Adjust Asset Allocation When Markets Are Over Valued

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invest2bfree
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Adjust Asset Allocation When Markets Are Over Valued

Post by invest2bfree »

Bogle goes into how he would allocate from 65/35 to 50/50 when you have extreme over valuation-

https://youtu.be/k6ra5POdsYg

Does any one follow any rules of them on allocation?

Benjamin Graham advised to have 50/50 as your default allocation. Then go to 75/25 when markets are over sold and 25/75 when markets are over valued.

What is your Asset Adjustment strategy if you use one?
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by jebmke »

I have no way to know if the market is overvalued.
Don't trust me, look it up. https://www.irs.gov/forms-instructions-and-publications
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by invest2bfree »

jebmke wrote: Tue Sep 28, 2021 8:30 am I have no way to know if the market is overvalued.
p/e goes to 40 like in 2000.

p/e goes to 80 like in Japan.


p/e is currently 35.

https://www.multpl.com/s-p-500-pe-ratio
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by anoop »

Do either Bogle or Graham provide any guidance on what they think constitutes overvalued, correctly valued, and undervalued?
Last edited by anoop on Tue Sep 28, 2021 9:29 am, edited 2 times in total.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by anoop »

invest2bfree wrote: Tue Sep 28, 2021 8:34 am
jebmke wrote: Tue Sep 28, 2021 8:30 am I have no way to know if the market is overvalued.
p/e goes to 40 like in 2000.

p/e goes to 80 like in Japan.


p/e is currently 35.

https://www.multpl.com/s-p-500-pe-ratio
Doesn't mean anything given how negative real yields are and with no chance of normalization for the foreseeable future.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by invest2bfree »

anoop wrote: Tue Sep 28, 2021 8:37 am
invest2bfree wrote: Tue Sep 28, 2021 8:34 am
jebmke wrote: Tue Sep 28, 2021 8:30 am I have no way to know if the market is overvalued.
p/e goes to 40 like in 2000.

p/e goes to 80 like in Japan.


p/e is currently 35.

https://www.multpl.com/s-p-500-pe-ratio
Doesn't mean anything given how negative real yields are and with no chance of normalization for the foreseeable future.
Yes you are right yields are sensitive to valuation.

I did do a thread on this.

viewtopic.php?f=10&t=357916
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by jebmke »

invest2bfree wrote: Tue Sep 28, 2021 8:34 am
jebmke wrote: Tue Sep 28, 2021 8:30 am I have no way to know if the market is overvalued.
p/e goes to 40 like in 2000.

p/e goes to 80 like in Japan.


p/e is currently 35.

https://www.multpl.com/s-p-500-pe-ratio
so, which is it? 40 or 80?
Don't trust me, look it up. https://www.irs.gov/forms-instructions-and-publications
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by am »

invest2bfree wrote: Tue Sep 28, 2021 8:34 am
jebmke wrote: Tue Sep 28, 2021 8:30 am I have no way to know if the market is overvalued.
p/e goes to 40 like in 2000.

p/e goes to 80 like in Japan.


p/e is currently 35.

https://www.multpl.com/s-p-500-pe-ratio
Valuations of 35 when 10 yr treasury is 1.35 versus 6% in 2000 are apples to oranges,

PE is poor at predicting future returns.

Valuations can stay low, sideways or go higher for a very long time.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by asif408 »

I wouldn't make any major adjustments to my stock/bond allocation unless all markets and sectors were overvalued. That is rarely the case and currently definitely not the case. I do believe you should adjust your stock allocation periodically (maybe once a decade or so) based on valuations. Value stocks in international and emerging markets are fairly valued to undervalued. From a sector perspective energy stocks are undervalued. Even plain old US value stocks (large and small) are fairly valued. Individual countries like Turkey, Russia, and Poland are undervalued. So that's where most of my money is.

Now if all markets and sectors were overvalued (which was almost the case in 2007) then I would adjust, but even then I'd look at sectors. In 2000 US REITs were yielding 9%, small cap value stocks, precious metals equities and energy stocks had done poorly leading up, and Australian stocks were fairly valued, so there were pockets of markets that were fairly valued to undervalued. These sectors provided positive returns during the 2000-2002 bear market. The Australian stock market fell about 7% during the same time frame the US fell 40%. Even emerging markets provided some cushion, as they had a shorter bear market and recovered faster than US stocks in that bear market. So diversification worked, you just had to tilt to sectors that had done poorly leading up, which is pretty much the case today.

In 2007 there wasn't much cover, so maybe that was a time to take some chips off the table and adjust your stock/bond mix. I was just starting out investing and didn't know much so I just rode the wave down and back up. In 2007 emerging markets had higher valuations than US stocks, foreign developed stocks were highly valued, and there weren't any sectors undervalued (you could argue tech stocks were probably the least overvalued then, but that wasn't saying much). But only if all markets, sectors, and styles were overvalued would I make a significant adjust to my stock/bond allocation. There always seems to be some area of the world market that is out of favor, and today is no different.
Last edited by asif408 on Tue Sep 28, 2021 10:02 am, edited 1 time in total.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by BJJ_GUY »

am wrote: Tue Sep 28, 2021 9:22 am
invest2bfree wrote: Tue Sep 28, 2021 8:34 am
jebmke wrote: Tue Sep 28, 2021 8:30 am I have no way to know if the market is overvalued.
p/e goes to 40 like in 2000.

p/e goes to 80 like in Japan.


p/e is currently 35.

https://www.multpl.com/s-p-500-pe-ratio
Valuations of 35 when 10 yr treasury is 1.35 versus 6% in 2000 are apples to oranges,

PE is poor at predicting future returns.

