David Leonhardt: Remembering a Classic Investing Theory

David Leonhardt says the "stock run-up of the 1990s was so big ... that the market may still not have fully worked it off"

Remembering a Classic Investing Theory, by David Leonhardt, New York Times: More than 70 years ago, two Columbia professors named Benjamin Graham and David L. Dodd came up with a simple investing idea that remains ... influential... In the wake of the stock market crash in 1929, they urged investors to focus on hard facts — like a company’s past earnings and the value of its assets...

Their classic 1934 textbook, “Security Analysis,” became the bible for what is now known as value investing. Warren E. Buffett took Mr. Graham’s course at Columbia Business School in the 1950s and, after working briefly for Mr. Graham’s investment firm, set out on his own to put the theories into practice. Mr. Buffett’s billions are just one part of the professors’ giant legacy.

Yet somehow, one of their big ideas about how to analyze stock prices has been almost entirely forgotten. The idea essentially reminds investors to focus on long-term trends and not to get caught up in the moment. Unfortunately, when you apply it to today’s stock market, you get even more nervous about what’s going on.

Most Wall Street analysts, of course, say there is nothing to be worried about, at least not beyond the mortgage market. In an effort to calm investors after the recent volatility, analysts have been arguing that stocks are not very expensive right now. The basis for this argument is the standard measure of the market: the price-to-earnings ratio. ...

In its most common form, the ratio is equal to a company’s stock price divided by its earnings per share over the last 12 months. ... The higher the ratio, the more expensive the stock is — and the stronger the argument that it won’t do very well going forward.

Right now, the stocks in the Standard & Poor’s 500-stock index have an average P/E ratio of about 16.5, which by historical standards is quite normal. ... The core of Wall Street’s reassuring message, then, is that even if the mortgage mess leads to a full-blown credit squeeze, the damage will not last long because stocks don’t have far to fall. ...

Mr. Graham and Mr. Dodd ... would have had a problem with the way that the number is calculated today. ... They realized that a few months, or even a year, of financial information could be deeply misleading. ...

So they argued that P/E ratios should not be based on only one year’s worth of earnings. It is much better, they wrote in “Security Analysis,” to look at profits for “not less than five years, preferably seven or ten years.” This advice has been largely lost to history. ...

Today, the Graham-Dodd approach produces a very different picture from the one that Wall Street has been offering. Based on average profits over the last 10 years, the P/E ratio has been hovering around 27 recently. That’s higher than it has been at any other point over the last 130 years, save the great bubbles of the 1920s and the 1990s. The stock run-up of the 1990s was so big, in other words, that the market may still not have fully worked it off.

Now, this one statistic does not mean that a bear market is inevitable. But it does offer a good framework for thinking about stocks. Over the last few years, corporate profits have soared. ... In just three years, from 2003 to 2006, inflation-adjusted corporate profits jumped more than 30 percent... This profit boom has allowed standard, one-year P/E ratios to remain fairly low.

Going forward, one possibility is that the boom will continue. In this case, the Graham-Dodd P/E ratio doesn’t really matter. It is capturing a reality that no longer exists... The other possibility is that the boom will prove fleeting. Perhaps the recent productivity gains will peter out (as some measures suggest is already happening). Or perhaps the world’s major economies will slump in the next few years. If something along these lines happens, stocks may suddenly start to look very expensive.

In the long term, the stock market will almost certainly continue to be a good investment. But the next few years do seem to depend on a more rickety foundation than Wall Street’s soothing words suggest. Many investors are banking on the idea that the economy has entered a new era of rapid profit growth, and investments that depend on the words “new era” don’t usually do so well. ...

Dean Baker says he gets it "almost" right:

Leonhardt Gets It Right on Stock Market Valuations (Almost), by Dean Baker: NYT columnist David Leonhardt does a good job of spreading some basic commonsense on stock prices. The stock price should reflect earnings. Leonhardt notes that current PEs are about 27 against trend earnings, far higher than the historic average.

The reason for including the "almost" is that Leonhardt felt the need to say that maybe stocks aren't over-valued if profits keep growing rapidly (sounds like Alan Greenspan in the 90s). Well don't hold your breath on that one. Profits peaked in the 3rd quarter of 2006 and were down sharply in the 4th quarter of 2006 and the first quarter of 2007. It's always possible that they will bounce back, just like it's possible that President Bush will sign the Kyoto agreement, but I don't know anyone who will bet on either event.

