[Rich Toscano]

[quote=svelte][quote=Rich Toscano]

Where we might part ways is in other risk assets. There are areas of the global stock market that — even after this huge rally — are still priced for positive long-term returns. In specific, developed intl value stocks are priced for returns that are slightly under the average stock returns — not great but ok. Emerging value stocks are priced for substantially higher than normal returns.
[/quote]

So here is where I get confused.

I’m pretty sure I’ve heard you say, Rich, that one shouldn’t try and time the market but should invest for the long term as in decades.

But the above sounds like you’re advocating investing in those areas that, at the present time, give the best chance for above average returns.

Is that not timing the market?[/quote]

No, that is not timing the market!

And also no, the thing above that is not what I am saying. I’ll start with that one. I’m not saying you have to invest for decades. I’m saying that you have to consider that the price for stocks is based on decades’ worth of their expected earnings. So, shorter term changes to that earnings stream should not, in theory, change their fair value all that much. (In practice, of course, it often does, but that’s a whole separate topic). But that’s not the same as saying that an investor necessarily needs to hold them for decades.

OK, onto the fun question. This is one that I have strong opinions on, so apologies in advance for what will probably be a surfeit of exclamation points.

Anyway no, a thousand times no — value investing is NOT market timing!

Let me illustrate with an example to start. Let’s say there is a modest condo that, if you bought it, you could rent out for $1,000/month. It’s for sale for $5 million.

Would you buy it? No, of course not. Why would you buy something for $5 mil when it only rents out for $1k/month? It’s way too expensive.

Is this market timing? Again — of course not. You simply evaluated what the investment is worth, and compared that to the actual price (the key point here being that those 2 things can be different).

It’s no different with stocks or anything else.

Market timing entails making guesses about what the market will do over the short term. It’s path dependent.

The thing I’m talking about here (which I describe as value investing as shorthand) entails having an estimate of likely longer term returns, and investing accordingly. It is not path dependent.

Let’s take US stocks as an example. I mentioned that I’m bearish on the S&P500. Is this because of a necessarily dismal economic outlook? No! It’s due to valuation. The S&P500 is very expensive. It is pricing in an unusually great outcome. If you merely get an average or even above-average outcome… it is likely to do poorly.

So my “claim” here is that the S&P500 is likely to generate poor returns over the coming 7-10 years.

But how will that look? Will there be a crash? Will it just waffle along sideways, without going much of anywhere for many years? Something in between?

I have no idea. To answer that question would be market timing.

But what I’m saying here is: I don’t know the path it will take, but I think it’s likely that when we look back a decade from now, this thing will have done pretty poorly. That’s not market timing. It’s simply having an awareness of what something is worth, and thus the likely returns, before you invest in it.

Does this distinction make sense?

[Rich Toscano]

[quote=davelj]
This is an outlier position but it wouldn’t shock me if we didn’t see the real bottom until after the vaccine is available, as that’s when there will be no more excuses for what I think is coming. Similar to the tech bubble, until the vaccine comes out, folks can hope and dream about what the post-covid world will look like – fantasies can run wild. Post-vaccine, the truth will be revealed… a GDP hole and massive, massive leverage accompanied by impaired long-term demand.
[/quote]

That actually sounds pretty plausible to me. I have had similar, if less well-articulated, thoughts (when I allow myself to indulge in thinking about the timing of things).

[Rich Toscano]

[quote=zk][quote=Rich Toscano]
Whoa, hold on. Since I wrote that passage, markets (both US and intl) are up 36%. That changes the situation considerably in terms of what the market is pricing in, and in terms of prospective returns.

[/quote]

Sorry, I was trusting readers (and Dave) to factor that in. I should know better than that. Obviously you, Rich, could factor in the change and read your previous comments in the light of the 36% surge and extrapolate them. But I shouldn’t expect everybody to. I’m not even sure I could do that accurately. My bad.[/quote]

No worries… just wanted to make sure the timeline was clear to everyone, especially if they didn’t know the context of the last thread.

[Rich Toscano]

[quote=zk]Davelj, your take is (I think) similar to my OP on the
thread

https://www.piggington.com/coronaviruseconomystock_market

(except yours is more informed and better stated).

I would be very interested in your ideas on Rich’s take on the situation:

[quote=Rich Toscano] when you buy stocks, you are buying a VERY long-term stream of earnings. Like, decades. This recession looks to be very severe, but it is short term by its very nature (at some point we contain the virus, or everyone has gotten it… this can’t go on for all that long).

So as bad as this recession may be, it’s hard to see it moving the dial all that much on the DECADES worth of earnings that determine what stocks are actually worth.

I should note here that I think the US stock market started out very overvalued, which complicates things. But assuming stocks were starting out reasonably valued (as many international stock markets were, imo) — then I think a 30%+ decline is a huge overreaction.

Whether the stock downturn gets worse before it gets better, I have no idea. But I think there’s a good chance that several years hence, people will look back at this as having been a good time to be investing in what everyone else was panicking out of. (Again, assuming it hadn’t started out very overvalued to being with).

