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The Challenges Of Value Investing

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I am a fan of value investing. James Montier wrote an excellent book on the subject that I think would align with your thnking.

The thing about value investing is risk management. No one really knows what direction a share or market will take in the future. If you can buy at 7 times earnings and a yield of 5-6%, your long term risk is much lower than buying a growth stock on 20 times earnings and no yield, merely on the promise of future earnings growth in an uncertain world.

Value nvesting is principly about conserving capital and reducing risk. What is interesting though as Montier shows is that for the long term investor, this approach actually produces much higher returns than chasing growth and momentum plays.

Montier makes an interesting point that 95% of people can't grasp - Risk reduces when a stock has fallen massively.

I still wonder whethere buy and hold is still applicable today. I think after a decade in a secular bear market then it is no wonder everyone is saying the death of equities. This in my eyes is a good sign. I subscribe to the dow theory of 20-30 year bull runs followed by 10-17 year secular bear markets. I think the worst of the equity bear is over. Perhaps we will regress further to low multiples of P/Es on the basis of rising earnings as much as falling share prices before the next boom can take hold.

The best stock/commodity buys I have made are when I feel uncomfortable doing so. When sentiment is low and people think it will be a bad buy. BP recently was a classic value buy. It hit BBC news every night for a month. The worst buys have been when everyone is talking up the stock.

Edited by ringledman

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Good blog post. It is the disconnect between human timescales and investing timescales that is hardest to manage I feel. You can have so many thoughts in between and it would take a very stubborn type to remain constant in the face of adverse moves for periods of years. Best just to go with the flow I say.

Thanks HAM

Agree very much that it would take a very stubborn type to remain constant in the face of adverse moves for years on end. That though is the mantra that a buy, hold and rebalance periodically asset allocation type of person needs to have. A value investor also needs to stick to his guns and trust his/her valuation methods.

As soon as you change tack and follow the heard I can't help but feel you will have missed the exuberance phase (and the big profits) and probably be just in time to catch the decline. Whether it be commodities, equities or houses.

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I am a fan of value investing. James Montier wrote an excellent book on the subject that I think would align with your thnking.

The thing about value investing is risk management. No one really knows what direction a share or market will take in the future. If you can buy at 7 times earnings and a yield of 5-6%, your long term risk is much lower than buying a growth stock on 20 times earnings and no yield, merely on the promise of future earnings growth in an uncertain world.

Value nvesting is principly about conserving capital and reducing risk. What is interesting though as Montier shows is that for the long term investor, this approach actually produces much higher returns than chashing growth and momentum plays.

Montier makes an interesting point that 95% of people can't grasp - Risk reduces when a stock has fallen massively.

I still wonder whethere buy and hold is still applicable today. I think after a decade in a secular bear market then it is no wonder everyone is saying the death of equities. This in my eyes is a good sign. I subscribe to the dow theory of 20-30 year bull runs followed by 10-17 year secular bear markets. I think the worst of the equity bear is over. Perhaps we will regress further to low multiples of P/Es on the basis of rising earnings as much as falling share prices before the next boom can take hold.

The best stock/commodity buys I have made are when I feel uncomfortable doing so. When sentiment is low and people think it will be a bad buy. BP recently was a classic value buy. It hit BBC news every night for a month. The worst buys have been when everyone is talking up the stock.

"The thing about value investing is risk management. No one really knows what direction a share or market will take in the future"

Did you see the Hedge funders threatening the Irish Finance Minister with court action and or mass hedge funder withdrawl out of Ireland (purposely to collapse Ireland's banking system) if he let one of the banks go down with it's debts?

They won't put up with risk on their part if their bonuses are threatened - it's all a one-way bet nowadays for the bent City boys!

'They' are now far bigger than countries and have taken us over en masse!

Edited by erranta

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...

The thing about value investing is risk management. No one really knows what direction a share or market will take in the future. If you can buy at 7 times earnings and a yield of 5-6%, your long term risk is much lower than buying a growth stock on 20 times earnings and no yield, merely on the promise of future earnings growth in an uncertain world.

...

