Speculative Rebalancing

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jsnikeris
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Speculative Rebalancing

Post by jsnikeris » Fri Aug 14, 2015 3:30 pm

After reviewing some of the literature on market valuation, it seems to me that the stock market is currently overpriced. I'm aware that an orthodox PP implementation eschews speculation of any kind, but how bad of an idea would it be to tactically underweight an asset class while still remaining within the traditional 15-35 bands? Let's take taxes and transaction costs out of the equation for the purposes of this discussion.
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Re: Speculative Rebalancing

Post by stuper1 » Fri Aug 14, 2015 3:59 pm

What does the literature suggest on the current valuation of gold and long-term bonds?
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Re: Speculative Rebalancing

Post by jsnikeris » Fri Aug 14, 2015 5:59 pm

stuper1 wrote: What does the literature suggest on the current valuation of gold and long-term bonds?
I take your point to be that in order to underweight stocks, the money needs to be allocated elsewhere. If one doesn't know how to value the alternatives to stocks, who's to say that they aren't even more overpriced than stocks are? If so, touch�.

I'm curious to know why you didn't also mention the value of cash. Is it because it doesn't really make sense to say that cash is overpriced or underpriced?

For what it's worth, I'm thinking about holding a slightly higher cash allocation (30%) and a slightly lower stock allocation (20%).
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Re: Speculative Rebalancing

Post by stuper1 » Fri Aug 14, 2015 6:05 pm

My point is just that nobody really knows which components are overvalued or undervalued at this time, or almost at any time.  From what little I've read recently, I wouldn't say that there is a consensus that the stock market is overvalued.  Holding more cash is almost always a less risky proposition, but comes at the sake of forgoing possible gains.
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Re: Speculative Rebalancing

Post by Stewardship » Fri Aug 14, 2015 6:11 pm

jsnikeris wrote: After reviewing some of the literature on market valuation, it seems to me that the stock market is currently overpriced. I'm aware that an orthodox PP implementation eschews speculation of any kind, but how bad of an idea would it be to tactically underweight an asset class while still remaining within the traditional 15-35 bands? Let's take taxes and transaction costs out of the equation for the purposes of this discussion.
Some may be confident that they don't need their portfolio to protect them in times of prosperity.  Afterall, making ends meet or earning a higher income is often easier during times of prosperity.

Others could have trouble coping with a losing portfolio during times when everyone else is making lots of money.

So I guess the question is do you want an all-weather portfolio or more of a rainy-weather portfolio?
In a world of ever-increasing financial intangibility and government imposition, I tend to expect otherwise.
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Re: Speculative Rebalancing

Post by jsnikeris » Fri Aug 14, 2015 6:32 pm

Stewardship wrote: So I guess the question is do you want an all-weather portfolio or more of a rainy-weather portfolio?
Well, when it Looks Like Rain, I want a rainy-weather portfolio.

Image
Last edited by jsnikeris on Fri Aug 14, 2015 6:39 pm, edited 1 time in total.
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Re: Speculative Rebalancing

Post by ochotona » Fri Aug 14, 2015 6:46 pm

Exhibit 3 of "The Golden Constant" by Claude B. Erb, Los Angeles, CA 90272 and Campbell R. Harvey, Duke University, Durham, NC 27708 and National Bureau of Economic Research, Cambridge, MA pretty much tells me that you don't want to pay more than 2x the Consumer Price Index for gold. You can find this paper posted on the Internet. I found a link on this forum in a recent gold thread. If you pay much more than 2x CPI, you risk having 0% real return over the next decade. 2x CPI is about $430. Therefore, I am way underweight gold now. I have some, but really a token amount. If I can't get it for the price I want it for, I'll pass this lifetime.Maybe I missed my chance in 2001. Maybe not.

Should you underweight stocks? Well, the PP is perpetually underweight stocks, from the point of view of conventional investing, a 25% stock allocation is OK for a very risk averse or elderly person. So I would not do that.

Treasuries? It certainly is a puzzle what interest rates may do. We've ended a 35 year bull market in bonds, but maybe we just stay in a trading range for a while and bang around. I shortened my maturities because I can't stand the noise, and the extra coupon does not make it worth my while.