Here is a very good (though pretty finance-y) piece examining the potential impact on long-term value of stock markets: https://www.gmo.com/americas/research-library/asset-allocation-covid-19-update%5B/quote%5D%5B/quote%5D

Whoa, hold on. Since I wrote that passage, markets (both US and intl) are up 36%. That changes the situation considerably in terms of what the market is pricing in, and in terms of prospective returns.

To put it in perspective, if we use the historical return of global stocks (5.2% real) — we just got over 6 years’ worth of return in less than 2 months. If you assume, as I do, that markets mean revert over time to deliver something close to the historical average return over the long haul, then the prospects for future returns just got a whole lot worse.

So, my opinion on the markets now is not the same as it was then… I would love to hear Dave’s take on my take, of course, but it’s important to adjust for the fact that my take was written 36% ago. (And for the record, I know and like Dave and he’s a great investor, so I always like hearing his take!).

A second thing I want to note is that Dave is really focused here on the S&P500. There I agree completely. In my view, it came into this very overvalued to begin with, and it is pricing in virtually no uncertainty about the cv19 outcome. I am completely on board with his assessment of the S&P500.

Where we might part ways is in other risk assets. There are areas of the global stock market that — even after this huge rally — are still priced for positive long-term returns. In specific, developed intl value stocks are priced for returns that are slightly under the average stock returns — not great but ok. Emerging value stocks are priced for substantially higher than normal returns.

I know it makes things more complex but I think it’s important not to lump all stocks together. At times, you can, but this is not one of those times. The valuation spread between the S&P500 and value anywhere (including US), and between the S&P500 and international, has literally never been higher. So the prospective returns of those things are very different.

One last note. In the other thread, zk made a very good point, which I will paraphrase here: “ok maybe the underlying value of that long term income stream has not changed, but still, in recessions and other crises, markets tend to drop.” That’s a great point and I totally agree. The thing is, though… you are now in the realm of market timing. When will it drop? How much? When will it stop dropping? When do you buy back in? I don’t know. I don’t think anyone does, really, and I know for sure I don’t. This past 2+ months should show how hard that is… who was expecting a 36% rally from the day I posted that last thing? Not me, that’s for sure.

So I largely focus on fair value and the assumption that markets will get back there at some point. Because that’s what I think I have a handle on, and I have absolutely no handle on timing. (Subnote: with that said, I do think it’s fair to adjust for very heightened medium-term uncertainty as we have now. But the valuation/expected return thing is the main thing for me, and that’s what I have been addressing).

[Rich Toscano]

Brian, take it to another thread. Nobody cares.

[Rich Toscano]

Thanks, good to hear that someone besides my mom finds these interesting!

(Just kidding – my mom doesn’t read them either).

Historically, US and intl stocks have traded leadership back and forth over time.

(Note: Japan is removed from developed int’l in this chart because the late 80s Japan bubble jacks up the otherwise pretty clear pattern).

Tough to say why they cycle back and forth like that. In this latest cycle, it’s definitely the case that US earnings held up better than international, so some of the outperformance was legit. But then it went way beyond that.

It just seems that these cycles reinforce themselves… something goes up, then people think it must be better, so they buy it, and it goes up more, etc. And the whole way, people rationalize it, and the continued trend justifies and strengthens their rationalizations. Until something puts the cycles into reverse.

BTW, the EAFE-ex Japan series outperformed the US (slightly) from 1972-2008. The entirety of US outperformance has happened in just the last 12 years. I’ll bet a lot of the “US stocks are inherently superior” crowd would be surprised to learn that.

Anyway that’s my take. As for what causes a potential reversion, I don’t think that’s identifiable in advance. There’s a big shakeup happening right now; I wouldn’t be surprised if this turns out to be it. But there’s no way to know, in my view.

[Rich Toscano]

Gunslinger blocked for flagrant trolling. Don’t be a troll, it’s not really clever or funny.

[Rich Toscano]

[quote=pinkflamingo]Thank you so much Rich for moderating this blog. Does anyone know if there is a graph of market cap vs gdp for Europe?[/quote]

Market cap to gdp isn’t a very good measure imo. It’s comparing apples to oranges… stock prices to GDP (which includes all economic activity, not just those of public corporations). So it can be distorted if the ratio of public to non-public companies change, as has been the case. (The result in the case of the US is to overstate valuations).

This website has CAPE (price to 10 year inflation adjusted earnings), which is a better measure than mkt cap to gdp: https://interactive.researchaffiliates.com/asset-allocation

In specific, if you hit the “download” button near the lower right, you can get a spreadsheet with CAPE data for various countries/regions. The site has lots of other good info too.

Looking at the spreadsheet, as of 2/29, the CAPE for Europe was 16.6, and for the US it was 30.7. Both of those have gone down quite a bit since, though!

[Rich Toscano]

[quote=zk][quote=Rich Toscano]
I should note here that I think the US stock market started out very overvalued, which complicates things. But assuming stocks were starting out reasonably valued (as many international stock markets were, imo) — then I think a 30%+ decline is a huge overreaction.

