Invest And Speculate Revisited
By now, most our readers would agree that US stocks are extremely expensive based on many well known long term valuation metrics. Furthermore, it has also been widely pointed out that the future stock returns will be extremely low. John Hussman has argued for some time now that US stocks would virtually return nothing or even lose in the coming 12 years. A recent white paper The S&P 500, Just Say No by James Montier in GMO even predicts -3.9% annual loss in their 7-year forecast:
As always, the GMO white paper is full of good insights and we highly recommend it.
One of the main problems with these predictions is that they are often hit and miss: in fact, it would be highly unusual for someone or some firm to make consistently accurate (or ‘correct’) prediction. Often these predictions can come way earlier, only making investors lose their patience and dismiss them altogether.
The reality is that as always, there is no 100% bull’s eye prediction. If investors have a very long term investment horizon, these predictions will eventually be proven to be correct, with the expense of excruciating underperformance in a prolonged period.
To be pragmatic, one can choose to continue investing in stocks even when it’s very clear that they are very overvalued. In this case, like it or not, these investors actually turn into a speculator: they ‘hope’ or ‘speculate’ that stocks will continue to rise.
However, an investor can also turn into a ‘smart’ speculator when markets are overvalued: they can use long term timing or Tactical Asset Allocation(TAA) in those ‘overvalued’ periods. In the meantime, he/she can still become an investor when markets finally become undervalued.
We introduced this type of strategies in November 30, 2015: Investors and Speculators Combined. As US stocks are persistently stuck at a high level and it’s approaching closer and closer to a correction, we want to revisit this concept in some more details.
We now make the representative portfolio discussed in the previous newsletter available in our Advanced Strategies. We have changed this portfolio’s name from P Shiller Cyclically Adjusted PE 10 SO SU SMA 200 Days Total Return Bond As Cash And Strategic Switch Monthly 0.8x to P Invest and Speculate.
To recap, this portfolio becomes
- Investor: when US stocks are undervalued, it buys VFINX (Vanguard 500 Index Investor) (or any S&P 500 index fund such as SPY). The valuation metric here is P Shiller Cyclically Adjusted PE 10 (CAPE 10). When CAPE 10 is less than 0.8 times of its long term average, it deems that stocks are undervalued.
- Speculator: when US stocks’ CAPE10 is no less than 0.8 times of its long term average, it now chooses to become a speculator by investing in a long term timing based portfolio: P SMA 200d VFINX Total Return Bond As Cash Monthly. What this portfolio does is that when S&P 500 total return is above its 200 days Simple Moving Average, it buys VFINX, otherwise, it chooses to invest in a total return bond fund portfolio P_46880 (Schwab Total Return Bond).
Let’s look at its latest performance:
|1Yr AR||3Yr AR||5Yr AR||10Yr AR||Since 12/31/2000|
|P Invest and Speculate||11.2%||15.0%||7.7%||13.2%||13.2%||12.5%|
|P SMA 200d VFINX Total Return Bond As Cash Monthly||11.2%||15.0%||7.7%||13.2%||12.5%||12.1%|
|VFINX (Vanguard 500 Index Investor)||12.1%||16.3%||9.5%||14.2%||7.5%||5.9%|
So the ‘investor and speculator’ is outperforming both ‘investor (VFINX)’ and ‘speculator (SMA 200d VFINX)’.
At this moment, the portfolio is in a speculator mode. It is still in the crowded trade: invests in S&P 500 (VFINX). So let’s first look at what it means to be a speculator.
Being a speculator
Currently, this portfolio’s owner (we don’t using ‘investor’ term here to avoid confusion) is speculating. As we are closer to a correction, it relies on the price/total return technical indicator, i.e. the 200 days moving average, to be ready to abandon stocks when they are in a downtrend.
If the future corrections are small enough, it’s possible that the portfolio will remain in the speculator mode, getting in and out of stocks many times, until an eventual big correction arrives to bring stocks’ valuation down to an undervalued level. This is what happened in 2009 (see below). Historically, markets always swing to two extremes: very overvalued and very undervalued. In a severe downturn, stocks can undershoot. For example, known investors predict that in the next big ‘one’, S&P 500 might correct as much as like 50% or even 60%. That will surely present a good opportunity to be a true investor.
