Cigarbutt

Did not plan to come back here but re-visited an article written by Mr. Benjamin Graham who "could not understand how securities were valued in the later 1950s". https://www8.gsb.columbia.edu/sites/valueinvesting/files/files/DOC003.pdf For some reason this article came across my desk at the same time as an issue leading me to President Eisenhower's Farewell Address to the Nation (1961). Excerpts: "But each proposal must be weighed in light of a broader consideration; the need to maintain balance in and among national programs – balance between the private and the public economy, balance between the cost and hoped for advantages – balance between the clearly necessary and the comfortably desirable; balance between our essential requirements as a nation and the duties imposed by the nation upon the individual; balance between the actions of the moment and the national welfare of the future. Good judgment seeks balance and progress; lack of it eventually finds imbalance and frustration." ... "Another factor in maintaining balance involves the element of time. As we peer into society's future, we – you and I, and our government – must avoid the impulse to live only for today, plundering for, for our own ease and convenience, the precious resources of tomorrow. We cannot mortgage the material assets of our grandchildren without asking the loss also of their political and spiritual heritage. We want democracy to survive for all generations to come, not to become the insolvent phantom of tomorrow." An hypothesis is that the comments from the past simply come from another epoch and only have historical value. Another hypothesis is that Mr. Graham's 1974-5 comments may have an unusual degree of relevance in our time. Haunted by the absolute/relative valuation conundrum. The problem is that one of the options is moronic.

Thinleyw, Looked at this (partly identified firm...) in more details. The "lease" arrangement is relatively unusual. The initial 10 yr lease was initiated in 2003 and was deemed to be modified shortly after in connection to a significant investment in leasehold improvements by the lessee. Various disclosures suggest that the lessee effectively has ownership of the "improvements" which are very long term in nature and there were 4 10-yr renewal options that could be applied "unilaterally" by the lessee. At least under US GAAP, this combination of circumstances means that the capitalized asset is being amortized over the useful life of the assets and not over the period leading to the shorter term of the renewal date. Numbers disclosed concerning amortization and the relative absence of change that occurred at the last renewal (2013) would tend to validate this conclusion. I would expect then that, given an unexpected termination of the lease or non-renewal in 2023, the legal title to the "capital leased assets" may go against a simple writing down of the asset to zero. Interesting case overall in terms of value. The possibility of unlocking of value is highly correlated to a potential catalyst. If looking for potential validation of the underlying assets realizable value, there are potential digging avenues. For instance, access to appraisal value through insurance protection contracts (property/casualty) or through land/property tax documents. My limited experience has shown that the value discovered in those documents can show higher (sometimes more reliable) values than what is reported on the balance sheet. Of course, if you are in a scuttlebutt mode, eventually playing the 18 holes may do the job. Good luck.

If you like the character, you may like: Since we may have this galaxy to ourselves.

Each contract is different and if the lessee has to return the "property" to the lessor, you'd have to look at the specific terms of the contract (disclosed?). I would guess though that both lessee and lessor have a long term mindset and either the term of the lease is very long or renewal is quasi-automatic (for personal or contractual reasons). Who would significantly invest in leased premises if you have no guarantees about what happens at renewal?

Not much info but will give it a try. Given that you have signed a contract for some kind of commercial lease, significant changes after may trigger a re-assessment of the deal terms and reporting. So, unplanned significant leasehold improvements that occur during the lease contract may require to record the "investment" as an asset to be amortized over the economic life of the of the asset or until the end of the lease. Let's say you rent a relatively large office under a typical commercial long term loan resulting in an operating lease and, after a while, you make a significant investment to upgrade and have a Starbucks-like café integrated to the office. My understanding is that the lease may "become" a capital lease and the new capital investment that you "own" (leasehold improvements) is capitalized, recorded as an asset and amortized. Makes sense?

