100% Cash, Ready for the Crash

[rb]

John,

 

My universe is global. I go where the value is. Though I would say North America is higher on my list than other geographies of a couple of reasons:

1. I have a clients with tax free accounts that can only invest is N.A. listed stocks

2. Despite living in Europe on and off over the years I think that I have a better understanding of N.A. than other places. Some places that I have no clue about I wouldn't even touch. Like say... the Philippines.

3. The US is a more target rich environment because there is so much public listed business. In Europe much more business is private. A lot of time the really good business :(.

 

My discussion in this topic has been more related to N.A. like index P/Es, growth rates, and such but I think it some of it applies to other areas as well. As I've said, if US rates go up, then Europe stocks will probably do well and low yield Europe bonds will do very bad.

[John Hjorth]

Thanks, rb. I understand your position on this.

[Uccmal]

John, Strictly North America so far, except many of the companies I have invested in have significant world wide operations. 

 

Its enough so far to work in two currencies. 

 

Does it show in the way we talk?

[cmlber]

Let's look at a simple DDM. Say that we're gonna have inflation around 2%, real growth around 2%, and long term rates around 3%. This implies a fair market return of about 8%. So we have:

 

P=E(1+g)/(r-g) => P=1.04E/(.08-.04) => P/E=26

 

Alternatively, since 8% is just a guess, we could just as easily guess 7% is a fair market return and P/E = 1/(.07-.04) = 33x.  It doesn't strike me as unreasonable to think people would accept 7% returns in a world with the 30 year at 3%.

It's not just a guess. Historically market return has been about. Long rates + 5%. I you look another way, historical market return has been about inflation +6%. If you keep to those historical norms you get r=8%. But hey if you want to assume that risk premiums diminished then you can assume that r=4% and then we're in for one hell of a bull market.

 

It is definitely a guess.  To quote WEB, if past history was all there was to the game, the richest people would be librarians.  You're referring to history but 1) how do you know investors didn't expect to earn less than they did?  Isnt it possible that investors didn't expect 35 years of constantly declining interest rates and therefore got a windfall, but would have been satisfied with lower returns? And 2) isn't it possible that the zero lower bound alters investors' risk tolerance?  In the history you're referring to, investors could rely on low single digit (if not better) real returns owning treasuries.  Today they may not even earn above 0% after inflation.  Nobody can retire compounding at 0%, it could force people to accept a lower risk premium to be in equities if the cause of low interest rates is a savings glut. 

 

There's nothing wrong with making an educated guess.  I have absolutely no idea what the right number is, but I'd say anything in the 6-9% range seems reasonable in a world with 3% 30 year treasuries.  That's one persons opinion that you're welcome to ignore, but it's dangerous to assume the future will definitely look like the past. Any projection is a guess.

[rb]

It is definitely a guess.  To quote WEB, if past history was all there was to the game, the richest people would be librarians.  You're referring to history but 1) how do you know investors didn't expect to earn less than they did?  Isnt it possible that investors didn't expect 35 years of constantly declining interest rates and therefore got a windfall, but would have been satisfied with lower returns? And 2) isn't it possible that the zero lower bound alters investors' risk tolerance?  In the history you're referring to, investors could rely on low single digit (if not better) real returns owning treasuries.  Today they may not even earn above 0% after inflation.  Nobody can retire compounding at 0%, it could force people to accept a lower risk premium to be in equities if the cause of low interest rates is a savings glut. 

 

There's nothing wrong with making an educated guess.  I have absolutely no idea what the right number is, but I'd say anything in the 6-9% range seems reasonable in a world with 3% 30 year treasuries.  That's one persons opinion that you're welcome to ignore, but it's dangerous to assume the future will definitely look like the past. Any projection is a guess.