Valuations can stay low, sideways or go higher for a very long time.
Interest rates can alter investor behavior by reducing the risk premiums across asset classes, and altering opportunity cost decisions etc., but there is no reason current interest rates should change valuation analysis. Stocks are claims to cash flows in perpetuity, so the next 5 years should not have any material impact on fundamentals.

I do agree with the last point though, and that is a key concept in this discussion. Valuations are not great at timing precise future returns, however, it's still the only way to understand what is being purchased at a given price.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by burritoLover »

Waste of time. It is impossible for even hedge fund managers, earnings buckets of money and ten times smarter than the rest of us, to pull it off. If it were that simple, everyone would be doing it and then it would cease to work. The market doesn't exist in isolation.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by am »

BJJ_GUY wrote: Tue Sep 28, 2021 9:48 am
am wrote: Tue Sep 28, 2021 9:22 am
invest2bfree wrote: Tue Sep 28, 2021 8:34 am
jebmke wrote: Tue Sep 28, 2021 8:30 am I have no way to know if the market is overvalued.
p/e goes to 40 like in 2000.

p/e goes to 80 like in Japan.


p/e is currently 35.

https://www.multpl.com/s-p-500-pe-ratio
Valuations of 35 when 10 yr treasury is 1.35 versus 6% in 2000 are apples to oranges,

PE is poor at predicting future returns.

Valuations can stay low, sideways or go higher for a very long time.
Interest rates can alter investor behavior by reducing the risk premiums across asset classes, and altering opportunity cost decisions etc., but there is no reason current interest rates should change valuation analysis. Stocks are claims to cash flows in perpetuity, so the next 5 years should not have any material impact on fundamentals.

I do agree with the last point though, and that is a key concept in this discussion. Valuations are not great at timing precise future returns, however, it's still the only way to understand what is being purchased at a given price.
Regardless, staying the course has worked for the last century. Market timing, changing allocations based on valuations and active management has not for the most part.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by BJJ_GUY »

am wrote: Tue Sep 28, 2021 9:52 am
BJJ_GUY wrote: Tue Sep 28, 2021 9:48 am Interest rates can alter investor behavior by reducing the risk premiums across asset classes, and altering opportunity cost decisions etc., but there is no reason current interest rates should change valuation analysis. Stocks are claims to cash flows in perpetuity, so the next 5 years should not have any material impact on fundamentals.

I do agree with the last point though, and that is a key concept in this discussion. Valuations are not great at timing precise future returns, however, it's still the only way to understand what is being purchased at a given price.
Regardless, staying the course has worked for the last century. Market timing, changing allocations based on valuations and active management has not for the most part.
I'd agree with the point you are trying to make, if you are saying that staying the course is almost always going to be the ideal default for nearly all of us retail investors.

I don't know how you can test the other statements you made. Market timing is more of an investment style, and a definition not widely agreed upon. Altering allocations based on valuations could have been greatly beneficial over the last 25 years, but this would also be a silly statement (because it's not easily testable on a large scale, so not worth saying it actually worked or didn't unless citing a specific example).
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by jebmke »

I am never going to sell our equity so I suppose our equity allocation will tend to rise as valuations increase.
Don't trust me, look it up. https://www.irs.gov/forms-instructions-and-publications
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by abc132 »

The much better way to do this is to adjust AA based on reaching milestones such as 5x, 10x, 20, 30x expected retirement expenses.

Whether one thinks the market is overvalued is a horrible way to invest for most people, simply because of the overwhelming preference to focus on one metric. Someone will be spooked by PE without considering growth, someone else will be spooked by the latest entertainment news that simultaneously provides coverage that the sky is falling and that gains may be great. Someone else will think they have two factors, and that this is somehow more meaningful than one factor.

Anyone that can rationally consider all factors will recognize the uncertainty in forecasting and will be better off adjusting AA using investment milestones where the choice of AA is related to the probability of achieving a goal relative to ones desire to take risk to achieve rewards.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by Candor »

I do this a little around the edges. I'm currently at 50/50 and that is where I feel comfortable at present. If the market stays relatively stable or continues to increase I'm fine with this AA indefinitely but if the market has a significant drop in the next year or two I intend to increase my equities up to 60/40. Both AA's are conservative and it won't move the needle much but I don't like to completely "just sit there" when I see an opportunity for a sale.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by steve r »

duplicate deleted
Last edited by steve r on Tue Sep 28, 2021 12:35 pm, edited 1 time in total.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by steve r »

What to make about the belief that bond markets are also overvalued? (There certainly is a mass amount of bonds being purchased by central banks around the world.)

I get that the OP thinks equity market are overvalued (and tend to agree somewhat). This may be a sign that their (or my) asset allocation is too aggressive. I guess it is OK to dial it back a few years ahead of time. Not so much because of evaluations but because a better understanding of risk tolerance. I wouldn't do much more than that though. Personally, I am not changing things.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by Godot »

invest2bfree wrote: Tue Sep 28, 2021 8:34 am
jebmke wrote: Tue Sep 28, 2021 8:30 am I have no way to know if the market is overvalued.
p/e goes to 40 like in 2000.

p/e goes to 80 like in Japan.


p/e is currently 35.

https://www.multpl.com/s-p-500-pe-ratio
I've seen other posters use www.multpl.com as some kind of definitive/credible source, but have no idea who owns that site, and the site itself (from what I can see) does not mention it. Do you know?
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by make_a_better_world »

I believe it makes sense to react and adjust to what's occurred sometimes.