This thread has a lot to do with the hypothesis that book value for BRK is becoming less relevant as a valuation input. My understanding is that this may be true in the sense that book value will eventually reflect the unrecognized intangible value now. A relatively simple way to deal with this "lag" effect is to put a higher multiple of the IV/BV ratio. How much higher depends on your analysis but, in my book, the difference is relatively small. Of course, over time, small differences do compound. However this higher multiple due to the unrecognized potential may not apply to the whole market. Last time I looked for the S&P, price to book was around three to one. If you apply a simplified way that Mr. Buffett has described over the years to use this parameter as a valuation input, the "coupon" on the stock index would be around 4% (retained portion compounding at 12%). The yield on USA 10 yr Treasuries is 2,33% this morning and the 30yr is 2,76%. The yield on cash this morning is 0%. Ceteris paribus. Simple but not easy.

SlowAppreciation, Thanks for bringing up the brooklyninvestor link. Convincing data about the relative disregard for bonds. Reviewing this, came across that, from another era: http://fortune.com/2011/06/12/buffett-how-inflation-swindles-the-equity-investor-fortune-classics-1977/

Earlier in this thread there were questions about trends and correlations: http://politicalcalculations.blogspot.ca/2017/11/are-turkeys-calling-market-top.html#.WhQcDbpFzuh Turkeys have gotten bigger, haven't they? This has a spurious look but, if the correlation holds, maybe turkeys will keep on getting bigger. Have always enjoyed physics but perhaps what they need to fly is simply to get bigger. On a more serious (?relevant) note about the price, yield and "expectations": http://markets.businessinsider.com/news/stocks/veolia-successfully-issues-a-3-year-bond-with-a-negative-yield-1008324867 Veolia is a French-based transnational utility which is BBB rated. The 3-year bond's yield is -0,026% and the issue was massively over-subscribed. With certain assumptions going forward, as there may be more room for the credit spread, the quality of the investor base expects a profit. Today, I will get myself a new financial calculator. (and a turkey)

Your points are well taken and I want to move on. "If you can make a case for widespread persistent shortages and thus inflation & mean reverting interest rates, these guys would be correct but they have not made such as a case. If you have heard one I would like to hear it." Here's a recent link: https://www.hussmanfunds.com/comment/mmc171009/ I know, Mr. Hussman has been "wrong" for so long etc My take is that he tries to explain that low interest rates explanations suffer form double counting and suggests that low interest rates may point to a low growth environment. You can't have your cake and eat it too argument. I think it makes some sense. The issue for me is that, lately, I haven't found securities with a sufficient margin of safety; that's my problem. I am happy that others don't have this problem. And this is not about looking for macro "signals". I'm simply trying to understand. Interesting times.

You may be right in a lot of ways. In investing, the rear-view mirror is always clearer then the windshield. Who can say what's in store: a dreaded black swan?, a new Gilded Age? or just sideways muddle through? Who cares in a way. Historically, one has to care only rarely and caring has a price. The bottom line for expectations about the next few years is that the outlook for returns is colored by our interpretation of present levels and our interpretation of fundamentals (also sentiment) going forward. This is art and science. As far as the ERP "concept", Asness, Arnott and Bernstein, Gross (Bill), and others have given rational explanations about the possibility of (much) lower ERPs than "conventionally" accepted in general and even negative numbers for certain relatively long periods. I can provide specific references about this but suggest that it is probably not worth your time unless you have a quasi-autistic interest in the matter. To keep the discussion on solid ground, here are some interesting (and perhaps relevant) historical facts: -the time it took for an index to reach back to the same level, DJ 1929 to 1954 (yes 25 years, but more like 16 to 17 years if you think in total returns) S&P 1968 to 1979 (time of relatively high inflation, ouch) I know, this is retrospective cherry picking and dividend yields were relatively higher during these periods of the past but these two periods represent about 30 to 35% of the last century when the going forward ERP for the typical investor was closer to zero or even negative. In terms of low interest rates, if they remain low, stocks may be cheap but, to make a long story short, I submit that there may be an element of double counting here. For instance, if you buy a house and get an unusually low 5yr rate on your 95% value mortgage, a reasonable assessment of margin of safety may have to include scenarios whereby interest rates may be different down the road. I am assuming here that the "value" of the house itself is not overvalued because of the low interest rate "environment"... For additional perspective, debt can be thought of as forward consumption brought today. This would imply that you will eventually consume less (especially if recent debt accumulation has been unusually high). So, if recent returns have been unusually good, irrespective of interest rates, future returns may be unusually lower. The fact that there is no place to hide is not sufficient, in itself, to justify higher valuations. Long post as I have spent quite some time on this issue in the last few months, which is unusual. Opinion In terms of "framing issues", if I would run a fund now, I would close it and distribute funds (not because of retrospective reasons) because I think that, for the next +/- 10 years, there is an unusually high risk of disappointing returns and, to link with this thread, if history is any guide, I would submit the opinion that, for the typical market participant, there is an unusually high risk of permanent capital loss. This is a zero-sum game against the average. That's why I'm here. I expect that future posts will eventually focus on the flip side of the coin.

