Uncharted Waters?

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stpeter
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Uncharted Waters?

Post by stpeter » Sun Feb 08, 2015 8:13 pm

While reading the latest weekly market comment  from John Hussman - http://www.hussmanfunds.com/wmc/wmc150209.htm - I came across this sobering paragraph:

[quote]
By our estimates, never in history, prior to the past 5 weeks, have the prospective 10-year nominal annual total returns of both stocks and Treasury bonds been below 2% at the same time. We currently project a 10-year nominal annual portfolio total return averaging only about 1.7% annually for anything close to a standard portfolio mix of equities, bonds and cash – regardless of how much diversification one has within each of those asset classes. 
[quote]

Yikes! Yes yes, I realize, no one can predict the future, but I do tend to agree that prospective returns look awful. Maybe gold will come through for us. :-)
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Re: Uncharted Waters?

Post by Tyler » Sun Feb 08, 2015 9:13 pm

Hussman is a reliable permabear.  It's when he predicts great market growth that you know we're truly in uncharted waters. 

In any case, it's important not to look at individual returns in isolation.  Stocks and bonds can both post a 10-year average return of ZERO percent and one can still turn a nice profit if the ride is volatile enough and you reliably move money between the two at rebalancing bands.  Throw in some gold for a third uncorrelated asset and it gets even better.  This is why we diversify and rebalance.  The Permanent Portfolio performance is greater than the sum of its parts.
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Re: Uncharted Waters?

Post by Pointedstick » Sun Feb 08, 2015 10:03 pm

The waters are always uncharted. That's why we're on them.
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Re: Uncharted Waters?

Post by MachineGhost » Mon Feb 09, 2015 9:40 am

Tyler wrote: Hussman is a reliable permabear.  It's when he predicts great market growth that you know we're truly in uncharted waters. 
He's not a reliable permabear.  He royally screwed up in deciding to make sure his investment model was robust to the Great Depression experience during late 2008 exactly just as he was preparing to buy stocks.  Did anyone else but Buffett even call a bottom in that time frame?  As a consequence, he missed the 2009-2011 rally from being overly conservative and the eventual model changes to reduce the 80%+ maximum drawdown of the Great Depression also lopped off the 2011-2015 period of historically unprecedented extreme speculation from QEternity that he only declared finally solved in the middle of 2014 (with a technical risk overlay).  So the whole situation is not a simple hand waving away of the alarming historical evidence by calling him a convenient falsehood.  Context matters.  He was fully bearish post-2007, fully bullish from 2003 to 2007 and fully bearish from the late 1990's to 2003.  Does that strike you as a broken clock "permabear"?

The major difference between Hussman and other true perma-bears is Hussman uses a quantitative model; the others are subjective ideologue hucksters that couldn't time the market if their life depended on it (Dent, Schiff, Prechter, Weiss, etc.).

I've said it before that if Hussman cannot pull it off (publically), there is no hope for market timing and the "dumb model" PP will be the only strategy that will work, at least until the unforseen consequence hits the PP.  Fortunately, I think the biggest admission Hussman has made from the experience was that valuation and sentiment do not matter except in the very long-term of 10+ years via mean reversion.  Technicals rule supreme.  It's only when technicals go negative that bad valuation and bad sentiment can add tremendous insult to injury.  That is coming and in all likely after we take out the 2000 record for extremism (about 15% more from here).  People just do not learn.

Image
Last edited by MachineGhost on Mon Feb 09, 2015 9:52 am, edited 1 time in total.
"All generous minds have a horror of what are commonly called 'Facts'. They are the brute beasts of the intellectual domain." -- Thomas Hobbes

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Re: Uncharted Waters?

Post by Gosso » Mon Feb 09, 2015 10:11 am

I'll suggest the work by Jesse Livermore (this is a pseudonym to protect his day job) who dives deep into the reliability of valuation models.  His general conclusions are that valuation models are curve-fitted and of little value.