Being an investor
Let’s look at what it means to be a ‘true’ investor. In the case that stocks are undervalued, this portfolio’s owner will simply invest in S&P 500 (VFINX), regardless of whether the index is below or above its 200 days moving average or any other technical/tactical indicators. The premise here is that when stocks as a whole are undervalued, they will eventually revert back to their mean, delivering some of their long term average returns (8-10% nominal annualized returns, see, for example, October 31, 2016: Economy Power And Long Term Stock Returns).
Simply put, when stocks are undervalued, investors can rest assured that by simply buying and holding S&P 500 index, it will eventually achieve a reasonable return (even though in an interim, it might still experience loss).
The advantage of holding stocks when they are undervalued is that one can avoid price whipsaws that often happen in a gloomy market environment. The whipsaws can be detrimental to a timing based strategy.
However, when stocks are overvalued, holding stocks can incur some big loss, at least for many years. In fact, for example, if one holds S&P 500 from now on, it will be very likely that he/she might lose money even after 10 years! Yes, maybe 20 years later, the investment will turn into some reasonable returns, but that only happens after so many years (like 20 years or even longer).
Looking closely the following chart:
we find that the portfolio became an investor in February 2009 when S&P 500 was at its lowest level. However, just in one month, it rose enough such that it was out of the undervalued level and the portfolio became speculator by adopting the moving average portfolio. This brief period helps the portfolio beat the pure moving average portfolio.
Given the current investment environment, it’s pertinent to revisit the invest and speculate combined strategy. Looking ahead, we will certainly encounter a bear market or a deep correction one day. This strategy presents a sensible, pragmatic and intuitive way to deal with an unruly stock market that can swing to two extremes.
As stated above, plenty of known investors have sounded alarm or shown uneasiness on the current overvalued and over-bullish stock market. Near term, however, investors are showing no sign of panic. Risk assets including US stocks, international stocks, emerging market stocks and REITs are still in an uptrend. We are cautious but should stay the course and stick to a good strategy just like the one above.
For more detailed asset trend scores, please refer to 360° Market Overview.
Now that the Trump administration has been in the office for more than half a year, it has stumbled and encountered many difficulties to implement its promised changes in terms of tax cuts, job stimulation and infrastructure spending. On the other hand, stocks continued to ascend, regardless of the progress. Looking ahead, however, we remain convinced that markets will experience more volatilities at some point when reality finally sets in.
In terms of investments, U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future.
We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.
- August 28, 2017: Total Return Bond Fund Portfolios: Where Do They Fit?
- August 21, 2017: Portfolio Performance: A Walk In The Past
- August 14, 2017: Fidelity Commission Free ETFs Update
- August 7, 2017: I Didn’t Learn Anything — Mistake vs. Temporary Underperformance
- July 31, 2017: Asset Classes And Fund Choices: A Primer
- July 24, 2017: Total Return Bond Fund Portfolios And Cash
- July 17, 2017: Long Term Stock Holding Periods For Retirement
- July 10, 2017: Half Year Asset Trend Review
- June 26, 2017: How To Beat The Best Balanced Allocation Fund
- June 19, 2017: Newsletter Collection Update
- June 12, 2017: A Mixed Bag Performance of Momentum Investing
- June 5, 2017: How To Start A New Portfolio
- May 29, 2017: Alternative Assets And Their Role In Portfolios
- May 22, 2017: Summer Seasonality And Portfolio Management
- May 15, 2017: Cash: Banking Or Investing?