[/quote]

Goldman Sachs predicts a 24% contraction in the second quarter followed by growth of 12% (3rd quarter) and 10% (fourth quarter).

I can see how the decades-long earning stream you described (and thus stock prices) would be minimally affected (or at least not 30%) in the long run by such a thing.

I guess I was under the impression that these things (huge contractions) had more…I don’t know, momentum or long-term effects than that. Or residual effects or ripple effects or indirect negative effects.

https://www.cnbc.com/2020/03/20/goldman-sees-an-unprecedented-stop-of-economic-activity-with-2nd-quarter-gdp-contracting-by-24percent.html%5B/quote%5D

I just want to be clear that I am not denying that the economic effects could be brutal — as bad as GS predicts, or worse. My whole argument revolves around the idea of what stocks are, and what you are buying — if you view them as buying a long term stream of earnings (which is really an objectively true definition of what they are!), then even a brutal slowdown shouldn’t have that much effect on long-term fair value.

There are some caveats. One is that it will reduce the long-term earnings stream to some degree. There will be a bounceback, but not enough to offset the decline (eg, people aren’t going to go out to dinner twice in a day just because they stopped going out now). So that reduces long term earnings, but not to anywhere near the degree that markets have fallen.

The second caveat is bankruptices, which could wipe out shareholder equity. But even in the Great Depression, the bankruptcies weren’t enough to have a huge effect on long-term value. See this chart in this article for more (in the section called “Why value investing works”, which explains the chart in more detail):

So, I’m not denying that it’s going to get economically ugly. (It is). But I do think it’s important to focus on what stocks are, what you are paying for, and what impact this ugliness will have on their underlying long-term value.

Again, with the disclaimer that US stocks went into this already well above their fair value (in my view). US stock prices may revert to their long-term fair value, but the underlying value itself has probably not changed all that much due to the virus shock.

Those are two different mechanisms and it’s important to distinguish them, because if a stock market started out reasonably valued (as did international and especially emerging market stocks, in my view), then they are now very underpriced vs. their long-term fair value.

zk, did you get a chance to read that Ben Inker piece I linked to in the last post? It’s written for finance nerds so not very accessible, but it does a great job of assessing long-term stock value, including looking back at history. Check it out… if there is any jargon or concept you have questions about, post it here, I’ll be happy to try to answer.

Here’s the link again: https://www.gmo.com/americas/research-library/asset-allocation-covid-19-update

[Rich Toscano]

[quote=TheBrianNarrative]Please go ahead and banish me if you like.[/quote]

OK

[Rich Toscano]

[quote=TheBrianNarrative][quote=Rich Toscano][quote=Rich Toscano]PS see how I brought this conversation back on track? Now don’t anyone bring it off. My patience is wearing very thin.[/quote]

Haha, before I even had a chance to hit submit, Brian had already started the pissing contest back up.

This is a good question zk asked, and an interesting conversation. So — trying again here — I’m bringing it back on track.

If you absolutely must continue with your insipid pissing match, please do it elsewhere (a different website would be good!).[/quote]

If you would perform the good service of removing Brian from the site just as you did years ago and for which he should’ve stayed banished I’d gladly return to my hiatus[/quote]

Is that what you consider staying on topic?

[Rich Toscano]

[quote=Rich Toscano]PS see how I brought this conversation back on track? Now don’t anyone bring it off. My patience is wearing very thin.[/quote]

Haha, before I even had a chance to hit submit, Brian had already started the pissing contest back up.

This is a good question zk asked, and an interesting conversation. So — trying again here — I’m bringing it back on track.

If you absolutely must continue with your insipid pissing match, please do it elsewhere (a different website would be good!).

[Rich Toscano]

PS see how I brought this conversation back on track? Now don’t anyone bring it off. My patience is wearing very thin.

[Rich Toscano]

Back to the OP (for the love of all that is holy… this Brian-vs-various-people pissing contest is profoundly tedious and I’m embarrassed that it’s on my website).

Anyway back to the OP: when you buy stocks, you are buying a VERY long-term stream of earnings. Like, decades. This recession looks to be very severe, but it is short term by its very nature (at some point we contain the virus, or everyone has gotten it… this can’t go on for all that long).

So as bad as this recession may be, it’s hard to see it moving the dial all that much on the DECADES worth of earnings that determine what stocks are actually worth.

I should note here that I think the US stock market started out very overvalued, which complicates things. But assuming stocks were starting out reasonably valued (as many international stock markets were, imo) — then I think a 30%+ decline is a huge overreaction.

Whether the stock downturn gets worse before it gets better, I have no idea. But I think there’s a good chance that several years hence, people will look back at this as having been a good time to be investing in what everyone else was panicking out of. (Again, assuming it hadn’t started out very overvalued to being with).

Here is a very good (though pretty finance-y) piece examining the potential impact on long-term value of stock markets: https://www.gmo.com/americas/research-library/asset-allocation-covid-19-update

[Rich Toscano]

The bottom in San Diego was January, 2012. (Inflation-adjusted low in the SD Case Shiller index.)

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