Here is one graph that shows out-of-sample data for the Hussman model:

Image

The model is essentially useless.  When it predicts sub 5% returns over the next 10 years the actual returns were typically 10-20%, that is a MASSIVE error.

Here are a few relevant posts from Livermore (they are quite wonky):

A Critique of John Hussman’s Chart of Estimated Future Equity Returns

Valuation and Stock Market Returns: Adventures in Curve Fitting

All of Jesse's work is great and I highly recommend it, although a strong cup/pot of coffee might be needed to get through a few of his longer posts.
Last edited by Gosso on Mon Feb 09, 2015 8:55 pm, edited 1 time in total.
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Re: Uncharted Waters?

Post by MachineGhost » Mon Feb 09, 2015 4:00 pm

Gosso wrote: All of Jesse's work is great and I highly recommend it, although a strong cup/pot of coffee might be needed to get through a few of his longer posts.
To quote Bill and Ted, "Excellent!"  Although the "Hussmann Model" referenced isn't actually the proprietary model that Hussman uses for his unitholders (it is used as a simple model for public illustrative purposes), I think this sums it up best about "macro" valuation models:
http://www.philosophicaleconomics.com/2014/06/sixpercent/ wrote:Now–and this is the key takeaway–every single forecasting method in existence that purports to use valuation to accurately predict point-to-point equity market returns in U.S. historical data exploits this same trick.  The data set that we’re working with, covering the U.S. equity market from 1871 to 2014, contains significant variability in the average valuations and average rates of return that it exhibits.  That variability can be dampened by limiting the analysis to very large time horizons and by using Shillerization, but it can’t be eliminated. It’s been especially pronounced in the last two decades, with valuations having migrated to what might otherwise be described as a “permanently high plateau.”?  Given this migration, any model that attempts to predict returns in the data set on the basis of a normal rate of return is bound to produce significant errors, even when the returns are Shillerized.  The only way for the predictions of the model to fit with the actual results in the presence of the errors is for the errors to cancel.  When you see a tight fit, that’s always what’s happening.

When a person sits behind a computer and sifts through different configurations of a model (different prediction time horizons, different mean valuations, different growth rate assumptions, different date ranges for testing, etc.) to find the configuration in which the predictions best “fit”? with the actual subsequent results, that person is unwittingly “selecting out”? the configuration that, by chance, happens to best achieve the necessary cancellation of the model’s errors.  The result ends up being inherently biased. For this reason, we should be deeply skeptical of models that claim to reliably predict returns in historical data on the basis of successful in-sample testing.  We should judge them not by the superficial accuracy of their fits (an accuracy that is almost always engineered), but by the accuracy of their underlying assumptions.

Mean-reversion methods make the assumption that non-cyclical valuation metrics will eventually fall from their “permanently high plateaus”? of the last two decades down to their prior long-term averages–with respect to the the Shiller CAPE, the assumption is that the metric is going to fall from 26.5 to 17.  Is that assumption going to prove true? Forget the curve-fits, forget the backtests, forget the data-mining, and just examine the assumption itself.  If it’s going to prove true, and if the normal return would otherwise be 6% real, then the actual return will be 1.4% real. If it isn’t going to prove true, then the return will be something else.

...

Now, to be clear, I’m not saying that valuation doesn’t matter.  Valuation definitely matters–its power as a return factor has been demonstrated in stock markets all over the world.  Holding other factors constant, if you buy cheap, you’ll do better, on average, than if you buy expensive.  This is true whether we’re talking about individual stocks, or the aggregate market.

What I’m taking issue with is the notion that we can use valuation to build “historically reliable”? prediction models whose specific predictions closely align with actual past results, models that give us warrant to attach special “scientific”? or “empirical”? privilege to our bullish or bearish opinions.  That, we cannot do.  Given the significant variability in the historical data set, the best we can do is mine curve-fits whose errors conveniently offset and whose deviations conveniently disappear.  These are not worth the effort.

