Do Indexers even need to pay attention to market valuation?

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

Post by Da5id »

Nathan Drake wrote: Sun Jul 25, 2021 11:17 am
Da5id wrote: Sun Jul 25, 2021 10:58 am I have no studies in mind. Just the generic historical failures of peoples attempts at market timing. Of which this clearly is an instance.
Market timing is generally short term trading. I have no delusions that I can predict what the market is going to do in the short term or the long term. I can try and put the odds in my favor, but I agree there is no guarantee I will be correct. Historically you can see countless examples of one country having a humongous gap in P/E only to be an awful investment in the future relative to assets that haven’t done as well recently.

I am more comfortable limiting my exposure a bit when that occurs.
Investopedia (which I don't always agree with mind you) gives this definition:
Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
Nothing about long or short term per se, though the reference to "trades" may suggest short term. I consider what you do market timing by the definition I use. I guess you consider it otherwise.
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HomerJ
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Re: Do Indexers even need to pay attention to market valuation?

Post by HomerJ »

Da5id wrote: Sun Jul 25, 2021 11:53 am
Nathan Drake wrote: Sun Jul 25, 2021 11:17 am
Da5id wrote: Sun Jul 25, 2021 10:58 am I have no studies in mind. Just the generic historical failures of peoples attempts at market timing. Of which this clearly is an instance.
Market timing is generally short term trading. I have no delusions that I can predict what the market is going to do in the short term or the long term. I can try and put the odds in my favor, but I agree there is no guarantee I will be correct. Historically you can see countless examples of one country having a humongous gap in P/E only to be an awful investment in the future relative to assets that haven’t done as well recently.

I am more comfortable limiting my exposure a bit when that occurs.
Investopedia (which I don't always agree with mind you) gives this definition:
Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
Nothing about long or short term per se, though the reference to "trades" may suggest short term. I consider what you do market timing by the definition I use. I guess you consider it otherwise.
Diversification is fine. Many people here are focused only on U.S. Total Stock, and Nathan has a legitimate point that that may not be diversified enough.

So I see no problem with him and others advising that we should diversify across different asset classes.

I don't have a problem with tilting either... Putting a little extra in Small Cap Value because it supposedly has higher long-term returns than the total stock market. I don't do it, but I can understand why people do.

Setting up an AA that is diversified and possibly tilted is not market-timing.

BUT, if you change your AA because of what you think the future will hold (long-term or short-term), then yes, it's market timing.

At THIS time, with THESE indicators, Nathan thinks THIS asset class will do better going forward. Later, at a different time, with different indicators, he will think THAT asset class will do better going forward, and he'll change his AA again.

He makes small moves, so it's not serious market-timing, nor that dangerous. But it is market-timing.

I understand completely the need to do SOMETHING, to tinker with one's AA. Very easy to find people on the web who will tell you that it IS possible to time markets, to pick the next winners based on this or that indicator or metric.

But small 10% moves won't break anyone. And can maybe scratch the itch to keep one from making larger moves.
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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 »

HomerJ wrote: Sun Jul 25, 2021 11:48 am
Nathan Drake wrote: Sun Jul 25, 2021 10:52 am I believe I will be rewarded given how wide the spreads are, you can disagree if you want. If I’m wrong, it’s doubtful there will be much harm.
What percentage of International are you now?

You went from 50% to 60% 7 years ago based on valuations differences... Since valuations spreads have only gotten larger... Have you increased your International since then?
I'm still 60% international. 40% US. The only change I've made recently is that instead of the US portion being 100% VTSAX, it is now half VTSAX and half SCV. So while I think large cap growth is quite a bit overvalued, SCV US still seems reasonably priced.

I haven't gone up beyond 60% international. Maybe if US has a Japan style melt up I will start increasing even more, but for now this allocation seems appropriate to me based upon where I suspect the hockey puck is going. I don't think it makes much sense that US companies should represent over 60% of global market cap over the long term. The world is a big place.

I am comfortable with this allocation as it's very broadly diversified across regions and risk premiums. I don't suspect I'll tinker much going forward. Any tilt I make is usually on the basis of extreme spreads. I believe we are going through such a time right now. But back in 2009, the spreads didn't seem all that large between US vs Intl vs SCV vs EM. Today US LCG has taken off in a way I don't feel is justified or sustainable. This feels very much like the dot com era to me.
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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 »

Da5id wrote: Sun Jul 25, 2021 11:53 am
Nathan Drake wrote: Sun Jul 25, 2021 11:17 am
Da5id wrote: Sun Jul 25, 2021 10:58 am I have no studies in mind. Just the generic historical failures of peoples attempts at market timing. Of which this clearly is an instance.
Market timing is generally short term trading. I have no delusions that I can predict what the market is going to do in the short term or the long term. I can try and put the odds in my favor, but I agree there is no guarantee I will be correct. Historically you can see countless examples of one country having a humongous gap in P/E only to be an awful investment in the future relative to assets that haven’t done as well recently.

I am more comfortable limiting my exposure a bit when that occurs.
Investopedia (which I don't always agree with mind you) gives this definition:
Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
Nothing about long or short term per se, though the reference to "trades" may suggest short term. I consider what you do market timing by the definition I use. I guess you consider it otherwise.
You can consider it market timing, but the truth is everyone is making a market timing move by putting together a personal allocation and either sticking with it or changing it. If you are sticking with it, you are making a bet that stocks will continue going up in the future based on what's happened in the past. You are using a predictive method to make that trade based upon the definition. You believe it will turn out to be profitable. Why is market cap the appropriate way to build a portfolio? Why not something like fundamental indexing which weights companies by their economic value?
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Da5id
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

Nathan Drake wrote: Sun Jul 25, 2021 1:13 pm You can consider it market timing, but the truth is everyone is making a market timing move by putting together a personal allocation and either sticking with it or changing it. If you are sticking with it, you are making a bet that stocks will continue going up in the future based on what's happened in the past. You are using a predictive method to make that trade based upon the definition. You believe it will turn out to be profitable. Why is market cap the appropriate way to build a portfolio? Why not something like fundamental indexing which weights companies by their economic value?
That is a useless definition of market timing if its meaning is merely "a synonym for investing". I believe that any definition of market timing that includes "a static allocation that doesn't change over time", or even "a changing allocation that is planned in advance without regard to external inputs like valuations (e.g. target date funds glide paths)" is plainly wrong as the term is commonly understood.

Worth noting that I have beliefs and opinions about markets. I think US stocks are overpriced. Int'l stocks are probably better priced. Bonds look pretty grim these days, and "temporary" inflation looks kinda scary. I just don't think those beliefs are useful for changing my asset allocation, as the ways (if any) these will play out is unclear. I think it is better if I pay a bit less attention and avoid any impulse to tinker. Which isn't that hard for me at this point, as I'm not naturally inclined to tinker anyway.
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Re: Do Indexers even need to pay attention to market valuation?

Post by UpperNwGuy »

I think most of us think of market timing in terms of making some kind of change to one's portfolio, not staying the course.
Nathan Drake
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Re: Do Indexers even need to pay attention to market valuation?

Post by Nathan Drake »

Da5id wrote: Sun Jul 25, 2021 1:34 pm
Nathan Drake wrote: Sun Jul 25, 2021 1:13 pm You can consider it market timing, but the truth is everyone is making a market timing move by putting together a personal allocation and either sticking with it or changing it. If you are sticking with it, you are making a bet that stocks will continue going up in the future based on what's happened in the past. You are using a predictive method to make that trade based upon the definition. You believe it will turn out to be profitable. Why is market cap the appropriate way to build a portfolio? Why not something like fundamental indexing which weights companies by their economic value?
That is a useless definition of market timing if its meaning is merely "a synonym for investing". I believe that any definition of market timing that includes "a static allocation that doesn't change over time", or even "a changing allocation that is planned in advance without regard to external inputs like valuations (e.g. target date funds glide paths)" is plainly wrong as the term is commonly understood.

