Can someone convince me we aren't in for a decade or two of no return?

[SHDL]

I don't want to get directly involved in this dicussion but I've read this in the past and thought the discussion fun to read and Mr. Montier talks about the margin effect:

http://lwmconsultants.com/wp-content/uploads/2014/04/JM_CAPECrusader1.pdf

 

That’s a decent piece.  The “Shiller Full Reversion” model is actually pretty close to what I personally use.  One caveat I would add however is that these valuation-based forecasts over 7 year horizons (which is what the article focuses on), are significantly less reliable than their 15-20 year counterparts — mainly because they depend more on terminal valuations which are hard to predict.

[wachtwoord]

I don't want to get directly involved in this dicussion but I've read this in the past and thought the discussion fun to read and Mr. Montier talks about the margin effect:

http://lwmconsultants.com/wp-content/uploads/2014/04/JM_CAPECrusader1.pdf

 

Thanks for the report! Now I really want to read an update (post mortem): how did the margins, valuations and metrics evolve over the 5 year period?

 

Can the difference between the prediction (-1.1% p/a) and reality (+9.8% p/a) be explained by variance or is the model invalidated? What are the chances of either? Did they update their model?

 

Edit:

 

For anyone interested they speak about it in their 2018Q4 report: https://www.gmo.com/europe/research-library/and-the-winner-wast-bills/

 

 

[Cigarbutt]

Thanks for the report! Now I really want to read an update (post mortem): how did the margins, valuations and metrics evolve over the 5 year period?

 

Can the difference between the prediction (-1.1% p/a) and reality (+9.8% p/a) be explained by variance or is the model invalidated? What are the chances of either? Did they update their model?

 

Edit:

 

For anyone interested they speak about it in their 2018Q4 report: https://www.gmo.com/europe/research-library/and-the-winner-wast-bills/

Hi wachtwoord,

I'm not sure this is worth time spent especially in terms of short-term forecasting but if you give importance to where we may be in the cycle, here are some useful tools to answer your questions:

https://www.brandes.com/docs/default-source/brandes-institute/2018/the-cape-ratio-and-future-returns-a-note-on-market-timing.pdf

 

From an academic point of view, models are never wrong and one has to adapt the reality to the model. ::)

People who publicly discuss these valuation models as potential forecasting tools tend to mention that deviations can occur and say that pendulums do swing and underline that they will eventually be proven right but broken clocks can also be right.

 

In reality, as individual investors interested in that line of thinking we have to decide which scenario applies:

-markets can sometimes stay irrational for long periods

-this time is different

 

It's interesting because the opening post referred to an article written by Mr. Buffett in 1999 (I still have the original article with contemporary hand-written notes on it) and, from 1999 to today, his “prediction” about reasonable expectations ended up quite prescient. Maybe that's because of his long-term outlook and because he avoided to think in a binary fashion. I guess then that it would be reasonable to maintain a similar outlook for the next twenty years with a nearer-term path defined by ultra-low interest rates (whatever the implications of that).

 

BTW, I meant to ask you a question about Bitcoin but found out the fundamental explanation behind the price action: the price of avocado. :)

https://www.newsbtc.com/2019/04/03/analyst-bitcoin-btc-likely-to-continue-surging-to-5500-but-significant-pullback-is-imminent/

 

[CorpRaider]

Good stuff guys.  My parting thought back to the original question is that we could be Japan in the early 70s heading toward a CAPE of like 100 (or higher) and like two decades of 20+% CAGRs, so it could be quite risky to make big binary decisions with real money based on predictions around this kind of stuff. 

[DooDiligence]

Thanks for the report! Now I really want to read an update (post mortem): how did the margins, valuations and metrics evolve over the 5 year period?

 

Can the difference between the prediction (-1.1% p/a) and reality (+9.8% p/a) be explained by variance or is the model invalidated? What are the chances of either? Did they update their model?

 

Edit:

 

For anyone interested they speak about it in their 2018Q4 report: https://www.gmo.com/europe/research-library/and-the-winner-wast-bills/

Hi wachtwoord,

I'm not sure this is worth time spent especially in terms of short-term forecasting but if you give importance to where we may be in the cycle, here are some useful tools to answer your questions:

https://www.brandes.com/docs/default-source/brandes-institute/2018/the-cape-ratio-and-future-returns-a-note-on-market-timing.pdf

 

From an academic point of view, models are never wrong and one has to adapt the reality to the model. ::)

People who publicly discuss these valuation models as potential forecasting tools tend to mention that deviations can occur and say that pendulums do swing and underline that they will eventually be proven right but broken clocks can also be right.

 

In reality, as individual investors interested in that line of thinking we have to decide which scenario applies:

-markets can sometimes stay irrational for long periods

-this time is different

 

It's interesting because the opening post referred to an article written by Mr. Buffett in 1999 (I still have the original article with contemporary hand-written notes on it) and, from 1999 to today, his “prediction” about reasonable expectations ended up quite prescient. Maybe that's because of his long-term outlook and because he avoided to think in a binary fashion. I guess then that it would be reasonable to maintain a similar outlook for the next twenty years with a nearer-term path defined by ultra-low interest rates (whatever the implications of that).

