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James Montier: S&P 500 Just Say No


dcollon
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The GMO paper deals with equities.

A lot can be said about the bond markets too.

I know, the link provided is coming from a site often tainted by doom and gloom but the graphs are food for thought.

European junk bonds spreads gravitate towards US treasuries. (!)

Some of these CFA equations that I still use from time to time really give weird answers these days.

 

http://www.zerohedge.com/news/2017-08-10/italian-junk-bonds-yield-less-treasurys-insanity-bond-market-4-charts

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On a valuation basis, all makes sense, but:

 

1) In reality does it make a difference? When there is a "correction" or "crash" seems like markets tend to be correlated. That is to say the undervalued or fairly valued companies seem to get hit just as hard as the overvalued companies. In 2008 if one owned a selection of good, productive businesses that traded at attractive P/E multiples, one's portfolio still took a 30%+ hit. The question I have is: As value investors we care about the price of a company. However, if markets are correlated (i.e.: markets don't care), then does all the theory behind valuation matter?

If there were to be another financial calamity along the lines of Lehman Brothers/junk mortgage backed security, huge interest rate changes or a geo political event, I wonder if the entire market goes down regardless of valuation?

 

2)What would W. Buffett say to avoiding passive US equity investment? He has advocated that most individuals should put 95% of their savings in an indexed fund of US equities. I think he would still be optimistic long term on US equities.

 

 

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Good points investmd.

 

Unfortunately, it may boil down to your investing style or even personality.

I am not sure I would be able to, in a secular downturn, sell securities at a loss in order to take advantage of other opportunities. Maybe?

 

Your arguments are convincing but, for perspective, I would add the following paragraph from a recent commentary by Frank Martin:

 

"  Benjamin Graham once noted, “You don’t need to know a man’s exact weight to know he’s obese.” In an early 1929 exchange between Graham and Bernard Baruch, both agreed that the market had advanced to such “inordinate heights, that the speculators had gone crazy, respected investment bankers were indulging in inexcusable hijinks, and that the whole thing would have to end up one day in a major crash.” Several years later Graham lamented, “What seems really strange now is that I could make a prediction of that kind in all seriousness, yet not have the sense to realize the dangers to which I continued to subject the account’s capital.” Baruch, in writing the foreword to the 1932 edition of Extraordinary Popular Delusions and the Madness of Crowds, expressed sentiments others will feel again should this current episode in financial folly end badly.    "

 

I am quite optimistic in general, but my opinion is that we live in an unusually benign period.

 

An investor I respect a lot, Irving Kahn, spent literally decades investing in securities with a fairly consistent value attitude. He started short selling though.

 

This is not an easy question and even Fairfax seems to be struggling somehow with this aspect.

 

When you manage portfolios for others, it gets even more complicated.

 

For now, I will stay on the sidelines and will do more thinking. Thank you for the comments.

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Thank you Cigarbutt.

I'm beginning to wonder if the niche for Value Investing is actually in "good" markets - pick the undervalued companies that Mr. Market has not come to terms with yet and wait it out? During time of recession, everything seems to go on massive sale. I agree with you that I too would have a hard time selling my undervalued securities at a loss during a downturn in order to buy other equities that are selling at even more discount!

 

Thus, currently, GMO and Howard Marks and Chou and others have all said markets are v. expensive. Yet, from what I know, I have to believe that staying fully invested (with some cash to deploy component) is the way to go. When there is a downturn, future income would have to be deployed into equities on sale. FFH tried timing the market and just got back in 9 months ago and now...

 

Does anyone think the long term investor should be lightening up on equities and moving large % to cash because of market valuations? My money is with deep value managers and some in ETFs - I'm not selling today in anticipation of crash tomorrow.

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I don't have a strong view whether S&P is fair valued or not against other indices out there.  I am curious though, since the lead in question was posed to a fictional pension trustee presumably in the US, how does the principal of asset / liability matching fit in this analysis.  i.e. If your future liability will all be in USD, primarily directed towards a group of people who will retire in the US, how much of your assets should be directed towards an emerging market index? 

 

 

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I don't have a strong view whether S&P is fair valued or not against other indices out there.  I am curious though, since the lead in question was posed to a fictional pension trustee presumably in the US, how does the principal of asset / liability matching fit in this analysis.  i.e. If your future liability will all be in USD, primarily directed towards a group of people who will retire in the US, how much of your assets should be directed towards an emerging market index?

 

For the average investor, Buffett would say none - put 95% in S&P index and 5% in cash. I would think that the reason to go elsewhere is if one has a desire to get extra gain - i.e.: most people on this webpage are interested in doing a little better than "average".

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  • 2 weeks later...

