What's happened to my portfolio in the last 2 weeks?!

Ryan_Futuristics

guymo wrote: »

Thanks, that's clear. It is a bit like value averaging I guess: if you had an initial investment of £6900 in your example, the moves you'd make would keep the total value of your investment steady at £6900 until the FTSE broke its peak.
(With value-averaging things work a little differently, in that you estimate a rate of return and top up your fund so that the value of your investment grows steadily at that rate -- but you also withdraw funds if the value breaks that rate. This way you not only buy low, as in the strategy you've described, but also sell high. If I recall correctly, this method has higher expected returns than dollar-cost-averaging, and lower risk than lump-summing. Of course, nothing is magic.)

Oh I'd not actually heard of that value averaging approach - and yeah, it would have a similar effect, and would probably be more sustainable as a long-term strategy ... Buying the difference from peak can be very aggressive on dips (in my backtests it turns a 5% annual return into about 10%, but you need the cash reserves), so it might be interesting to try averaging the two

Valuation is probably a better strategy overall though ... E.g. my Eastern Europe allocation's storming ahead of my UK and Emerging Markets ... So you'd think: top up the UK and Emerging while they're down ... But in fact Eastern Europe's still much cheaper (relative to them, and relative to its own averages) so I'm actually increasing that allocation more aggressively (because the risk is that it keeps storming ahead and I miss the buying opportunity) (Not that I'm advocating buying Eastern Europe ... Only as part of a diversified value strategy)

masonic

Ryan_Futuristics wrote: »

I think that Trustnet chart shows the same thing, where the two practically touch on the dip (which is where you'd have briefly switched into equities), but where US equities have continued to rocket under stimulus ...

Yes, they do show the same thing, but the Trustnet chart shows it in a linear, rather than logarithmic, scale so the differences are clearer and can be read off the chart. You are right of course that at the bottom of the second dip you would have only been about 75% better off only having been in the S&P500, but almost everywhere else you would have been considerably better off. So it's key to avoid selling at the bottom of a crash and that's where defensive asset classes come into play. But if you are several decades away from selling, having equities as the minor component to your portfolio is going to be a drag on returns. 'Lifestyling' from equities into bonds towards the end of your desired investment period is the alternative.

The trouble with the tactical CAPE allocation over the past 30 years or so is that the average over that whole period has been a lot higher than it ever has been in the past, so picking a figure of 20 and stating that represents the time to sell out of the market in a binary fashion (as modelled by your chart above), did not work very well, whereas a graduated transition from CAPE 15 up to perhaps CAPE 30 may have been much more successful both in this case and generally. For example, you could set up a linear scale whereby for every unit CAPE is above its long-term average, deduct 3% from your target allocation to the S&P500 and put the proceeds in bonds (or if you were feeling brave, add it on to your lowest CAPE equity investments).

What will the equities line look like after the next dip? (To get back down to a CAPE 16, US equities need to almost halve)

There are two aspects to alleviating this issue - diversification and earnings growth. First, the typical well diversified passive portfolio (e.g. Tim Hale's) would be invested only around 20-25% in US equities. Supposing there was a 50% drop in US equities, then that would translate to a direct loss of a little more than 10% from the portfolio (and trigger some rebalancing). Of course, falls would likely be precipitated elsewhere by an event like that, but most other markets are better valued and some will be relatively less correlated than others. Rebalancing between these markets will have a similar effect to rebalancing between equities and bonds. The second aspect is that it is not necessary for the price (P) to halve to get back to CAPE 16; earnings (E) growth is also possible. While the economic situation in the short term suggests this is likely to be a very small effect, over a decade or two it is likely to have a significant dampening effect. Again, outside the US, the case for companies being able to grow their earnings is more compelling, which reinforces the diversification message.

I'd say, if you're a value investor, you probably can have a 90-100% equities allocation (although I'd not feel safe without at very least £15k in cash) ... The Global CAPE line on that chart comes from buying regions which can't get much cheaper ... But you also have to appreciate that recent history tells us nothing of where markets may go - every major market's experienced 20-30 year downturns before, where being 100% equities would've just seen your capital slowly rot away ... For buy-and-hold investors, I'd always prepare for the worst case scenario

Looking back at the last century, there has been at least one 20 year period where investing a lump sum in a static, globally diversified portfolio of only equities would have led to a negative real return (although it was positive in absolute terms). However, the worst case scenario for a 30 year investment period was a positive real return of just under 2%.