 

BTW, I meant to ask you a question about Bitcoin but found out the fundamental explanation behind the price action: the price of avocado. :)

https://www.newsbtc.com/2019/04/03/analyst-bitcoin-btc-likely-to-continue-surging-to-5500-but-significant-pullback-is-imminent/

 

I'd rather eat an avocado but to each his own.

 

https://diegorod.github.io/WillMcAfeeEatHisOwnDick/

 

:D

[scorpioncapital]

Good stuff guys.  My parting thought back to the original question is that we could be Japan in the early 70s heading toward a CAPE of like 100 (or higher) and like two decades of 20+% CAGRs, so it could be quite risky to make big binary decisions with real money based on predictions around this kind of stuff.

 

If this comes to pass it pays to be reckless, 2x margin, hold for a while longer.

If it doesn't and stays flattish, also might be worth to be semi-reckless.

If there is some crashes ahead, pays to be prudent.

 

So take an average...but if you have a margin account an argument for 'fully invested' 100% can be made under the above uncertainties. If there is a crash you dip into your borrowing power (at lower rates).

If there is a melt-up boom you can always sell on the way up.

If there is just chiseling away at carrying cost , you can just collect dividends and have some prudent ratio of stocks to cash.

[james22]

Or go "anti-fragile" (BRK, BAM/OAK, etc.).

[Spekulatius]

Or go "anti-fragile" (BRK, BAM/OAK, etc.).

 

With the largest  BAM  sub (BIP/BPR) at 12x debt/EBITDA, I wouldn’t call BAM antifragile. It is essentially a bet on having low interests for a long time to come, IMO.

[scorpioncapital]

Bam went to $8.49 in 2008. Anti-fragile it is not. It is also a lesson in debt with a cost (as opposed to say float with no cost if done well). Even Berkshire can drop 50% even though it has a war chest in the subsequent recovery to pounce. Well, it's not a straight line to riches. You can go down 30% and up 300% several years after that. I am not as extreme as buffett with debt since he was always rich, even when he started , or could at least get a million bucks from friends. But I think anything above max 1.5x leverage is very very risky.

[Spekulatius]

Bam went to $8.49 in 2008. Anti-fragile it is not. It is also a lesson in debt with a cost (as opposed to say float with no cost if done well). Even Berkshire can drop 50% even though it has a war chest in the subsequent recovery to pounce. Well, it's not a straight line to riches. You can go down 30% and up 300% several years after that. I am not as extreme as buffett with debt since he was always rich, even when he started , or could at least get a million bucks from friends. But I think anything above max 1.5x leverage is very very risky.

 

The max “safe” leverage depends on the predictability of the cash. Pipeline companies typically have 10 year contracts spore or less guaranteeing stable or slowly growing cash flows during that time, so a 4-5x EBITDA coverage is considered “safe”, E&P’s have very volatile cashflows, so everything higher than 2.5x EBITDA can be dangerous (depend on asset life of course ), high quality real estate can be leveraged 6x or even a bit higher and is considered safe.

 

12x leverage is very high and in my opinion unsafe, no matter the underlying asset, imo.

[SHDL]

I agree that BAM probably won’t do great if interest rates were to rise materially.  I can see the rationale for having it in your portfolio alongside BRK (which should benefit from rising interest rates) though, because that can help hedge your portfolio against interest rate risk.

 

It also helps that they have Oaktree this time.  They’re very well positioned to make a killing during the next downturn IMO.

[Cigarbutt]

^This is morphing into a BAM topic but the point is how a company can thrive whatever environment in the next decade or two.

BAM is highly levered but a lot of the debt is structured at the asset level (real assets) and maturities are quite long. But the high leverage makes it an inadequate candidate for the tight definition of anti-fragility.

 

If the 2008-9 episode is considered a test for fragility, at the height of the crisis, AUM did decline by 5% but, in the end, BAM was able to raise $1.2B in 2008 and $14B in 2009. And to thrive, it was able.

 

In 2008-9, the crisis was unusually deep but the recovery was unusually steep (at least for the assets relevant to BAM) so how BAM deals and comes out of the next one may be different.

 

Since then, AUM has pretty much tripled and as of now, BAM has $35B of deployable capital (year-end) and a committed $35B.

 

https://archive.nytimes.com/www.nytimes.com/imagepages/2010/12/19/business/19brook-gfc.html?action=click&contentCollection=Business%2520Day&module=RelatedCoverage&pgtype=article&region=EndOfArticle

 

Unless the future test is unusually deflationary and unless capital in general disappears for a prolonged period, I think BAM meets the relaxed definition of anti-fragility.

 

-----)Back to expectations of market returns for the next decade or two.

 

[james22]

I don't doubt that BRK and BAM/OAK will fall with the expected larger correction. But believing they'll come out of it strenghened allows me to be more fully invested at a time of overvaluation than I otherwise would be.

 

They hedge against the possibility of there being no correction too, of course.