Comments

[robertdfeinman]

Generalizations about the stock market "bouncing back" or earnings "recovering" need to be qualified as to the time frame the author is considering.

In the past decade the demand for performance has shrunk the horizon from years to days. This despite the fact that Warren Buffet's old fashioned approach has done better than all the hot shots over the long term. Is it really necessary that car sales be reported weekly or that Walmart report monthly with projections for the following month?

The stocks move not on the fundamentals but on whether the news meets "analysts" expectations. Since there are as many misses as not why does anyone continue to pay attention to what the "analysts" expect? The only reason that I can see is that they are part of the trading game. They contribute trading noise which allows players to make very short term bets. Just look at the churn ratio of some mutual funds to see how out of hand this has gotten.

After the most unsophisticated speculators have all been taken to the cleaners, the cycle will start again with "value" coming into the fore.

[groucho]

"After the most unsophisticated speculators have all been taken to the cleaners, the cycle will start again with "value" coming into the fore."

Amen

[kharris]

The argument that one should look at earnings over a 5-10 year period seems to thing that performance over the course of a business cycle is what we should look at. It also seems to call for prudence. This is partly a risk-tolerance issue. That, say Fed officials, is a big deal because we have been tolerating too much risk.

Does Dean Baker mean to say profits fell, or grew more slowly, in recent quarters? The difference between profits and profit growth ...?

[anne]

"After the most unsophisticated speculators have all been taken to the cleaners, the cycle will start again with "value" coming into the fore."

Nonsense, complete nonsense. There may well be a bear market or there may be a continuation of what has been the broadest and deepest international bull market in stocks I can find record of, but millions of unsophisticated "investors" at Vanguard and other such companies are just fine and will continue to be fine. The speculators who have been at all hurt in the minor market fluctuations so far are interestingly enough highly sophisticated however mistaken they may have been or may prove to be.

[spencer]

it depends on what profits you are talking about.
After tax profits as reported in the gdp data has peaked and actually fell over the last couple of quarters. But earnings per share as reported by S&P are still rising. Part of the difference is that the BEA is the quarterly number at seasonally adjusted rates while the S&P number is the trailing four quarter sum. Moreover, the S&P data is influenced by the number of shares outstanding and that has been falling about 2% per year over the past few years.

[anne]

This is mere market timing fear-mongering, and paying attention to such 10 year this and 20 year that and 30 year the other nonsense will insure investment idiocy. What is always the case with investment fear-mongers, is never ever telling investors how to be protective beyond never investing.

[robertdfeinman]

Anne: from the early 1970's to the mid 1980's the stock market was flat to negative. Don't be too sure that this is a blip. The fundamentals for an economic decline are all there. We have the same guns and butter policies that LBJ used to pursue the Vietnam war. We also have looming resource shortages which are similar to the oil embargo even if the causes are different.

During the 1970's lots of regular folks saw their investments lose value. Even bonds were not safe since the inflation and high interest rates caused them to lose value

Sometimes even prudent people get swept along by large forces.

[Gavin]

Leonhardt suggests that something "bad" has to happen for stocks to fall, either productivity growth stalling or a recession.

However even if neither of the two occur company profits and stocks can fall. If capitalism is functioning properly, competition should drive down profits. This will cause profits to fall and most of the benefits should accrue not to shareholders but to the customers in the form of better products at lower prices.

[Gavin]

Anne: I hope your review of the history of investing starts before 1982. Millions of unsophisticated investors at Vanguard in diversified low cost index funds MAY NOT do just fine.

I define doing poorly as not being able to keep up with inflation over 15 years. If you invested in a diversified index fund of U.S. stocks in the late 1960s you would not have been able to beat inflation with all dividends reinvested over the next 15 years. For most of that time a low-cost index fund wasn't available and you would have fared even worse if you include expenses.

There were ways to keep up with inflation but a simple strategy of investing in a U.S. total market index fund was not it.

[anne]

"During the 1970's lots of regular folks saw their investments lose value. Even bonds were not safe since the inflation and high interest rates caused them to lose value."

Looking at peak to peak investing returns is meaningless, as though a million dollars were investe at market peak and then nothing for however long. What is always ignored aobut the 1970s is, dividends which were substantial. Only index levels are generally accounted for. Returns with dividends were just fine. However there are bear markets.

