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Beware of using market valuations because they might use you


claphands22
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I had committed a cardinal sin: I had become a market timer. It was a slow process cataloged by a first glace at a Case-Shiller's index then by a monthly, then weekly, then daily look at GuruFocus's "Where Are We With Market Valuations."  I became skittish about investing because I thought the markets were too overvalued, I figured I should be timid about my positions because of a possible market revaluation.  Yet now, I see I was just being a market timer. To use the supermarket analogy of investing, I was saying no to 50 cent pound bananas because the strawberries and peaches were selling for 10 dollars a pound. I was letting the prices of other securities dictate my position size and what I invested in - not my own independent valuations.

 

To be clear, I'm not saying you should be fully invested 100% of the time. If you don't see a security with a large enough margin of safety, don't buy it or if a position size keeps you up in night you should trim it down. Yet, don't let the market's valuation keep you from purchasing a great idea.

 

Here is a comment from Buffett about investing his personal money during the 2000 Nasdaq high. Notice market valuations didn't keep him away from making a rational investment choice.

 

    I have less than 1% of my net worth outside Berkshire and when the Nasdaq hit its high, I had nearly all of it in REITs, which were selling at a discount to their liquidation values. (BRK Annual Meeting 2005 Tilson Notes, via http://buffettfaq.com/ )

 

Market valuations is a tool you should be careful using since they can infect your thinking. Beware of using market valuations because they might use you.

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Actually you are making a mistake, REITs are not the same as ordinary stocks, so the index that you would value them against would be different.

 

See the following post:

 

In January 2002, Inker had 8.7% of the fund's assets in REITs, because the firm estimated that the asset class would return about 9.1% per year in real terms over the next seven years. By Dec. 31, 2005, however, the fund's real estate exposure was less than 1%, when the firm estimated that the asset class would return negative 0.6% per year for the next seven years. The GMO fund had less real estate exposure than did the PIMCO fund in the spring of 2004, but they both cut their exposure dramatically at roughly the same time. The GMO fund currently has no real estate exposure.

 

http://advisor.morningstar.com/articles/printfriendly.asp?s=&docId=20355&print=yes

 

So they are actually considering them an entirely different asset class.

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Hi TariqAli, I am a big fan of your blog http://streetcapitalist.com/, I appreciate the reply to the thread.

 

I got to be honest, I don't think I understand your criticism. Are you saying that, using my Buffett factoid was a misinterpretation of buying cheap stocks irrelevant of overall market valuations because REITs are assets that don't follow the overall index? Therefore, Buffett only bought those REITs in 2000 because he thought they wouldn't be dragged down when the overall market got re-priced?

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Claphands22,

Well said. In case your Buffett REIT example is insufficient, here's another. The Shiller P/E hit its all time high in early 2000 (at around 43x). In April 2000, the Baupost Fund had 62% of its assets in US public equities, plus 10% in Western Europe equities. If Klarman had been guided by the Shiller P/E, this type of exposure would not have made much sense. Over the next 12 months that fund did pretty well, up 27% vs. S&P500 down 13%.

 

Metrics like the Shiller P/E seem like a poor excuse for those who don't want to do the work. Is it realistic to think that you can get rich by spending a few moments every now and then on a website that is available to everyone?

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Hi TariqAli, I am a big fan of your blog http://streetcapitalist.com/, I appreciate the reply to the thread.

 

I got to be honest, I don't think I understand your criticism. Are you saying that, using my Buffett factoid was a misinterpretation of buying cheap stocks irrelevant of overall market valuations because REITs are assets that don't follow the overall index? Therefore, Buffett only bought those REITs in 2000 because he thought they wouldn't be dragged down when the overall market got re-priced?

 

Right, REITs are a separate asset class. Small cap stocks might be one asset class. REITs might be another. You might compare the returns offerered by both to make decisions on where to allocate capital, but it would be incorrect to use the valuation of an equity index, such as the nasdaq, to tell you whether or not REITs are cheap or expensive.

 

So using Buffett, he was not choosing to ignore the market. Instead he ignored the market for one asset class in favor of the market for another asset class.

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Tariq do you know of a good way to find beat up sectors in equities. Everything as far as I can see has ran except for large cap technology and banking. I am wondering if I perhaps missed a sector.

 

Also thanks for the link to the Joy of Stats Video. I am a big fan of Rosling, didnt know he had a documentary out.

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Hey Tariq,

 

Looking at asset class valuations compared to market valuations is a more reasonable technique. Yet, you would also be making the same mistake of not investing in certain stocks because they were part of an asset class that is, as a whole, over valued. Most of these of asset allocators currently feel small cap stocks are over valued, yet using the asset-class idea, they would would be staying away from companies like EVI, MGAM, ITEX and IDT: which I think are undervalued.