100115-4.jpg

http://retirementinvestingtoday.blogspot.com/2010/01/further-reasons-why-i-use-shiller-pe10.html

Hi ringledman

This is the point I try and play on with my cyclically adjusted PE (PE10) "value" investing strategy where I am underweight equities if the PE10 is over valued and vice versa. The chart I've posted (ignore the y-axis label, it is 10 year total real return as per the title) above demonstrates why I follow this strategy as a long term investor. As you say I have no idea whether the market will rise or fall tomorrow however history suggests over a long investment period that if the PE10 is 5 then on average you should make a higher return than if it is 25.

Of course only time will tell if it works.

Edit: Not sure why the chart won't post. It's the fourth chart on the link.

Edited by wish I could afford one

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"The thing about value investing is risk management. No one really knows what direction a share or market will take in the future"

Did you see the Hedge funders threatening the Irish Finance Minister with court action and or mass hedge funder withdrawl (purposely to to collapse Ireland) if he let one of the banks go down with it's debts?

They won't put up with risk on their part if their bonuses are threatened - it's all a one-way bet nowadays for the bent City boys!

'They' are now far bigger than countries and have taken us over en masse!

This type of mainstream thinking is part of the reason I like equities.

Joe bloggs hates the city, hates stocks, thinks every stock is like the banking stocks and confuses the bond debt problems of a country with that of the stockmarket (conversely debt problems are good for the stock market but that is a different argument).

As Buffett says (and does by being thousands of miles away from Wall Street) - buy stocks as businesses and ignore the spin of the market over the years of ownership.

There are many excellent firms out there producing real products to a growing world demand and priced on extremely low valuations. The type of stock to buy and forget about the market spin for the next decade.

Erranta - Contary to popular delusions amongst the uber bears on here, the market is not made up of only financial stocks that reward their employees over shareholders.

Negative sentiment towards stocks amongst virtually everyone I know is a good sign. There is no serious bubble in the stockmarket. The real bubble is in bonds where people have pilled in as reminiscent fo the 2000 equities peak.

Edited by ringledman

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I like to think of myself as a sceptical follower. But anyway - that's enough about me. On what basis would you rebalance your asset allocation? DJIA977's excellent Juggler System does this monthly on the basis of ma's and strength. That is straight 'following' but involves asset re-balancing each month potentially. Do you have a specific process to help you undertake this task?

I follower DJIA's Juggler System with much interest. I personally wouldn't want to be rebalancing every month as I can't help feeling that buy/sell spreads and buying costs would hurt over time potentially leading to underperformance. Although I'm sure DJIA will prove me wrong :)

Personally, I'm still struggling with when to rebalance. I'm not yet convinced of any method but remain sceptical of the simple every year rebalance type idea. At the moment I haven't had to make a decision as my new contributions are still effectively rebalancing for me as I regularly buy into the worst perfoming asset class. The best I've come up with at the moment is to rebalance when the asset class of interest moves 20-25% away from the target allocation however I still haven't settled on that yet.

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This type of mainstream thinking is part of the reason I like equities.

...

I like equities (Emerging, UK and International), gold (sorry I've gone and said it), bonds and commercial property plus moving exchange rates (the more wild the better). I particualrly like the fact that they all have different correlations with each other (particularly gold with equities). Gives me a chance to be selling one asset class "high" while buying another "low".

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I agree - nice blog post. I think one solution is to have ranges of allocation for each of the major asset classes. Let's say you follow Harry Browne's approach and have a base allocation of 25% each in stocks, bonds, cash and gold then when the market looks expensive as in 1997 maybe the stock allocation drops to 15%. You will still make money out of the bubble at which point you might lower the share of stocks to 10%. Then the crash won't hurt so much.

As for rebalancing the important thing is just to do it and not worry about how often, although don't make it too often or transaction charges will eat into your return. I don't have any hard rules regarding this; it was easier when I was starting out as I would just use new money as the rebalancing element.

I would definitely overweight equities at this point. Dividend yields in most of the developed world are higher than 10 year government bond yields and that hasn't happened much since the 1950s. That's not a prediction that equities will do well just that they will likely fare much better than gov't bonds.

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I agree - nice blog post. I think one solution is to have ranges of allocation for each of the major asset classes. Let's say you follow Harry Browne's approach and have a base allocation of 25% each in stocks, bonds, cash and gold then when the market looks expensive as in 1997 maybe the stock allocation drops to 15%. You will still make money out of the bubble at which point you might lower the share of stocks to 10%. Then the crash won't hurt so much.

...