Of course, the biggest weapon most people have against long-term depressed markets is that they are gradually building their portfolios by drip-feeding from income. This gives rise to a further dampening effect and also means that, in the case of a well diversified portfolio, an investor will be unwittingly value investing by topping up the better value holdings even before any other tactical asset allocation decisions they may choose to make. However, I can understand those who are in the post-accumulation phase of investment choosing to take a more cautious view.

Ryan_Futuristics

masonic wrote: »

Yes, they do show the same thing, but the Trustnet chart shows it in a linear, rather than logarithmic, scale so the differences are clearer and can be read off the chart. You are right of course that at the bottom of the second dip you would have only been about 75% better off only having been in the S&P500, but almost everywhere else you would have been considerably better off. So it's key to avoid selling at the bottom of a crash and that's where defensive asset classes come into play. But if you are several decades away from selling, having equities as the minor component to your portfolio is going to be a drag on returns. 'Lifestyling' from equities into bonds towards the end of your desired investment period is the alternative.

The trouble with the tactical CAPE allocation over the past 30 years or so is that the average over that whole period has been a lot higher than it ever has been in the past, so picking a figure of 20 and stating that represents the time to sell out of the market in a binary fashion (as modelled by your chart above), did not work very well, whereas a graduated transition from CAPE 15 up to perhaps CAPE 30 may have been much more successful both in this case and generally. For example, you could set up a linear scale whereby for every unit CAPE is above its long-term average, deduct 3% from your target allocation to the S&P500 and put the proceeds in bonds (or if you were feeling brave, add it on to your lowest CAPE equity investments).

Yep, this would be along the lines of Benjamin Graham's tactical asset allocation - and at the moment, with the UK around a CAPE of 12.5, his approach would have you about 60% in equities

But the S&P500, at >26, would be much lower (for me: preferably none ... I don't want to hold anything I think is going to drag)

And of course the charts showing moving from all equities into bonds are illustrative - it would be a very unusual way to invest!

There are two aspects to alleviating this issue - diversification and earnings growth. First, the typical well diversified passive portfolio (e.g. Tim Hale's) would be invested only around 20-25% in US equities. Supposing there was a 50% drop in US equities, then that would translate to a direct loss of a little more than 10% from the portfolio (and trigger some rebalancing). Of course, falls would likely be precipitated elsewhere by an event like that, but most other markets are better valued and some will be relatively less correlated than others. Rebalancing between these markets will have a similar effect to rebalancing between equities and bonds. The second aspect is that it is not necessary for the price (P) to halve to get back to CAPE 16; earnings (E) growth is also possible. While the economic situation in the short term suggests this is likely to be a very small effect, over a decade or two it is likely to have a significant dampening effect. Again, outside the US, the case for companies being able to grow their earnings is more compelling, which reinforces the diversification message.

Growth is possible, but then that's where Buffett's phrase comes in - we don't really know where things stand at the moment with so much loose cash floating around the system (but you'd have to assume a pessimistic stance)

Looking back at the last century, there has been at least one 20 year period where investing a lump sum in a static, globally diversified portfolio of only equities would have led to a negative real return (although it was positive in absolute terms). However, the worst case scenario for a 30 year investment period was a positive real return of just under 2%.

Of course, the biggest weapon most people have against long-term depressed markets is that they are gradually building their portfolios by drip-feeding from income. This gives rise to a further dampening effect and also means that, in the case of a well diversified portfolio, an investor will be unwittingly value investing by topping up the better value holdings even before any other tactical asset allocation decisions they may choose to make. However, I can understand those who are in the post-accumulation phase of investment choosing to take a more cautious view.

A real return of 2 or 3% over 30 years is a disaster in my books - it's the bulk of your investing window out the window ... How much better to have avoided buying equities when valuations were that high?

My main concern is that since the 90s, adjusting for inflation, developed markets have been stagnant ... The amount of stimulus our markets need to stay propped up at the moment is difficult for economists to understand

But what I think we're running into is the developed world already having reached 100% efficiency (possibly decades ago), and the next significant shift for markets being an ageing demographic, and then running into hard resource and environmental limits

Buffett thinks we've got a few more years growth in the markets - but he's not seeing it as an indefinite thing - I could certainly believe 100 years of stagnation or decline mirroring 100 years of growth (it's how you'd expect things to operate in a closed system)

Annie021063

I may be in the wrong place but here goes...
Where would be a good place to go for some advice/ info about starting out buying/ selling shares?
Thanks

ColdIron

You could have a look at a thread a little below this one titled How to buy shares

masonic

Ryan_Futuristics wrote: »

A real return of 2 or 3% over 30 years is a disaster in my books - it's the bulk of your investing window out the window ... How much better to have avoided buying equities when valuations were that high?