I am paraphrasing from Buffet here: The best way to minimize risk is to think. I believe having a set asset allocation of 60% stocks and 40% bonds or whatever is nonsense. What you ought to do is have your default position always in short-term instruments and whenever you see anything intelligent to do, you should do it.

I follow this fundamental philosophy and basically try to allocate my money to places I can get a better return. Most people I know who are very successful do the same to seize opportunities. I cannot think of a single very successful person I know that got there at an age where having the wealth materially mattered by accepting the market return. I enjoy business, however, and am confident enough in my own abilities to look for investments that make sense as well as to deal with the consequences of being wrong. If you view the world as full of "wallstreet pros" that cannot be beat because they employ devices to make themselves "all smarty pants and high-fallutin' and such" then achieving the market return is substantially better than not investing.

The problem specifically with CAPE in this discussion is that I do not believe CAPE by itself is predictive of future stock prices. If we have zero/negative interest rates, I think we should expect to live in a different world where P/E's are substantially higher. Many US companies still return yields substantially higher than the risk-free rate at their current valuations. Quoting from Buffet again, "Interest rates are to the value of assets what gravity is to matter."

https://youtu.be/L4N0eQ01FMs?t=84

anoop wrote: Tue Sep 28, 2021 8:35 am Do either Bogle or Graham provide any guidance on what they think constitutes overvalued, correctly valued, and undervalued?
Yes: A book called Security Analysis: 6th Edition by Benjamin Graham (Author), David Dodd (Author), Warren Buffett (Foreword)
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by invest2bfree »

make_a_better_world wrote: Tue Sep 28, 2021 2:06 pm I believe it makes sense to react and adjust to what's occurred sometimes.

I am paraphrasing from Buffet here: The best way to minimize risk is to think. I believe having a set asset allocation of 60% stocks and 40% bonds or whatever is nonsense. What you ought to do is have your default position always in short-term instruments and whenever you see anything intelligent to do, you should do it.

I follow this fundamental philosophy and basically try to allocate my money to places I can get a better return. Most people I know who are very successful do the same to seize opportunities. I cannot think of a single very successful person I know that got there at an age where having the wealth materially mattered by accepting the market return. I enjoy business, however, and am confident enough in my own abilities to look for investments that make sense as well as to deal with the consequences of being wrong. If you view the world as full of "wallstreet pros" that cannot be beat because they employ devices to make themselves "all smarty pants and high-fallutin' and such" then achieving the market return is substantially better than not investing.

The problem specifically with CAPE in this discussion is that I do not believe CAPE by itself is predictive of future stock prices. If we have zero/negative interest rates, I think we should expect to live in a different world where P/E's are substantially higher. Many US companies still return yields substantially higher than the risk-free rate at their current valuations. Quoting from Buffet again, "Interest rates are to the value of assets what gravity is to matter."

https://youtu.be/L4N0eQ01FMs?t=84

anoop wrote: Tue Sep 28, 2021 8:35 am Do either Bogle or Graham provide any guidance on what they think constitutes overvalued, correctly valued, and undervalued?
Yes: A book called Security Analysis: 6th Edition by Benjamin Graham (Author), David Dodd (Author), Warren Buffett (Foreword)
I have done that all my life and it is not easy.
Yes at 20 you can do that but not at 50.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by BJJ_GUY »

make_a_better_world wrote: Tue Sep 28, 2021 2:06 pm I believe it makes sense to react and adjust to what's occurred sometimes.

I am paraphrasing from Buffet here: The best way to minimize risk is to think. I believe having a set asset allocation of 60% stocks and 40% bonds or whatever is nonsense. What you ought to do is have your default position always in short-term instruments and whenever you see anything intelligent to do, you should do it.

I follow this fundamental philosophy and basically try to allocate my money to places I can get a better return. Most people I know who are very successful do the same to seize opportunities. I cannot think of a single very successful person I know that got there at an age where having the wealth materially mattered by accepting the market return. I enjoy business, however, and am confident enough in my own abilities to look for investments that make sense as well as to deal with the consequences of being wrong. If you view the world as full of "wallstreet pros" that cannot be beat because they employ devices to make themselves "all smarty pants and high-fallutin' and such" then achieving the market return is substantially better than not investing.

The problem specifically with CAPE in this discussion is that I do not believe CAPE by itself is predictive of future stock prices. If we have zero/negative interest rates, I think we should expect to live in a different world where P/E's are substantially higher. Many US companies still return yields substantially higher than the risk-free rate at their current valuations. Quoting from Buffet again, "Interest rates are to the value of assets what gravity is to matter."

https://youtu.be/L4N0eQ01FMs?t=84

anoop wrote: Tue Sep 28, 2021 8:35 am Do either Bogle or Graham provide any guidance on what they think constitutes overvalued, correctly valued, and undervalued?
Yes: A book called Security Analysis: 6th Edition by Benjamin Graham (Author), David Dodd (Author), Warren Buffett (Foreword)
I don't think it makes sense to interpret short-term rates as the input for a discount rate on an incredibly long duration asset like stocks. Current rates impact behavior, financing etc., but does not have the impact on valuations as you seem to be interpreting it. (Maybe I'm misunderstanding your point, so who knows.)