Bond investing in the 1970s was however an important problem, because investors did not understand how to control risk by limiting duration. That was understood and implemented by Vanguard just after the 1980s began.

Also, stock index fund investing only begins in autumn 1976 and was not much understood for years.

[anne]

"If you invested in a diversified index fund of U.S. stocks in the late 1960s you would not have been able to beat inflation with all dividends reinvested over the next 15 years."

Real schmeal, blah blah blah.... Investment returns were fine during the 1970s for long term investors, and values graually became sensational so not investing was a drastic mistake. The real problem for investors was the absence of a Vanguard simply for competitive purposes until 1973 and the absence of indexing until 1976.

Whenever I find nonsense about real returns during the 1970s, I turn elsewhere. Investing even with increasing inflation was better than not investing; enough.

[robertdfeinman]

Anne:
If we assume that long term investors are saving for retirement then when you cash out is only slightly flexible. If you are forced to retire during a down period or during stagflation it is the value at that moment that counts.

Assuming that you take your investments and put them into an annuity the end point makes a big difference. If you retired in 1972 instead of 1970 you would have seen about 1/3 of the value of your investments disappear. That means that, effectively, ten years of the 30 that you had diligently saved for retirement had just been wiped out.

I know that people can diversify and use other tactics to minimize risk (I do it myself), but risk is risk and one can't always chose how best to deal with it. Options for investors have increased since the 1970's, but there are no sure things in life.

[Gavin]

Anne: The choice is not between "investing" and "not investing". The decision is between looking at current valuations (price/10 years earnings) and not looking at current valuations.

If I remember correctly you have been critical of Shiller. You noted that if you invested in bonds in 1996 when he stated the stock market was over-valued you would have done poorly when compared with investing in stocks since then.

But that is not a valid comparision. Bonds are much less risky than stocks and you would expect lower returns. If you had invested in alternate asset classes that have similar risk to a U.S. stock market index fund you would have fared much better. Commodities, real estate as well as small stocks have performed excellently over the last decade.

Paying attention to current valuations is important, especially (price/10 year earnings) that help explain returns over a decade or so. Over the short term, say 1-5 years valuations explain almost nothing.

[Nate]

Robert: When you begin spending your retirement savings you don't "cash (it all) out". As you approach this point your investment portfolio should be gradually transitioning to a portfolio with a fairly heavy weight on short term liquid debt securities. This portion of the portfolio should be targeted at funding your expected consumption over the short term. But with people retiring at say 65, and planning to live to say 90, you have another 25 year investment horizon to consider. This is where even if some of your investments take a 20% hit before you retire, you have 15 years to recover.
The key to retirement savings is proper asset allocation. If you take on risk early in life, and tend towards that 0 Beta SS portfolio I was talking about yesterday, the only thing you have to worry about is run away inflation (which can be hedged against by investing in TIPS ,gold, and rolling T-Bills).

[Jim Harrison]

The productivity gains of the last several years have gone disproportionately into profits instead of wages, at least in part because the administration worked tirelessly to achieve just this result. I find it hard to believe that this policy can go on indefinitely without generating a political reaction that will eventually lower the artificially high profit rate even if it could be maintained in the face of resource shortages and other unfavorable trends.

[Richard]

Why would the PE/10, using the 10-year average earnings be a better measure than the current PE based on the trailing 12 months? Don't I care more about the price of stocks today than what they were 10 years ago? For example, if you average 10 years earnings, you get the exact same PE/10 going from a period of low valuation to a high valuation as going from a period of high valuation to a low valuation, yet wouldn't a reasonable person conclude that the second case is a much more favorable time to invest than the first? I prefer buying things when they gotten cheaper, not when they've gotten more expensive. PE/10 does not distinguish between the two.

[anne]

"If we assume that long term investors are saving for retirement then when you cash out is only slightly flexible. If you are forced to retire during a down period or during stagflation it is the value at that moment that counts."

Absurd nonsense. Imagine I will need every dollar I have ever invested tomorrow because tomorrow I retire. Please, this is an analyst's fear-mongering.

Robert Shiller, as typical, never suggested investing in bonds in late 1996, only getting out of the stock market for a decade or so. This was a ridiculous suggestion, especially so since Shiller never offerws an alternative. I am so tired of these fear-mongers.

As for me, I have never suggested that long-term investment-grade bonds in late 1996 would not have been a fine investment which they were. Similarly so was real estate, so were all sorts of value stocks and selected but obvious conservatively valued growth stocks.