Worth noting that I have beliefs and opinions about markets. I think US stocks are overpriced. Int'l stocks are probably better priced. Bonds look pretty grim these days, and "temporary" inflation looks kinda scary. I just don't think those beliefs are useful for changing my asset allocation, as the ways (if any) these will play out is unclear. I think it is better if I pay a bit less attention and avoid any impulse to tinker. Which isn't that hard for me at this point, as I'm not naturally inclined to tinker anyway.

Well, you should forward your complaint to those that defined market timing in your original statement. Because per that definition, making any kind of bet into a market is some kind of market timing.

If I have a pre-defined allocation model that takes into account valuation spreads at the extremes, isn't that staying the course with my strategy? You can feel free to just stay the course with a fixed allocation, that's perfectly fine. I personally think that you can use valuations to improve the probabilities of better outcomes, so shifting slightly at certain market extremes makes sense to me and I have included it in my allocation plan.
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Da5id
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

Nathan Drake wrote: Sun Jul 25, 2021 3:39 pm
Da5id wrote: Sun Jul 25, 2021 1:34 pm That is a useless definition of market timing if its meaning is merely "a synonym for investing". I believe that any definition of market timing that includes "a static allocation that doesn't change over time", or even "a changing allocation that is planned in advance without regard to external inputs like valuations (e.g. target date funds glide paths)" is plainly wrong as the term is commonly understood.

Worth noting that I have beliefs and opinions about markets. I think US stocks are overpriced. Int'l stocks are probably better priced. Bonds look pretty grim these days, and "temporary" inflation looks kinda scary. I just don't think those beliefs are useful for changing my asset allocation, as the ways (if any) these will play out is unclear. I think it is better if I pay a bit less attention and avoid any impulse to tinker. Which isn't that hard for me at this point, as I'm not naturally inclined to tinker anyway.

Well, you should forward your complaint to those that defined market timing in your original statement. Because per that definition, making any kind of bet into a market is some kind of market timing.

If I have a pre-defined allocation model that takes into account valuation spreads at the extremes, isn't that staying the course with my strategy? You can feel free to just stay the course with a fixed allocation, that's perfectly fine. I personally think that you can use valuations to improve the probabilities of better outcomes, so shifting slightly at certain market extremes makes sense to me and I have included it in my allocation plan.
Wait you read
Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
And get that keeping a static allocation is "market timing"? I'm baffled. That is an extraordinarily strained interpretation of the quote, but I think this is probably exhausted as a topic for me.
Nathan Drake
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Re: Do Indexers even need to pay attention to market valuation?

Post by Nathan Drake »

Da5id wrote: Sun Jul 25, 2021 3:45 pm
Nathan Drake wrote: Sun Jul 25, 2021 3:39 pm
Da5id wrote: Sun Jul 25, 2021 1:34 pm That is a useless definition of market timing if its meaning is merely "a synonym for investing". I believe that any definition of market timing that includes "a static allocation that doesn't change over time", or even "a changing allocation that is planned in advance without regard to external inputs like valuations (e.g. target date funds glide paths)" is plainly wrong as the term is commonly understood.

Worth noting that I have beliefs and opinions about markets. I think US stocks are overpriced. Int'l stocks are probably better priced. Bonds look pretty grim these days, and "temporary" inflation looks kinda scary. I just don't think those beliefs are useful for changing my asset allocation, as the ways (if any) these will play out is unclear. I think it is better if I pay a bit less attention and avoid any impulse to tinker. Which isn't that hard for me at this point, as I'm not naturally inclined to tinker anyway.

Well, you should forward your complaint to those that defined market timing in your original statement. Because per that definition, making any kind of bet into a market is some kind of market timing.

If I have a pre-defined allocation model that takes into account valuation spreads at the extremes, isn't that staying the course with my strategy? You can feel free to just stay the course with a fixed allocation, that's perfectly fine. I personally think that you can use valuations to improve the probabilities of better outcomes, so shifting slightly at certain market extremes makes sense to me and I have included it in my allocation plan.
Wait you read
Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
And get that keeping a static allocation is "market timing"? I'm baffled. That is an extraordinarily strained interpretation of the quote, but I think this is probably exhausted as a topic for me.
Yes, expecting the market to return a profit, is a predictive method.

It's arguing semantics. I am not suggesting a fixed allocation IS market timing, but per that definition it could be interpreted as such. On the contrary, if an asset allocating strategy includes adjustments for risk or valuations, and it's part of a pre-deterined plan, how is that "market timing"?

In my mind, market timing is something like getting all out of the market because you woke up one day feeling fearful. I am not doing that.
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Da5id
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

Nathan Drake wrote: Sun Jul 25, 2021 3:48 pm
Da5id wrote: Sun Jul 25, 2021 3:45 pm Wait you read
Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
And get that keeping a static allocation is "market timing"? I'm baffled. That is an extraordinarily strained interpretation of the quote, but I think this is probably exhausted as a topic for me.
Yes, expecting the market to return a profit, is a predictive method.

It's arguing semantics. I am not suggesting a fixed allocation IS market timing, but per that definition it could be interpreted as such.
Wait I was done, but you believe that ignoring part of the first sentence saying
the act of moving investment money in or out of a financial market—or switching funds between asset classes...
is in the least bit a reasonable way to read the definition? I don't get it, but I guess you do you.
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Re: Do Indexers even need to pay attention to market valuation?

Post by Nathan Drake »

Da5id wrote: Sun Jul 25, 2021 3:52 pm
Nathan Drake wrote: Sun Jul 25, 2021 3:48 pm
Da5id wrote: Sun Jul 25, 2021 3:45 pm Wait you read
Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
And get that keeping a static allocation is "market timing"? I'm baffled. That is an extraordinarily strained interpretation of the quote, but I think this is probably exhausted as a topic for me.
Yes, expecting the market to return a profit, is a predictive method.

It's arguing semantics. I am not suggesting a fixed allocation IS market timing, but per that definition it could be interpreted as such.
Wait I was done, but you believe that ignoring part of the first sentence saying
the act of moving investment money in or out of a financial market—or switching funds between asset classes...
is in the least bit a reasonable way to read the definition? I don't get it, but I guess you do you.
By definition whatever you are buying per your AA model is moving into a financial market. But yes, you are timing it because you expect the price to be higher sometime in the future. Of course, that's not a guarantee.

You do you, not sure why you care what I do personally so much. I never said anyone NEEDED to pay attention to valuations. However, I see enough compelling evidence to make valuations part of my strategy.
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HomerJ
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Re: Do Indexers even need to pay attention to market valuation?

Post by HomerJ »

Nathan Drake wrote: Sun Jul 25, 2021 3:59 pm
By definition whatever you are buying per your AA model is moving into a financial market. But yes, you are timing it because you expect the price to be higher sometime in the future. Of course, that's not a guarantee.
You are torturing the definition of market-timing into oblivion.

You are saying all investing is market-timing. You are trying to avoid being called a market-timer by saying everything is market-timing.

Please stop. I'm pretty sure this thread is finished at this point.
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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 »

HomerJ wrote: Sun Jul 25, 2021 4:04 pm
Nathan Drake wrote: Sun Jul 25, 2021 3:59 pm
By definition whatever you are buying per your AA model is moving into a financial market. But yes, you are timing it because you expect the price to be higher sometime in the future. Of course, that's not a guarantee.
You are torturing the definition of market-timing into oblivion.

You are saying all investing is market-timing. You are trying to avoid being called a market-timer by saying everything is market-timing.

Please stop. I'm pretty sure this thread is finished at this point.
No, I'm really not. I'm just saying someone could interpret that definition to include effectively all types of investing if you are claiming that what I'm doing is market timing.

If somebody has some dynamic model for asset allocation - is that timing? Or is that just part of the plan?
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Triple digit golfer
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Re: Do Indexers even need to pay attention to market valuation?

