Missing Monevator alert: For some sinister reason, Monevator email subscribers didn’t get my article on this week’s Budget. It was a spirited old ramble followed by some good comments from readers, so go check it out if you missed it!
People have been fretting about the stock market being too frothy all year (and for long before that…) But it’s worth remembering the majority of pundits are American.
I’d agree, for what it’s worth, that the US market is looking dear, especially the small to mid-sized companies.
But personally I think that the UK and Europe still look fair-to-good value. And some emerging countries like China and Russia are now in a bear market.
Supporting my feeling about the UK market is this interesting graph from John Kingham, posted on his UK Value Investor blog:
The black line shows where we are now.
The graph suggests the FTSE 100 is still in the green ‘safety’ zone, when comparing its longer-run earnings to valuation.
John writes:
While a slightly cheap market isn’t particularly exciting, it does imply slightly better future returns than normal.
If we have 2% inflation and 2% real growth from the underlying companies, plus 3.5% or so from the dividend and a little bit more if the market mean reverts upwards towards fair value, then over the next 7 years we may get something like a 10% annualised return over that time.
At the end of that period in 2021, the FTSE 100 would be at 10,700.
Note the sensible use of the word “imply”. There’s nothing in this sort of valuation work that guarantees anything, and indeed the market could halve this year – or double.
But as an antidote to doom brought on by a few good years of decent returns, I think it is reassuring.
Keep on keeping on
Of course, passive investors know better than to try to time markets. Keeping your allocations, rebalancing, and ideally adding new money every month or year is how that strategy wins.
Barron’s has a short and interesting post on how those who save steadily over time can afford to ignore valuation:
For three decades, two investors put an annual $1,000 into Vanguard 500 Index starting in 1983.
One of them is Disciplined Dave. Dave invests his money on the last trading day of each year. He doesn’t try to time the market.
The second investor is Hapless Harry. Harry wants to time his annual contribution, but he has “the worst timing in modern Wall Street history.” He invests his $1,000 at the market peak every single year.
The result from 1983 to 2013?
- Dave’s $31,000 grew to $177,176. That’s 9.9% a year.
- The same money from Harry hit $169,153, for 9.5% a year.
There wasn’t too much difference between picking the worst days to invest and picking a regular day – just $8,000 or so.
It was time in the market that counted.
Of course you could argue that Harry would have done better to sit out the bear markets, if he’d somehow been able to see them coming in advance.
But The Brooklyn Investor warned this week that even the great value investors owe very little of their success – if any – to trying to time the market:
All of this is not to say that valuations don’t matter. They matter a lot. We are “value” investors, so of course “valuations” matter.
When we say don’t worry about warnings about overvalued stocks, bears will call us perma-bulls; that we bulls think markets always go up.
Well, they don’t. They will go up and down as they always have.
My argument is that it’s going to be hard to predict the market based on it. Higher valuations will mean lower prospective returns but higher valuations don’t necessarily lead to an imminent bear market or correction.
A bear market or correction will always be inevitable, but it’s hard to say when it will happen. And if you don’t know when it’s going to happen, it’s going to be very hard to capitalize on it
A lot of stupid comments that people leave on websites annoy me – I’m sensitive soul, in truth.
But the most annoying of all are glib comments about the market being obviously expensive and certain to crash, and so me or anyone else being muppets to write about shares.
The worse thing isn’t that these people are misleading everyone who reads their comments by giving some specious illusion of prescience – though that’s annoying and potentially costly enough.
But it’s that some tiny percentage of them will be right, by luck, every few years when the market does crash, as all long-term investors know it will now and then.
By all means follow valuation and have a sense of whether you think it’s time to add more of your funds to cash, bonds, or shares.
But run screaming from anyone who claims to know what’s going to happen.
They don’t. Nobody knows.
That’s why it’s a market, not a savings account.
From the blogs
Making good use of the things that we find…
Passive investing
- Don’t be as dumb as a pension fund – Canadian Couch Potato
- Portfolio managers, not traders – Abnormal Returns
Active investing
- How to come up with investing ideas – Wexboy
- On diversification – Oddball Stocks
- The power of dividends – Zone of Competence
- Investing, housing, and speculating – Investing Caffeine
Other articles
- Get it together before you make it big – Mr Money Mustache
- Why do people leave it so late to fill their ISAs? – Simple Living in Suffolk
- Everything is now a sport – Kottke
Product of the week: Getting 5% on cash in an ISA is coming closer, with the Budget announcing that peer-to-peer lenders like Zopa will soon be eligible for ISAs. The exact details and timeline are to be confirmed. Remember peer-to-peer accounts are not the same – nor as safe – as cash deposits. But Zopa’s safeguard guarantee and similar backstops from rivals have probably made ministers more comfortable.