[anne]

Also, when next an analyst begins to tell you what sort of Beta your have in your portfolio, run and run fast.

[sk]

Anne: Absurd nonsense. Imagine I will need every dollar I have ever invested tomorrow because tomorrow I retire. Please, this is an analyst's fear-mongering.

What Rdf and others said doesn't sound like a nonsense. I would rather call it prudence or risk preference. Btw, i thought analysts are always greed-mongering, if there is such word.
Back in the late 90s, over 98% of all the US stocks had "buy" ratings. During the market downturn of the early 2000s, more than 90% of the analysts were still recommending "buy". Are the analysts are different these days? With all the new regulations and the change of the atmosphere, do the majority of the analysts are now "fear-mongering"?
Check out your Bloomberg for analyst ratings.

[donna]

The problem is companies are not built for the long haul anymore. Even when I got my MBA in the 90s, the strategy for creating a new business was to plan to cash out on seven years, pay off the venture capitalists and retire. We don't build companies anymore to last decades, only to make a profit this quarter.

The "me first" attitude of the current generation of CEOs and business owners is killing American businesses and America's economy. The price we all will pay has yet to be totaled.

[anne]

I suggest learning how to invest simply and safely and efficiently. Try reading some John Bogle, and enough with the nonsense of fear-mongers like a certain perpetually bearish economist who was privately showing off a new beach front home while publicly moaning and groaning about the end-of-the world in housing.

This is a moderately difficult time, and time to be thoughtful about what is happening in several markets, but I am not the least interested in market timing and not worried about investing only interested in the possibilities.

This time, last year, another economist was yelling about bear markets to end bear markets, with never a way to be protective discussed, but as usual the economist was wrong. I am not concerned about the wrongness, but what is always a dire warning followed by no sensible idea on protection.

Oh well, watch your Beta.

[anne]

Donna, has made an important comment indeed. The separation of management and ownership, the growing divorce of ownership and management from employees, the short term objectives of management do worry me considerably.

[BJ Feng]

Although Anne is too confident, I think she has the right idea this time. The stock market is just too hard to predict in the short-term. I've been investing in stocks since 1996, when I was still in college, and what I've noticed is that there's always some reason or danger given for why THIS isn't the best time to invest. We had the Asian crisis, followed by Long Term Capital Management, followed by Y2K, the tech bubble, September 11, Enron, and so forth. Only during 1999 did most of the reasons seem to disappear. Remember, stocks climb a wall of worry, when everyone is euphoric, that's the real time to be afraid.

Like Anne said, regular investments into a low cost index fund with Vanguard (the cheapest and where I have most of my money) is the best plan of action. The key is to keep on buying a set amount, even when (and especially when) the market goes down. Those who started at the top in 2000 would be ahead by a decent amount right now using that tactic.

While the P/E ratio of US stocks are around 16-17, foreign markets enjoy lower ratios. The US market makes up 50% of the World total market capitalization, and I believe that the best strategy is to spread around your assets everywhere.

I recommend a 80% stock 20% short-term bond mix to contain volatility. Of the stock mix, 60% should be in the US, and 40% in foreign markets. Of the 40% in foreign markets, at least 15% should be in emerging markets with no more than 35%. I believe with such a diversified world portfolio, the average investor stands a very good chance of doing well. Again, all this is possible using index funds with Vanguard.

The biggest obstacle to wealth for the average American is their total lack of knowledge when it comes to investments. Since no one can predict the future, you have a million different ideas and recommendations, and not everyone can be trusted. I've tried to steer my friends in the right direction, and they've thanked me for that, but most Americans don't have a friend as interested in the stock market as I am. To spot a scam, you have to know something about that subject in the first place. Most Americans are just clueless, which is why they get taken to the cleaners by financial advisors. What we need is a mandatory economics/finance class taught in high-school. I haven't used calculus (or trig. for that matter) since I left college, but I deal with economic and financial issues everyday.

[BJ Feng]

It's hard to build a company for the next decade nowadays, given the pace of innovation and new developments. Can anyone even predict if Ford will be around as an independent business 10 years from now? I won't bother to ask about Netflix, Tivo, or anything tech related.

A good CEO tries to smooth short-term fluctuations, but understands that long-term growth is ultimately the goal. That's why Verizon is willing to put up billions to get cable TV into your living room, and why Coke and Pepsi are slugging it out in emerging nations that earn barely $5 a day per person.