Post by Triple digit golfer »

Investing a certain way because of valuations and expectations of future returns is market timing. I don't care how others define it.

I'm not saying this particular type of market timing is awful or something to be shamed for. But it is market timing. It's probably the most acceptable form of market timing.

Broadly diversified across all equity risk types.
Weighted toward recent losers.

One could do a lot worse.

I'm not interested in any of it. Total World (ideal for me) or a very slight U.S. tilt (say 5-10% over world market cap) is about the only equity portfolio I think I can ever be comfortable with.

I say slight U.S. tilt simply because it is lower risk and I'd prefer to err on the side of less risky if I have to veer from world market cap.
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Re: Do Indexers even need to pay attention to market valuation?

Post by Portfolio7 »

My answer is no. I will elaborate a little below, but I think valuation techniques are broad brush, fail to capture underlying changes in circumstances, and very difficult to time.

I rebalance whenever equities or bonds shift more than 5% away from my base AA. Over the long run I expect this might capture the low-hanging fruit derived from market valuation arbitrage? I have little faith that I can accomplish much more than that.

Trend following may give some risk benefits, but it's not expected to offer higher returns. I have a trend skew in my monthly process, but it's a very minor skew.

So, while I feel slightly hypocritical when I suggest buy and hold gets you 95% of the available benefits (some would say more) for 5% of the work - the truth is my portfolio is pretty static over all.
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Hoongajji
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Re: Do Indexers even need to pay attention to market valuation?

Post by Hoongajji »

Index or intuition?

You enter a restaurant to dine. You are ignored and made to wait. The host finally seats you and then ignores you. The server does not acknowledge you or approach your table to make contact.

Do you wait for worse service or leave?

Toxic work environment...the company you work for has no ethics or leadership. Do you stay the course or leave?

This current market valuation feels like Miami in the 1990’s.

Are trillion dollar valuations correct?

Of those trillion dollar valuations what is your stake?

Hoongajji has a three year old $200 iPad - Hoon will replace it with whatever is most affordable when needed. Hoon spends $300 per month for groceries locally. $600 annual vehicle insurance.

Fluff is the hype.

Hype is the index?

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

Post by alex_686 »

Call_Me_Op wrote: Sun Jul 25, 2021 7:14 am
alex_686 wrote: Sat Jul 17, 2021 8:18 pm What we can say is that long run expected returns will be lower in the future. So you should adjust your allocation according.
How do you do that when expected returns of other assets classes are also lower (compared to their respective historical averages)?
First, ignore historical averages. The only way that historical averages work is if you assume the market mean reverts. Historically it hasn't. What you want to focus on is expected future returns, risk, and the relationship between the assets.

The answer is highly specific to your situation. I am doing 2 things.

While the expected returns of equities are low and the risk is high, bond's are relatively worse. As such I am increasing my allocations to equities. I am confident in this analysis. To offset change, I am increasing my allocation to "Low Beta / Low Volatility" index ETFs. I think this is the right call, but I am less confident.

Since expected returns are lower and risks are high across a wide range of assets I am increasing contributions to meet my goals.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: Do Indexers even need to pay attention to market valuation?

Post by BJJ_GUY »

Da5id wrote: Fri Jul 23, 2021 11:02 pm OK. But as far as I'm aware historically (non back tested) strategies to use valuations tactically/strategically were unsuccessful. Do you disagree with the claim that using CAPE or other valuation measures to set asset allocations wasn't a win? If so why you think strongly that it is different now?
Strategic allocations are made with, typically, about a 10 year time horizon. These assumptions tend to be revisited annually, and updated for the subsequent 10 year period. This is iterative.

Tactical allocations are more short term in nature, and the successful long-term investors will tactically allocate capital opportunistically, typically when there is a material price dislocation (like distressed credit in 2008/9). This is different from market timing, but is rather value-driven. However, the idea of market timing is closer in nature to tactical decisions than strategic ones.

With that background, it's probably useful to think about allocators like us, but also institutional investors (endowments, foundations etc.) use valuations when they assess their strategic asset allocation targets annually. Remember, these targets are based on fundamental valuations over approximately a ten year horizon. Because this exercise is repeated annually, the changes over the previous year are accounted for in the subsequent strategic allocation targets. (Tactical trading or short term allocations are not a part of this).

I would say that over the last 30 years there are a lot of very good endowments and foundations who have increased returns, and reduced their drawdowns based on strategic allocation decisions.

Valuations are not really used as a trading strategy, at least not explicitly, because sentiment is much stronger over the short-term. Strategic allocations and return expectations over the next 10 years (re-done annually), assume a standard deviation input because we all know the implied returns from fundamental valuations are not going to be perfectly timed.

To say the last 30 years proves that using valuations is a failure, is really an indication of misinterpretation of the discussion. (And, in the event that some people are saying valuations are predictive of short term results, or - in isolation - can be used as a trading strategy within a fund construct, then I would disagree with that claim as well.)
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

BJJ_GUY wrote: Wed Jul 28, 2021 12:55 pm
Da5id wrote: Fri Jul 23, 2021 11:02 pm OK. But as far as I'm aware historically (non back tested) strategies to use valuations tactically/strategically were unsuccessful. Do you disagree with the claim that using CAPE or other valuation measures to set asset allocations wasn't a win? If so why you think strongly that it is different now?
Strategic allocations are made with, typically, about a 10 year time horizon. These assumptions tend to be revisited annually, and updated for the subsequent 10 year period. This is iterative.

Tactical allocations are more short term in nature, and the successful long-term investors will tactically allocate capital opportunistically, typically when there is a material price dislocation (like distressed credit in 2008/9). This is different from market timing, but is rather value-driven. However, the idea of market timing is closer in nature to tactical decisions than strategic ones.

With that background, it's probably useful to think about allocators like us, but also institutional investors (endowments, foundations etc.) use valuations when they assess their strategic asset allocation targets annually. Remember, these targets are based on fundamental valuations over approximately a ten year horizon. Because this exercise is repeated annually, the changes over the previous year are accounted for in the subsequent strategic allocation targets. (Tactical trading or short term allocations are not a part of this).

I would say that over the last 30 years there are a lot of very good endowments and foundations who have increased returns, and reduced their drawdowns based on strategic allocation decisions.

Valuations are not really used as a trading strategy, at least not explicitly, because sentiment is much stronger over the short-term. Strategic allocations and return expectations over the next 10 years (re-done annually), assume a standard deviation input because we all know the implied returns from fundamental valuations are not going to be perfectly timed.

To say the last 30 years proves that using valuations is a failure, is really an indication of misinterpretation of the discussion. (And, in the event that some people are saying valuations are predictive of short term results, or - in isolation - can be used as a trading strategy within a fund construct, then I would disagree with that claim as well.)
This is all rather vague. What, specifically, would you suggest that indexers who have adequate international exposure do in response to market valuations (e.g. today's US and international CAPEs, low interest rate environment, high and allegedly transient inflation)? And if you can't be quite specific and prescriptive, IMO, the clear answer to the question is "probably nothing productive".
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Re: Do Indexers even need to pay attention to market valuation?

Post by BJJ_GUY »

Da5id wrote: Wed Jul 28, 2021 3:44 pm
BJJ_GUY wrote: Wed Jul 28, 2021 12:55 pm
Da5id wrote: Fri Jul 23, 2021 11:02 pm OK. But as far as I'm aware historically (non back tested) strategies to use valuations tactically/strategically were unsuccessful. Do you disagree with the claim that using CAPE or other valuation measures to set asset allocations wasn't a win? If so why you think strongly that it is different now?
Strategic allocations are made with, typically, about a 10 year time horizon. These assumptions tend to be revisited annually, and updated for the subsequent 10 year period. This is iterative.

Tactical allocations are more short term in nature, and the successful long-term investors will tactically allocate capital opportunistically, typically when there is a material price dislocation (like distressed credit in 2008/9). This is different from market timing, but is rather value-driven. However, the idea of market timing is closer in nature to tactical decisions than strategic ones.