Mainstream media money
Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1
Passive investing
- The default portfolio – Morningstar
- Debating Smart Beta index funds – WSJ
- US index funds are now 43% -above pre-crash highs – Ferri/CBS News
- US investors can run an ETF portfolio for 0.09% a year – ETF.com
Active investing
- Are good fund managers just lucky? – Fortune
- US small caps look expensive compared to large caps – Barrons
- Be careful you’re not reading paid-for promotions of a stock – Fortune
Other stuff worth reading
- Official: Pension pots can be used to buy Lamborghinis – Guardian
- A deep explanation of how the new pension system will work – Telegraph
- Budget is an uncommon outbreak of common sense [Search result] – FT
- How to earn 6.8% in your cash ISA this year – Yahoo
- Sainsbury’s and the fragile economy – Peston/BBC
Book of the week: John Lee could have become an ISA millionaire double quick with the new higher £15,000 allowance. Find out how he did it anyway in his book: How to Make a Million Slowly.
Like these links? Subscribe to get them every week!
- Reader Ken notes that: “FT articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.” [↩]
This brilliant video is doing the rounds
‘Hitler buys an annuity the day before the budget’
https://www.youtube.com/watch?v=1YU7EhvfwwU
Mr Money Moustache is on good form – thanks for the link.
Interesting article and interesting to see UK figures for the CAPE.
While I am always wary of any suggestion there is an average CAPE that markets will eventually revert to (because markets are complex adaptive systems and not just a series of coin tosses) , it does give a little bit of insight into where we are at the moment.
After all valuations are dependant on a valuation of a future stream of earnings, and a cyclically adjusted measure at least shows what is underpinning current pricing.
Thanks for sharing that heat map. I might create one for the UK housing market (although with housing you don’t need to cyclically adjust wages because they’re pretty stable anyway). Would be interesting I think.
John – a heat map of the UK housing market would be very interesting to me and no doubt many others. Better still would be a heat map of the London market and the saner ex-London market.
The Barron’s link above reminds me of a similar excellent piece from last month:
http://awealthofcommonsense.com/worlds-worst-market-timer/
Is that heatmap really saying that FTSE100 valuations are roughly where they were in 2009? It doesn’t really feel now like it did then though Vlad is helping to reduce prices a bit.
The thing people miss is that earnings have risen hugely from the base too. 🙂 Perhaps because they listen to the news and the bears too much! 😉
That is the other way that P/E ratios come down/stay level.
Of course that is not to say that earnings are on a permanently upward trajectory…
At some point they will fall/plunge again 🙂
@ermine – The data are taken at 1st Jan (or nearest trading day) each year, so it’s somewhat chunky rather than fine grained. So for 2009 (the bottom of the bear market) the figure is 4,561, while the absolute low came in March at more or less 3,500 (a pretty huge percentage drop in just 3 months).
If I had used 3,500 for the 2009 number then the 2009 low would look much lower, and touch the very bottom green band.
I think moving to monthly data would have some value, so I’ll try to do that at some point (time and motivation allowing!).
From that Guardian link and related articles it appears half of Guardian readers believe the new rules allow you to cash in your entire pension pot without paying ANY tax on it.
Realistically no one is going to be cashing in more than 40k pa unless they have been diagnosed with cancer, and anything over 10.5k will be taxed at at least 20%.
Bearing in mind you need a certain amount to pay for the bare essentials of living, even if your mortgage is paid off, then I don’t think many will be buying supercars and BTL houses outright.
Still, it shouldn’t be a huge surprise that the party of the nanny state is horrified at the thought of people having more freedom to do as they see fit with their own hard earned money.
To Catch A Trader—-Thurs–Sky 9pm
http://www.sky.com/tv/show/to-catch-a-trader?dcmp=emc-MSW13WEB/SPT/TOCATCHATRADER
Okay I’m going to say my piece and then probably get flamed…
These two studies were both conducted during a 30 year period when the interest rates on 10 year US and UK government bonds went from low teens to a little over 2%
That just isn’t normal
That one working life time long event is now on the cusp of reversing
What happens next could be interesting
@snowman
That’s one of the funniest things I’ve seen in ages.
@neverland — I don’t want to disappoint you… 😉
I agree it will be interesting. If you’re an investing nerd like me it will always be interesting!
But what do you do? We can all see the past. Speculating that things will be worse in the future leads most people to do very demonstrably worse with their investing if it leads them to take action. That’s been shown time and again.
The comments on this blog have also shown that to me in spades. Over the years, the logical conclusion of the majority of comments would have been to sell up in the US and miss one of the biggest bull markets there in its history.
I can’t remember more than a tiny handful of people ever saying “buy” in Monevator’s comments with any conviction, and even fewer were talking about the US when they did. (Ironically most were saying buy emerging markets — just as they peaked).
Incidentally, there were other great periods for the US markets — e.g. the 1950s.
I’m confident that unless valuations are at ridiculous extremes (and I don’t mean on a potentially dubious CAPE basis, I mean on a current/next year P/E basis) the average person is best off staying invested, diversified, and reinvesting dividends, and trying not to reach conclusions.
Even if valuations are extreme, it’d be sensible to reduce exposure, not eliminate it, IMHO.
@Snowman — I do have a soft spot for those Downfall videos. I thought that one started well but petered out with the repetitive big boobies. 🙂