Valuation-driven, contrarian investing

[JWR1945]

Delawaredave; you hit the head on the nail.

While I enjoy peteys and hocus's discussions I see the problem you mention. Money where your mouth is: petey is not in market at all yet and as he mentions still talking small money available for that, and hocus about $400k in TIPs and CDs (besides a paid of $300k house).

Hocus have mentioned elsewhere that he is looking into putting about 20% in single stock - trying to pick some not too overvalued. Hocus; any change in status on that?
...
Now petey can tell you to look at some New Zeeland timber "scam" and some UK microcapfund your broker can't get to, while hocus can tell you to wait until PE10 drops about 50% and meanwhile just sleep on the lump!

CORRECTION: Hocus is looking to put $5000 into a single stock.

Hocus has presented a good argument in favor of allocating 20% of one's investments into stocks even when valuations are high.

If you read my research on switching stock allocations and apply the numbers without thinking, you would allocate 20% to stocks whenever P/E10 is between 21 and 24. You would allocate 30% or more into stocks when P/E10 is below 21.

P/E10 has fallen below 24 occasionally in recent years.

I recommend against using my numbers mindlessly. They can get you into the ballpark. But they will not be exactly the best numbers to use. In addition, shifting allocations needs to be a deliberate act, not a trading strategy.

Have fun.

John R.

[peteyperson]

Hi Ben,

Well certainly I made my point forcefully, but I never mentioned you by name, nor did I mean any disrespect. We are friends and I would not want to jeopardize that.

I disagree with you on owning everything. It is certainly an attractive methodology and it will reduce the bumps far more than someone who owns S&P 500|Total Bond Fund etc. I don't doubt that for a second, I just think that consideration of valuations and future expected returns is important too. I certainly see that some posters on both boards agree with that thinking. Some have reduced REITs, others lowered junk or TIPS allocations. So it may not be their express policy and rebalancing does some of the job for you of course, but I think it is still going on around the fringes.

Petey

Guess my tone just got a bit sharper after being called (directly or indirectly) devoid of logic, idiotic and have a bad case of denial and ignorance on threads here recently. All based on my "no asset class left behind" attitude. Might be over sensitive these days.

I agree that EM equity looks good still - 10% is in EEM in my base portfolio and a bit more via VTRIX.

Delawaredave; let me know whe you have opened those international brokers and been to new zeeland...

Cheers, Ben

[JWR1945]

Great discussion. I'm learning a lot about allocations and changing them based on valuations.

I guess the question is not "whether or not to be in stocks" - rather what percentage of stocks is most appropriate and what mix.

Lot of good information of what is overvalued (seemingly everything).

What's undervalued or fair value right now ?
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If you inherited $100,000 right now - and didn't need it for 10 years - where would you put it today ?

Thanks for any thoughts !!

You may find my recent post helpful. It is an Accumulation Overview. It brings a lot of details together into one place. I put my emphasis on how to interpret the results. It is dated Sun Feb 06, 2005.
http://nofeeboards.com/boards/viewtopic.php?t=3369

I can now take advantage of gummy's database and generate numbers from it. His database divides stocks into Large Cap Growth, Small Cap Growth, Large Cap Value and Small Cap Value as well as including the entire S&P500. All of the slices responded well to varying allocations according to P/E10 (which is derived from the S&P500 as a whole). The thresholds are similar as well.

[These initial results are with two thresholds and three allocations. I did not include more levels of switching during my initial investigation. With TIPS and S&P500 stocks, I have examined four thresholds and five allocations.]

As for what to do with $100000 and ten years, I have included the answer when allocating between TIPS at 2% interest and the S&P500 index. You can assess what is worth the risk. You can see the upside potential and the downside penalty.

Have fun.

John R.

[hocus2004]

Hocus have mentioned elsewhere that he is looking into putting about 20% in single stock - trying to pick some not too overvalued. Hocus; any change in status on that?

There's no change in status.