With that background, it's probably useful to think about allocators like us, but also institutional investors (endowments, foundations etc.) use valuations when they assess their strategic asset allocation targets annually. Remember, these targets are based on fundamental valuations over approximately a ten year horizon. Because this exercise is repeated annually, the changes over the previous year are accounted for in the subsequent strategic allocation targets. (Tactical trading or short term allocations are not a part of this).

I would say that over the last 30 years there are a lot of very good endowments and foundations who have increased returns, and reduced their drawdowns based on strategic allocation decisions.

Valuations are not really used as a trading strategy, at least not explicitly, because sentiment is much stronger over the short-term. Strategic allocations and return expectations over the next 10 years (re-done annually), assume a standard deviation input because we all know the implied returns from fundamental valuations are not going to be perfectly timed.

To say the last 30 years proves that using valuations is a failure, is really an indication of misinterpretation of the discussion. (And, in the event that some people are saying valuations are predictive of short term results, or - in isolation - can be used as a trading strategy within a fund construct, then I would disagree with that claim as well.)
This is all rather vague. What, specifically, would you suggest that indexers who have adequate international exposure do in response to market valuations (e.g. today's US and international CAPEs, low interest rate environment, high and allegedly transient inflation)? And if you can't be quite specific and prescriptive, IMO, the clear answer to the question is "probably nothing productive".
I never said that I could tell everyone what to do, or even make the claim that I make any big changes. The long outline I wrote about the appropriate use of valuations, and large groups of examples of success utilizing this approach at the core of what they do was a direct reply to the following comment that you previously made:
OK. But as far as I'm aware historically (non back tested) strategies to use valuations tactically/strategically were unsuccessful.
So, based on all of what I wrote, I disagree with the following (second half of your initial comment). My point is that people who make statements like this often simply misunderstand the way sophisticated investors use valuations to inform their strategic asset allocation.
Do you disagree with the claim that using CAPE or other valuation measures to set asset allocations wasn't a win? If so why you think strongly that it is different now?
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

BJJ_GUY wrote: Wed Jul 28, 2021 4:16 pm I never said that I could tell everyone what to do, or even make the claim that I make any big changes. The long outline I wrote about the appropriate use of valuations, and large groups of examples of success utilizing this approach at the core of what they do was a direct reply to the following comment that you previously made:
OK. But as far as I'm aware historically (non back tested) strategies to use valuations tactically/strategically were unsuccessful.
So, based on all of what I wrote, I disagree with the following (second half of your initial comment). My point is that people who make statements like this often simply misunderstand the way sophisticated investors use valuations to inform their strategic asset allocation.
Do you disagree with the claim that using CAPE or other valuation measures to set asset allocations wasn't a win? If so why you think strongly that it is different now?
I guess then we agree on the useless to the typical "unsophisticated" investor like most of us. And honestly, if you can't or won't articulate clear prescriptive guidelines on how you personally make your "not big" changes I'm dubious that it is very useful to you either.

Mind you I'm not believing you much on the sophisticated investors either. Many (most?) endowments and hedge funds (which allegedly can take a longer view) don't do much towards achieving superior returns with all that sophistication (and talent) available to them.
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Re: Do Indexers even need to pay attention to market valuation?

Post by alex_686 »

Da5id wrote: Wed Jul 28, 2021 3:44 pm This is all rather vague. What, specifically, would you suggest that indexers who have adequate international exposure do in response to market valuations (e.g. today's US and international CAPEs, low interest rate environment, high and allegedly transient inflation)? And if you can't be quite specific and prescriptive, IMO, the clear answer to the question is "probably nothing productive".
Sure. I would be glad to help. I sort of do this for a living.

It would be a very similar on how you rationally generated your current asset allocation.

All I need is your 1) market expectations and relationships for US equities, International equites, bonds, and inflation 2) risk tolerances (I need ability, but would prefer willingness as well), goals (priority, length of time to the goal, required return to reach said goal). Taxes and other special circumstances would be helpful.

To give you a quantifiable answer you need to quantify your inputs.

For example, we certainly can use CAPE10 to generate a estimated return for US and DM equities. But how do you want to quantify the range of possibilities? There is a possibility of a large US equites crash. Standard deviation is the simplest tool here, but there are issues. If there is a large US crash, what impact would that have on DM equities? Market expectations of inflation are low, but there is a low probability of major increases.

For pragmatic purposes, it is a bit like a river pilot taking constants soundings as they try to navigate a boat through a spot know for shifting underwater sandbars. You have a goal and you are going to have to make adjustments on the go.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: Do Indexers even need to pay attention to market valuation?

Post by BJJ_GUY »

Da5id wrote: Wed Jul 28, 2021 4:40 pm
BJJ_GUY wrote: Wed Jul 28, 2021 4:16 pm I never said that I could tell everyone what to do, or even make the claim that I make any big changes. The long outline I wrote about the appropriate use of valuations, and large groups of examples of success utilizing this approach at the core of what they do was a direct reply to the following comment that you previously made:
OK. But as far as I'm aware historically (non back tested) strategies to use valuations tactically/strategically were unsuccessful.
So, based on all of what I wrote, I disagree with the following (second half of your initial comment). My point is that people who make statements like this often simply misunderstand the way sophisticated investors use valuations to inform their strategic asset allocation.
Do you disagree with the claim that using CAPE or other valuation measures to set asset allocations wasn't a win? If so why you think strongly that it is different now?
I guess then we agree on the useless to the typical "unsophisticated" investor like most of us. And honestly, if you can't or won't articulate clear prescriptive guidelines on how you personally make your "not big" changes I'm dubious that it is very useful to you either.

Mind you I'm not believing you much on the sophisticated investors either. Many (most?) endowments and hedge funds (which allegedly can take a longer view) don't do much towards achieving superior returns with all that sophistication (and talent) available to them.
The fact that you're even mentioning endowments along with hedge funds as a benchmark for this conversation already shows the disconnect. Endowments who employ their own investment office with a reasonable staff and resources absolutely do outperform passive blends over the long-term. The last ten years has been tough to beat a 70/30 blend, but that's because it hasn't paid to be diversified, it has nothing to do with their use of valuations. Even still, a pretty decent percentage are beating the passive blend despite taking substantially less risk. Same goes for the top tier foundations, and Canadian pensions.

For retail investors, the reason I'm hesitant to answer the question is because there are so many variables unique to each person. Additionally, this is a Bogleheads group, so anything other than still to your allocation blindly is immediately ridiculed -- and more often than not, labeled market timing. I really don't feel like arguing about the difference between strategic decisions, and market timing. But if you must know, as an example, I've reduced my exposure to the passive global stock index and reallocated that money into active managers with very little overlap with the index fund (and especially not large caps). There are some US managers, European, Japanese, and smaller cap EM slightly overweight to Asia. Despite what sounds like a lot of moving parts, the entire goal was to reduce exposure to the most overvalued stocks in the US, but also abroad. This was a relatively moderate reduction in the passive exposure, but meaningful enough to avoid some downside should valuations revert back anywhere near the historical median. I also have almost no fixed income duration in the portfolio as I see terrible asymmetry in owning IG bonds.
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

alex_686 wrote: Wed Jul 28, 2021 5:05 pm
Da5id wrote: Wed Jul 28, 2021 3:44 pm This is all rather vague. What, specifically, would you suggest that indexers who have adequate international exposure do in response to market valuations (e.g. today's US and international CAPEs, low interest rate environment, high and allegedly transient inflation)? And if you can't be quite specific and prescriptive, IMO, the clear answer to the question is "probably nothing productive".
Sure. I would be glad to help. I sort of do this for a living.

It would be a very similar on how you rationally generated your current asset allocation.