So my opinion is shorten maturities, underweight gold. I like the PP, but not sure if it's the right time to get in. Maybe in a few years. It's a good retirement allocation at the right gold price, that's 10 years off for me yet.
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Re: Speculative Rebalancing

Post by craigr » Fri Aug 14, 2015 7:00 pm

jsnikeris wrote: After reviewing some of the literature on market valuation, it seems to me that the stock market is currently overpriced. I'm aware that an orthodox PP implementation eschews speculation of any kind, but how bad of an idea would it be to tactically underweight an asset class while still remaining within the traditional 15-35 bands? Let's take taxes and transaction costs out of the equation for the purposes of this discussion.
I've never seen market timing work consistently for anyone. They get some lucky streaks, but eventually the luck ends.

For those that are nervous about letting things alone, I generally recommend just using lower rebalancing bands of 20/30 instead of 15/35 for the asset slices. You could also "over-rebalance" by selling an asset down to say 20% instead of 25% as you are implying if you really feel like it. But taking it below 20% I don't know about just based on my experience.

Just remember that at any point in time you can find research that will support your own biases. I have seen this over and over and over and over and over again. One year bonds are doing great and the news media finds pundits talking about the coming depression as to why they will do well going forward. Then another year gold is doing great and the guys come out of the woodwork with their $10,000 an ounce predictions. Stocks doing well always brings out the guys talking about leveraging, etc. to make more dough.

Really I've seen it all and it should just be ignored. I've made far more money ignoring market predictions than I have by following them. A mechanical rebalancing strategy just works better. It protects you from taxes, transaction fees, worrying about the latest news, and waking up in the morning and seeing something in the news overnight that causes big drama because you bet wrong.

So no, I don't think speculative rebalancing is a good idea for your core portfolio. It is perfectly fine though if you want to take some money you can afford to lose and wager it that way.
Last edited by craigr on Fri Aug 14, 2015 7:02 pm, edited 1 time in total.
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Re: Speculative Rebalancing

Post by LC475 » Fri Aug 14, 2015 8:15 pm

jsnikeris wrote: I'm thinking about holding a slightly higher cash allocation (30%) and a slightly lower stock allocation (20%).
Well, cash is a conservative investment.  One of Harry Browne's rules was that it's best to err on the side of safety.  That is, better to be safe then sorry.

So, might you miss out on some returns from stocks if you only have 20% stocks?  Yes.  But, are those extra percentage points worth the sleepless nights and mental agony?  If you are really convinced that a crash is probably coming soon, wouldn't it be better to lower the allocation and be able to relax?

I think that it would be.

What's more, the performance of 25/25/20/30 is going to be very close to that of a 25/25/25/25 portfolio.  You get the benefit of the Permanent Portfolio, but with less heartburn for you, personally.

If that is going to be what you're most comfortable with, I would recommend that you go for it.  Then, in a year, re-examine the situation.  If the crash has happened, consider buying back in at the lower price.  If it hasn't, decide if the factors leading you to believe a crash is coming are still true, or whether you have changed your mind and it's time to re-balance up to 25%.
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Re: Speculative Rebalancing

Post by ochotona » Fri Aug 14, 2015 10:56 pm

You won't regret being 5% cash heavy until you and the world economy can decide what to do... you can always spend it later. Other things may go on sale.

LC475 wrote:
jsnikeris wrote: I'm thinking about holding a slightly higher cash allocation (30%) and a slightly lower stock allocation (20%).
Well, cash is a conservative investment.  One of Harry Browne's rules was that it's best to err on the side of safety.  That is, better to be safe then sorry.

So, might you miss out on some returns from stocks if you only have 20% stocks?  Yes.  But, are those extra percentage points worth the sleepless nights and mental agony?  If you are really convinced that a crash is probably coming soon, wouldn't it be better to lower the allocation and be able to relax?

I think that it would be.

What's more, the performance of 25/25/20/30 is going to be very close to that of a 25/25/25/25 portfolio.  You get the benefit of the Permanent Portfolio, but with less heartburn for you, personally.

If that is going to be what you're most comfortable with, I would recommend that you go for it.  Then, in a year, re-examine the situation.  If the crash has happened, consider buying back in at the lower price.  If it hasn't, decide if the factors leading you to believe a crash is coming are still true, or whether you have changed your mind and it's time to re-balance up to 25%.
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Re: Speculative Rebalancing

Post by Stewardship » Sat Aug 15, 2015 4:06 am

jsnikeris wrote:
Well, when it Looks Like Rain, I want a rainy-weather portfolio.