I am persuaded that it would be a good idea for me to put perhaps 20 percent in stocks. I lean toward going with the high-dividend stock approach. I wouldn't put the entire 20 percent in one stock. I would probably go with something like what JWR1945 suggested above, perhaps $5,000 each in a number of high-dividend stocks.

My problem is that I have not been able to find the time to do the research that I need to do to feel comfortable making such a change in my allocation. Blame the boards! Blame the Great SWR Debate!

The boards are part of my investment strategy in an indirect way. Part of my "portfolio" is my writing business and I hope to be able to use the boards to learn about this subject matter for many years to come. So the health of the boards are very important to me. When it is a choice between doing something to help out the boards when they are in trouble and spending time selecting a stock to invest in, I believe that there is likely to be a bigger payoff from helping out the boards.

I don't feel a pressing need to move money into stocks quickly. It's just something that I would like to do when time permits.

[hocus2004]

Guess my tone just got a bit sharper after being called (directly or indirectly) devoid of logic, idiotic and have a bad case of denial and ignorance on threads here recently.

I think this is a fair comment.

The other side of the story is that there has been a good bit of dogmatism from the other side of the table in earlier days.

Dogmatism breeds dogmatism. It hurts us all, in my view. I learn little from those who agree with me. I potentially learn a good deal from those who have views other than mine if I am able to pick up on what they are saying and why they are saying it.

For a learning exchange to take place, posters need to be able to state their views without compromise but with evident respect for the other side. Those are just words, of course. The hard part is putting the thought expressed by those words into action.

[ben]

No worries Petey; no grudge here!

Only about 2% of my base portfolio is in large cap growth (via VTI being 70% SP500 of which about 60% is large growth) so I also seriously under weight that specific asset class, being the main one we find overvalued, myself.

Hocus: Ok, so I had it right - 20% into stocks which I think is a good idea and generally, as JWR point out, also in line with his research findings. Especially if focus on value.

A comment to the JWR advise on the $100k: trust you do not recommend a tips/SP500 portfolio? You might want to clarify your response as easy to read like that.

I have included the answer when allocating between TIPS at 2% interest and the S&P500 index

Cheers, Ben

[hocus2004]

If you inherited $100,000 right now - and didn't need it for 10 years - where would you put it today ?

I don't view myself as being qualified to answer this question. I do think that there are others in the board community who are qualified to answer it at least in part, and that, if you review all of the possible answers that have been put forth in different places, you have available to you at least a number of ideas worth exploring.

Here are some of the options that I recall being discussed at various times:

1) Putting money into TIPS or ibonds or CDs as a holding place until stock valuations move to more moderate levels;

2) Investing in high-dividend stocks on the thinking that a high-dividend portfolio may permit you to avoid selling stocks during a price downturn;

3) Investing a portion of one's assets in stock indexes other than the S&P index. There have been arguments that small caps may be better, that value stocks may be better, and that some international stocks may be better;

4) Going with a total diversification approach of the type favored by Ben so that you own assets that may do well when U.S. stocks do poorly;

5) Learning enough about how to invest in real estate to do so successfully;

6) Getting involved in a post-retirement income-producing activity that one enjoys so much that one does not view it as work;

7) Studying stocks to the point at which one develops the ability to do better than the indexes through intelligent selection of good individual stocks (the Warren Buffett approach);

Staying in TIPS or ibonds puchased at times when they paid a higher return than they pay today. This option is not available to investors who own no TIPS or ibonds today. I mention it because it is available to me as a result of having purchased TIPS annd ibonds at times when they were paying a higher return, and my decision to do so was the product of SWR analysis. So this option shows how an analytically valid SWR analysis can permit an aspiring early retiree to position himself in advance to get through difficult investing time-periods successfully. It may be that there is positioning that can be done today that will help prepare some of us for circumstances that will come upon us at some later date;

9) Cutting spending enough so that one is not concerned about what will happen as a result of big price drops for stocks. This is not an option for all, but it is an option for some;

10) Going with some form of the Sensible Withdrawal Strategy advocated by Gummy, where one employs a different take-out number depending on the results that have applied for one's portfolio in the prior year.