All I need is your 1) market expectations and relationships for US equities, International equites, bonds, and inflation 2) risk tolerances (I need ability, but would prefer willingness as well), goals (priority, length of time to the goal, required return to reach said goal). Taxes and other special circumstances would be helpful.
No thanks. I'm not personally interested in implementing such a project, just curious about what people believe they can do. I'm roughly world weighted (60% US/40% Int'l), and not really interested in tilting or in being responsive to valuations.

And I think most answers I see lack specifics need to implement such a plan. I don't have specific "market expectations and relationships for US equities, International equites, bonds, and inflation". I doubt most here do, and I doubt the value of specific expectations for any of them. Forecasts tend to have large error bars, particularly for equities. Inflation is a mystery to a degree (transient? here for a while? who knows?).
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

BJJ_GUY wrote: Wed Jul 28, 2021 5:08 pm For retail investors, the reason I'm hesitant to answer the question is because there are so many variables unique to each person. Additionally, this is a Bogleheads group, so anything other than still to your allocation blindly is immediately ridiculed -- and more often than not, labeled market timing. I really don't feel like arguing about the difference between strategic decisions, and market timing. But if you must know, as an example, I've reduced my exposure to the passive global stock index and reallocated that money into active managers with very little overlap with the index fund (and especially not large caps). There are some US managers, European, Japanese, and smaller cap EM slightly overweight to Asia. Despite what sounds like a lot of moving parts, the entire goal was to reduce exposure to the most overvalued stocks in the US, but also abroad. This was a relatively moderate reduction in the passive exposure, but meaningful enough to avoid some downside should valuations revert back anywhere near the historical median. I also have almost no fixed income duration in the portfolio as I see terrible asymmetry in owning IG bonds.
I'm actually less interested in *what* people do, but rather in the specific methodology they apply. You've described what you've done, but not a useful methodology about how the inputs (inflation, current valuations of US vs international and subsections of those markets, interest rates, etc) led to the specific choices you've made, and how and when those inputs would lead to future changes. I'd not ridicule someone for doing other than my (simple and straightforward) approach, but am somewhat dubious about the value added.
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Re: Do Indexers even need to pay attention to market valuation?

Post by BJJ_GUY »

Da5id wrote: Wed Jul 28, 2021 5:24 pm
BJJ_GUY wrote: Wed Jul 28, 2021 5:08 pm For retail investors, the reason I'm hesitant to answer the question is because there are so many variables unique to each person. Additionally, this is a Bogleheads group, so anything other than still to your allocation blindly is immediately ridiculed -- and more often than not, labeled market timing. I really don't feel like arguing about the difference between strategic decisions, and market timing. But if you must know, as an example, I've reduced my exposure to the passive global stock index and reallocated that money into active managers with very little overlap with the index fund (and especially not large caps). There are some US managers, European, Japanese, and smaller cap EM slightly overweight to Asia. Despite what sounds like a lot of moving parts, the entire goal was to reduce exposure to the most overvalued stocks in the US, but also abroad. This was a relatively moderate reduction in the passive exposure, but meaningful enough to avoid some downside should valuations revert back anywhere near the historical median. I also have almost no fixed income duration in the portfolio as I see terrible asymmetry in owning IG bonds.
I'm actually less interested in *what* people do, but rather in the specific methodology they apply. You've described what you've done, but not a useful methodology about how the inputs (inflation, current valuations of US vs international and subsections of those markets, interest rates, etc) led to the specific choices you've made, and how and when those inputs would lead to future changes. I'd not ridicule someone for doing other than my (simple and straightforward) approach, but am somewhat dubious about the value added.
Equity valuations are high globally. Some more than others, but pretty much all are significantly above their historical norms. This makes the question you are asking even more challenging. Like in times in history there were obvious ways to reallocate to far more attractive markets. When Japan was over-valued, it would have made sense to reallocate away and into other DM markets to keep the general portfolio weightings sans Japan. In the mid-to-late 90s, the Tech bubble was more contained to a sector so relative valuations within the US market allowed for reallocation to the rest of the index, as a crude example.

Today DM equity is very expensive (based on index level data). I like to use non-financial market cap / gross value add (similar to market cap / GDP) as my preferred valuation method. Looking across DM markets, and even within each sector making up each index, the overvalued nature is wide-spread. This is a challenge for all of us. There is some relatively better priced markets in EM, especially if you look at small caps, and further, if you go into small cap value. I've chosen to gain exposure to these more attractive assets via active management. But, again, even the active managers I use in the US have very little overlap with the global index fund I own, and their portfolios are priced at substantial discounts to the broad market.

Following up specifically to your question - it seems like you're asking what the playbook is for these decisions on an ex ante basis. That is a fools game. Everything is relative, so you can't just say that when the US market is overpriced by xx % (or std deviations), then I will reallocated a certain % to xyz market. You have to base the decisions on what information we have available. What I do know is that large cap US stocks at current valuation do not offer much value from current prices, and so I slowly began implementing my plan.

Unlike the endowments etc. we referenced earlier, I don't do this full-time. My personal investments tend to be the broadest possible index funds (global equity) so I don't have to pay much attention. So, yeah, I don't have a plan to spell out, but I do understand how the fundamentals work, and eventually it got so crazy to me that I felt it prudent to make changes as the expected value of the global equity fund was so diminished. Even for the pros it's a combination of art and science -- with us, we have to rely even more on the art, because we can't afford all the data and tools to do what they do on the science side.
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

BJJ_GUY wrote: Wed Jul 28, 2021 6:00 pm Following up specifically to your question - it seems like you're asking what the playbook is for these decisions on an ex ante basis. That is a fools game. Everything is relative, so you can't just say that when the US market is overpriced by xx % (or std deviations), then I will reallocated a certain % to xyz market. You have to base the decisions on what information we have available. What I do know is that large cap US stocks at current valuation do not offer much value from current prices, and so I slowly began implementing my plan.

Unlike the endowments etc. we referenced earlier, I don't do this full-time. My personal investments tend to be the broadest possible index funds (global equity) so I don't have to pay much attention. So, yeah, I don't have a plan to spell out, but I do understand how the fundamentals work, and eventually it got so crazy to me that I felt it prudent to make changes as the expected value of the global equity fund was so diminished. Even for the pros it's a combination of art and science -- with us, we have to rely even more on the art, because we can't afford all the data and tools to do what they do on the science side.
I think such things (if not based on definable numerical criteria) would not be for me. Sounds a bit seat of the pants for my taste, which I'm not fond of. Such subjective judgements get influenced by emotions and feelings which I'd rather leave out of investing. But fair enough, you certainly do you. And I certainly don't disagree that US stock market is overpriced by historic measures (and is top heavy), just doubt that my taking steps beyond holding 40% international would be productive. US has been overpriced for quite a while.
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Re: Do Indexers even need to pay attention to market valuation?

Post by fwellimort »

BJJ_GUY wrote: Wed Jul 28, 2021 6:00 pm Equity valuations are high globally. Some more than others, but pretty much all are significantly above their historical norms. This makes the question you are asking even more challenging. Like in times in history there were obvious ways to reallocate to far more attractive markets. When Japan was over-valued, it would have made sense to reallocate away and into other DM markets to keep the general portfolio weightings sans Japan. In the mid-to-late 90s, the Tech bubble was more contained to a sector so relative valuations within the US market allowed for reallocation to the rest of the index, as a crude example.

Today DM equity is very expensive (based on index level data). I like to use non-financial market cap / gross value add (similar to market cap / GDP) as my preferred valuation method. Looking across DM markets, and even within each sector making up each index, the overvalued nature is wide-spread. This is a challenge for all of us. There is some relatively better priced markets in EM, especially if you look at small caps, and further, if you go into small cap value. I've chosen to gain exposure to these more attractive assets via active management. But, again, even the active managers I use in the US have very little overlap with the global index fund I own, and their portfolios are priced at substantial discounts to the broad market.
This is the biggest issue. Where do you put your money to grow if all options are 'expensive' relative to historical valuations.