In the end, valuation metrics are only capable of giving us a crude idea of what future returns will be.  In the present context, they can tell us what we already know and accept: that future real returns will be less than the 6% historical average (a perfectly appropriate outcome that we should expect at equilibrium, given the secular decline in interest rates and the below-average implied returns on the assets that most directly compete with equities: cash and bonds). But they can’t tell us much more. They can’t arbitrate the debate between those of us who expect, say, 3% real returns for U.S. equities going forward, and who therefore judge the market to be fairly valued (relative to cash at a likely negative long-term real return), and those of us who expect negative real returns for equities, and who therefore find the market to be egregiously overvalued.  The reason valuations can’t arbitrate that debate is that they don’t reliably mean-revert.  If they did, we wouldn’t be having this discussion.
Last edited by MachineGhost on Mon Feb 09, 2015 4:05 pm, edited 1 time in total.
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Re: Uncharted Waters?

Post by babysquirrel » Mon Feb 09, 2015 8:31 pm

To quote Bill and Ted, "Excellent!"

Actually that was Wayne and Garth there Mr. Know-It-All...
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Re: Uncharted Waters?

Post by Gosso » Mon Feb 09, 2015 8:59 pm

MachineGhost wrote: To quote Bill and Ted, "Excellent!"
Ha!  I figured Mr. Livermore's work would be right up your alley.
babysquirrel wrote: To quote Bill and Ted, "Excellent!"
Actually that was Wayne and Garth there Mr. Know-It-All...
Uh oh, I smell another flame war coming on.  :P
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Re: Uncharted Waters?

Post by l82start » Mon Feb 09, 2015 9:54 pm

i don't like uncharted waters,  had a terrible boating accident in uncharted waters...
  i get especially nervous if i see people heading into them hauling diving gear ...  ;)
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Re: Uncharted Waters?

Post by Dieter » Mon Feb 09, 2015 11:14 pm

"Be excellent to each other....and....PARTY ON, DUDES!"
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Re: Uncharted Waters?

Post by MachineGhost » Tue Feb 10, 2015 8:36 am

babysquirrel wrote: To quote Bill and Ted, "Excellent!"

Actually that was Wayne and Garth there Mr. Know-It-All...
Actually it was both, buttwipe. ;)
Bill: Ted, while I agree that, in time, our band will be most triumphant. The truth is, Wyld Stallyns will never be a super band until we have Eddie Van Halen on guitar.

Ted: Yes, Bill. But, I do not believe we will get Eddie Van Halen until we have a triumphant video.

Bill: Ted, it's pointless to have a triumphant video before we even have decent instruments.

Ted: Well, how can we have decent instruments when we don't really even know how to play?

Bill: That is why we NEED Eddie Van Halen!

Ted: And THAT is why we need a triumphant video.

Bill, Ted: EXCELLENT!

[air guitar, the clock chimes 8:00 am]

Bill: Uh oh, we're late!

Ted: For what?

Bill: For school, dude!

Ted: Oh yeah.
Last edited by MachineGhost on Tue Feb 10, 2015 8:39 am, edited 1 time in total.
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Re: Uncharted Waters?

Post by MachineGhost » Tue Feb 10, 2015 9:28 am

BTW, Hussman never modified his valuation model during his 5-year Mr. Fix It slog.  He does seem to be aware of the tracking error of the model's 10-year outlook, but justifies it by saying the gap reflects over/under-sentiment extremes from what is "historically normal".

In the end, I have to ask...  couldn't a simple 200-day MA have done the job better than paying Hussman almost 1% a year in fees and continously losing due to the cost of hedging for 5-years?  What difference does it make if a downtrend is accompanied by overvaluation or extreme sentiment or not?  A downtrend is a downtrend; get the hell out!!!
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Re: Uncharted Waters?

Post by I Shrugged » Wed Feb 11, 2015 3:31 pm

OK, the Hussman calculus goes to what I was mentioning a few weeks ago.  With only half of the PP assets being of a type that beats inflation in the long run, and with the yields and prices being what they are, there is no way in heck a PPer should be counting on more than about 2% real over the coming years.
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Re: Uncharted Waters?