Hi MP

If you're a fan of Harry Browne you might like this blog http://crawlingroad.com/blog/

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I like equities (Emerging, UK and International), gold (sorry I've gone and said it), bonds and commercial property plus moving exchange rates (the more wild the better). I particualrly like the fact that they all have different correlations with each other (particularly gold with equities). Gives me a chance to be selling one asset class "high" while buying another "low".

I believe in diversification and owning uncorrelated assets. I am extremely light on bonds as I cant seem to find much vaule there.

The downturn though made all assets corrrelated except for the dollar and government bonds. I think over time this situation will change with people realising that the dollar and government bonds are far from being safe havens but infact may turn out to be the riskiest asset to own.

I am looking for real diversification in the likes of precious metals, timber (if I can find a good way in - anyone know?), frontier markets (Vietnam, Zimbabwe, etc - but very small allocation), REITs (but only in Asia), etc.

The days of a 60% equities / 40% bonds asset alloaction are over.

Also I think one needs to be much more international (and truely international not just a bit in USA but also Asia, Africa, Europe, India, South America). The problem is not to buy at high multiples. I am probably 50% invested in Asia/Emerging Markets but not willing to buy back in until valuations fall. Nonetheless over time I think the Western currencies will fall v Asia so returns may be as much from currency moves as dividends or capital rises.

I currently really like Western defensive global blue chips with decent yields. The type of firms that are cheap and produce real products to a world of rising living standards and 3billion more people over the next 30 years. The demand for Western expertise in the Emerging Markets is going to be huge.

Asset alloaction is key. Just buy what is out of favour. Currenltly I would say Vietnam, some Western defensives, Japanese stocks etc.

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In the current market especially, value investment seems to be the best route.

There are plenty of high yielding stocks out there. Vodafone has a yield near 6%, United Utilities 6.6% - there are plenty of opportunities out there like these and compounded over years through reinvested dividends will produce a high return.

You may miss out on the current bull run on growth stocks, commodities or tulip bulbs, but it is a relatively low risk, low stress way of getting an excellent return. Yes, take profits from time to time and keep an eye on the companies, but try to ignore short-term fluctuation in share prices.

I would like to always practice what I preach and sometimes do...I bought an Asian Growth fund in 1997, held it through the Asian crisis and the depressed prices of the past decade. It is now worth 300% of the purchase price. Admittedly I complete forgot I held it until earlier this year, so I had a load of money from nowhere and sold half to pay for some building costs. Just goes to show, long term holds pay out.

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I believe in diversification and owning uncorrelated assets. I am extremely light on bonds as I cant seem to find much vaule there.

...

I too own very few bonds at the moment. What I own is also mostly index linked gilts. I do however have plenty of NS&I Index Linked Savings Certificates. I just wish I could buy more.

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I believe in diversification and owning uncorrelated assets. I am extremely light on bonds as I cant seem to find much vaule there.

Absolutely - but not to the extend of over-diversification and buying stuff you don't have time to research into.

The reason diversification and margin of safety are needed are because things can inherently go wrong, Kraft can decide to pay a pretty high price for CBRY and then some other stuffs come up, government intervention etc. An apparently good CEO can one day decide to do crazy things etc.

Think the core of value investing is margin of safety..

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This type of mainstream thinking is part of the reason I like equities.

Joe bloggs hates the city, hates stocks, thinks every stock is like the banking stocks and confuses the bond debt problems of a country with that of the stockmarket (conversely debt problems are good for the stock market but that is a different argument).

I like a lot of your thinking I just personally believe you are 10 years early. I see very little hatred of stocks. Most people I know still trade them. When I last worked in an office it was Autumn 08 and people were a little confused but they were certain stocks always recover. I pointed out that the a Japanese investor would beg to differ but the belief is the West can perpetually inflate/"grow". Some made good gains on bank shares (some did not). The belief by the sheeple, in my opinion, is still unshaken and they have no clue how bad this is going to get.

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Absolutely - but not to the extend of over-diversification and buying stuff you don't have time to research into.

The reason diversification and margin of safety are needed are because things can inherently go wrong, Kraft can decide to pay a pretty high price for CBRY and then some other stuffs come up, government intervention etc. An apparently good CEO can one day decide to do crazy things etc.

Think the core of value investing is margin of safety..

This is a great thread. Good to talk asset allocation.