And the countries with 'a bit better valuation' like China, Turkey, etc. have their own sets for risks:
1. China. I'm sure people here are well aware of what CCP is capable of. There are great companies like Tencent and Alibaba but there's no guarantees foreign investors will be able to partake in that growth.
2. Turkey, Brazil, etc. Again, huge government issues.
Countries that seem to have 'great companies' at more 'reasonable valuations' have their own subsets of issues investors would have to deal with. The main one being political. It doesn't matter how well run a company is, a corrupt government can just end anything at any point without much rationality.
How do you even 'value' these political risks? Look at stocks like TAL until yesterday. Sudden drop of -95% because the government decided to consider nationalizing the sector. At the same time, if these end up just being 'rumours', there's so much upside. But at same time, the downside is 'zero'. The possibilities are so 'extreme' that it's hard to 'value' the stocks.
(I own shares of BABA and plan to hold for many years so I am 'experiencing' this effect first hand)

Anyways, I would ignore and accept 'I'll just be getting low returns'.
People buying at these valuations in the US should be comfortable with accepting that real returns could be very low. Just the world of low interest rates.
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Re: Do Indexers even need to pay attention to market valuation?

Post by BJJ_GUY »

fwellimort wrote: Wed Jul 28, 2021 6:09 pm
BJJ_GUY wrote: Wed Jul 28, 2021 6:00 pm Equity valuations are high globally. Some more than others, but pretty much all are significantly above their historical norms. This makes the question you are asking even more challenging. Like in times in history there were obvious ways to reallocate to far more attractive markets. When Japan was over-valued, it would have made sense to reallocate away and into other DM markets to keep the general portfolio weightings sans Japan. In the mid-to-late 90s, the Tech bubble was more contained to a sector so relative valuations within the US market allowed for reallocation to the rest of the index, as a crude example.

Today DM equity is very expensive (based on index level data). I like to use non-financial market cap / gross value add (similar to market cap / GDP) as my preferred valuation method. Looking across DM markets, and even within each sector making up each index, the overvalued nature is wide-spread. This is a challenge for all of us. There is some relatively better priced markets in EM, especially if you look at small caps, and further, if you go into small cap value. I've chosen to gain exposure to these more attractive assets via active management. But, again, even the active managers I use in the US have very little overlap with the global index fund I own, and their portfolios are priced at substantial discounts to the broad market.
This is the biggest issue. Where do you put your money to grow if all options are 'expensive' relative to historical valuations.

And the countries with 'a bit better valuation' like China, Turkey, etc. have their own sets for risks:
1. China. I'm sure people here are well aware of what CCP is capable of. There are great companies like Tencent and Alibaba but there's no guarantees foreign investors will be able to partake in that growth.
2. Turkey, Brazil, etc. Again, huge government issues.
Countries that seem to have 'great companies' at more 'reasonable valuations' have their own subsets of issues investors would have to deal with. The main one being political. It doesn't matter how well run a company is, a corrupt government can just end anything at any point without much rationality.
How do you even 'value' these political risks? Look at stocks like TAL until yesterday. Sudden drop of -95% because the government decided to consider nationalizing the sector. At the same time, if these end up just being 'rumours', there's so much upside. But at same time, the downside is 'zero'. The possibilities are so 'extreme' that it's hard to 'value' the stocks.
(I own shares of BABA and plan to hold for many years so I am 'experiencing' this effect first hand)

Anyways, I would ignore and accept 'I'll just be getting low returns'.
People buying at these valuations in the US should be comfortable with accepting that real returns could be very low. Just the world of low interest rates.
This is the exact reason why I opted for active managers who invest largely in stocks that are not in the broad indices. There are a lot of stocks out there that have not been bid up to crazy levels, aided by the passive investing tailwind. And to the extent they do own stocks in the small or mid cap indices, they are selected after careful consideration (after all, not every single stock is as overpriced as the mkt weighted average). I'm well aware that this could ultimately still underperform the passive fund, but I believe the odds are in my favor, even after fees -- that's how much I believe the index has already priced in years of future returns.
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

BJJ_GUY wrote: Wed Jul 28, 2021 6:25 pm This is the exact reason why I opted for active managers who invest largely in stocks that are not in the broad indices. There are a lot of stocks out there that have not been bid up to crazy levels, aided by the passive investing tailwind. And to the extent they do own stocks in the small or mid cap indices, they are selected after careful consideration (after all, not every single stock is as overpriced as the mkt weighted average). I'm well aware that this could ultimately still underperform the passive fund, but I believe the odds are in my favor, even after fees -- that's how much I believe the index has already priced in years of future returns.
SPIVA https://www.spglobal.com/spdji/en/docum ... d-2020.pdf doesn't present a very pretty picture of ability of active management to add value, even in the small and midcap space where you'd think better pickings could be had. mid-cap growth has had a few good years recently for active managers. But perhaps you have some knack to prospectively identify funds that will fight the continued poor showing of active management.
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Re: Do Indexers even need to pay attention to market valuation?

Post by BJJ_GUY »

Da5id wrote: Wed Jul 28, 2021 6:07 pm
BJJ_GUY wrote: Wed Jul 28, 2021 6:00 pm Following up specifically to your question - it seems like you're asking what the playbook is for these decisions on an ex ante basis. That is a fools game. Everything is relative, so you can't just say that when the US market is overpriced by xx % (or std deviations), then I will reallocated a certain % to xyz market. You have to base the decisions on what information we have available. What I do know is that large cap US stocks at current valuation do not offer much value from current prices, and so I slowly began implementing my plan.

Unlike the endowments etc. we referenced earlier, I don't do this full-time. My personal investments tend to be the broadest possible index funds (global equity) so I don't have to pay much attention. So, yeah, I don't have a plan to spell out, but I do understand how the fundamentals work, and eventually it got so crazy to me that I felt it prudent to make changes as the expected value of the global equity fund was so diminished. Even for the pros it's a combination of art and science -- with us, we have to rely even more on the art, because we can't afford all the data and tools to do what they do on the science side.
I think such things (if not based on definable numerical criteria) would not be for me. Sounds a bit seat of the pants for my taste, which I'm not fond of. Such subjective judgements get influenced by emotions and feelings which I'd rather leave out of investing. But fair enough, you certainly do you. And I certainly don't disagree that US stock market is overpriced by historic measures (and is top heavy), just doubt that my taking steps beyond holding 40% international would be productive. US has been overpriced for quite a while.
I'm summarizing the process and trying to avoid the math in this discussion. While there are no rigid rules that would tell you when to make any changes, this shouldn't be confused with decisions being made based on gut feeling or entirely arbitrarily.

First, Alex put together a good list in a previous post. You need to be able to determine you expected return, standard deviation, and cross correlations for each asset class (the fewer the better, so I do separate value from growth, or small from large in the framework stages).

Then using the fundamentals you can determine the implied market return over the next ten years. Inputs needed 1.) growth (g) rate in fundamentals which is gross valued added, or GDP can proxy (and should probably be adjusted for reasons driving record earnings, profit margins etc.... basically, earnings growth cannot perpetually outpace revenue growth like it has recently), 2.) A ratio (V) between current valuation multiple and historical average (or some baseline, even if you think it deserves some premium compared to the past), 3.) the number of years (t) over which we can reasonably believe fundamentals begin to overpower sentiment (history shows that to be 10-12 years pretty reliably), 4) dividend yield (d)

Basic formula to back into implied returns:
(g)(avg v/current v)^(1/12)+(d) = expected annual return over the next 12 years
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

BJJ_GUY wrote: Wed Jul 28, 2021 6:47 pm First, Alex put together a good list in a previous post. You need to be able to determine you expected return, standard deviation, and cross correlations for each asset class (the fewer the better, so I do separate value from growth, or small from large in the framework stages).