Post by MachineGhost » Wed Feb 11, 2015 5:53 pm

I Shrugged wrote: OK, the Hussman calculus goes to what I was mentioning a few weeks ago.  With only half of the PP assets being of a type that beats inflation in the long run, and with the yields and prices being what they are, there is no way in heck a PPer should be counting on more than about 2% real over the coming years.
I think you're confused.  All assets of the PP beat inflation in the long run, but not in the short run.  When disinflation/deflation and low nominal interest rates is a predominate theme such as in Japan, real returns are higher than economic growth. 
Last edited by MachineGhost on Wed Feb 11, 2015 5:55 pm, edited 1 time in total.
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Re: Uncharted Waters?

Post by I Shrugged » Wed Feb 11, 2015 6:08 pm

Gold matches inflation.  "You can buy the same suit" and all that.  How can it be otherwise, other than for shorter term ups and downs?
Cash matches inflation over the long term, according to studies by, or published by, John Bogle.
Both make perfect sense to me.
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Re: Uncharted Waters?

Post by MachineGhost » Wed Feb 11, 2015 6:14 pm

I Shrugged wrote: Gold matches inflation.  "You can buy the same suit" and all that.  How can it be otherwise, other than for shorter term ups and downs?
Cash matches inflation over the long term, according to studies by, or published by, John Bogle.
Both make perfect sense to me.
My bad.  Gold has no real return, but T-Bills have a .1% real return.  Nitpicking.
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Re: Uncharted Waters?

Post by stuper1 » Wed Feb 11, 2015 7:40 pm

I Shrugged wrote: OK, the Hussman calculus goes to what I was mentioning a few weeks ago.  With only half of the PP assets being of a type that beats inflation in the long run, and with the yields and prices being what they are, there is no way in heck a PPer should be counting on more than about 2% real over the coming years.
Do you have a better recipe to suggest?
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Re: Uncharted Waters?

Post by ochotona » Wed Feb 11, 2015 7:53 pm

2% real return would be better than another late 2008 - early 2009 scenario, especially for someone near or in retirement.
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Re: Uncharted Waters?

Post by Alanw » Wed Feb 11, 2015 10:17 pm

ochotona wrote: 2% real return would be better than another late 2008 - early 2009 scenario, especially for someone near or in retirement.
Being in retirement, it is difficult trying to decide asset allocation to have some income but not risk principal reduction. Your basic choices are stocks, bonds, cash and hard assets. None look real enticing at the moment. If you don't like gold, maybe real estate.  Go all cash and hope for deflation?  Bonds may be in a bubble?  Stocks overvalued?  Maybe just hold your nose and spread across all asset classes. Like everyone else, I'm not sure what to do. But I guess that could be said about any other point in time.  On the bright side, I have assets to work with. Some folks in or nearing retirement may have much larger issues.
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Re: Uncharted Waters?

Post by sophie » Thu Feb 12, 2015 8:08 am

Alanw wrote: Being in retirement, it is difficult trying to decide asset allocation to have some income but not risk principal reduction. Your basic choices are stocks, bonds, cash and hard assets. None look real enticing at the moment. If you don't like gold, maybe real estate.  Go all cash and hope for deflation?  Bonds may be in a bubble?  Stocks overvalued?  Maybe just hold your nose and spread across all asset classes. Like everyone else, I'm not sure what to do. But I guess that could be said about any other point in time.
Well said sir!!!!

When I go to add more money to the PP these days I'm confronted with the same issue:  nothing looks "safe" to buy.  In retrospect there will have been one asset poised to take off, but lacking a crystal ball, we can't know that right now, and that will always be the case.  In another thread someone mentioned that the direction of the stock market after 2008 was "obvious".  Well, it wasn't obvious - many people were terrified of the market and there were predictions that it would continue to drop, not recover for decades, etc. 