[robertdfeinman]

Anne and Nate:
Neither of you read closely enough what I said. I said that one would convert their investments into an annuity.

My retirement plan (TIAA-CREF) permits investing in an annuity based upon stocks, but most insurance plans don't. Do think it is prudent for a person who has been a relatively passive investor in a mutual fund to now take an active role in figuring out how to withdraw their funds over the remainder of their lives? What happens if they guess wrong and they run out of money before they die?

There is a web site devoted to such strategies. Here's the link:
http://www.retireearlyhomepage.com/

I don't think the average investor feels comfortable gambling with their retirement funds once they are no longer earning an income.

Overheated rhetoric doesn't do much to advance your position either.

[Peter Schaeffer]

Robertdfeinman,

“Anne: from the early 1970's to the mid 1980's the stock market was flat to negative”

This is a very good point. However, you have seriously understated your case. In February of 1966 the market hit 1001. By August of 1982 it had fallen to 770. However, the truth is much worse. The CPI (CPI-U) tripled over the same period (from 32.4 in 1966 to 96.5 in 1982). Adjusted for the CPI, the stock market lost 74% of its value from the high in 1966 to the low in 1982. As history shows, buying at the peak is a very dangerous proposition. The market will eventually recover. However, you may not live to see it.

Anyone care to guess when the Nasdaq will hit 5000 again?

[BJ Feng]

Anne, it's good to see that you're a solid capitalist looking to make a profit. The beauty of the US system is that anyone can get into the game and get a share of the profits, even those that come from supposed imaginary conspiracies. Did the administration have a deal with Halliburton? Well why not own it and you can profit too. Was the war fought for the benefit of big oil? Well you can buy Exxon-Mobil and Chevron-Texaco to boot. Are the drug companies making unfair profits? Might as well get your share. Do big bad corporations own Congress and the world? Good thing you can own the big bad corporations.

It doesn't matter if the profits come from real or imaginary sources, anyone can get their share. For the price of 5 coffee drinks from Starbucks, you could own Starbucks. Glad to see everyone profiting so much, Anne included.

[BJ Feng]

Peter is right when he recommends that people get into safer investments as they near retirement. The only problem with annuities are the high costs that often come with them. However, you can get lower cost ones if you shop around.

The goal is to build up your portfolio until you have enough to live off of. Optimally, you could just live off of the interest, or mostly off of the interest. That's why you have to begin to save and invest early in your life, and take some risk by buying stocks or other assets. You need to build up your wealth so that you can live off of it, much like a bear has to gorge himself on salmon before winter hits.

[anne]

TIAA-CREF is by the way a terrific company and for several years open to the public. I am told, the salaried advisers are client-centered and excellent and do not doubt they are.

[robertdfeinman]

BJ:

There is a whole "science" of retirement investing. The short answer is that if one wants almost 100% assurance that they won't outlive their funds the most you can withdraw is 4% per year (capital draw down and interest). If you are a married couple getting social security you probably are getting about $20K per year. To reach the median family income would mean about another $20-30K. A quick calculation will show that this means a nest egg of $500-750K. Latest projections seem to indicate that the median for boomers will fall within this range, but this includes non-income producing assets like one's home.

It is not clear that the next generation will be able to save as much as many start in a hole from college expenses and as the cost of middle class essentials continues to rise.

Anne:
TIAA offers mutual funds to the general public which can be used in IRA's and the like, but their core products are only open to those at participating institutions. The performance of their mutual funds is nothing special. Their advice, however, is excellent and there are a whole bunch of useful publications on their web site.

[op]

marvelous

rentiers trading portfolio tips
just as i suspected

i come to u in an ally

"your portfolio or your job"

the answer tells much

[burritoboy]

You know, I'm not sure if a 10-year P/E is really valuable. To make any long equity investment, you really do need to build a financial model and do a DCF, rather than rely on a P/E valuation. So, a multi-year P/E valuation is still going to have most of the problems of any other P/E valuation.

But a 10-year P/E is really going to be most valuable for cyclical companies. It doesn't make very much sense for a growth company (of course, you always want to consider whether that label of growth is correct - it often isn't). But when you're investing in a cyclical company or industry, the thing you want to know is "where in the cycle are we?" which is better addressed by understanding the particular industry as opposed to doing a historic P/E analysis.