Thought the following is interesting in terms of expectations: http://www.collaborativefund.com/blog/were-all-out-of-touch/ http://www.lse.ac.uk/fmg/documents/events/seminars/capitalMarket/2008/1032_S_Nagel.pdf What's the point: Your investing experience (especially the recent one (recency bias), and actually going through booms and busts even a long time ago) will have, in general, a significant impact on your risk/return expectations. So, the decision to index/invest or not, for the typical investor, has a lot to do with when you were born and when you started investing. Of course, as individual investors with strong egos, that does not really matter. The trouble/challenge/fun aspect of this is that you find out how you did only looking retrospectively. The future, as always, remains uncertain. Focus on process, they say, not results. The first step though is to win the genetic lottery. http://tonyisola.com/2017/11/if-you-are-reading-this-you-already-won-the-genetic-lottery/

OK. Just beware of adventurous curve fitting. http://www.philosophicaleconomics.com/2013/12/valuation-and-returns-adventures-in-curve-fitting/ "But, admittedly, the metric doesn’t deserve the reputation for predictive precision that the chart, by chance, affords it."

"Why do you think he would be difficult to deal with?" Nothing personal against Mr. Thiel. Just wanted to convey that innovation tends to be disruptive. It depends how one values stability. Bias: prefer incremental changes.

"What is the best place to park short term to medium term cash part of this anti fragile portfolio?" You just have to find a security that will provide a safe, consistent and high return that will not be influenced by an adverse currency exchange volatility and that is not a Ponzi scheme. :) "I'm amazed there is even any debate about this. Taleb literally talks about this in his books. He made his own money by seeking extreme payoffs with a small portion of his portfolio." Maybe it's not a debate but more variations on a common theme. Historical example: WWII ranked as the most destructive in human history (although debatable, could be considered a black swan). 400 000 Americans died. But the United States emerged from the war stronger than when it began as the Eurocentric international order fell apart and as the nation's GDP doubled between 1941 and 1945. I submit that this would meet one of the definitions of Anti-Fragility.