I'm dealing with it using the lagging-asset approach for small contributions.  Large ones still get divided evenly though.  I just kind of make myself do it by being completely mechanical about the whole thing and not checking trends or anything.  I do try to use limit orders rather than market orders because those sometimes do weird things, but that caused an issue a while back when I put in a limit order of TLT and then the next day it took off and hasn't come back to that level yet!
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Re: Uncharted Waters?

Post by barrett » Thu Feb 12, 2015 8:34 am

Alanw wrote: On the bright side, I have assets to work with. Some folks in or nearing retirement may have much larger issues.
Yes, having assets is a big plus! And something will perform but I definitely get what you are saying about income. I only recently read Your Money Or Your Life. Most of the book continues to be relevant today but the investment angle was to put all your money in LTTs. Well, that is still fine if you have several million dollars to park there and don't care about interest rate risk.
sophie wrote: In another thread someone mentioned that the direction of the stock market after 2008 was "obvious".  Well, it wasn't obvious - many people were terrified of the market and there were predictions that it would continue to drop, not recover for decades, etc. 
Yes, how soon people forget, especially if they were young and had no assets invested at that time. Even if we take the position that it was "obvious", when was the obvious jumping in point? 10,000 on the Dow? 8,000? Was the direction still obvious when it was down below 7,000 and people were looking at losses of greater than 50%?

Let's also not forget that the direction of interest rates has been "obvious" for about two decades. If these things are obvious, then someone please tell me where gold and stocks are going from here. Nobody has a clue. To quote The Dwead Piwate Woberts, "Anyone who says differently is selling something."
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Re: Uncharted Waters?

Post by MachineGhost » Thu Feb 12, 2015 9:11 am

Just remember when cash "performs" all three assets are losing gobs of money, so it won't feel like it.  Fortunately that only happens in two situations...  when liquidity dries up or people lose confidence in sovereign debt.  Greece now has 3-year yields of over 20% which hasn't been seen here in the USA since the late 70's.

The PP requires Monetary Realism to work.  If there is a confidence crisis, I don't think we know 100% for sure if people will still have enough confidence in reserve sovereign debt backed by a printing press not to repeat the Iceland experience.  So while diehard PPers may lose a net 25% compared to someone who goes all in gold, you'd still be ahead of 99.99% of everyone else.  You just got to outrun everyone else to win, not the bear!

Also, the PP is about economic environments, not asset classes.  There are more assets available for diversification, including absolute return CD-style, than just the public secondary markets.  I consider that prudent for retirees who need the comfort of capital stability (even if a mirage in the end since when the tide goes out, it all goes out).
Last edited by MachineGhost on Thu Feb 12, 2015 9:22 am, edited 1 time in total.
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Re: Uncharted Waters?

Post by I Shrugged » Thu Feb 12, 2015 3:34 pm

stuper1 wrote:
I Shrugged wrote: OK, the Hussman calculus goes to what I was mentioning a few weeks ago.  With only half of the PP assets being of a type that beats inflation in the long run, and with the yields and prices being what they are, there is no way in heck a PPer should be counting on more than about 2% real over the coming years.
Do you have a better recipe to suggest?
I do not.
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Re: Uncharted Waters?

Post by dragoncar » Thu Feb 12, 2015 10:35 pm

I Shrugged wrote:
stuper1 wrote:
I Shrugged wrote: OK, the Hussman calculus goes to what I was mentioning a few weeks ago.  With only half of the PP assets being of a type that beats inflation in the long run, and with the yields and prices being what they are, there is no way in heck a PPer should be counting on more than about 2% real over the coming years.
Do you have a better recipe to suggest?
I do not.
I'm adding a 5% tilt towards Cinnamon, but Nutmeg is probably a good choice too.  Covers the famine condition.
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Re: Uncharted Waters?

Post by barrett » Fri Feb 13, 2015 7:08 am

dragoncar wrote: I'm adding a 5% tilt towards Cinnamon, but Nutmeg is probably a good choice too.  Covers the famine condition.
That's a very good point. Let's also remember that the long-term expected return of salt is zero. It could over-perform in certain baking conditions but it's basically just a chuck of white stuff that pays no dividends
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