Valuation methods, like CAPE, but also a few more reliable, are not great at timing future returns with precision. But, what's more important for long-term results is to buy assets at a price that is consistent with the fundamentals of the business (and future prospects of growth, improvement etc.), such that the desired return solves the equation. Valuations and future returns are a pretty straight forward equation, but again, not great at premise timing.

A companies stock performance, or however you're defining a 'companies yield' in relation to short-term rates, I don't understand what this means. CAPE and others are still getting at the idea of how many dollars you are paying today for a long-term claim on future results far far into the future. Short term, or even current long term rates should be looked at as a minor blip for whether the price paid today is good value
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by nisiprius »

anoop wrote: Tue Sep 28, 2021 8:35 am [Does] Graham provide any guidance on what they think constitutes overvalued, correctly valued, and undervalued?
Read his words, from the 1973 edition of The Intelligent Investor, and then you tell me.
If, as we have long believed, the stock market has lost contact with its old bounds, and if new ones have not yet been established, then we can give the investor no reliable rules by which to reduce his common-stock holdings toward the 25% minimum and rebuild them later to the 75% maximum. We can urge that in general the investor should not have more than one-half in equities unless he has strong confidence in the soundness of his stock position and is sure that he could view a market decline of the 1969–70 type with equanimity. It is hard for us to see how such strong confidence can be justified at the levels existing in early 1972. Thus we would counsel against a greater than 50% apportionment to common stocks at this time. But, for complementary reasons, it is almost equally difficult to advise a reduction of the figure well below 50%, unless the investor is disquieted in his own mind about the current market level, and will be satisfied also to limit his participation in any further rise to, say, 25% of his total funds.

We are thus led to put forward for most of our readers what may appear to be an oversimplified 50–50 formula.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by Whitecap »

If you view the world as full of "wallstreet pros" that cannot be beat because they employ devices to make themselves "all smarty pants and high-fallutin' and such" then achieving the market return is substantially better than not investing.
Ok then. I’ll be the market - which, “is substantially better than not investing”.

Nobody knows nuthin’,
Whitecap

PS - if you are looking to rebalance your AA, why not simply do this?
https://www.kitces.com/blog/best-opport ... hresholds/
Last edited by Whitecap on Tue Sep 28, 2021 5:01 pm, edited 1 time in total.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by namajones »

asif408 wrote: Tue Sep 28, 2021 9:30 am Now if all markets and sectors were overvalued (which was almost the case in 2007) then I would adjust, but even then I'd look at sectors.
In 2007 there wasn't much cover, so maybe that was a time to take some chips off the table and adjust your stock/bond mix.
Very few (Roubini?) were saying that markets were overvalued in 2007.

Now we take this as self-evident?

Gotta love those 20/20 hindsight glasses.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by make_a_better_world »

BJJ_GUY wrote: Tue Sep 28, 2021 3:34 pm I don't think it makes sense to interpret short-term rates as the input for a discount rate on an incredibly long duration asset like stocks. Current rates impact behavior, financing etc., but does not have the impact on valuations as you seem to be interpreting it. (Maybe I'm misunderstanding your point, so who knows.)

Valuation methods, like CAPE, but also a few more reliable, are not great at timing future returns with precision. But, what's more important for long-term results is to buy assets at a price that is consistent with the fundamentals of the business (and future prospects of growth, improvement etc.), such that the desired return solves the equation. Valuations and future returns are a pretty straight forward equation, but again, not great at premise timing.

A companies stock performance, or however you're defining a 'companies yield' in relation to short-term rates, I don't understand what this means. CAPE and others are still getting at the idea of how many dollars you are paying today for a long-term claim on future results far far into the future. Short term, or even current long term rates should be looked at as a minor blip for whether the price paid today is good value
Whether or not a specific valuation is a good value is intimately dependent on interest rates. Maybe you'll appreciate it more from here:

https://youtu.be/vo_TWaV6Xy8?list=PLLkD ... B3sN&t=151
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by BJJ_GUY »

make_a_better_world wrote: Tue Sep 28, 2021 4:59 pm
BJJ_GUY wrote: Tue Sep 28, 2021 3:34 pm I don't think it makes sense to interpret short-term rates as the input for a discount rate on an incredibly long duration asset like stocks. Current rates impact behavior, financing etc., but does not have the impact on valuations as you seem to be interpreting it. (Maybe I'm misunderstanding your point, so who knows.)

Valuation methods, like CAPE, but also a few more reliable, are not great at timing future returns with precision. But, what's more important for long-term results is to buy assets at a price that is consistent with the fundamentals of the business (and future prospects of growth, improvement etc.), such that the desired return solves the equation. Valuations and future returns are a pretty straight forward equation, but again, not great at premise timing.

A companies stock performance, or however you're defining a 'companies yield' in relation to short-term rates, I don't understand what this means. CAPE and others are still getting at the idea of how many dollars you are paying today for a long-term claim on future results far far into the future. Short term, or even current long term rates should be looked at as a minor blip for whether the price paid today is good value
Whether or not a specific valuation is a good value is intimately dependent on interest rates. Maybe you'll appreciate it more from here:

https://youtu.be/vo_TWaV6Xy8?list=PLLkD ... B3sN&t=151
I think his statement is entirely consistent with what I've said above.