Then using the fundamentals you can ...
Expected returns in the forecasts given by pretty much everyone have immense error bars. Makes me doubt the quality of decisions based on picking single numbers (the average?) and plugging into a formula. gigo is clearly an issue in this space.
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Re: Do Indexers even need to pay attention to market valuation?

Post by BJJ_GUY »

Da5id wrote: Wed Jul 28, 2021 6:52 pm
BJJ_GUY wrote: Wed Jul 28, 2021 6:47 pm First, Alex put together a good list in a previous post. You need to be able to determine you expected return, standard deviation, and cross correlations for each asset class (the fewer the better, so I do separate value from growth, or small from large in the framework stages).

Then using the fundamentals you can ...
Expected returns in the forecasts given by pretty much everyone have immense error bars. Makes me doubt the quality of decisions based on picking single numbers (the average?) and plugging into a formula. gigo is clearly an issue in this space.
For someone who can find the flaws in some pretty well supported methods like what I'm summarizing, I'd be interested to hear the inputs you used to come up with your current asset allocation. I don't understand how you can argue against fundamentals and key building blocks to portfolio construction when you said you basically just guessed what your allocation should be.

This clearly isn't going anywhere, but just to provide the answer to your concern: The expected return is obviously seen as an estimated mean. This is the reason Alex said you need standard deviation expectations as well, you see the error bars you are talking about are actually the standard deviation.

Models are inherently problematic, and anyone who has done any of this seriously understands that portfolio optimization tools are error magnifiers in that they attempt to take imprecise data and provide a precise output. Careful consideration is taken to account for all the flaws and biases to various methods. Nothing should be interpreted literally from any portfolio allocation model, or you're doing it wrong. The idea is to begin understanding the interconnected pieces, what outputs are sensitive to which inputs. What is the relative value between different broad asset classes (given the dispersion in potential outcomes, or 'error bars'). Like I said earlier, there are a thousand ways people do this, but the core building blocks are pretty much the same. But this process can become really technical, and far beyond the scope of this topic for sure, but also likely any of our interests or time.

Honestly, it probably wouldn't hurt to go through a rudimentary exercise where you build a portfolio using these fundamental inputs and methods. It might help to see how the fundamentals are all interconnected, and that no one is engaging in this practice with the belief that a specific answer will be spit out
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

BJJ_GUY wrote: Wed Jul 28, 2021 7:09 pm For someone who can find the flaws in some pretty well supported methods like what I'm summarizing, I'd be interested to hear the inputs you used to come up with your current asset allocation. I don't understand how you can argue against fundamentals and key building blocks to portfolio construction when you said you basically just guessed what your allocation should be.
Some combination of ~market weight and what the Vanguard LifeStrategy funds do got me to "good enough for my purposes" for my equities. Nothing more sophisticated or deep than that. Was 100% US until 5-6 years ago prior to early retiring, which I did 3 years ago. I don't have a problem with people doing otherwise, just curious if they can articulate in a useful (to me) way why they do what they do. I think factor investing is perfectly reasonable, just haven't gone that way. I'm more doubtful about dynamic strategies with ill defined criteria for setting allocation, but of course people can do what works for them.
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Re: Do Indexers even need to pay attention to market valuation?

Post by HomerJ »

BJJ_GUY wrote: Wed Jul 28, 2021 7:09 pm Models are inherently problematic, and anyone who has done any of this seriously understands that portfolio optimization tools are error magnifiers in that they attempt to take imprecise data and provide a precise output. Careful consideration is taken to account for all the flaws and biases to various methods.
There are too many variables, not enough data points, even human emotions are involved.

You believe it's possible to account for all the flaws and variables. I do not believe it's possible.

It's not necessary to "pay attention to market valuations" (title thread), to become wealthy and financially independent, and doing so has proven to be just as likely (or more likely) to lead to under performance instead of better performance since valuations as a metric was invented.

Simple works. So far, there's been very little evidence that complex is better or worth all the extra effort.
"The best tools available to us are shovels, not scalpels. Don't get carried away." - vanBogle59
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Re: Do Indexers even need to pay attention to market valuation?

Post by BJJ_GUY »

HomerJ wrote: Wed Jul 28, 2021 8:28 pm
BJJ_GUY wrote: Wed Jul 28, 2021 7:09 pm Models are inherently problematic, and anyone who has done any of this seriously understands that portfolio optimization tools are error magnifiers in that they attempt to take imprecise data and provide a precise output. Careful consideration is taken to account for all the flaws and biases to various methods.
There are too many variables, not enough data points, even human emotions are involved.

You believe it's possible to account for all the flaws and variables. I do not believe it's possible.

It's not necessary to "pay attention to market valuations" (title thread), to become wealthy and financially independent, and doing so has proven to be just as likely (or more likely) to lead to under performance instead of better performance since valuations as a metric was invented.

Simple works. So far, there's been very little evidence that complex is better or worth all the extra effort.
I agree for the most part.

If fixed income is offering 1% yield on a long bond, or equity markets are so overpriced that a multiple reversion anywhere near historical median would imply little-to-negative expected return, then I make marginal changes to reduce exposure to what I know longer see as reasonable risk/reward.

The complex answer I provided was more just for informational purposes, as the point I was trying to make wasn't seeming to be clear enough. That point is, the very best institutions have the technology and the knowhow to use valuations in a way that is value additive over time. We retail investors are typically better off staying the course, but the caveat where I seemingly differ in opinion from most here is that when prices are so rich, or an opportunity is so cheap (leveraged HY and loan closed-end funds in 2009), I think marginal moves that veer away from a fixed investment are acceptable, perhaps favorable.
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Re: Do Indexers even need to pay attention to market valuation?

Post by HomerJ »

BJJ_GUY wrote: Wed Jul 28, 2021 9:24 pm
HomerJ wrote: Wed Jul 28, 2021 8:28 pm
BJJ_GUY wrote: Wed Jul 28, 2021 7:09 pm Models are inherently problematic, and anyone who has done any of this seriously understands that portfolio optimization tools are error magnifiers in that they attempt to take imprecise data and provide a precise output. Careful consideration is taken to account for all the flaws and biases to various methods.
There are too many variables, not enough data points, even human emotions are involved.

You believe it's possible to account for all the flaws and variables. I do not believe it's possible.

It's not necessary to "pay attention to market valuations" (title thread), to become wealthy and financially independent, and doing so has proven to be just as likely (or more likely) to lead to under performance instead of better performance since valuations as a metric was invented.

Simple works. So far, there's been very little evidence that complex is better or worth all the extra effort.
I agree for the most part.

If fixed income is offering 1% yield on a long bond, or equity markets are so overpriced that a multiple reversion anywhere near historical median would imply little-to-negative expected return, then I make marginal changes to reduce exposure to what I know longer see as reasonable risk/reward.

The complex answer I provided was more just for informational purposes, as the point I was trying to make wasn't seeming to be clear enough. That point is, the very best institutions have the technology and the knowhow to use valuations in a way that is value additive over time. We retail investors are typically better off staying the course, but the caveat where I seemingly differ in opinion from most here is that when prices are so rich, or an opportunity is so cheap (leveraged HY and loan closed-end funds in 2009), I think marginal moves that veer away from a fixed investment are acceptable, perhaps favorable.
Fair enough.
"The best tools available to us are shovels, not scalpels. Don't get carried away." - vanBogle59
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Re: Do Indexers even need to pay attention to market valuation?

Post by alex_686 »

I am going to bunch a posts together as a response.

Let us start with the creation of a IPS and the simplest asset allocation - equity / bond.
Da5id wrote: Wed Jul 28, 2021 5:20 pm And I think most answers I see lack specifics need to implement such a plan. ...
So, if you have no market expectations then how do you pick a allocation?
Da5id wrote: Wed Jul 28, 2021 7:21 pm Some combination of ~market weight and what the Vanguard LifeStrategy funds do got me to "good enough for my purposes" for my equities. Nothing more sophisticated or deep than that. Was 100% US until 5-6 years ago prior to early retiring, which I did 3 years ago. ... I'm more doubtful about dynamic strategies with ill defined criteria for setting allocation, but of course people can do what works for them.
This just kicks the can down the street. You don't pick a asset allocation, you pick a lifestyle fund and follow their allocation. O.k., how did you pick the lifestyle allocation?