- May 8, 2017: Holding Period of Long Term Timing Portfolios
- May 1, 2017: Debate on Risk vs. Volatility
- April 24, 2017: The Long Term Stock Market Timing Return Since 1871
- April 17, 2017: Risk vs. Volatility: Long Term Stock Market Returns
- April 10, 2017: Total Return Bond ETFs And Portfolios
- April 3, 2017: Quarter End Asset Trend Review
- March 27, 2017: Practical Consideration For IRAs And 401k Accounts
- March 20, 2017: Fund Fees: That’s (Still) Outrageous
- March 13, 2017: Long Term Stock Valuation Review
- March 6, 2017: Asset Classes for Retirement Investments
- February 27, 2017: Fidelity Total Bond Fund Review
- February 20, 2017: Long Term Stock Timing Based Portfolios And Their Roles
- February 13, 2017: Alternative Investment Portfolios Review
- February 6, 2017: Tax Free Municipal Bond Investments Review
- January 30, 2017: Brokerage Specific Conservative Portfolios
- January 23, 2017: Fixed Income Portfolio Review
- January 16, 2017: Long Term Trend Following Portfolio Review
- January 9, 2017: Tactical Asset Allocation Review
- January 3, 2017: Strategic Asset Allocation Review
- December 12, 2016: Enhanced Index Funds
- December 5, 2016: Review Of Broad Base Core Mutual Funds For Brokerages
- November 28, 2016: Core Index ETFs Review
- November 21, 2016: International Exposure Of U.S. Large Companies
- November 14, 2016: Asset Trends After The Election
- November 7, 2016: Rising Rate And Current Bond Trend
- October 31, 2016: Economy Power And Long Term Stock Returns
- October 24, 2016: Current Commodity Trend And Managed Futures
- October 17, 2016: Investment Mistakes And Good Or Bad Investment Strategies
- October 10, 2016: Momentum Investing Review
- October 3, 2016: Survey & Feedback
- September 26, 2016: Fixed Income Investing: Actively Managed Funds vs. Index Funds
- September 19, 2016: Stock Investing: Actively Managed Funds vs. Index Funds
- September 12, 2016: Newsletter Update
- September 5, 2016: Overvalued Markets And Long Term Timing Strategies
- August 29, 2016: Your 401K Finally Draws Attention
- August 22, 2016: Inflation Protected Securities TIPS For Current Overvalued Markets
- August 15, 2016: Risk On: Emerging Market Stocks And Small Cap Stocks
- August 8, 2016: Portfolio Construction Using Stock ETFs And Bond Mutual Funds
- August 1, 2016: Adding Value To Your Own Investments
- July 25, 2016: Tactical Asset Allocation Funds Review
- July 18, 2016: Strategic Asset Allocation & Lazy Portfolio Review
- July 11, 2016: Asset Trend Review
- June 27, 2016: Secular Cycles For Tactical And Strategic Investment Strategies
- June 20, 2016: A World of Debt
- June 13, 2016: Managed Futures For Portfolio Building
- June 6, 2016: Newsletter Summary
- May 30, 2016: Swensen Portfolio And Permanent Portfolios
- May 23, 2016: AAII Article And Some Web Changes
- May 16, 2016: The PIMCO (Dis)Advantages
- May 9, 2016: Boost Your Dull Summer Investments
- May 2, 2016: Low Cost Index Fund Investing
- April 25, 2016: Tax Free Municipal Bond Funds & Portfolios
- April 18, 2016: Asset Class Trend Review
- April 11, 2016: Construction of Sound And Conservative Portfolios
- March 28, 2016: Total Return Bond ETFs Review
- March 21, 2016: Small And Large Company Stock Performance In Different Economic Expansion Cycles
- March 14, 2016: Are Tactical And Timing Strategies Losing Steam?
- March 7, 2016: Defined Maturity Bond Fund Analysis
- February 29, 2016: Smart Strategic Asset Allocation Rebalance When Market Trend Changes
- February 22, 2016: Be Cash Smart
- February 15, 2016: Bond ETF Portfolios
- February 8, 2016: Newsletter Collection Update
- February 1, 2016: Total Return Bond Fund Portfolios In A Volatile Period
- January 25, 2016: Alternative Portfolios Review
- January 18, 2016: Strategic Asset Allocation: A Cautious Outlook
- January 11, 2016: Review Of Trend Following Tactical Asset Allocation
- January 4, 2016: What Worked And Didn’t In 2015
- December 21, 2015: Distressed Assets
- December 14, 2015: High Yield Bonds And Their Correlation With Stocks
- December 7, 2015: Diversification And Global Allocation
- November 30, 2015: Investors and Speculators Combined
- November 23, 2015: Active Stock Fund Performance Consistency
- November 16, 2015: Permanent, Risk Parity And Alternative Portfolios Review
- November 9, 2015: Broad Base Core Mutual Fund Review
- November 2, 2015: Broad Base Index Core ETFs Review
- October 26, 2015: Total Return Bond Fund Review
- October 19, 2015: Advanced Portfolio Review
- October 12, 2015: What About Commodities?