Current interest rates tend to impact investor behavior, for example, the opportunity cost decisions change. This is consistent with a bird in the hand analogy. When interest rates are higher you demand more from risk assets as government bonds set the floor for the risk curve. Low rates tend to push yield seeking, so yes, rates can result in more equity buying, but doesn't necessarily support a case of valuation to change.

He goes on to detail the reason valuation is important in determining whether you take the bird in hand, or opt for the bush. This is valuation being defined, and without an understanding of what the valuation means (specifically in relation to price paid), then it would be impossible to begin making a decision between choosing a bird in hand versus those in the bush.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by make_a_better_world »

BJJ_GUY wrote: Tue Sep 28, 2021 5:27 pm
I think his statement is entirely consistent with what I've said above.

Current interest rates tend to impact investor behavior, for example, the opportunity cost decisions change. This is consistent with a bird in the hand analogy. When interest rates are higher you demand more from risk assets as government bonds set the floor for the risk curve. Low rates tend to push yield seeking, so yes, rates can result in more equity buying, but doesn't necessarily support a case of valuation to change.

He goes on to detail the reason valuation is important in determining whether you take the bird in hand, or opt for the bush. This is valuation being defined, and without an understanding of what the valuation means (specifically in relation to price paid), then it would be impossible to begin making a decision between choosing a bird in hand versus those in the bush.
Not only do interest rates impact valuations- they are probably the most important variable in determining if the “markets are overvalued.” It’s not a “minor blip."

If rates on everything get very low it will mean stocks sell higher and we live in a different world than existed when rates were higher. Another way of saying that is we may have entered a world where P/E across the board is higher now without the stock market being overvalued because the interest rate is near zero. Thus to OP's original post- the current market prices may not be as out of line as assumed and might even be bargains if we are destined to live in a world of 0% interest.

I linked this video in my original post. Buffet speaks specifically on this topic here:
https://youtu.be/L4N0eQ01FMs?t=212

And here:
https://youtu.be/L4N0eQ01FMs?t=450
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by BJJ_GUY »

make_a_better_world wrote: Tue Sep 28, 2021 6:46 pm
BJJ_GUY wrote: Tue Sep 28, 2021 5:27 pm
I think his statement is entirely consistent with what I've said above.

Current interest rates tend to impact investor behavior, for example, the opportunity cost decisions change. This is consistent with a bird in the hand analogy. When interest rates are higher you demand more from risk assets as government bonds set the floor for the risk curve. Low rates tend to push yield seeking, so yes, rates can result in more equity buying, but doesn't necessarily support a case of valuation to change.

He goes on to detail the reason valuation is important in determining whether you take the bird in hand, or opt for the bush. This is valuation being defined, and without an understanding of what the valuation means (specifically in relation to price paid), then it would be impossible to begin making a decision between choosing a bird in hand versus those in the bush.
Not only do interest rates impact valuations- they are probably the most important variable in determining if the “markets are overvalued.” It’s not a “minor blip."

If rates on everything get very low it will mean stocks sell higher and we live in a different world than existed when rates were higher. Another way of saying that is we may have entered a world where P/E across the board is higher now without the stock market being overvalued because the interest rate is near zero. Thus to OP's original post- the current market prices may not be as out of line as assumed and might even be bargains if we are destined to live in a world of 0% interest.

I linked this video in my original post. Buffet speaks specifically on this topic here:
https://youtu.be/L4N0eQ01FMs?t=212

And here:
https://youtu.be/L4N0eQ01FMs?t=450
Okay, sure, you are correct if we assume current rates are held constant into the far distant future. (And we'd have to believe in a world where economic growth, revenues, profit margins, all maintain near-record levels... but interest rates remain frozen at historical lows.) Not sure this would be my base case, but I'm certainly not going to pretend I have the ability to do economic forecasting any better than anyone else's assumptions
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by LittleD »

Easy market timing solution. If you are worried to tears and can't sleep at night, increase your allocation to cash or short term bonds so that you can.
When your happy and sleeping like a baby at night, increase your allocation to diversified stock market assets.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by nisiprius »

The idea of adjusting asset allocation according to valuations, rather than holding them fixed, is one of those ideas that seems like common sense. It feels as if it simply has to work, it can't help working, the only question is "how well?"

And yet this is exactly what tactical asset allocation is, and the consistent failure of tactical asset allocation mutual funds and ETFs is strong evidence that it not as easy as it sounds.

In the 1980s and 1990s, tactical asset allocation was so popular that it was almost the norm for balanced funds offered in 401(k) accounts. Vanguard introduced tactical allocation in the LifeStrategy funds soon after inception, perhaps 1995. They formally abandoned it in 2011, freezing the funds at fixed allocations (in reality they had abandoned it years earlier because the "Vanguard asset allocation fund" which provided the adjustment component had not varied for years).

In 2006, Mebane Faber published a paper entitled A Quantitative Approach to Tactical Asset Allocation, that some people found convincing and impressive. So in 2010 Meb Faber's New Global Tactical ETF "GTAA" was welcomed.

During the years he managed it, this is how GTAA (orange line) performed, compared with a regular Vanguard balanced fund with a similar stock/bond allocation (blue line). The ETF was shuttered a year or two later.

Image
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by LittleD »

nisiprius wrote: Wed Sep 29, 2021 6:28 am The idea of adjusting asset allocation according to valuations, rather than holding them fixed, is one of those ideas that seems like common sense. It feels as if it simply has to work, it can't help working, the only question is "how well?"