In terms of overall market valuation, without knowing exactly what Leonhardt's methodology is, equity markets after 1981 are going to look very different from the period 1967-1981, which in turn looks very different from 1945-1966, etc. Part of the problem is that the historical analysis really doesn't provide us with some "ideal" valuation, both because there's no reason to think one of the many wildly different historical valuations was correct and because the whole process of just comparing P/E's is not fine-grained enough. Leonardt's methodology, besides telling us we should invest in 1934-1939 or 1978, doesn't have immediate applications to my mind. A system that tells you to invest twice in a century is probably not that useful to humans with limited life-spans.

[oops]

Anne, do you realize that the author of the 10, 20 yr p/e ratio that you mock (graham) was warren buffet's mentor?

[anne]

Good grief; then read John Bogle, or read the simplest of Vanguard guides because more is not necessary, get rid of as many stereotypes and rules about investing before and after retirement as possible, and learn what is needed about Vanguard at which every product will be available as will broad ideas. Though I do not track TIAA-CREF managed mutual stock funds, I would be surprised were they not reasonably competitive with indexes, but, to my surprise, possibly not. I know nothing about the bond finds, but assume even more decidedly they are competitive with appropriate duration indexes.

[anne]

Paine is right, and I should be more serious because investing is critical in most households though handled in various manners. I am sorry, then.

I always pay attention to market valuations, and always take Ben Graham's teaching seriously. Warren Buffett in 1999 wrote a seminal essay for Fortune in which with no complexity he explained that the share of national income going to corporate earnings and management was at record levels and could not be expected to continue to climb at the expense of employees. The stock market was exceedingly expensive because of existing prices and the limits on earnings shares. Then, expect lower market returns for quite a while.

Buffett was right as I expected him to be. That did not mean time out the market, but look to value. Besides, even for those willing to time out the market, long term bonds were priced for a dramatic bull market, and there were well priced alternative investments to stocks and bonds as such.

Buffett was right but also wrong, and I was right and wrong. Where we were wrong, was that after a brief recession the national income share going to employees rather than increasing as expected, or even holding, decreased. The American market though trailing most markets internationally has been driven by relatively increasing earnings much to my suprise and Buffett's. No matter, we were invested.

[Nate]

The other major problem with using a 10 year P/E ratio is that many businesses today do not look like they did 10 years ago.
Apple? HP? Exxon? Google?
With how dynamic companies are today, to try to use data from 10 years ago to evaluate future expectations for a company is irresponsible and very naive.
While Buffet does subscribe to Graham and long term value investing, I'd be willing to bet when he decided to buy more banking stocks this past quarter he wasn't too concerned about what market exposure that bank had 10 years ago, but what market exposure that bank has today.

[anne]

Now a bear market would not surprise me in the least, since I do find American stocks pricy, but I simply invest by finding relative value no matter my thoughts about general valuation. I do not time, because that is simply too difficult for any number of reasons.

But, though I attend to investing there is little reason for most people to do so as opposed to learning enough to invest passively for indefinite periods with a fine company. While long term stock investing through a Vanguard index has been successful since 1976, there have been bear markets including the recent fierce bear market. However long term bonds set off stock fund risk well and Vanguard's long-term investment-grade bond fund returns these 30 years in which stock indexing have been available have been strikingly attractive. Play a game then of mix and match for possible returns and limited volatility.

[anne]

Paine was completely right to caution me.

All I wish to argue for is looking for simplicity, unless we are trained for more, and knowing we can learn to efficient and safe fairly readily. Beyond John Bogle, look to David Swensen. But, Bogle and Swensen and Warren Buffett when writing or speaking on investing are remarkable free of jargon and complexity while being completely precise and always offering alternatives even when perceiving significant danger.

The stock market in 2000 was significantly dangerous, there were however fine obvious investments; most simply there were long term bonds, not to mention subsequent health care stock and commodity based stock and real estate investment trust stock investments....

Remember, this market is worrying but a perfect time to learn how to be protective and weather what may be a possibly difficult market.