Planned to fish at the bottom for ideas this morning, trying to spot the "pockets" of value left. Will share if applicable. My net mostly comes out empty these days. Maybe not looking at the right places. Will keep trying.

 

But got again distracted by an article that I think is not benign and suggests that maybe excessive (?) central bank interventions and attempts to manage the economy have introduced some serious distorsions in asset values.

 

http://viableopposition.blogspot.ca/2017/08/

 

And then they say that markets are efficient. :o

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I don't have a strong view whether S&P is fair valued or not against other indices out there.  I am curious though, since the lead in question was posed to a fictional pension trustee presumably in the US, how does the principal of asset / liability matching fit in this analysis.  i.e. If your future liability will all be in USD, primarily directed towards a group of people who will retire in the US, how much of your assets should be directed towards an emerging market index?

 

For the average investor, Buffett would say none - put 95% in S&P index and 5% in cash. I would think that the reason to go elsewhere is if one has a desire to get extra gain - i.e.: most people on this webpage are interested in doing a little better than "average".

 

Where has he said 95/5?  I just thought he said all investing assets in equities.

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The answer to the question may depend on what exactly you are talking about ie personal funds managed by himself, funds managed by fiduciaries or other.

 

The relevant answer maybe is:

 

From 2013 annual report,

 

"My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers."

 

I also seem to remember that he advised, based on the above concept, to adapt the withdrawal rule to retire funds from the bond side when stock markets did not do well.

 

My understanding too though is that he probably personally favored 100% stock allocation all/most of the time. Unless (that part remains somewhat fuzzy).

I would like to politely underline that the cash pile at Berkshire has grown at an incredibly high pace in the last few years.

Mr. Buffett's money tends to be where his mouth is. No?

 

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The answer to the question may depend on what exactly you are talking about ie personal funds managed by himself, funds managed by fiduciaries or other.

 

The relevant answer maybe is:

 

From 2013 annual report,

 

"My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers."

 

I also seem to remember that he advised, based on the above concept, to adapt the withdrawal rule to retire funds from the bond side when stock markets did not do well.

 

My understanding too though is that he probably personally favored 100% stock allocation all/most of the time. Unless (that part remains somewhat fuzzy).

I would like to politely underline that the cash pile at Berkshire has grown at an incredibly high pace in the last few years.

Mr. Buffett's money tends to be where his mouth is. No?

 

Not necessarily - his mouth is still saying that equities are attractive on a relative basis while cash is building on his balance sheet. He's also complained the rich don't pay enough in taxes, but I don't see him demonstrating that he's writing personal checks in excess of what he owes OR selling stocks with hundreds of millions in capital gains liabilities to pay those taxes either.

 

Do as he does. Ignore what he says. Ever since he decided to be a public figure, the value of his words has diminished markedly.

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He's also complained the rich don't pay enough in taxes, but I don't see him demonstrating that he's writing personal checks in excess of what he owes OR selling stocks with hundreds of millions in capital gains liabilities to pay those taxes either.

 

In the tennis world, a set of players are vocal for a rule change to invalidate the second serve rule. A player who is on the other side of the argument (that is, supporting the current rules) says, "those who do not like the current rule can intentionally fault the the second serve, others could play the regular game with the second serve."

 

You could see how absurd the above argument is.

 

Just because Buffett prefers a system where rich people need to pay more taxes, your expectation that Buffett should pay more taxes than the current laws mandate, is a similar one.

 

When Buffett says rich should pay more taxes, he is talking about changing the current tax laws. He is not asking the rich to pay more taxes than the law mandates.

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I would add that Mr. Buffett has cultivated his public image and, despite the folksy manners, is a really shrewd negotiator and investor.

Also, he has used strategies to diminish taxes at the corporate level and has been critical of holdings (think Kraft) that did not devise tax effective transactions.

 

However, my opinion is that he is sincere about personal tax reform that would include higher income tax rates for the very rich.

 

http://www.nytimes.com/2011/08/15/opinion/stop-coddling-the-super-rich.html

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I don't know if he is out of context, but the idea of throwing 90% heck even 50% of ones assets in an index fund at any one given point in time is asinine. At least, I would say to dollar cost average it in there over a span of 5-10 years if its a large sum of money. If you're a 25 year old kid, sure, throw your $10,000 in starter money there. But any sort of meaningful savings being chucked into anything, let alone an index fund in one shot, is incredibly risky. If the next big crash is right around the corner, you are f***ed. 