And yet this is exactly what tactical asset allocation is, and the consistent failure of tactical asset allocation mutual funds and ETFs is strong evidence that it not as easy as it sounds.

In the 1980s and 1990s, tactical asset allocation was so popular that it was almost the norm for balanced funds offered in 401(k) accounts. Vanguard introduced tactical allocation in the LifeStrategy funds soon after inception, perhaps 1995. They formally abandoned it in 2011, freezing the funds at fixed allocations (in reality they had abandoned it years earlier because the "Vanguard asset allocation fund" which provided the adjustment component had not varied for years).

In 2006, Mebane Faber published a paper entitled A Quantitative Approach to Tactical Asset Allocation, that some people found convincing and impressive. So in 2010 Meb Faber's New Global Tactical ETF "GTAA" was welcomed.

During the years he managed it, this is how GTAA (orange line) performed, compared with a regular Vanguard balanced fund with a similar stock/bond allocation (blue line). The ETF was shuttered a year or two later.

Image
Come now... Comparing one ten year period rather than 40 or 50 years is not research. Looking at a growth fund since 2010 with rock bottom interest rates is a biased evaluation. You should know that. If you picked the years from 2000 to 2009 you would get a completely different picture. No one knows what the future will bring us. Will the FED have to materialy raise interest rates to control out of control inflation? Too bad everyone is chasing performance short term.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by nisiprius »

LittleD wrote: Wed Sep 29, 2021 8:22 amCome, now. Looking at a growth fund since 2010 with rock bottom interest rates is a biased evaluation...
Come, now. VSCGX is no "growth fund." It's a 40/60 fund well inside the "large blend" style box.

Image

And it had a comparable bond allocation to GTAA, so whatever was going on with interest rates would have affected both of them similarly.

I can only look at what exists. The problem is that asset allocation funds have done poorly enough that most of them have not had long lifetimes.

That also means there's a danger of survivorship bias in what there is available to look at.

If you don't like my example, then show us a better one. Show us the tactical asset allocation mutual fund or ETF, operating in full view and running real money, over what you consider to be an appropriate time period, that shows a convincing benefit to tactical asset allocation.

Or, consider Larry Swedroe's article, Tactical Asset Allocation vs. Static Indexing: Who Wins?. He cites and summarizes a 2021 paper by Joseph McCarthy and Edward Tower, "Static Indexing Beats Tactical Asset Allocation," The Journal of Index Investing. "equally weighted TAA funds under-returned corresponding portfolios of index ETFs by gaps ranging from 1.77% to 5.15% per year."
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by LittleD »

Tactical allocation is really just active management is sheep's clothing. Just buy the 3 fund portfolio you need in the allocation you feel comfortable sleeping at night. Just find a comfortable amount of bonds or fixed income and let it go.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by magneto »

BJJ_GUY wrote: Tue Sep 28, 2021 9:48 am
am wrote: Tue Sep 28, 2021 9:22 am
invest2bfree wrote: Tue Sep 28, 2021 8:34 am
jebmke wrote: Tue Sep 28, 2021 8:30 am I have no way to know if the market is overvalued.
p/e goes to 40 like in 2000.

p/e goes to 80 like in Japan.


p/e is currently 35.

https://www.multpl.com/s-p-500-pe-ratio
Valuations of 35 when 10 yr treasury is 1.35 versus 6% in 2000 are apples to oranges,

PE is poor at predicting future returns.

Valuations can stay low, sideways or go higher for a very long time.
Interest rates can alter investor behavior by reducing the risk premiums across asset classes, and altering opportunity cost decisions etc., but there is no reason current interest rates should change valuation analysis. Stocks are claims to cash flows in perpetuity, so the next 5 years should not have any material impact on fundamentals.

I do agree with the last point though, and that is a key concept in this discussion. Valuations are not great at timing precise future returns, however, it's still the only way to understand what is being purchased at a given price.
+1

There is a basic question How Much and for What ?
Search as we may across the asset classes very little seem attractively priced, driven by Central Banks intervention low interest rates and buying in of assets.
In real life, we like to buy goods low and sell high - why should investing be any different ?

This investor has gradually withdrawn from those seemingly expensive trackers and other collectives and is searching around in the rubble for individual stocks not taken to excess. Dividend paying Gold Miners is one tentative glimmer of value hope, but own opinions must be formed based on firm foundations.

Think Swensen was correct in seeing Bonds as part of risk assets, they certainly are priced so at present.

Like other life-long value investors have seen the movie before, so in late retirement the portfolio is positioned 33/66 Risk/Riskless, far removed from the 60/40 hoovering up of Stocks in the dip of March 2020. To some degree now watching from the sidelines and keeping patient, the most difficult task of all.

Maybe a bear market started mid August, maybe not.
Price v Worth will determine future actions as always.
Meantime patience.

Happy and successful investing to us all.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by Coltrane75 »

As many have said, that is a futile strategy.
Valuation metrics are not actionable.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by vanbogle59 »

nisiprius wrote: Tue Sep 28, 2021 3:59 pm We are thus led to put forward for most of our readers what may appear to be an oversimplified 50–50 formula.
HA! That's ME! I got one right!
My AA is NOT just simple stupidity. It's the result of deep analysis by one of the greatest investing minds of all time!