Let’s see if we can agree on a few things. From the graphs (and basic math), we can infer that the major factor explaining (did not say causing) the change in % investor equity allocation is change in share price. The author shows that there is a tendency to have an inverse relationship between % investor equity allocation (and therefore share price) and returns going forward. This is just another example of valuation tools (stock market cap/GDP etc) used to infer forward returns. For example: (graph using marketCap/GVA) https://www.hussmanfunds.com/wmc/wmc170306.htm And I agree in principle. But these subsequent return "indicators" are not true "predictors", they are variables that will reveal self-fulfilling prophecies associated with the direction of prices in the context of mean-reverting financial variables. If you don't "believe" in mean reversion, just think of this concept as variations along the trend. There is nothing to suggest that % investor equity allocation is the single greatest predictor, as the author suggests in the title. In fact, the two lines on the graphs will continue to show a tendency to converge but the correlation may weaken intermittently. See recent update related to an alternative presentation that you provided in this discussion. https://www.marketwatch.com/story/why-rising-stock-ownership-by-us-households-may-be-a-bad-omen-2017-03-16 Now to go back to the thread, if you look at these types of analysis, the expected subsequent return over the next 10 to 12 years should gravitate towards the range of 0 to 2% per year. Quite unusual. No? Now, if your time horizon is 10 to 12 years and you reasonably expect that kind of return when you invest in an index fund, then everything is OK. But I doubt that the passive investing pool of investors truly understand the implications. Don’t want too pound too much on the issue but correlation is not causation. Some time ago, I read an article showing a correlation between breast cancer risk for women and the number of bathrooms in the house. The first thing to do is to rule out spurious correlation (statistical fluke). If a “true” correlation, before moving to a house with no bathrooms, it may be helpful to try to figure the driving force(s) behind this correlation. Referring to the link on reply #46, the driving forces behind rising share prices (and % investor equity allocation), in the last 20 to 30 years, have not been based upon fundamentals but on PE expansion and increased net margins. Disclosure: believer in long term mean-reverting tendencies. Also liked that book: https://www.amazon.com/Unexpected-Returns-Understanding-Secular-Market/dp/1879384620

If a concern, building an "AntiFragile" portfolio may involve holding some "AntiFragile" securities, holding cash or somehow hedging risks. At the company level, it represents the two sides of financial flexibility: to be able to survive AND thrive. Although appealing in nature, true Antifragility has a cost. As Taleb states: "redundancy is ambiguous because it seems like a waste if nothing unusual happens." I would submit that a P+C insurance firm that keeps a high (or very) high cash balance would reach the definition as it could withstand a blow to the asset or liability side and still be able to redeploy funds to opportunistically invest in securities and/or to participate materially in an ensuing hard market. Another area these days would be the firms that belong to an oligopoly and that have relatively low leverage as chaos may represent an opportunity to gain market share.

no_free_lunch, "Only question is what to do for someone with an existing portfolio. What time of allocation would you use then?" I only wish I had an answer. We all have to come to our own personal decisions. Maybe I don't know what I'm doing or maybe it takes character to sit there and do nothing with all that cash (Munger). I hate to think that I'm a know-nothing but it's possible. Want to learn and that's why I'm here. In the meantime, will continue to search companies (properly?).

When/if you enter a financial planner office, there is usually a big picture on the wall showing how equities "out-perform" over time. A way to see the forward looking equity risk premium is to evaluate the return that you will (expect to) obtain from investing in the market, over a specific time period, above the risk-free rate. Question for you now: -what risk-free rate (level) should you use? (Remember that risk-free rates are negative in many places these days) Of course, it does not really matter if you rely entirely on your inner score card and have a very long term focus.

Thank you for the wise words. Conventional wisdom: what counts is time in the market not timing the market. OK. Want to spend time on income statements this week (and for the next 20 years) but will add the following: The last 30 years (despite dot-com and real estate induced volatility episodes) have been unusually "good" for investors. The "excess" return was not based on fundamentals. Animal spirits. I'm not saying that the next period will be "bad". I'm suggesting that maintaining the same trajectory requires certain assumptions and that lower expectations may be reasonable. I'm not sure that investors who are indexing now have appropriate desired/required expectations. My understanding is that human nature has not changed. For reference, go to PDF document, exhibit 5 page 8. https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/why-investors-may-need-to-lower-their-sights Going forward, there are many ways that this can play out. One of the scenarios is that "stocks are cheap now". Before going "all-in" and "adjusting" some parameters in my investment universe, need to "see" how my investments would turn out in various scenarios. To conclude, one prediction (!). In 1997, Siegel and Thaler (recent Nobel for what it's worth) predicted a forward looking ERP of 3% for the next 20 years and said: "‘we are stressing long-term results and will not accept complaints for 20 years. Feel free to call us in 2017." My prediction is that the forward looking ERP for the next 20 years will be much closer to zero and I can discuss again this issue publicly in 20 years (2037). May we all do well. :)

Mixed feelings. Experiences with agencies are uneven. Sometimes, as Mr. Lewis describes, you get the impression that the person on the opposite end cares. But (anecdotal), that is not always the case (far from it). Reading the article leaves me under the impression that these large entities are somewhat self-sustaining which may be a larger problem. There are many ways to "restructuring". Reminded me also of another kind of attempt: The Common Sense Revolution in Ontario from a few years back. The jury is still out on this one.