 

I still stand by my original argument, which is investors should all but completely ignore market/asset-class valuations, as long as they find a company with a margin of safety. 

 

 

 

 

 

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I had committed a cardinal sin: I had become a market timer. It was a slow process cataloged by a first glace at a Case-Shiller's index then by a monthly, then weekly, then daily look at GuruFocus's "Where Are We With Market Valuations."  I became skittish about investing because I thought the markets were too overvalued, I figured I should be timid about my positions because of a possible market revaluation.  Yet now, I see I was just being a market timer. To use the supermarket analogy of investing, I was saying no to 50 cent pound bananas because the strawberries and peaches were selling for 10 dollars a pound. I was letting the prices of other securities dictate my position size and what I invested in - not my own independent valuations.

 

To be clear, I'm not saying you should be fully invested 100% of the time. If you don't see a security with a large enough margin of safety, don't buy it or if a position size keeps you up in night you should trim it down. Yet, don't let the market's valuation keep you from purchasing a great idea.

 

Here is a comment from Buffett about investing his personal money during the 2000 Nasdaq high. Notice market valuations didn't keep him away from making a rational investment choice.

 

    I have less than 1% of my net worth outside Berkshire and when the Nasdaq hit its high, I had nearly all of it in REITs, which were selling at a discount to their liquidation values. (BRK Annual Meeting 2005 Tilson Notes, via http://buffettfaq.com/ )

 

Market valuations is a tool you should be careful using since they can infect your thinking. Beware of using market valuations because they might use you.

 

WEB said at the recent AGM that he had most of his personal funds in t bills.

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I still stand by my original argument, which is investors should all but completely ignore market/asset-class valuations, as long as they find a company with a margin of safety. 

 

 

I don't disagree with your argument of looking at individual stocks within overvalued asset classes. What I disagree with is using Warren Buffett's investment in REITs at a time when the NASDAQ was overvalued to prove your point, because that does not prove your point. Rather, it confuses different asset classes.

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I don't disagree with your argument of looking at individual stocks within overvalued asset classes. What I disagree with is using Warren Buffett's investment in REITs at a time when the NASDAQ was overvalued to prove your point, because that does not prove your point. Rather, it confuses different asset classes.

 

I appreciate the feedback Tariq, it is a good point.

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I had committed a cardinal sin: I had become a market timer. It was a slow process cataloged by a first glace at a Case-Shiller's index then by a monthly, then weekly, then daily look at GuruFocus's "Where Are We With Market Valuations."  I became skittish about investing because I thought the markets were too overvalued, I figured I should be timid about my positions because of a possible market revaluation.  Yet now, I see I was just being a market timer. To use the supermarket analogy of investing, I was saying no to 50 cent pound bananas because the strawberries and peaches were selling for 10 dollars a pound. I was letting the prices of other securities dictate my position size and what I invested in - not my own independent valuations.

 

To be clear, I'm not saying you should be fully invested 100% of the time. If you don't see a security with a large enough margin of safety, don't buy it or if a position size keeps you up in night you should trim it down. Yet, don't let the market's valuation keep you from purchasing a great idea.

 

Here is a comment from Buffett about investing his personal money during the 2000 Nasdaq high. Notice market valuations didn't keep him away from making a rational investment choice.

 

    I have less than 1% of my net worth outside Berkshire and when the Nasdaq hit its high, I had nearly all of it in REITs, which were selling at a discount to their liquidation values. (BRK Annual Meeting 2005 Tilson Notes, via http://buffettfaq.com/ )

 

Market valuations is a tool you should be careful using since they can infect your thinking. Beware of using market valuations because they might use you.

 

WEB was also a little bit of an activist.  We owned one of the REITS he owned that agreed to sell most of their properties.  They were thinking of rolling them over into other properties.  WEB called their CEO and told him strongly that they should liquidate.  They took his advice.

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Take it for what it's worth, but back during Buffett's BPL days, even when he was finding 50 cent dollars such as Sanborn, Berkshire, and Dempster (prior to these moving into the private company portion of his portfolio), he was still allocating a portion of his portfolio to market-insensitive opportunities such as workouts and private company investments. I've always struggled to reconcile this, b/c if you find something that is selling for 50 cents but is worth a dollar, why worry about the overall market? But I think Buffett answers this in his early letters saying that tho the Generals will outperform over time, they will act very much in sympathy with the market - so in other words, even a 50-cent dollar bill will act marketwise, so it is prudent to allocate capital to market insensitive investments.

 

Again, take it for what it's worth.

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