Well it is an estimate. One that's been pretty good over the years. At zero bound it's true that weird stuff starts to happen. But we're talking about long term risk premium. Long term treasuries didn't go to zero. So I don't know whether that would compress the bonds-stock risk premium. Instead since rates are low maybe it made it even wider. In the past equity investors would go to bonds when stocks are expensive. Today a lot go to cash since lower yields made it a good proxy. Plenty examples on this board. Also it could very well be that the risk premium contracted a bit because let's say of present conditions. But it can just as well revert back to mean very easily inflicting painful losses.

 

Anyway you've missed the substance of my post which is that US stocks seem fully valued at best using a set of reasonable parameters and rosy environment. Sure you can say I'm guessing, that the risk premiums in the future will be lower than they have been in the past in which case yes there's a lot higher to go from here. But that's a guess as well and maybe the future risk premiums will be higher then historical. That means that the market is grossly overvalued and you're in for a world of hurt. I think I'll stick to being a librarian that heeds the lessons of history.

[cmlber]

It is definitely a guess.  To quote WEB, if past history was all there was to the game, the richest people would be librarians.  You're referring to history but 1) how do you know investors didn't expect to earn less than they did?  Isnt it possible that investors didn't expect 35 years of constantly declining interest rates and therefore got a windfall, but would have been satisfied with lower returns? And 2) isn't it possible that the zero lower bound alters investors' risk tolerance?  In the history you're referring to, investors could rely on low single digit (if not better) real returns owning treasuries.  Today they may not even earn above 0% after inflation.  Nobody can retire compounding at 0%, it could force people to accept a lower risk premium to be in equities if the cause of low interest rates is a savings glut. 

 

There's nothing wrong with making an educated guess.  I have absolutely no idea what the right number is, but I'd say anything in the 6-9% range seems reasonable in a world with 3% 30 year treasuries.  That's one persons opinion that you're welcome to ignore, but it's dangerous to assume the future will definitely look like the past. Any projection is a guess.

Well it is an estimate. One that's been pretty good over the years. At zero bound it's true that weird stuff starts to happen. But we're talking about long term risk premium. Long term treasuries didn't go to zero. So I don't know whether that would compress the bonds-stock risk premium. Instead since rates are low maybe it made it even wider. In the past equity investors would go to bonds when stocks are expensive. Today a lot go to cash since lower yields made it a good proxy. Plenty examples on this board. Also it could very well be that the risk premium contracted a bit because let's say of present conditions. But it can just as well revert back to mean very easily inflicting painful losses.

 

Anyway you've missed the substance of my post which is that US stocks seem fully valued at best using a set of reasonable parameters and rosy environment. Sure you can say I'm guessing, that the risk premiums in the future will be lower than they have been in the past in which case yes there's a lot higher to go from here. But that's a guess as well and maybe the future risk premiums will be higher then historical. That means that the market is grossly overvalued and you're in for a world of hurt. I think I'll stick to being a librarian that heeds the lessons of history.

 

Well, long term real yields did essentially go to 0%.  At 3% a high tax bracket investor is getting a -0.2%/year real return for locking up money for 30 years assuming 2% inflation.

 

But I generally agree with you.  I was making the point that in the context of a "what do you think about being 100% invested in cash?" thread, I think it's important to understand that there's a very really chance that stocks are very cheap at these prices, even if it's much more likely that they are fairly valued or overvalued. 

[james22]

65% fixed because believed today's over valuation temporary (and expected a relatively quick bear market resolution):

 

... today’s valuations for the U.S. stock market are a temporary issue that will be resolved either through a relatively quick bear market or a longer period of more or less flat returns... (GMO, Q3 2013)

 

But may now hedge my bet with the possibility of valuation as a permanent issue:

 

... almost all asset classes are priced at valuations that seem to guarantee returns lower than history.

 

Our standard forecasting approach assumes that this situation will gradually dissipate, such that seven years from now valuations will be back to historical norms. James calls this scenario Purgatory because it means a finite period of pain, followed by a return to better conditions for investors.

 

An alternative possibility, which James refers to as Hell, is that valuations have permanently shifted higher, leaving nearer-term returns to asset classes somewhat better than our standard methodology would suggest, but at the expense of lower long-term returns.