OK. I see your point. But this is playing on words with a chicken and egg question. -What the graph and basic deductions mean: --)% equity allocation in the aggregate is essentially explained by change in price. --)so we can conclude that markets are cyclical (we won't get the Nobel prize for that conclusion). --)another consensual conclusion is that if markets are high, returns will tend to be lower going forward (no need for thousands of words here). What this thread is about: 1-the level of the S&P now vs its "normalized" level 2-is indexing contributing to the divergence if any? 3-in combination, is it moronic to index now? From a previous post, you mention: "If investors increase their equity allocation, it will lead to higher prices" From the last post, you mention: "And as equity allocations go lower, returns will be lower." The points of my last post: These statements are truisms and derive form basic math. These statements, as expressed, suggest (wrongly in my opinion) that what causes markets going up or down is the actual "participation" of investors or absence thereof in the markets. From the last article: "It will undoubtedly come as a surprise to many of you that households’ equity allocations are at close to record highs, since the financial media in recent months have been serving up a steady drumbeat of stories about how the average investor, traumatized by the memory of the 2008-2009 Great Recession, is out of the stock market entirely." What seems to be surprising to the author of the article and the author of the previous links that you provide is not surprising at all. It can simply be explained by basic mathematics. Back to this specific thread. The links that you provide tend to show that markets are overvalued and that going forward returns will be lower thereby questioning if passive investing is a wise choice. The links that you provide and your own quotes tend to support the idea of mass movements, momentum and reflexivity. These are concepts that are self-reinforcing and may contribute to deviations from intrinsic value. My opinion is that price tend to correlate with intrinsic value but variations can occur. In terms of cause and effect, demand and supply factors can interact in a subjective manner to increase the divergence. My opinion is that there is a significant divergence between aggregate intrinsic value and the level of the S&P index, and indexing/passive investing is a contributing factor. I submit that the data you provide support those conclusions.

"I don't agree. The transition to indexing could lead to a bubble if it occurs too quickly but indexing in and of itself does not create bubbles. Indexing leads to less trading and possibly if adopted on a very very large scale , wider bid/ask spreads. Philosophical economics has already basically beautifully explained what happens when indexing is adopted on mass: http://www.philosophicaleconomics.com/2016/05/passive/ http://www.philosophicaleconomics.com/2016/05/indexville/ The real question is not about indexing. Its about equity allocation in investor portfolios. If investors increase their equity allocation, it will lead to higher prices. Again philosophical economics provides a great explanation: http://www.philosophicaleconomics.com/2013/12/the-single-greatest-predictor-of-future-stock-market-returns/" The first two links state that the ratio of active and passive investing does not matter in mathematical terms versus returns. This is the same type of premises which are used in quantitative investing that assume that investors are rational and that behavioral economics does not apply. The 3rd and last link is based on a fundamental flaw. The author suggests that 1)the % equity allocation by investors will vary according to supply and demand factors, 2)the % equity allocation by investors will closely predict future market returns. The article, in fact, in a lengthy and convoluted fashion, goes on a detailed circular discussion about these assumptions. But, simply looking at the top graph, the % equity allocation by investors simply coincidentally follows the market (price). For instance, when the market corrects by 50%, the % equity allocation will fall by close to 50%, as bond value overall changes much less and as cash, by definition, does not change value per unit. Also, when markets gradually increase, the market value of the equities held by investors will also gradually increase and that essentially explains the gradual increase in the % equity allocation. No wonder, the % equity allocation by investors can be interpreted as a predictor of future return as it constitutes a closely related coincident indicator. In fact, any significant deviation of this correlation would require a separate explanation. The reason behind this simple reasoning is that, for every investor who is a seller, there is an investor who is a buyer. Equity does not disappear when you sell it. I would submit that using conclusions based on a fundamental flaw may lead in the wrong direction. What is perhaps interesting is that the first two links (active versus passive investors) are based on the fact that even if individual investors change camp, the total number of investors does not change. Fair enough. Well then, concerning the third link, the author seems to forget that even if individual investors % equity allocation (in terms of quantity of equity held) will change over time, the total % equity allocation (in terms of quantity of equity held) will be relatively stable in the aggregate. The essential reason explaining the variation of % equity allocation in the aggregate is because of share price change per unit of equity held. So, when this philosophical explanation suggests: "If investors increase their equity allocation, it will lead to higher prices", I tend to reflect that, for my accounts, I will tend to increase the equity allocation when prices will be lower. And perhaps that discussion explains why a relative infatuation with passive investing may be a contrarian signal.