My point was that the worst of the "20-30 year downturns ... where being 100% equities would've just seen your capital slowly rot away" did not, in fact, lead to capital losses. My worst case 30 year example illustrates that even the unluckiest person, who decided to invest everything as a lump sum at the market peak before the biggest and longest lasting downturn in living memory would have done no worse than they would on average having instead eschewed equities in favour of bonds. Again, investing like that would be highly unusual and they'd have made much better returns had they invested gradually from money they saved from their income.

In a situation like that being discussed above, where over a 30 year period the return from equities was comparable to historic long term returns from bonds, I think it would be naive to assume a CAPE-based tactical approach would do significantly better. It can take many years for a reversion to the mean to occur and the recovery could have you selling back out of equities prematurely and missing out on a lot of the gains (just as happened with the green line in your chart in the earlier post, where CAPE was in the 20-40 range during most of its strongest months).

So in a situation where equities look overvalued for a sustained period of time, where you consequently want to maximise your overall exposure to equities to 25%, and you class real returns of 2-3% as a disaster, where else is there to turn? Property? Gold?

My main concern is that since the 90s, adjusting for inflation, developed markets have been stagnant ... The amount of stimulus our markets need to stay propped up at the moment is difficult for economists to understand

But what I think we're running into is the developed world already having reached 100% efficiency (possibly decades ago), and the next significant shift for markets being an ageing demographic, and then running into hard resource and environmental limits

Buffett thinks we've got a few more years growth in the markets - but he's not seeing it as an indefinite thing - I could certainly believe 100 years of stagnation or decline mirroring 100 years of growth (it's how you'd expect things to operate in a closed system)

Well there's been plenty of money to be made in those stagnant markets since the 90s, so I don't think it would necessarily be a disaster for equities if markets remained that way for the next few years.

Of course, in the doom and gloom view, where emerging and frontier markets fail to deliver (both in their own right and through delivery of a new wave of consumers that benefits developed markets) and there are no new technological advances for businesses to capitalise on, then prolonged stagnation or decline is going to have an effect on wages, inflation, property prices etc., so one can only guess at how best to prepare for that sort of situation. Gold might not even be the answer

Ryan_Futuristics

masonic wrote: »

My point was that the worst of the "20-30 year downturns ... where being 100% equities would've just seen your capital slowly rot away" did not, in fact, lead to capital losses. My worst case 30 year example illustrates that even the unluckiest person, who decided to invest everything as a lump sum at the market peak before the biggest and longest lasting downturn in living memory would have done no worse than they would on average having instead eschewed equities in favour of bonds. Again, investing like that would be highly unusual and they'd have made much better returns had they invested gradually from money they saved from their income.

In a situation like that being discussed above, where over a 30 year period the return from equities was comparable to historic long term returns from bonds, I think it would be naive to assume a CAPE-based tactical approach would do significantly better. It can take many years for a reversion to the mean to occur and the recovery could have you selling back out of equities prematurely and missing out on a lot of the gains (just as happened with the green line in your chart in the earlier post, where CAPE was in the 20-40 range during most of its strongest months).

So in a situation where equities look overvalued for a sustained period of time, where you consequently want to maximise your overall exposure to equities to 25%, and you class real returns of 2-3% as a disaster, where else is there to turn? Property? Gold?

Well, it depends what market we're talking about ... The S&P 500?

We've had a century in which the US became 80% of the global market, and now we're in one in which it's likely to shrink to below 15% ... The one thing we know is the developed markets of the future won't echo the past

A worst-case scenario would've been investing in Japan in the mid-80s, when the Nikkei peaked at almost 39,000

With any of these, you're not benefiting from being in the market on the way down - any simple valuation (or even a moving average) signal could've sheltered capital better

Well there's been plenty of money to be made in those stagnant markets since the 90s, so I don't think it would necessarily be a disaster for equities if markets remained that way for the next few years.