 

https://www.gmo.com/docs/default-source/public-commentary/gmo-quarterly-letter.pdf?sfvrsn=38

[John Hjorth]

John, Strictly North America so far, except many of the companies I have invested in have significant world wide operations. 

 

Its enough so far to work in two currencies. 

 

Does it show in the way we talk?

 

Uccmal,

 

Yes it does - and it certainly makes sense based on fellow board members overall perceptions of local economic conditions. This is what makes this board soo valuable for other board members located in other parts of the world.

 

- - - o 0 o - - -

 

For me locally, it has been striking to follow the difference in speed and how the banks on both sides of the Atlantic Ocean have recovered since the financial crisis, the major US Banks doing much better in the process than European banks in general.

 

The only major European bank that I have studied that seem to have come through the period since the finacial crisis without major scars and dents is the Swedish bank Svenska Handelsbanken AB.

 

Locally, I think Danish RE is perhaps relatively high right now, but not anywhere near a bubble [-and my perception might be totally wrong here]. The access to credit has been quite brutally restricted by the Danish FSA all over the place for certain groups of customers since the financial crisis by direct orders to banks and morgage institutions about their credit policy, and by direct orders about loss provisions, to avoid '08 and '09 to happen again.

[Packer16]

IMO one of the best perspective on stock, bonds & returns can be found on Damodaran's site here:

 

http://aswathdamodaran.blogspot.com/2016/08/superman-and-stocks-it-not-cape-cape-it.html

 

He has a nice balanced approach looking at both stocks & bonds using a FCF to the equity to calculate multiples.  Currently his P/FCFE is about 12.7.  So the real question is what do you think of LT (10-yr) interest rates.  If the current rate of 2.31% is appropriate & the historical average of ERP (1/FCFE-Rf)/Rf of 0.88 is also appropriate then market has an 80% upside.  The implied LT interest rate using today's S&P 500 price as fair value is 4.34%.  With these points I am bullish & still positive on stocks in general.

 

Packer

[hyten1]

imho, i'll echo some of you

 

concentrate on looking for good investment, sell when you don't think your investment is worth it relative to cash and potential future opportunity, everything else will take care of itself.

 

marco timing i have never been good at (some of you are surely better?). we have a great example recently with the trump win. the consensus was that market will crash when trump wins, i thought of buying some puts etc etc. but i end up not doing it, at least for me i have never been good at these macro hedges etc. (with these hedges u win some and u lose some, i can say with all honesty my past attempt at hedging have net net not made money for me). Even with the call right (trump win) you would of lost money (buying puts).

 

i constantly remind myself to focus on the individual companies etc. it is painful to see your portfolio go down and wish you bought those hedges or should of sold etc. but you forget the time you did buy hedges and lost money and sold too early due to some macro thing even though the individual company are still doing pretty good.

 

i do agree, looking at the marco picture, with stock market having gone up since 2009, it does seem like the market "should" be overvalue, maybe it is i am not saying it isn't, I just try not to concentrate on this.

 

I keep going down the list of stocks that i do own, one at a time and they just don't look overvalue to me.

 

I did some trimming, raising a little bit of cash here and there (hedging the trump unknown)

 

[rawraw]

65% fixed because believed today's over valuation temporary (and expected a relatively quick bear market resolution):

 

... today’s valuations for the U.S. stock market are a temporary issue that will be resolved either through a relatively quick bear market or a longer period of more or less flat returns... (GMO, Q3 2013)

 

But may now hedge my bet with the possibility of valuation as a permanent issue:

 

... almost all asset classes are priced at valuations that seem to guarantee returns lower than history.

 

Our standard forecasting approach assumes that this situation will gradually dissipate, such that seven years from now valuations will be back to historical norms. James calls this scenario Purgatory because it means a finite period of pain, followed by a return to better conditions for investors.