Which I think really gets to the core of the question, and is something that I think Bogleheads does poorly.

This is a tough hard question. You are required to make predications about a uncertain and chaotic future. Because it is hard and uncertain, the response can be "Nobody knows Nothing".

So they use some rule of thumb or heuristic to come up with a number and then hold tightly onto that number. This is little better than throwing a dart.
Da5id wrote: Wed Jul 28, 2021 6:52 pm Expected returns in the forecasts given by pretty much everyone have immense error bars. Makes me doubt the quality of decisions based on picking single numbers (the average?) and plugging into a formula. gigo is clearly an issue in this space.
Well, yes. Returns are based on the market, which is based on the economy. This is a dynamic social system.

20 years ago 10 year Treasuries had a expected real return of 3%, +/- 3%. Today it is a 0% return, and all of the risk is on the downside.

It is hard to generate actionable fine detailed analysis, but you can see the broad trends.

From a rational viewpoint, any asset allocation chosen 20 years ago can't be valid using the same logic as today.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: Do Indexers even need to pay attention to market valuation?

Post by alex_686 »

HomerJ wrote: Wed Jul 28, 2021 8:28 pm There are too many variables, not enough data points, even human emotions are involved.

You believe it's possible to account for all the flaws and variables. I do not believe it's possible.

It's not necessary to "pay attention to market valuations" (title thread), to become wealthy and financially independent, and doing so has proven to be just as likely (or more likely) to lead to under performance instead of better performance since valuations as a metric was invented.
While this is a valid observation I think you conclusion is wrong.

Medicine is a counter-example. It is a highly complex dripline. You are often working with incomplete or contradictory evidence. Outcomes are often uncertain. It is a applied art, not a science. This is a field that requires a high level of subjective opinion.

Yet, most of the time doctors give similar diagnose and treatments.
HomerJ wrote: Wed Jul 28, 2021 8:28 pm Simple works. So far, there's been very little evidence that complex is better or worth all the extra effort.
You can't use the simplicity argument because generating basic market expectations is the simplest method to come up with a rational asset allocation.

If you don't have market expectations then how do you come up with a equity/bond allocation?

See my prior post. A crystal healer offers a far simpler medical treatment plan than a doctor. It does not mean it is the right one.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: Do Indexers even need to pay attention to market valuation?

Post by Da5id »

alex_686 wrote: Thu Jul 29, 2021 2:04 pm So they use some rule of thumb or heuristic to come up with a number and then hold tightly onto that number. This is little better than throwing a dart.
So you are saying that from the point of view of results, risks assumed, etc selecting stock/bond percentage by throwing a dart is basically the same. 90/10, 50/50, 10/90 whatever the dart hits is equally appropriate. Huh. Seems dubious.

I maintain that if reasonably diversified a fixed allocation (or predetermined glide path or such) is "good enough". It may well not be "optimal", to the extent that optimal can be determined in advance. But I'd also guess that for a large majority of investors dynamically changing ones allocations in response to valuations, interest rates, or market forces like predicted inflation will lead them into behavioral errors. Picking an allocation (or glide path or whatever) and sticking to it is simple and has been reasonably effective.
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Re: Do Indexers even need to pay attention to market valuation?

Post by HomerJ »

alex_686 wrote: Thu Jul 29, 2021 2:13 pmIf you don't have market expectations then how do you come up with a equity/bond allocation?
Risk management.

I have ZERO market expectations except that there will be positive long-term real return, and that stocks will likely have a larger long-term real return than bonds.

That's how most people think.

Almost no one makes a plan around the numbers of "expected" returns.

The first 20 years, you don't even know what your retirement expenses will be. Most people are still progressing in their career, with only a vague idea of how much their salaries will be 15-20 years down the road. There is no precise retirement number goal at this stage of life.

You save a good chunk of your money, keep a small amount in bonds for safety/emergency fund, and put the rest in stocks, and you get what you get.

Absolutely no reason to care about valuations or "expected" returns at this point in life.

Later, as you get older, you have a better idea of what you'll need in retirement, and you see how are you doing. Still "X" (as in 25x) is still not easy to define, what with health care uncertainty.

I would suggest to anyone at this point to assume low returns, by historical standards, if one is planning on figuring how many more years to work and how much more to save.

You would have them use valuations to figure out how much they still need to save and how many years to work. Some people would try to use valuations to try to increase returns by changing their Asset Allocation so they could work less years or save less.

I think my way is more conservative. Plan around low returns... And adjust to ACTUAL returns, not making changes beforehand on "expected" returns (with large plus/minus 6% error bars)

But your way could work, I suppose.

But it certainly isn't necessary. No one has to have any kind of expectations about returns to make a retirement plan. The vast majority of successful retirees never bothered with valuations and expected returns.

You save, you invest, slowly move more to bonds as you get older to lower short-term risk, and you get what you get. If returns are good, maybe you retire early. If returns are poor, you work longer, or spend less.
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Re: Do Indexers even need to pay attention to market valuation?

Post by HomerJ »

alex_686 wrote: Thu Jul 29, 2021 2:04 pm So they use some rule of thumb or heuristic to come up with a number and then hold tightly onto that number. This is little better than throwing a dart.
This is, of course, incorrect. A dart gets you a random number.

Most of us here are pretty conservative. If we pick a number it's usually on the low-end historically. At worst, some people use the historical average. No one here assumes higher returns than that.

No one here plans around above-average returns for the next 30 years.
Some people plan around the average return for the next 30 years.
Most people plan around below-average return for the next 30 years.

This is why most of us think valuations don't matter.

If I'm planning for low returns, and you run in here with a thread titled "VALUATIONS PREDICT LOW RETURNS!", I just shrug, and say "Good thing I was already planning around low returns".

Now imagine you came in here with a thread titled "VALUATIONS PREDICT HIGH RETURNS!", do you really it would be wise for me to start planning around high returns? Maybe go out and buy a boat, save less, because valuations predict high returns?

Or would the wise, mature thing be to ignore that expected return prediction, wait for the ACTUAL returns, and if they are indeed good, maybe THEN go buy a boat?

I ignore expected return predictions completely. I will adjust to ACTUAL returns.
"The best tools available to us are shovels, not scalpels. Don't get carried away." - vanBogle59
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Re: Do Indexers even need to pay attention to market valuation?

Post by Nathan Drake »

HomerJ wrote: Thu Jul 29, 2021 3:02 pm
alex_686 wrote: Thu Jul 29, 2021 2:04 pm So they use some rule of thumb or heuristic to come up with a number and then hold tightly onto that number. This is little better than throwing a dart.
This is, of course, incorrect. A dart gets you a random number.

Most of us here are pretty conservative. If we pick a number it's usually on the low-end historically. At worst, some people use the historical average. No one here assumes higher returns than that.

No one here plans around above-average returns for the next 30 years.
Some people plan around the average return for the next 30 years.
Most people plan around below-average return for the next 30 years.

This is why most of us think valuations don't matter.

If I'm planning for low returns, and you run in here with a thread titled "VALUATIONS PREDICT LOW RETURNS!", I just shrug, and say "Good thing I was already planning around low returns".

Now imagine you came in here with a thread titled "VALUATIONS PREDICT HIGH RETURNS!", do you really it would be wise for me to start planning around high returns? Maybe go out and buy a boat, save less, because valuations predict high returns?

Or would the wise, mature thing be to ignore that expected return prediction, wait for the ACTUAL returns, and if they are indeed good, maybe THEN go buy a boat?

I ignore expected return predictions completely. I will adjust to ACTUAL returns.
I plan for low returns but use valuations and a highly diversified allocation to minimize the risk of subpar returns
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