Sorry I haven't blogged in a while. I've been swamped, between family visits and working on a journal article. Hopefully I'll find more mental energy to blog - that's the key, not time, but just the ability to sit and pen my thoughts.
Meanwhile, I'm quite excited to report about a website that has captured some of my concerns about average Joes and Janes and their saving for retirement. I haven't read the entire Passion Saving website, but have liked a lot of what I read. The website talks about valuations and how they affect future investment returns.
What do I mean? Ok, so if you have a 401k or ever read a financial advice column, they would advice you to follow a certain asset allocation. Maybe you're 30 years old. Maybe you are told to do 80% stocks, 20% bonds (Nowadays, there are more exotic choices than the two, but let's stick with those two) Why? Well, stocks return more than bonds, so as a younger person, you should be willing to load up on riskier stocks.
But wait, that tells you nothing about the value. Think about it this way. Tom Brady is a great football player, but you wouldn't be betting the club on him. An investment is only good when the price is right - buy low, sell high.
"But stocks are cheap" comes the chorus. According to data from Standard and Poor's, the P/E on the S&P is 17 - that's down from over 46 in 2001, just when the market crashed. Two problems with that. One - why look at 2001 as the base year? The median P/E of the S&P since 1936 has been 15.4, so stocks certainly don't look cheap on that basis. But that's only the beginning ...
Unfortunately, the P/E doesn't correct for the cyclical nature of earnings. I have previously pointed to the work of John Hussman, manager of the Hussman Funds (my fav fund) talk about this issue. What's nice about the Passion Saving website is that it uses a much simpler way to bring the valuation issue to focus. By using a 10-year moving average of earnings for the P/E, Prof Robert Shiller of Yale, of "Irrational Exuberance" fame, shows that the P/E10 of the stock market is close to 30, the highest level with the exception of during the dot-com boom. The median value historically has been closer to 14. The value in 1982 at the start of the great bull market in stocks was under 6.
Click on the return predictor, and you'll see that based on historical valuation models, the expected real (i.e. adjusted for inflattion) return over the next 10 years is about 0.5%, which is much less than available on government bonds and inflation securities. What if the P/E10 was at its historical median. Then we could expect a 10-year return of over 6%, a pretty handsome return.
Valuations matter, and in an environment where real estate and stocks and longer-term bonds have been pushed up, the best an investor can do is to select a flexible bond fund or keep money in a short-term bond fund yielding about 5% until better options emerge.