I agree totally. Don't over diversify into rubbish investments just to say 'I am diversified'. This is why I don't like bonds. I cant find any value currently.

Isn't 'margin of safety' Buffett's favourite chapter in 'intelligent investor'? Also 'Mr Market' the other, basically ignore the market city spivs until YOU want to sell or buy, not allow the market spin to decide on what you want to do in terms of equity allocation.

Edited by ringledman

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I like a lot of your thinking I just personally believe you are 10 years early. I see very little hatred of stocks. Most people I know still trade them. When I last worked in an office it was Autumn 08 and people were a little confused but they were certain stocks always recover. I pointed out that the a Japanese investor would beg to differ but the belief is the West can perpetually inflate/"grow". Some made good gains on bank shares (some did not). The belief by the sheeple, in my opinion, is still unshaken and they have no clue how bad this is going to get.

Possibly 10 years too early. I question my equity thinking a lot but what is the alternative? Property is 40-50% overvalued, bonds are in the last stage of an epic bubble that must burst in the next couple of years, cash is trash with negative interest rates. Commodities are the only other alternatve in the middle of a secular long term uptrend.

I think it is very difficult for any investor to know currently where to allocate their hard earned savings.

Personally I think I may be 5 years too early on the basis of emperical evidence of how long secular bear markets last. This is why I don't buy the indexes currently and base my equitiy purchases on low P/E and high dividend individual defensive stocks.

Stocks may not be hated but they are far from the 'bubble' that many uber bears ridiculously talk about on here. The ubers stupdlly link any asset that can fluctuate in capital price and believe this is 'high risk', whereas any asset that's capital remains 'fixed' is safe such as cash and capital protected bonds, despite the inflationary risks.

A decade long crash in equities has at least brought equities into reasoably priced territory. With no other well priced asset class except for perhaps commodities these are the only place to be currently as far as I can see......

Edited by ringledman

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Personally, I'm still struggling with when to rebalance. I'm not yet convinced of any method but remain sceptical of the simple every year rebalance type idea. At the moment I haven't had to make a decision as my new contributions are still effectively rebalancing for me as I regularly buy into the worst perfoming asset class. The best I've come up with at the moment is to rebalance when the asset class of interest moves 20-25% away from the target allocation however I still haven't settled on that yet.

The problem with rebalancing like this as far as I can see is;

1) When an asset class goes on a boom it rises a lot more than 20-25% before its peak.

2) Asset booms last a lot longer than on a yearly basis. Why then re-allocate yearly when you will be merely replacing the booming asset class with one that may still be in a long term downturn?

Personally I belive in a re-balancing based on mathematical valuation (i.e what is the P/E , yield, price to dow ratio, etc, compared to the historical average) than any mechanical method that totally ignores the facts and fundamentals representing each asset class.

Edited by ringledman

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The problem with rebalancing like this as far as I can see is;

1) When an asset class goes on a boom it rises a lot more than 20-25% before its peak.

2) Asset booms last a lot longer than on a yearly basis. Why then re-allocate yearly when you will be merely replacing the booming asset class with one that may still be in a long term downturn?

Personally I belive in a re-balancing based on mathematical valuation (i.e what is the P/E , yield, price to dow ratio, etc, compared to the historical average) than any mechanical method that totally ignores the facts and fundamentals representing each asset class.

This may be true in some cases and not in others and it is never possible to know if something is in a continued boom or will turn as soon as you invest in it. Gold spiked higher in 1993 but then went nowhere before drifiting to its low late in the decade and there were just as many goldbugs around in 93 as at any time.

Rebalancing is always a good idea due to this kind of uncertainty, it takes excess risk out of the portfolio, and to some extent you are always buying low and selling high.

I do agree with basing it on expected return rather than a forever fixed asset allocation (which should change by age anyway). 2008-9 threw up all kinds of interesting situations. Just looking at bonds alone: nominal bond yields dropped but TIPS and index linked gilts yields soared due to the deflation threat. All of a sudden you could get over a 3% real yield on 10 year TIPS which argued for a large over allocation in these and that "bet" has paid off as they now yield 0.75%.

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If its a system, its programmable.

how do you guys view competing with plugged in HFT systems?

what do you do about stop losses inadvertently kicking in in seconds, or milliseconds?

or, dont you need to?