- October 5, 2015: Core Satellite Portfolios In A 401k Account
- September 28, 2015: Risk Managed Strategic Asset Allocation Portfolios Revisited
- September 21, 2015: Quest For The Best Investment Strategy
- September 14, 2015: Core Satellite Portfolios In Market Turmoil
- September 7, 2015: Market Rout Creates An Opportunity to Reposition Your Portfolios
- August 31, 2015: Review of Asset Allocation Funds and Portfolios
- August 24, 2015: Market Rout And Your Portfolios
- August 17, 2015: ETF or Mutual Fund Based Portfolios
- August 10, 2015: Updated Newsletter Collection
- August 3, 2015: Slippery Asset Trends
- July 27, 2015: Performance Dispersion Among Momentum Based Portfolios
- July 20, 2015: Global Balanced Portfolio Benchmarks
- July 13, 2015: Pain in Tactical Portfolios
- July 6, 2015: Fixed Income Total Return Bond Funds In Strategic Asset Allocation Portfolios
- June 29, 2015: Core ETF Commission Free Portfolios
- June 22, 2015: Secular Asset Trends
- June 15, 2015: Giving Up Bonds?
- June 1, 2015: Summer Blues?
- May 26, 2015: Cash, Bonds and Stocks In A Rising Rate Environment
- May 18, 2015: Portfolio Update
- May 11, 2015: Pain in Fixed Income?
- May 4, 2015: The Balanced Stock and Long Term Treasury Bond Portfolios
- April 27, 2015: Long Term Treasury Bond Behavior
- April 20, 2015: 529 College Savings Plan Rebalance Policy Change
- April 13, 2015: Total Return Bond Funds As Smart Cash
- April 6, 2015: The Low Return Environment
- March 30, 2015: Brokerage Specific Core Mutual Fund Portfolios 2
- March 23, 2015: Investment Arithmetic for Long Term Investments
- March 16, 2015: Brokerage Specific Core Mutual Fund Portfolios
- March 9, 2015: Newsletter Collection Update
- March 2, 2015: Total Return Bond ETFs
- February 23, 2015: Why Is Global Tactical Asset Allocation Not Popular?
- February 16, 2015: Where Are Permanent Portfolios Going?
- February 9, 2015: How Have Asset Allocation Funds Done?
- February 2, 2015: Risk Management Everywhere
- January 26, 2015: Composite Portfolios Review
- January 19, 2015: Fixed Income Investing Review
- January 12, 2015: How Does Trend Following Tactical Asset Allocation Strategy Deliver Returns
- January 5, 2015: When Forecast Fails
- December 22, 2014: Long Term Asset Returns: How Long Is Long?
- December 15, 2014: Beaten Down Assets
- December 8, 2014: Implementing Core Asset Portfolios In a Brokerage
- December 1, 2014: Two Key Issues of Investment Strategies
- November 24, 2014: Holiday Readings
- November 17, 2014: Retirement Spending Portfolios Update
- November 10, 2014: Fixed Income Or Cash
- November 3, 2014: Asset Trend Review
- October 27, 2014: Investment Loss, Mistakes And Market Cycles
- October 20, 2014: Strategic Portfolios With Managed Volatility
- October 13, 2014: Embrace Volatility
- October 6, 2014: Tips For 401k Open Enrollment
- September 29, 2014: What Can We Learn From Bill Gross’ Departure From PIMCO?
- September 22, 2014: Why Total Return Bond Funds?
- September 15, 2014: Equity And Total Return Bond Fund Composite Portfolios
- September 8, 2014: Momentum Based Portfolios Review
- September 1, 2014: Risk & Diversification: Mint.com Interview
- August 25, 2014: Remember Risk
- August 18, 2014: Consistency, The Most Important Edge In Investing: Tactical Case
- August 11, 2014: What To Do In Overvalued Stock Markets
- August 4, 2014: Is This The Peak Or Correction?
- July 28, 2014: Stock Musings
- July 21, 2014: Permanent Portfolios & Four Pillar Foundation Based Framework
- July 14, 2014: Composite Portfolios Review
- July 7, 2014: Portfolio Behavior During Market Corrections
- June 30, 2014: Half Year Brokerage ETF and Mutual Fund Portfolios Review
- June 23, 2014: Newsletter Collection Update
- June 16, 2014: There Are Always Lottery Winners
- June 9, 2014: The Arithmetic of Investment Mistakes
- June 2, 2014: Tips On Portfolio Rebalance
- May 26, 2014: In Praise Of Low Cost Core Asset Class Based Portfolios
- May 19, 2014: Consistency, The Most Important Edge In Investing: Strategic Case
- May 12, 2014: How To Handle An Elevated Overvalued Market
- May 5, 2014: Asset Allocation Funds Review
- April 28, 2014: Now The Economy Backs To The ‘Old Normal’, Should Our Investments Too?
- April 21, 2014: Total Return Bond Investing In The Current Market Environment
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