I'm so good.
:wink:
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by secondopinion »

jebmke wrote: Tue Sep 28, 2021 9:21 am
invest2bfree wrote: Tue Sep 28, 2021 8:34 am
jebmke wrote: Tue Sep 28, 2021 8:30 am I have no way to know if the market is overvalued.
p/e goes to 40 like in 2000.

p/e goes to 80 like in Japan.


p/e is currently 35.

https://www.multpl.com/s-p-500-pe-ratio
so, which is it? 40 or 80?
If I do the numbers right (doing 10-year yield + 4%)*earnings, then it would take a 70 or so it be grossly overvalued. These days, to dropping to 25 or lower would be a fire sale. 30 to 35 would be reasonable. A correction of 15%-25% is possible, but so is a 75% gain before a pop.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by Johnathon Livingston »

I don’t adjust my allocations based on valuation. I don’t trust traditional valuation models with the Fed’s monetary policy in place. It’s logical to assume equity P/E ratios will be higher than the past since bonds are so unattractive now. So, I don’t know if equities are overvalued or undervalued.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by garlandwhizzer »

The problem is that the bond market is IMO more overvalued than the stock market at present. There is no place to hide out without losing money to inflation. All quality bonds have expected real yields currently of zero or less. It wasn't like that in Ben Graham's day when bonds had significantly positive real yields. Hiding out from equity risk these days is a more expensive proposition than it was 30 or 40 years ago when bonds offered not only total safety but also significant inflation beating returns. At least stocks have positive real expected returns.

If your portfolio needs to grow over time you may need to readjust your volatility tolerance to what appears to be a new era. The era of declining interest rates and declining inflation is the optimal scenario for maximal risk adjusted bond returns. that has been the case for the last 4 decades and it has juiced bond returns without any risk. It is more likely that the future will be much less rosy for real bond returns and their risk will also be higher due to possible principal loss if rates and inflation rise persistently in the future. Don't use backtesting as a guide to the future of bonds. The bond party was very long but it is over, more so IMO than with stocks which at least offer the probability of portfolio growth if you tolerate their volatility.

Garland Whizzer
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by LittleD »

garlandwhizzer wrote: Wed Sep 29, 2021 1:48 pm The problem is that the bond market is IMO more overvalued than the stock market at present. There is no place to hide out without losing money to inflation. All quality bonds have expected real yields currently of zero or less. It wasn't like that in Ben Graham's day when bonds had significantly positive real yields. Hiding out from equity risk these days is a more expensive proposition than it was 30 or 40 years ago when bonds offered not only total safety but also significant inflation beating returns. At least stocks have positive real expected returns.

If your portfolio needs to grow over time you may need to readjust your volatility tolerance to what appears to be a new era. The era of declining interest rates and declining inflation is the optimal scenario for maximal risk adjusted bond returns. that has been the case for the last 4 decades and it has juiced bond returns without any risk. It is more likely that the future will be much less rosy for real bond returns and their risk will also be higher due to possible principal loss if rates and inflation rise persistently in the future. Don't use backtesting as a guide to the future of bonds. The bond party was very long but it is over, more so IMO than with stocks which at least offer the probability of portfolio growth if you tolerate their volatility.

Garland Whizzer
I totally agree with you that bonds of any length are potentially horrible investments right now. You could park money in cash, cash equivalents or very short term bonds and most likely be okay. Interest rates can't be raised much in the next few years due to our enormous national debt that we have to pay interest on. Actually bonds are just the brakes that mitigates the short term volatility of the stock market in portfolios.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by tomsense76 »

nisiprius wrote: Wed Sep 29, 2021 8:45 am Or, consider Larry Swedroe's article, Tactical Asset Allocation vs. Static Indexing: Who Wins?. He cites and summarizes a 2021 paper by Joseph McCarthy and Edward Tower, "Static Indexing Beats Tactical Asset Allocation," The Journal of Index Investing. "equally weighted TAA funds under-returned corresponding portfolios of index ETFs by gaps ranging from 1.77% to 5.15% per year."
Agreed or Cliff Asness' piece on attempting to time the market based on CAPE10. Or for that matter all the various pieces of research Ben Felix has collected from various researchers in this field. Covered here: viewtopic.php?t=352948

AFAICT value averaging tries to do something similar and seems to on average underperform lump summing (and in some cases even dollar cost averaging).

Not to mention all of these strategies are extraordinarily complicated and that complexity translates into higher fees that drag on returns making the hurdle for beating buy-and-hold that much higher.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by tomsense76 »

The data on tactical allocation suggests it is a poor alternative to buy-and-hold from a performance standpoint. That said, as humans we are pretty bad at staying put when threatened (it's hardwired into us to do otherwise and for good reason). So either one caves to this need to do something and accepts lower returns as a consequence or one fights the impulse and just stands there (which is easier said than done). If one does the former, it will effectively behave like having a lower allocation to stocks on average, which one might consider just making their new permanent portfolio. Even if one does opt to stand there, it is worth asking how much risk one still needs (as it sounds like one's willingness to take risk is declining).
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by reln »

invest2bfree wrote: Tue Sep 28, 2021 8:22 am Bogle goes into how he would allocate from 65/35 to 50/50 when you have extreme over valuation-

https://youtu.be/k6ra5POdsYg

Does any one follow any rules of them on allocation?

Benjamin Graham advised to have 50/50 as your default allocation. Then go to 75/25 when markets are over sold and 25/75 when markets are over valued.