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Possibly 10 years too early. I question my equity thinking a lot but what is the alternative? Property is 40-50% overvalued, bonds are in the last stage of an epic bubble that must burst in the next couple of years, cash is trash with negative interest rates. Commodities are the only other alternatve in the middle of a secular long term uptrend.

I think it is very difficult for any investor to know currently where to allocate their hard earned savings.

Personally I think I may be 5 years too early on the basis of emperical evidence of how long secular bear markets last. This is why I don't buy the indexes currently and base my equitiy purchases on low P/E and high dividend individual defensive stocks.

Stocks may not be hated but they are far from the 'bubble' that many uber bears ridiculously talk about on here. The ubers stupdlly link any asset that can fluctuate in capital price and believe this is 'high risk', whereas any asset that's capital remains 'fixed' is safe such as cash and capital protected bonds, despite the inflationary risks.

A decade long crash in equities has at least brought equities into reasoably priced territory. With no other well priced asset class except for perhaps commodities these are the only place to be currently as far as I can see......

I think this is the point of the crash that comes at the end of a credit expansion cycle, and I think this is the stance of the uber bear. The belief is (that I still share atm) is we are at the end of a huge credit cycle. So much money has been created in the preceding years that it is chasing real yields into negative territory. We will stay in this trap until the imbalances are addressed, either 10-20 years of Japanese style grinding collapse, if lucky, or if money is destroyed (the natural and essential part of any bust) over 5 years in a dramatic crash.

It looks like we are heading for the former but because I am young I would prefer the later. In either scenario I can see tough times ahead for equities.

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My ears were burning WICAO.

The rebalancing every month aspect you talk about isn't exactly true in my system. Although there is a monthly review to see if any asset classes should be rotated out of due to recent changes in relative strength, the actual fine-tuning element of rebalancing only needs to take place every 6 or 12 months. Over 6 years there's only been 22 positions opened using my system to fill the 4 portions of the portfolio.

Hi cannedfish

Apologies for the confusion. It's good news that there has only been less than 4 individual asset rebalancing acts per year on average. That gives even more weight to your method.

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The problem with rebalancing like this as far as I can see is;

1) When an asset class goes on a boom it rises a lot more than 20-25% before its peak.

1. Yes that is possible but for me asset allocation is also about balancing risk versus return. The method I am following is almost tortoise versus hare where I am the tortoise. On average I am looking for a return of 4% + inflation over the long term. Also I'm not considering a 20-25% rise in the asset class but a 20-25% change in my asset allocation. So if for example I have 20% UK Equities then I rebalance when it has grown to 25%. Therefore if all asset classes rise together in a boom there is much more growth than 20-25% before a reallocation. That is then one of the negatives as potentially you are holding a portfolio which is over valued everywhere. However hopefully I partially correct that by increasing or decreasing my target equity allocations based on the PE10.

2) Asset booms last a lot longer than on a yearly basis. Why then re-allocate yearly when you will be merely replacing the booming asset class with one that may still be in a long term downturn?

2. I also personally can't see how rebalancing based on a date is the best method. However I guess it is a method that manages risk by not allowing any asset class to get out of control. Probably also good for people who have no interest in their personal finance as you just set the calender and wake up in 12 months (or whatever period you have set). I'm still struggling to find the right method and to use asset class % movement from target seems a little more logical to me than a fixed date in time which is why I'm heading in that direction. I'm sure it's also not the perfect method either.

Personally I belive in a re-balancing based on mathematical valuation (i.e what is the P/E , yield, price to dow ratio, etc, compared to the historical average) than any mechanical method that totally ignores the facts and fundamentals representing each asset class.

Yes but what is your mechanical method to take all the emotion out of it? I'm contributing a lot per month into my portfolio and so I am also pseudo rebalancing by buying into the lowest performing asset class. That has prevented me from having to take an active rebalancing decision yet. I'm also changing my target equity allocation based on the PE10 valuation.

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If its a system, its programmable.

how do you guys view competing with plugged in HFT systems?

what do you do about stop losses inadvertently kicking in in seconds, or milliseconds?

or, dont you need to?

You can't and you don't need to. Remember that chess game between the russian chess expert (can't remember his name) and Big Blue - he opted for simplicity

and won some games. HFT can screw up big time (like the flash crash), and then it will be time to get in.

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  • 259 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


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