[taq]

These are complex discussions, that unfortunately are skewed by the marketing of an industry getting very wealthy off "free" advice. The first concern I have is with the american obsession with retirement. The "wealthiest" people i know never discuss retirement , but rather invest in their own and other businesses. If one decides from the start to insure against disability, support social safety nets and save diligently, one will be suprised at one's wealth (both financially and as a human being).
There is no "science" to retirement recommendations. Please don't insult the process of scientific research. There are only models based on looking in the rearview mirror and fitting to old trends. As everyone does them they become useless. The closest you will find is Laurence Kotlikoff's idea of consumption smoothing. But even his assumptions may not pan out in the future.
If one is going to "invest" in the market or bonds or growth (usually stated for momentum plays), you will be lucky to survive. buying into an index when it is overpriced is only slightly more wise.
The value vs. growth conundrum is also nonsense as one must value the growth potential of a company and expect to pay for that growth.
Better, invest in businesses with some combination of sound models, good management, solid plans for the present and future, reasonable price tag (by various metrics). As with finding a soul mate, no company is likely to have all factors, but one may weigh each. This can be done by purchasing a business in your own community, however, it is unlikely someone will sell a business for a significant discount. Diversification limits your downside risk and firesales are common amongst publlicly sold companies. For example, small cap and value in the early 1970's and 2000's. Emerging markets in the early 2000's. Large cap growth in the early 80's and by some measures today. I, by no means, mean that good deals were only found in these areas, rather that the herd mentality tends to cause sectors to rise and fall together, so that discounted sectors may be easier to identify than discounted companies within an expensive sector.

I find that the return on my invested time is much greater in my own line of work and paying others who have demonstrated an aptitude for finding such companies, either public or private, such as Ian Cummings, David Winters, Arnold Vandenberg, Chris Davis, Chuck Royce, Bill Miller, Jeremy Grantham, Marty Whitman, Mark Yockey, Mark Mobius, Warren Buffett, John Buckingham, Hakan Castegren amongst a few others...

Days like these are opportunities for those who are prepared to pick up the babies who are being thrown out with the bathwater. You cannot expect to know when the hysterical sellers will turn into hysterical buyers, but you can happily buy good companies at discount pricing during a fire sale.

[anne]

Nate makes a fine point, I never for a moment think I know how Warren Buffett is investing, but I know that Buffett always has a reserve, what I would consider bonds though may be other forms of liquid assets for Buffett, a reserve that is available for investment in well priced assets. Of course, why try to be Buffett all these years when Berkshire Hathaway can be owned.

The reason I do not pay attention to peak investing, is that investing should occur over time not at a single point. An investor who bought through the 1970s, was going to be a happy investor indeed. Stocks from 1975 on were remarkably well priced, but stock investing became increasingly less attractive even though the bear market was done.

John Bogle told us that Vanguard had net withdrawals from the stock index every quarter from 1976 until 1982. Of course the time to buy, but that only became evident in retrospect even to many professionals.

[anne]

Ah, I am reminded, there has been little damage to investment market so far, but where there has been most damage it is in parts of the market that are supposed more scientifically managed, and managed by awfully smart folks who non-professionals could not hope to compete with. There may be however an advantage in simplicity. That was why I was complaining, for want of simplicity.

[ECONOMISTA NON GRATA]

"............David Leonhardt says the "stock run-up of the 1990s was so big ... that the market may still not have fully worked it off"......."

It's just another view that I can appriciate.... Fear mongering, it's not....

I strongly support the idea that equities are hightly overvalued basis the S&P 500 and the approach stated by Mr. Leonhardt is in fact a extraordinarily valid. However on a stand alone baisis, it's a weak argument and justifiably ignored by the market.

Earnings are yesterrday's news. The rate of growth in earnings is not sustainable nor is productivity. Remember "the law of diminishing returns"? I would suggest that any of you who are willing to hang your hat on a single, simple theory, examine the new reality and in doing so you will find that equities are priced like Miami condos.

The key word is "saturation". It's happened in real estate, it's happened in the credit markets, it's happened in technology and it's happened in equities. Unfortunately, the timing couldn't be worse because it's happening to all at the same time. It's a technological crisis that saturated and exhausted the maximum efficiency of the global market place. Again, why do we need more economic growth? Why do we demand that?

Markets are efficient under any form of social structure, they succeed efficiently and fail efficiently. Now we are going to see just how efficient our markets really are.