Image
Understood.  So that chart makes it look like rain to you?
In a world of ever-increasing financial intangibility and government imposition, I tend to expect otherwise.
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Re: Speculative Rebalancing

Post by Desert » Sat Aug 15, 2015 7:31 am

ochotona wrote: Exhibit 3 of "The Golden Constant" by Claude B. Erb, Los Angeles, CA 90272 and Campbell R. Harvey, Duke University, Durham, NC 27708 and National Bureau of Economic Research, Cambridge, MA pretty much tells me that you don't want to pay more than 2x the Consumer Price Index for gold. You can find this paper posted on the Internet. I found a link on this forum in a recent gold thread. If you pay much more than 2x CPI, you risk having 0% real return over the next decade. 2x CPI is about $430. Therefore, I am way underweight gold now. I have some, but really a token amount. If I can't get it for the price I want it for, I'll pass this lifetime.Maybe I missed my chance in 2001. Maybe not.

Should you underweight stocks? Well, the PP is perpetually underweight stocks, from the point of view of conventional investing, a 25% stock allocation is OK for a very risk averse or elderly person. So I would not do that.

Treasuries? It certainly is a puzzle what interest rates may do. We've ended a 35 year bull market in bonds, but maybe we just stay in a trading range for a while and bang around. I shortened my maturities because I can't stand the noise, and the extra coupon does not make it worth my while.

So my opinion is shorten maturities, underweight gold. I like the PP, but not sure if it's the right time to get in. Maybe in a few years. It's a good retirement allocation at the right gold price, that's 10 years off for me yet.
I like that summary.  I think we're converging at a similar destination. 
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Re: Speculative Rebalancing

Post by Desert » Sat Aug 15, 2015 7:39 am

Stewardship wrote:
jsnikeris wrote:
Well, when it Looks Like Rain, I want a rainy-weather portfolio.

Image
Understood.  So that chart makes it look like rain to you?
I have been looking at the CAPE 10 charts recently as well.  Historically, the PE10 has averaged around 17 in the U.S.  With recent accounting rules changes, some believe 19 is a more accurate average.  So at 26, we're in a range where we'd expect lower returns going forward.  That doesn't mean we have to have a 2008-style crash, even though valuations are at about the same level as pre-2008 crash levels.  But reduced returns over the next decade are more likely.  CAPE10 has been shown to have only about 40% correlation with future returns though, so it's a very, very blunt instrument, at best. 

My view is this:  I wouldn't use CAPE 10 to rotate in and out of stock allocations, but I think it's worth a glance if/when one is thinking of changing one's equity allocation. 
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Re: Speculative Rebalancing

Post by Libertarian666 » Sat Aug 15, 2015 8:19 pm

ochotona wrote: Exhibit 3 of "The Golden Constant" by Claude B. Erb, Los Angeles, CA 90272 and Campbell R. Harvey, Duke University, Durham, NC 27708 and National Bureau of Economic Research, Cambridge, MA pretty much tells me that you don't want to pay more than 2x the Consumer Price Index for gold. You can find this paper posted on the Internet. I found a link on this forum in a recent gold thread. If you pay much more than 2x CPI, you risk having 0% real return over the next decade. 2x CPI is about $430. Therefore, I am way underweight gold now. I have some, but really a token amount. If I can't get it for the price I want it for, I'll pass this lifetime.Maybe I missed my chance in 2001. Maybe not.

Should you underweight stocks? Well, the PP is perpetually underweight stocks, from the point of view of conventional investing, a 25% stock allocation is OK for a very risk averse or elderly person. So I would not do that.

Treasuries? It certainly is a puzzle what interest rates may do. We've ended a 35 year bull market in bonds, but maybe we just stay in a trading range for a while and bang around. I shortened my maturities because I can't stand the noise, and the extra coupon does not make it worth my while.