Of course, in the doom and gloom view, where emerging and frontier markets fail to deliver (both in their own right and through delivery of a new wave of consumers that benefits developed markets) and there are no new technological advances for businesses to capitalise on, then prolonged stagnation or decline is going to have an effect on wages, inflation, property prices etc., so one can only guess at how best to prepare for that sort of situation. Gold might not even be the answer

I think the worry is that since the 90s the US has been riding on long-term overvaluation - so any money made isn't necessarily a reflection of positive markets, so much as habitual speculation

As for alternatives - it could be real return funds, P2P lending, some altogether new asset class ... but most real value from the markets has come from mean reversion

masonic

Ryan_Futuristics wrote: »

Well, it depends what market we're talking about ... The S&P 500?

Well no, as with my previous posts, I'm talking about a globally diversified portfolio, including a some (20-25%) allocation to the US. In a situation where global markets are on a 20-30 year decline, how would one invest to guarantee better returns than inflation+3%...

With any of these, you're not benefiting from being in the market on the way down - any simple valuation (or even a moving average) signal could've sheltered capital better

I don't think it's the case that valuation/moving average approaches fare much better over a long term decline. As I pointed out above, positive returns are achieved over long periods in equities even in the worst case scenarios of the past. Being out of the market requires one to put the money somewhere else. If you stick it in bonds, then you get the same result over a 30 year horizon, which is a ~2% real return. If you wait to invest when CAPE is low and then pull out again when prices recover, you tend to end up in bonds most of the time, with a result somewhere between bonds and equities, which in the case when both return around 2-3% real is a disaster in your books. The only thing that looks like it breaks this trend is Meb Faber's idea of staying in equities, but allocating to the lowest CAPE markets.

As for alternatives - it could be real return funds, P2P lending, some altogether new asset class ... but most real value from the markets has come from mean reversion

The P2P lending example might be of some interest in the future when one can stick it in an ISA. Your 7% return is currently taxable, so for a basic rate taxpayer it is going to deliver real returns of about 3% (and it will probably beat bonds in the short term). Absolute return funds haven't really delivered in my view, so I wouldn't want to pile into those now, and some altogether new asset class is not something one can invest in at present.

I disagree that most real value from equities has come from mean reversion. Even lump sum fixed global investors have been able to make an average real return of 6.3% from equities. Things like tactical asset allocation certainly can bolster returns, but the market timing required to time the transitions means that a lot of growth can actually be thrown away in practice.

bowlhead99

I think the worry is that since the 90s the US has been riding on long-term overvaluation - so any money made isn't necessarily a reflection of positive markets, so much as habitual speculation

What you seem to be saying is that although people have quadrupled their money on investing a lump sum when CAPE went over 20 in 1994 to today, it is not because markets are positive or that companies are fundamentally making profits and breaking new ground through innovation, technology and efficiency and unprecedented infrastructure (cheap flights everywhere, alternative energy, internet everywhere you turn), but it's just simple dumb luck that if you speculate on something it might come good even though all shares ought to be cheaper in terms of earnings multiple.

Basically you are saying that CAPE (a measure acknowledged as flawed by a whole range of commentators, as are all measures of value) is the one true way of judging something. If you get good results despite what CAPE tells you, then the results are a fluke and are only there because people still believe in buying companies in the developed world, which should be decried as speculation so long as your flawed measure is above some hundred year average.

I find that difficult to take on board. You acknowledge that Japan had a huge 30 year cycle and therefore anyone waiting for growth might wait a long time. That is surely the same both ways. Anyone waiting for US long term decline, might wait a long time.

You also say that the US will decline as a proportion of world GDP. That is inevitable as the people in developing world come out of their caves and start generating new GDP alongside the old GDP. It doesn't mean all the old GDP gets killed off. There are new Asian and African customers for Americans to sell to and there are new Asian and African suppliers for Americans to buy from, and the Asians and Africans will find plenty of domestic customers to keep them busy in a domestic consumption rather than cheap export led economy. That doesn't mean all US companies halve in value overnight when the billions of new customers start to exist, merely that the economies may work in different ways and some companies die, some survive, and others positively thrive.

The one thing we know is the developed markets of the future won't echo the past

That is one reason why waiting for mean reversion may be an exercise in futility, surely.

You are saying on the one hand that we don't know quite what will drive the US economy or the world economy but opportunities and investment attitudes will certainly be far far different to what they were in the last century. OK, I agree.

And then you are saying that the long term average CAPE
- which you derived by including data from 1885 when we were all running around in the Old West like in the Michael J Fox classic Back to The Future Part III,
- or when the CAPE was 5 at the end of The Great War,
- or in the whole of the first seven decades of CAPE data points when transistors didn't even exist,
should be the mean that everything reverts to.