Arguments from LC: "All excellent points." 1+ But there is a risk of a fallacious basis in a multi-variable problem where critical variables are not clearly defined. To illustrate: If the S&P is not in bubble territory or in fact if stocks are cheap, then why do BRK, FFH, Klarman and other value investors have high cash levels in their portfolios and why do they not simply invest in index ETFs? Or is the argument that indexing creates opportunities for value investors outside the indices, then why do BRK, FFH, Klarman and other value investors have high cash levels in their portfolios and why do they not simply invest in equities outside of the S&P? The argument may not be that indexing is causing a bubble. It may be that passive investing is contributing to crowd psychology in any market (up or down).

"Do you have evidence of this?" Trying to look at this objectively with data. The growth in ETFs has been matched to some degree by investors getting out of mutual funds. So, in a way, what we see may just be a new distribution of the same pool of investors. However, some numbers suggest that, overall, the level of "passive" investing is on the rise. Nothing wrong with that if guiding lights are rational and act based on fundamentals. The inherent risk is that crowd psychology associated with passivity can go both ways. In terms of evidence, have you been in a moving crowd recently? Better hope that the crowd is moving in the right direction. https://www.amazon.ca/Crowd-Study-Popular-Mind/dp/1773230190/ref=sr_1_3?s=books&ie=UTF8&qid=1510349533&sr=1-3&keywords=the+crowd+le+bon Data from GS: http://www.goldmansachs.com/our-thinking/public-policy/directors-dilemma-f/report.pdf Having said all that, if your time horizon is 20 years or more, with time, these "crowd" issues become progressively inconsequential.

Instructive. Would add an opinion that the increasing market share of ETFs (now very significant) has had a tendency to reinforce the general upward trend and to decrease short term volatility. That's OK. A big question is how the typical investor will react when trends change. As GregS says, history offers some suggestions. Would also add that the significant rise in synthetic replication ETFs has created a new potential risk, especially in the leveraged category. The risk is related to the opacity and lengthened financial intermediation process. It reminds me of the period when the market of credit default swaps on a specific underlying asset was actually much larger than the value of the underlying asset. I don't know exactly how this may play out if risk management is eventually tested but the 2008-9 period for the CDS market showed that price discovery may be a painful process when the true market value of an asset is difficult to appraise in a fire sale context even if the pool of assets is said to be over-collateralized. Ask AIG. Of course then, systemic risk was socialized. Who could have predicted that? A word on ERP mentioned by Packer16 along the way. Probably not worth discussing but Damadoran has written a lot of interesting stuff on the topic. What I find particularly fascinating are not the numbers he comes up with but the actual "models" used. There is a relatively large consensus on historically realised ERP. But, I would humbly submit that, going forward (let's say for a relatively short term horizon like 10 or 15 years), you can hypothesize a number but need also to include a standard deviation that is much larger than the number.