 

An alternative possibility, which James refers to as Hell, is that valuations have permanently shifted higher, leaving nearer-term returns to asset classes somewhat better than our standard methodology would suggest, but at the expense of lower long-term returns.

 

https://www.gmo.com/docs/default-source/public-commentary/gmo-quarterly-letter.pdf?sfvrsn=38

Why are you quoting 2013? There most recent letter changed their opinion on this matter. .  .

[SharperDingaan]

For us the universe is primarily Canada and the UK - and only industries that we've worked in.

Stay within what you know - and know it very well.

 

We also diversify across skill set. Our Canadian side does the investment, the UK side does the building/construction surveying, & everyone is professionally designated within their fields. A London (UK) property investment would be assessed by professionals on both sides of the pond; a comparative advantage very similar to importing/exporting - as market depression/optimism is often very local.

 

To maintain skill levels & train future generations, we will also do periodic 'one-off's'; typically limited investments, with a specific object objective in mind.

 

Our recent DB 'adventure' was to demonstrate that 'fear is the mind killer' (Hubert, F) - it can be used. Our ADV 100,000 share+ investment demonstrates the nature of trade; send many small ships (ADV type portfolio) to the 'new world' - if even just one of them eventually makes it back, you'll become very rich. But you need a lot of ships, & they each need to be big enough to make it worthwhile - diversification. 

 

Sweating the small stuff isn't very useful.

 

SD

 

 

Just a question here for the gents participating in this topic: What do you consider your investment universe? - Just to get get some further shade on what has been posted in this topic so far.

 

Especially:

 

Cardboard:

 

Do you focus only on North American companies?

 

Uccmal:

 

Same question.

 

rb:

 

Same question, however I have noticed that you have bought BUD recently.

[Uccmal]

John, Strictly North America so far, except many of the companies I have invested in have significant world wide operations. 

 

Its enough so far to work in two currencies. 

 

Does it show in the way we talk?

 

Uccmal,

 

Yes it does - and it certainly makes sense based on fellow board members overall perceptions of local economic conditions. This is what makes this board soo valuable for other board members located in other parts of the world.

 

- - - o 0 o - - -

 

For me locally, it has been striking to follow the difference in speed and how the banks on both sides of the Atlantic Ocean have recovered since the financial crisis, the major US Banks doing much better in the process than European banks in general.

 

The only major European bank that I have studied that seem to have come through the period since the finacial crisis without major scars and dents is the Swedish bank Svenska Handelsbanken AB.

 

Locally, I think Danish RE is perhaps relatively high right now, but not anywhere near a bubble [-and my perception might be totally wrong here]. The access to credit has been quite brutally restricted by the Danish FSA all over the place for certain groups of customers since the financial crisis by direct orders to banks and morgage institutions about their credit policy, and by direct orders about loss provisions, to avoid '08 and '09 to happen again.

 

I have been wrong on Canadian Housing for 13 years now.  By all metrics Toronto prices are out way out of line but they are still way below New York prices. 

[james22]

65% fixed because believed today's over valuation temporary (and expected a relatively quick bear market resolution):

 

... today’s valuations for the U.S. stock market are a temporary issue that will be resolved either through a relatively quick bear market or a longer period of more or less flat returns... (GMO, Q3 2013)

 

But may now hedge my bet with the possibility of valuation as a permanent issue:

 

... almost all asset classes are priced at valuations that seem to guarantee returns lower than history.

 

Our standard forecasting approach assumes that this situation will gradually dissipate, such that seven years from now valuations will be back to historical norms. James calls this scenario Purgatory because it means a finite period of pain, followed by a return to better conditions for investors.

 

An alternative possibility, which James refers to as Hell, is that valuations have permanently shifted higher, leaving nearer-term returns to asset classes somewhat better than our standard methodology would suggest, but at the expense of lower long-term returns.

 

https://www.gmo.com/docs/default-source/public-commentary/gmo-quarterly-letter.pdf?sfvrsn=38

Why are you quoting 2013? There most recent letter changed their opinion on this matter. .  .

