhelming that a thousand timer's who try to buy when stocks are low, and sell when they are high, is a damnably awful record."

Jim Schmidt, Editor of Timers Digest: "For the 10 years that ended 12-31-2000, only one newsletter out of the 112 that Timers Digest follows managed to beat the S&P 500 Benchmark."

Bill Schultheis, adviser and author of The Coffeehouse Investor : "I have learned the hard way that market timing and trying to pick a fund that will out-perform the market are both losing strategies."

Charles Schwab: "I'm a strong advocate of buying and holding."

Fred Schwed Jr., author of 'Where are the Customers' Yachts?: "It turns out that I should have just bought them (securities), and thereafter I should have just sat on them like a fat, stupid peasant. A peasant however, who is rich beyond his limited dreams of avarice."

Chandan Sengupta author of The Only Proven Road to Investment Success: "Any investment method that relies on predicting the future is doomed to fail."

W. Scott Simon, author of Index Funds: "Investors should look with a jaundiced eye at any market timing system being peddled by its guru-creator."

Stein & DeMuth, authors of Yes, You Can Get A Financial Life!: "Buying and holding a few broad market index funds is perhaps the most important move ordinary invests can make to supercharge their portfolios."

James Stewart, Smart Money columnist": It's my belief that it's a waste of time to try to time any market decline, or try to pinpoint a market bottom."

Larry Swedroe, author and adviser: "It's a staple of personal finance advice: Buy-and-hold, because trading the stock market is a sucker's bet."

David Swensen, Manager of Yale Investments: "People should stop chasing performance and just put together a sensible portfolio regardless of the ups and downs of the market."

Eric Tyson, author of Mutual Funds for Dummies: "Only two newsletters have managed to keep ahead of the market averages over the past decade (and none have done so over the past 15 years."

Andrew Tobias, author of The Only Investment Guide You Will Ever Need: "Don't waste money subscribing to investment letters or expensive services.

Tweddell & Pierce, financial authors: "Trust in time and forget market timing. Allow time to work its compounding magic for you. Let market timing inflict its miseries on someone else."

Eric Tyson, author, Mutual Funds for Dummies: "Stay invested. Not only does buy-and-hold investing offer better returns, but it's also less work."

Wall Street Journal Lifetime Guide to Money: "Few if any investors manage to be consistently successful in timing markets."

John Waggoner, USA Today financial columnist: "If you're considering doing your own market timing, the best advice is this: Don't."

Jason Zweig, author and Wall Street Journal columnist: "If you buy, and then hold a total-stock-market index fund, it is mathematically certain that you will outperform the vast majority of all other investors in the long run."
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

ShiftF5
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by ShiftF5 » Tue Mar 10, 2015 10:35 am

bigred77 wrote:Its human nature to look for patterns in random data.

I have to think at least some of this article comes from this tendency.
I remember hearing someone say it is human nature to have a story in our heads about why things are the way they are.

It makes us feel like things make sense, even though the story we've created is 100% hogwash.

staythecourse
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by staythecourse » Tue Mar 10, 2015 10:36 am

Taylor Larimore wrote: Looking back it is easy to see what worked. Looking forward is another story.
Sage advice.

In the end I am not sure why anyone cares to find out how to predict future stock returns. If you find some formula are you so confident to put a MAJORITY of your money based on the formula? If not then who cares. Putting 5% this way or that way based on the next great valuation is not going to make a difference anyway.

Of all the concerns I have in investing predicting how asset classes will do in the next 10-20 years is not one of them. You get what you get. Your asset allocation should be based on controlling volatility and NOT the expected return you randomly choose to use for different asset classes.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

Browser
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by Browser » Tue Mar 10, 2015 10:58 am

How successful is anyone at predicting anything (let alone the stock market) for periods more than one day ahead? Hail, if I could do that I wouldn't need to predict the stock market -- I'd just predict when I'm going to croak and spend accordingly.
We don't know where we are, or where we're going -- but we're making good time.

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rca1824
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by rca1824 » Wed Mar 11, 2015 6:05 am

Read the other thread, but I don't see the truth in the criticism. This model is just a straightforward application of supply and demand. Given a fixed supply, it is changes in demand (measured by average equity asset allocation) that drive changes in price. Since dividends are more or less constant, the major source of fluctuation comes form changes in demand. Hence we can generate an accurate prediction of future returns from the present level of demand with 91.3% certainty. The other 8.7% error is driven by measurement error and fluctuations in dividends.