Good luck to all and best regards,

Econolicious

[BJ Feng]

Yes there are those who have the ability to consistently pick stocks that outperform in their sectors. But first, you have to identify that person and hope his record isn't due to luck. The longer his record, the less likely it was luck, but those with proven track records demand high fees. You'll have to make it worthwhile for him not to put up his own capital and earn above market returns himself. The most talented will either start up their own hedge funds, or have to manage a huge mutual fund. The fund has to be huge in order to generate enough fees to pay for the talent, and that creates its own problems. Even the most talented stockpickers will have trouble with a $20+ billion dollar fund. He'll only be able to invest in large cap stocks and will have to accumulate and decrease his holdings over a significant amount of time. I've been watching Will Danoff of Fidelity Contrafund for some time (don't own the fund) and I'm amazed he's been able to beat the S&P500 for the past few years given the huge amount of money he has to manage. It can't be easy.

For most Americans, they're not going to be able to invest in a top quality hedge fund. And finding a great mutual fund manager is harder than it sounds, the best companies will always close their funds to prevent asset bloat. That's why I believe most Americans are just better off sticking with an index fund as John Bogle has argued. As Robertfeinman pointed out, there is a science to this, but like most sciences, it takes a lot of time and effort to understand. Finally, no one can predict the future, which is why you get so many different opinions. We can only figure out what looks relatively "cheap" based on past models and assumptions. There's no guarantee the same metrics used in the past will hold up today. P/E is a good example. In the past, the "science" of investing wasn't as developed as it is today, and people might not have understood the expected returns from stocks. Plus, fees made it tough for anyone to invest, especially in small cap companies. Now that most people understand that stocks can provide a good return, and the average Joe has nearly cost free access to the market, are the P/E ratios of the past still valid? How likely is it that we'll ever see the overall market with a P/E of under 10 and dividend yield above 5% again? Too many people would both understand the value of such a proposition and have access to the markets. The median and average historical P/E's included time periods where people neither understood nor had access. That's why we should be careful of these historical comparisons on value because the situation has changed. Like in baseball, 50HR's ain't what it used to be.

[richard (not the previous poster, Richard)]

One poster made the comment of buying an annuity at retirement. While that is the normal (default) delivery of trust funds from a pension plan (both defined contribution and defined benefit), it can be waived with a lump-sum distribution by the participant into a conduit IRA.

Note that this means, for all practical purposes, that the participant can buy a series of annuities over time. Annuities can now be bought through Vanguard that are inflation adjusted, and annuitizing wealth over a period of time has some real benefits, and the participant can gradually reduce exposure to outliving benefits while averaging out the interest rate at which the annuity is purchased. If the participant has no bequest motive (or if any bequest is set aside separately), then an inflation-adjusted annuity benefit gives the maximum return with the minimum risk -- somewhat more than the 4% formula often used by retirement planners.

Not everyone will want to annuitize all that they have saved, but a case can be made for annuitizing some of one's retirement assets during retirement.

[Rob Bennett]

"The short answer is that if one wants almost 100% assurance that they won't outlive their funds the most you can withdraw is 4% per year (capital draw down and interest)."

The studies that give us the 4 percent withdrawal rate do not include adjustments for valuations. If you adjust for valuations, the withdrawal rate identified as safe for retirements beginning in January 2000 is 1.6 percent. Today's safe withdrawal rate is a bit under 3 percent. In the event that stocks perform in the future somewhat as they always have in the past, there are going to be millions of busted retirements resulting from the demonstrably false claims put forward in the Old School safe-withdrawal rates studies.

I provide a New School safe-withdrawal-rate calculator ("The Retirement Risk Evaluatior") at my site for those interested in learning more about the New School numbers and how they are determined.

Rob

[Rob Bennett]

"John Bogle told us that Vanguard had net withdrawals from the stock index every quarter from 1976 until 1982. Of course the time to buy, but that only became evident in retrospect even to many professionals."

P/E10 is a tool that helps investors stick with a buy-and-hold strategy. P/E10 tells us what to expect down the road (not one year down the road but 5 or 10 years down the road). If the "professionals" all paid attention to P/E10, what you say above would not be so. The "professionals" should have been telling us to lower our stock allocations in the mid-60s and to increase them again after the P/E10 level fell dramatically. The problem with ignoring valuations is that you get hit with surprises and that causes you to panic and lose confidence in buy-and-hold.

Bogle's ideas have not been tested in a major bear market. I believe that indexing is here to stay. But I favor a valuation-informed approach to indexing (one in which the investor lowers his stock allocation during times of absurdly high prices).

Rob

says...

Is the trailing ten year earnings data available?
Anyone know of a website that tracks PE for the trailing ten year data?