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I would tend to agree with you. In fact, I am trying to define some kind of simple formula, to help trustees deal with funds when I'm gone, that would follow +/-  Mr. Buffett's 90/10 rule but, at the same time, would prescribe a way to deploy funds.(to try to avoid what you describe)

 

Very long term though, common stocks remain the way to go even with bad timing. Nice studies and reports have shown that, even if your entry was at the worst possible time, long term results of investing in a basket of inflated nifty-fifty stocks are quite satisfactory. (not in the first years though)

 

I would add also that, if you follow the "be always fully invested in stocks" mantra, and if you maintain cognitive coherence, you should have no problem plowing a large amount like an inheritance into common stocks in one single shot.

 

Long term, things get easier but investing is not easy. The goal is to do better than the index. Isn't it?

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Dollar cost averaging is going to be suboptimal simply because over most 5-10 year periods the direction of the general market is upwards so your average cost is likely to be higher than lower than a lump sum investment. Plus you are missing out on dividends.

 

The models that show the market to be overvalued tend to be based upon the idea we have to revert to mean profit margins and interest rates and valuation multiples.

But even then they do not imply negative returns or that the market is going to crash or that cash is a better option. They just simply say it is a low return environment going forward and a valuation headwind means that returns on stocks might lag the returns on underlying businesses.

 

But if the models are wrong and there have been structural changes in the economy that mean higher profit margins and valuation multiples and lower interest rates can be maintained

then markets are probably fairly valued and prospective returns are healthy enough that if you sit it out in cash you may never get the chance to re-enter at a lower market level and by dollar

cost averaging you would end up paying a much higher average cost than the current market level. And if the economy really takes off and people become very optimistic then we could easily see the market go up another 50% over the next 3-5 years which will be psychologically very difficult if you have a high cash allocation.

 

And when markets are valued based on the prevailing psychology and difficult to predict economic fundamentals there isn't really a scientific basis for trying to time the market especially considering the risks of missing the market altogether if you are wrong

 

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Thank you for this first post mattee2264 and welcome.

 

Agree in substance with the gist of your message. Animal Spirits are intangibles difficult to value.

 

Questions:

 

-When something is true most of the times, is there a risk that you end up thinking that it is true all the time?

-Do you imply that we have reached some kind of plateau in terms of margins, multiples and interest rates?

 

I personally know very little and am often wrong but I tend to think long term.

 

I will keep the following quote: "And if the economy really takes off and people become very optimistic then we could easily see the market go up another 50% over the next 3-5 years which will be psychologically very difficult if you have a high cash allocation." and promise to re-engage this conversation (whatever the outcome).

 

 

 

 

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One thing that's infrequently mentioned in these conversations is whether or not the correction is economic based or not. If you go back through us history, many of the stock market corrections weren't necessarily based on the underlying economy tanking and/or the corrections magnitude exceeded the underlying economic contraction. If you were strictly a value investor, dot com, 87', nifty fifty, wouldn't have been very difficult. In the future we could see crashes exacerbated due to ubiquity of etf's that some prominent investors have alluded to. Where a minor, say 10% economic contraction causes a much larger sell off.

 

That said, where we are today could be different, as the median stocks valuation is high as opposed to a smaller cohort as in times past.

 

 

 

 

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And if the economy really takes off and people become very optimistic then we could easily see the market go up another 50% over the next 3-5 years which will be psychologically very difficult if you have a high cash allocation.

 

Speaking as someone who has a high cash allocation, I won't find this difficult.  People tend to forget that even if you're (say) 25% in cash, you're still 75% invested.  If 75% of my money goes up 50% over the next 5 years I'll be delighted.  Stressing yourself over the fact that you could have been a little richer if you'd made different decisions seems like a great way to reduce happiness!  (What I would find extremely difficult is being fully invested into a drawdown, because I'd look back and ask myself: why were you fully invested when valuations and margins were high, you moron?)

 

But that is me, and my psychology.  I'm not recommending anyone follows me.  Each to their own. 

 

I should say that I am a firm believer in margin and valuation mean reversion over the long term.  It was ever thus - and if free markets don't cause it, social policy will.  In particular I wonder if the stock market would go up 50% if the economy boomed.  If the economy boomed inflation would probably rise, and even if it didn't rates would because the Fed would probably use the cover of a strong economy to raise rates and given themselves some wiggle room for the next downturn.  Also, if the economy booms employment and wages will presumably rise, depressing margins.  The last 8 years have (with hindsight) been a goldilocks period for the stock market: low rates, abundant money, gently rising revenues, no cost pressures, low starting valuations, and lots of buybacks because there's been no need to invest cash flows in capex.  The only one of these that would get better in an economic boom is revenues.   

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And if the economy really takes off and people become very optimistic then we could easily see the market go up another 50% over the next 3-5 years which will be psychologically very difficult if you have a high cash allocation.

 

Only a durable sense of doom could survive such discouragement. John Kenneth Galbraith

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