There is no one perfect answer to the question posed by DelawareDave. There are lots of potential partial answers. Add them all together, and I think that as a community we have been able to provide at least a bit of useful guidance for just about all of the various investing circumstances in which members of our board community find themselves.

[hocus2004]

Hocus: Ok, so I had it right - 20% into stocks which I think is a good idea and generally, as JWR point out, also in line with his research findings. Especially if focus on value.

The 20 percent is a rough number.

My general rule (which is a tentative one, subject to change as we learn more) is that the average investor might want to go from 30 percent stocks at times of extreme overvaluation to 50 percent at times of moderate valuation to 70 percent at times of extreme undervaluation.

However, I don't believe that you can apply the same percentages to all sorts of different life goals and financial circumstances. So you need to make adjustments upward or downward when implementing the general rules.

In my particular circumstances, a downward adjustment is needed (I require a lower risk in the stock portion of my portfolio than the average investor). So, in my case, a good stock percentage might be 15 percent less than the numbers cited above--perhaps 15 percent, 35 percent, and 55 percent. Again, these are all rough numbers.

I don't see that 15 percent as being an exact number. So the number I might go with at today's valuations for my stock allocation would probably be something between 10 percent and 20 percent. I doubt very much that I would go higher than that until valuations went down some. But I could see going as high as 20 percent if, when I did my research, I saw some highly appealing value propositions among the high-dividend stocks that I examined.

In the event that I didn't see anything too exciting when I did the research, I might go with just a 10 percent allocation to stocks, with the thought that I would wait a bit and see if some better opportunities opened up in days to come.

[hocus2004]

I didn't intentionally include the smiley face that appears at the start of Option 8 in my list of 10 investing options above. I think that the software added that automatically because I had an 8 followed by a parentheses. I guess that combination causes the smiley face to pop up.

[JWR1945]

...
Hocus: Ok, so I had it right - 20% into stocks which I think is a good idea and generally, as JWR point out, also in line with his research findings. Especially if focus on value.

A comment to the JWR advise on the $100k: trust you do not recommend a tips/SP500 portfolio? You might want to clarify your response as easy to read like that.

I have included the answer when allocating between TIPS at 2% interest and the S&P500 index

Cheers, Ben

During my professional career, I was asked many questions that I could not answer but to which I could respond. I always provided whatever helpful information that I could. Sometimes, that was enough. At other times, I would describe (with a reasonable amount of detail) what would be needed to get the answer.

Frequently, the words in the original question were not meant to be definitive or restrictive. My responses helped the person asking the question to clarify his thinking. That led him to ask better questions. Eventually, he asked excellent questions and got good, accurate and precise answers.

What I aim to provide is helpful information.

I have provided specific details that apply directly to a limited situation, a situation in which a person restricts his allocations to TIPS and the S&P500.

I do not expect this to answer DelawareDave's question. OTOH, I am confident that it provides him with helpful information.

If DelawareDave or someone else is interested, I can expand my investigation along the following lines:

I can now take advantage of gummy's database and generate numbers from it. His database divides stocks into Large Cap Growth, Small Cap Growth, Large Cap Value and Small Cap Value as well as including the entire S&P500. All of the slices responded well to varying allocations according to P/E10 (which is derived from the S&P500 as a whole). The thresholds are similar as well.

It is unlikely that I will be able to produce comparable information involving other asset classes.

Have fun.

John R.

[JWR1945]

I didn't intentionally include the smiley face that appears at the start of Option 8 in my list of 10 investing options above. I think that the software added that automatically because I had an 8 followed by a parentheses. I guess that combination causes the smiley face to pop up.

You are correct.

My own work around is to add a space between the 8 and the ), which produces 8 ) instead of the smiley face.

An alternative is to put in an apostrophe or something similar: 8').

There is also the right way to do it. I don't know what that happens to be

Have fun.

John R.