Sorry but that is laughable. The world has moved on. People may no longer think that 20x a company's average earnings is too high, given growth prospects for the company and the economy, and the fact that the '10 year average' earnings you're using is inherently on average 5 years out of date.

In Russia there is conflict and low GDP growth prospects acknowledged by most including themselves and the IMF. So their CAPE is lower. It's up to you whether you buy into a high growth area with solid companies (US) or a low growth area with shaky political system and undeveloped markets (Russia). One will cost more than the other but it doesn't mean it is bad value for money. It is a higher price for a different product. Maybe the cheap product will remain a cheap product for the next 3 decades just like the lost decades in Japan's markets.

As it happens I have a number of investments that include Russia and Eastern Europe and I have trimmed back some US exposure over the last year or so after performance had taken my weighting quite high. But I would not be so steadfastly opposed to other points of view that I keep coming back to the historic CAPE from the 1800s to 'prove' that everything in strong economies is priced wrong and offers limited growth and that everyone should get their US exposure down to below 2% because it's destined to go down. It will go down when it wants.

CAPE is a single perspective out of many and even if it were a 100% non-flawed perfect measure, there is truth in the comment from Keynes: "Markets can remain irrational a lot longer than you and I can remain solvent.".

Investing in a dog market because every dog has its day, or avoiding a bull market because what goes up must come down, severely limits opportunities. That is why your previous graph of the last 20 years shows your 'returns from investing all in SP500 equities when CAPE is <20 and bonds otherwise' give a relatively smooth path. Because it's mostly been following bonds and hardly any of the equities opportunities were taken even though a lot of growth was available from that source from time to time.

Meanwhile a multi asset portfolio heavier in equities could have given a lot of good returns to rebalance into bonds after enjoying the growth. And the bond-heavy portfolio only performed well because the bonds performed great as they moved to unprecedented all time highs, from which such growth is no longer available.

Relative to bonds, equities do not seem so expensive, and ultimately a US investor may not feel the equities are overpriced regardless of CAPE, because he doesn't think a Russian index is a remotely comparable product. Therefore US equities could be sustained at similar 'high CAPE' valuations for a long time before Russian 'value' delivers on its potential.

Ryan_Futuristics

masonic wrote: »

Well no, as with my previous posts, I'm talking about a globally diversified portfolio, including a some (20-25%) allocation to the US. In a situation where global markets are on a 20-30 year decline, how would one invest to guarantee better returns than inflation+3%...


I don't think it's the case that valuation/moving average approaches fare much better over a long term decline. As I pointed out above, positive returns are achieved over long periods in equities even in the worst case scenarios of the past. Being out of the market requires one to put the money somewhere else. If you stick it in bonds, then you get the same result over a 30 year horizon, which is a ~2% real return. If you wait to invest when CAPE is low and then pull out again when prices recover, you tend to end up in bonds most of the time, with a result somewhere between bonds and equities, which in the case when both return around 2-3% real is a disaster in your books. The only thing that looks like it breaks this trend is Meb Faber's idea of staying in equities, but allocating to the lowest CAPE markets.

Well what I'm really getting at is that it's very easy to invest retroactively

My personal feeling is that Vanguard are partly responsible for a climate of unrealistic expectations through aggressively marketing their trackers

The idea that markets act one particular way over long periods isn't quite true ... Every major phase markets have gone through has been uncharted territory ... Of course that doesn't inspire people to go out and buy-and-hold index funds

The P2P lending example might be of some interest in the future when one can stick it in an ISA. Your 7% return is currently taxable, so for a basic rate taxpayer it is going to deliver real returns of about 3% (and it will probably beat bonds in the short term). Absolute return funds haven't really delivered in my view, so I wouldn't want to pile into those now, and some altogether new asset class is not something one can invest in at present.

I disagree that most real value from equities has come from mean reversion. Even lump sum fixed global investors have been able to make an average real return of 6.3% from equities. Things like tactical asset allocation certainly can bolster returns, but the market timing required to time the transitions means that a lot of growth can actually be thrown away in practice.

Tactical asset allocation doesn't generally involve market timing ... You wouldn't move out of US equities because you expect a crash: you'd move out because they're overvalued

Stable assets in a portfolio (even with real returns of 0%) can be valuable in any situation that doesn't involve having 100% of your portfolio in equities (which I'd call either gambling or naive faith)

If you ask me which trend I've got more faith in: the continuing growth of the global economy or the fact that the herd has always been wrong, I'd go with the latter (and with the herd piling into buy-and-hold passive indexes, I don't expect this trend to reverse)