I don't see this as market timing per se, just a straightforward prediction of future returns given some basic economic reasoning and math.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB

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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by in_reality » Wed Mar 11, 2015 6:24 am

rca1824 wrote:Read the other thread, but I don't see the truth in the criticism. This model is just a straightforward application of supply and demand. Given a fixed supply, it is changes in demand (measured by average equity asset allocation) that drive changes in price. Since dividends are more or less constant, the major source of fluctuation comes form changes in demand. Hence we can generate an accurate prediction of future returns from the present level of demand with 91.3% certainty. The other 8.7% error is driven by measurement error and fluctuations in dividends.

I don't see this as market timing per se, just a straightforward prediction of future returns given some basic economic reasoning and math.
Sure:

average equity allocation * total investable amount (including leverage) = returns

Assuming you can know the average allocation, how can you know if the labor market is going to start doling out pay raises that let's people invest more.

In other words, if everyone reallocates 90% to stocks but has no new money to invest will stocks rise more than if everyone stays at 60% but can make new contributions?

I don't think looking at the allocation rate can predict anything. Perhaps it is descriptive of the past but since other things are in play, it can't hold for the future.

What if taxes doubled as a result of the need to pay off debt? Even if no one changed allocations, I bet returns - from companies paying less in dividends to people having less to reinvest - are less.

Allocation doesn't and can't measure demand. That would only work if the amount of investable money were held constant which I think practically is too variable for using allocation as a proxy for demand to work.

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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by ryman554 » Wed Mar 11, 2015 8:56 am

in_reality wrote: I don't think looking at the allocation rate can predict anything. Perhaps it is descriptive of the past but since other things are in play, it can't hold for the future.

....

Allocation doesn't and can't measure demand. That would only work if the amount of investable money were held constant which I think practically is too variable for using allocation as a proxy for demand to work.
Wow... strong statements. Not that I particularly believe in the predictive power either, but it's quite a stretch to go from "it worked in the past, but that's no guarantee as the future may be different" to "it worked in past so it can't work in the future because the future is different".

Who says the future is different?

joebh
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by joebh » Wed Mar 11, 2015 9:00 am

ryman554 wrote:Who says the future is different?
The future is a long time...

Everything is always different, if you wait long enough.

giskard
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by giskard » Wed Mar 11, 2015 9:33 am

It doesn't appear that this study accounted for "serial correlation".

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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by MossySF » Wed Mar 11, 2015 9:42 am

I would never use these predictions for market timing. But these predictions (e.g. the Bernstein thread about 2% real for 50/50 AA) can be useful for planning your savings rate. If the signs point to lower than historic returns due to high demand (too much money chasing limited investments), bumping up your savings rate 20 years beforehand will have a better outcome versus waiting 20 years to realize you should have saved more.

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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by chessmannextmove » Wed Mar 11, 2015 11:16 am

rca1824 wrote:I read a fascinating article:

The Single Greatest Predictor of Future Stock Market Returns
http://www.philosophicaleconomics.com/2 ... t-returns/

They use the current average investor's equity allocation to predict future 10-year market returns with an R^2 of 0.913. That seems like a strong predictor to me.

Any criticisms of this theory? I'm skeptical of most investing theory I read but this one seems correct to me.
R-squared is a measure of fit. It is not a predictor. High r-squared doesn't imply anything (refer to any regression textbook).

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siamond
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by siamond » Wed Mar 11, 2015 2:26 pm

rca1824 wrote:I read a fascinating article:

The Single Greatest Predictor of Future Stock Market Returns
http://www.philosophicaleconomics.com/2 ... t-returns/

They use the current average investor's equity allocation to predict future 10-year market returns with an R^2 of 0.913. That seems like a strong predictor to me.

Any criticisms of this theory? I'm skeptical of most investing theory I read but this one seems correct to me.
This individual is a truly amazing writer, very creative and amazingly insightful. I read this article a while ago, and found it fascinating. The title was of course tongue-in-cheek, but the content is terrific. I am not quite sure what to do with it though. Doesn't seem quite straightforward to reproduce the math and update it every year. I'd be quite curious to do so though, and compare it to other 'expected returns' forecasting methods.

mosu
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by mosu » Wed Mar 11, 2015 7:11 pm

.....
Last edited by mosu on Thu Mar 12, 2015 9:09 pm, edited 1 time in total.

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siamond
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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by siamond » Wed Mar 11, 2015 7:24 pm

Well said, Mosu. Couldn't agree more. There is little progress to be gained by being close-minded.

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Re: The Single Greatest Predictor of Future Stock Market Ret

Post by stlutz » Wed Mar 11, 2015 7:29 pm

Adding to mosu's comments, the point of the series of articles that this was a part of was to critique PE-10 based market timing strategies!

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