 

I took my fixed position based (partly) upon their 2013 opinion - I didn't seriously consider the possibility of permanently higher valuations.

 

Now that they've changed their opinion, I may need reconsider mine and hedge the position.

[rawraw]

65% fixed because believed today's over valuation temporary (and expected a relatively quick bear market resolution):

 

... today’s valuations for the U.S. stock market are a temporary issue that will be resolved either through a relatively quick bear market or a longer period of more or less flat returns... (GMO, Q3 2013)

 

But may now hedge my bet with the possibility of valuation as a permanent issue:

 

... almost all asset classes are priced at valuations that seem to guarantee returns lower than history.

 

Our standard forecasting approach assumes that this situation will gradually dissipate, such that seven years from now valuations will be back to historical norms. James calls this scenario Purgatory because it means a finite period of pain, followed by a return to better conditions for investors.

 

An alternative possibility, which James refers to as Hell, is that valuations have permanently shifted higher, leaving nearer-term returns to asset classes somewhat better than our standard methodology would suggest, but at the expense of lower long-term returns.

 

https://www.gmo.com/docs/default-source/public-commentary/gmo-quarterly-letter.pdf?sfvrsn=38

Why are you quoting 2013? There most recent letter changed their opinion on this matter. .  .

 

I took my fixed position based (partly) upon their 2013 opinion - I didn't seriously consider the possibility of permanently higher valuations.

 

Now that they've changed their opinion, I may need reconsider mine and hedge the position.

Makes sense.  I thought his most recent thoughts were very interesting and looking forward to the next letter.  BTW I don't think Montier has changed his opinion, just Grantham.

[John Hjorth]

High RE markets, unsustaiable low interest rates, QE in vein, markets supposed to be crashing in due course, "Cash in King", and I don't know what.

 

I always try to stay "realistic" - it's just not always easy.

 

Letter received yesterday - including some plastic and I don't know what -, dated 14th november 2016 - even ordinary old fashion mail does not work properly any longer here:

 

"Invitation to screening for bowell cancer

 

Region Southern Denmark hereby invites you to get examined for bowell cancer. Screening for bowell cancer is a new offer, and it applies for all citizens at the age between 50 and 74 years."

 

This will get messy - beeing under water on/in[?] something - or not.

 

*Sigh*

 

 

 

 

[no_free_lunch]

I just wonder if you will be able to deploy in time.  Either you put everything back in with a relative small 10-15 % drop in which case what is the point, or else you wait for a bigger drop which might never happen.  You might get the timing right too and then turn into hussman and sit on your hands for the next bull market.  I say just try to find good quality businesses.  Go look at the peformance of some of the better quality companies from their peak in 07 to today, they did allright didn't they?

[John Hjorth]

... You might get the timing right too and then turn into hussman and sit on your hands for the next bull market.  I say just try to find good quality businesses.  Go look at the peformance of some of the better quality companies from their peak in 07 to today, they did allright didn't they?

 

I can't agree more with no_free_lunch here than just : +1. They are out there [i think], still. It's cumbersome, dull work to pinpoint them, and it takes lots a hours - but they are out there - even right now.

 

All this macro talk on this board has always made me dizzy.

[rb]

 

All this macro talk on this board has always made me dizzy.

That's good. it means that maybe you're starting to understand it. Macro is very hard. Everyone things that micro is hard because it has a lot of fancy and very complicated math. But math is just mechanics. Once you get a handle on that it gets very easy. Macro just seems easy because it doesn't have the weird symbols.

 

However in micro you deal with an open system which can absorb a lot of things. In macro you mainly deal with a closed system which causes feedback loops, distributional effects, and other such messiness. All this stuff adds up to make it very hard.

 

I don't think that being a macro expert makes you a great investor, but i think that in order to be a good investor you need to have a good grip on macro. So a bit of dizziness maybe isn't so bad.

[james22]

I say just try to find good quality businesses.

 

But most individual investors have a significant fraction of their portfolio in a 401k with limited investment options.