What is your Asset Adjustment strategy if you use one?
No. I stick with 100% stock all the time. What I have done is rotate between stock funds leaning towards value funds or to growth funds on the edges.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by Horton »

garlandwhizzer wrote: Wed Sep 29, 2021 1:48 pm The problem is that the bond market is IMO more overvalued than the stock market at present. There is no place to hide out without losing money to inflation. All quality bonds have expected real yields currently of zero or less. It wasn't like that in Ben Graham's day when bonds had significantly positive real yields. Hiding out from equity risk these days is a more expensive proposition than it was 30 or 40 years ago when bonds offered not only total safety but also significant inflation beating returns. At least stocks have positive real expected returns.

If your portfolio needs to grow over time you may need to readjust your volatility tolerance to what appears to be a new era. The era of declining interest rates and declining inflation is the optimal scenario for maximal risk adjusted bond returns. that has been the case for the last 4 decades and it has juiced bond returns without any risk. It is more likely that the future will be much less rosy for real bond returns and their risk will also be higher due to possible principal loss if rates and inflation rise persistently in the future. Don't use backtesting as a guide to the future of bonds. The bond party was very long but it is over, more so IMO than with stocks which at least offer the probability of portfolio growth if you tolerate their volatility.

Garland Whizzer
Nisi will probably chime in on this, but has the equity risk premium changed? If not, then lower bond yields simply translates into lower expected stock returns. From a risk/reward perspective, the future can resemble the past even in this low interest rate environment. The result is that you just have to adjust your expectations and plan accordingly.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by Spinola »

I think Mr. Bogle went 50/50 when he thought the market was overvalued? I'm sticking to 65/35. It saw me through the dot.com bust and 2008.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by secondopinion »

Horton wrote: Wed Sep 29, 2021 4:29 pm
garlandwhizzer wrote: Wed Sep 29, 2021 1:48 pm The problem is that the bond market is IMO more overvalued than the stock market at present. There is no place to hide out without losing money to inflation. All quality bonds have expected real yields currently of zero or less. It wasn't like that in Ben Graham's day when bonds had significantly positive real yields. Hiding out from equity risk these days is a more expensive proposition than it was 30 or 40 years ago when bonds offered not only total safety but also significant inflation beating returns. At least stocks have positive real expected returns.

If your portfolio needs to grow over time you may need to readjust your volatility tolerance to what appears to be a new era. The era of declining interest rates and declining inflation is the optimal scenario for maximal risk adjusted bond returns. that has been the case for the last 4 decades and it has juiced bond returns without any risk. It is more likely that the future will be much less rosy for real bond returns and their risk will also be higher due to possible principal loss if rates and inflation rise persistently in the future. Don't use backtesting as a guide to the future of bonds. The bond party was very long but it is over, more so IMO than with stocks which at least offer the probability of portfolio growth if you tolerate their volatility.

Garland Whizzer
Nisi will probably chime in on this, but has the equity risk premium changed? If not, then lower bond yields simply translates into lower expected stock returns. From a risk/reward perspective, the future can resemble the past even in this low interest rate environment. The result is that you just have to adjust your expectations and plan accordingly.
Define the equity risk premium. Are we talking US equities, international equities, or both? Also, are we talking percentiles, arithmetic averages, or geometric averages?

It just not as simple as supposing that the number exists. Volatility and skew plays tricks on this notion.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by nisiprius »

secondopinion wrote: Thu Sep 30, 2021 4:28 pm...Define the equity risk premium...
:twisted: :twisted:

As mentioned by Simba in this thread:

The Equity Premium in 150 Textbooks - Pablo Fernandez
Abstract:
I review 150 textbooks on corporate finance and valuation published between 1979 and 2009 by authors such as Brealey, Myers, Copeland, Damodaran, Merton, Ross, Bruner, Bodie, Penman, Arzac… and find that their recommendations regarding the equity premium range from 3% to 10%, and that 51 books use different equity premia in various pages. The 5-year moving average has declined from 8.4% in 1990 to 5.7% in 2008 and 2009.

Some confusion arises from not distinguishing among the four concepts that the phrase equity premium designates: the Historical, the Expected, the Required and the Implied equity premium. 129 of the books identify Expected and Required equity premium and 82 identify Expected and Historical equity premium.

Finance textbooks should clarify the equity premium by incorporating distinguishing definitions of the four different concepts and conveying a clearer message about their sensible magnitudes.
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Re: Adjust Asset Allocation When Markets Are Over Valued

Post by secondopinion »

nisiprius wrote: Fri Oct 01, 2021 4:21 pm
secondopinion wrote: Thu Sep 30, 2021 4:28 pm...Define the equity risk premium...
:twisted: :twisted:

As mentioned by Simba in this thread:

The Equity Premium in 150 Textbooks - Pablo Fernandez
Abstract:
I review 150 textbooks on corporate finance and valuation published between 1979 and 2009 by authors such as Brealey, Myers, Copeland, Damodaran, Merton, Ross, Bruner, Bodie, Penman, Arzac… and find that their recommendations regarding the equity premium range from 3% to 10%, and that 51 books use different equity premia in various pages. The 5-year moving average has declined from 8.4% in 1990 to 5.7% in 2008 and 2009.

Some confusion arises from not distinguishing among the four concepts that the phrase equity premium designates: the Historical, the Expected, the Required and the Implied equity premium. 129 of the books identify Expected and Required equity premium and 82 identify Expected and Historical equity premium.

Finance textbooks should clarify the equity premium by incorporating distinguishing definitions of the four different concepts and conveying a clearer message about their sensible magnitudes.
Precisely. And sadly none of this will tell me what next X years returns will look like.
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