So my opinion is shorten maturities, underweight gold. I like the PP, but not sure if it's the right time to get in. Maybe in a few years. It's a good retirement allocation at the right gold price, that's 10 years off for me yet.
I have no idea what "2x CPI" means. And exactly how long has the CPI been around? Not as long as gold, I suspect.
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Re: Speculative Rebalancing

Post by ochotona » Sat Aug 15, 2015 8:52 pm

Libertarian666 wrote: I have no idea what "2x CPI" means. And exactly how long has the CPI been around? Not as long as gold, I suspect.
CPI is Consumer Price Index. The span of the study was 1975 - Present. The exhibit I referred to plots how much the 10 year ahead real return actually was based on how much the investor paid for gold as a multiple of the CPI. It shows pretty clearly that it is very easy to pay too much for gold. Gold is great if you get it on sale, and very terrible if you get at high prices, and right now it's still too high priced.
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Re: Speculative Rebalancing

Post by sophie » Mon Aug 17, 2015 12:39 pm

Before you go and muck with your portfolios, you might want to read this book:

http://www.amazon.com/Best-Laid-Investm ... uckgo-d-20

It contains the most intelligent debunking of various market timing strategies you'll find anywhere - including the ones brought up in this thread.

To respond to the OP's original question - if you are getting antsy about the stock market and want to rebalance now, then go right ahead if it will make you more comfortable.  I've been debating the same since I'm close to a rebalance band in stocks anyway.  But any strategy that involves deliberately modifying the allocation as an attempt to time the market is essentially a PP plus some speculation.  Nothing wrong with that, but do recognize it for what it is.

It's also kind of nice that the PP has a built-in panic button (i.e. rebalancing) that lets you feel like you're doing something to protect yourself while not actually letting you dig yourself into a pile of trouble.
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Re: Speculative Rebalancing

Post by Libertarian666 » Wed Aug 19, 2015 6:22 am

ochotona wrote:
Libertarian666 wrote: I have no idea what "2x CPI" means. And exactly how long has the CPI been around? Not as long as gold, I suspect.
CPI is Consumer Price Index. The span of the study was 1975 - Present. The exhibit I referred to plots how much the 10 year ahead real return actually was based on how much the investor paid for gold as a multiple of the CPI. It shows pretty clearly that it is very easy to pay too much for gold. Gold is great if you get it on sale, and very terrible if you get at high prices, and right now it's still too high priced.
So the time span it covers is insignificant compared to the amount of time that gold has been a valuable asset class, and includes only the US, which is far from representative.

In other words, it is worthless. The study, that is, not gold.
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Re: Speculative Rebalancing

Post by jsnikeris » Mon Aug 24, 2015 10:37 am

Anybody else feeling good about being light on stocks?  :)

Now, I just need to figure out how to not let this luck go to my head...
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Re: Speculative Rebalancing

Post by Libertarian666 » Mon Aug 24, 2015 11:20 am

jsnikeris wrote: Anybody else feeling good about being light on stocks?  :)

Now, I just need to figure out how to not let this luck go to my head...
Me, me, me!
However, it is unlikely to go to my head, because I almost never change my allocations, and have no intention of doing that now...
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Re: Speculative Rebalancing

Post by frugal » Mon Aug 24, 2015 4:32 pm

Hi,

rebalancing once a year is still probably the best option?


Regards!
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Re: Speculative Rebalancing

Post by blackomen » Tue Aug 25, 2015 9:59 am

I'll admit I sometimes engage in speculative rebalancing if the asset over 30% is overbought or under 20% is oversold..  but I'll still respect the rebalancing bands and manually rebalance at 15/35.
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Re: Speculative Rebalancing

Post by Xan » Tue Aug 25, 2015 10:55 am

I think as long as you're within the rebalancing bands, you have a PP, and there's nothing particularly wrong with rebalancing any time you feel like it.  I might even go so far as to say it's "okay" to aim for a different allocation for a while, as long as you're within the bands.  You need to be willing to admit that doing so may be just as likely to cost you money as make you money.  But you're still well within the PP framework, and still have the protection that affords.

I don't do it myself, because I have zero trust in my ability to predict what's going to happen next.  Even if I do get it right, I'll get it right until I don't, and my gains would go poof.  But I bet there are some folks who would sleep better if they played these games, and I'd be hesitant to say they were wrong to do it.
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Re: Speculative Rebalancing

Post by Jack Jones » Tue Aug 25, 2015 3:07 pm

Xan wrote: I think as long as you're within the rebalancing bands, you have a PP, and there's nothing particularly wrong with rebalancing any time you feel like it.  I might even go so far as to say it's "okay" to aim for a different allocation for a while, as long as you're within the bands.  You need to be willing to admit that doing so may be just as likely to cost you money as make you money.  But you're still well within the PP framework, and still have the protection that affords.
Yeah this is how I feel as well. The only caveat being that "rebalancing any time you feel like it" can be costly in terms of transaction costs.
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