 

30% of my portfolio is in a 401k that limits me to Total Stock Market Index, Total International Stock Index, Total Bond Market Index, and Target Retirement funds, for example.

 

As a value investor, I'm forced to consider macro when allocating this fraction.

[Hielko]

I say just try to find good quality businesses.

 

But most individual investors have a significant fraction of their portfolio in a 401k with limited investment options.

 

30% of my portfolio is in a 401k that limits me to Total Stock Market Index, Total International Stock Index, Total Bond Market Index, and Target Retirement funds, for example.

 

As a value investor, I'm forced to consider macro when allocating this fraction.

I don't think you are. What's wrong with just an allocation based on your risk tolerance, age, something along those lines?

[Jurgis]

I say just try to find good quality businesses.

 

But most individual investors have a significant fraction of their portfolio in a 401k with limited investment options.

 

30% of my portfolio is in a 401k that limits me to Total Stock Market Index, Total International Stock Index, Total Bond Market Index, and Target Retirement funds, for example.

 

As a value investor, I'm forced to consider macro when allocating this fraction.

I don't think you are. What's wrong with just an allocation based on your risk tolerance, age, something along those lines?

 

+1.

 

Of course, you can shift like Graham suggested between 75% stocks/25% bonds and 25% stocks/75% bonds. But it's likely you won't outperform 50/50 (or 60/40) much if at all.

[no_free_lunch]

I say just try to find good quality businesses.

 

But most individual investors have a significant fraction of their portfolio in a 401k with limited investment options.

 

30% of my portfolio is in a 401k that limits me to Total Stock Market Index, Total International Stock Index, Total Bond Market Index, and Target Retirement funds, for example.

 

As a value investor, I'm forced to consider macro when allocating this fraction.

 

I am in the same boat.  The thing is you can come up with a reasonable asset allocation (25% bonds/ 75% stocks) and just tweak the numbers slightly up and down as your confidence in the market changes.  So S&P hits 2200 maybe you're now 30% bonds, S&P hits 1800 maybe you're down to 15% bonds.  As Jurgis said, I have very little confidence that you will beat the market with these tweaks but there is true value to being able to sleep at night.  I think it is better to make small adjustments than to jump in and out of the market completely.

 

If you look at long term results, like over an entire century, the market returns come in just a handful of periods where stocks go up 5-10 fold over 10 to 20 years followed by 10-20 year periods where markets go nowhere.  It is very risky to step out and potentially miss those huge moves.

 

I also will note that Berkshire doesn't do macro.  Maybe a little bit with their cash hoarding but they primary stay fully invested.

 

Fairfax does do macro and look how well that has turned out.

 

So are we really smarter than Berkshire and Fairfax?

 

[james22]

I say just try to find good quality businesses.

 

But most individual investors have a significant fraction of their portfolio in a 401k with limited investment options.

 

30% of my portfolio is in a 401k that limits me to Total Stock Market Index, Total International Stock Index, Total Bond Market Index, and Target Retirement funds, for example.

 

As a value investor, I'm forced to consider macro when allocating this fraction.

I don't think you are. What's wrong with just an allocation based on your risk tolerance, age, something along those lines?

 

Because valuation always matters: I'm less risk tolerant when I believe the market overvalued, especially so with age.

 

http://www.hussmanfunds.com/wmc/wmc130506.htm

 

http://www.cbsnews.com/news/asset-allocation-guide-how-much-risk-should-you-take/

http://www.cbsnews.com/news/asset-allocation-guide-what-is-your-risk-tolerance/

http://www.cbsnews.com/news/asset-allocation-guide-how-much-risk-do-you-need/

[james22]

I also will note that Berkshire doesn't do macro.  Maybe a little bit with their cash hoarding but they primary stay fully invested.

 

Fairfax does do macro and look how well that has turned out.

 

So are we really smarter than Berkshire and Fairfax?

 

I'm hoarding cash until valuations are more attractive.

 

How is that different from Berkshire?