Thought Bubbles from the Deep

[DeepState]

@DeepState, do you use a checklist in your investment activities?

In the past, I tried to avoid the man with a hammer syndrome by talking with people with different hammers. It's much harder in my current (hopefully permanent) position of not being in executive employment. That's where something like ASF can be helpful. There is a genuine ecology of opinion here.

In general, I am no where near as checklist oriented as you appear to be. I think that my current practice is below par on this front at present.

I am going to be building some simple tools to assist in the coming period. These will gather and manipulate data for me and present them in a structured fashion. I can add data and analysis as I evolve what I think might be important to examine. Doing this sort of codifies experience gains. It will be kind of like an assistant analyst with a set work task. This might include some forms of artificial intel and a low level to seek out new or changed relationships and highlight them. These comments are referring to gross features of the markets and the economy at this time. Nothing in super detail. I think detailed work should follow once something interesting has been identified.

If this proves a good way forward, I will do the same with stocks. My list of questions can be automatically answered if numerically available. That doesn't replace the fact that everything needs to actually make sense and that's hard to do on a rules-based basis. All I seek is to be as aware as I can be of issues. Making decisions without awareness is not terribly informed.

 

[DeepState]

Help Sought on a Technical Question:

Does anyone have any views about the relationship between market wide EPS growth and nominal GDP over the longer term for valuation purposes? This figure is useful for long term estimates of market returns.

 

[artist]

Help Sought on a Technical Question:

Does anyone have any views about the relationship between market wide EPS growth and nominal GDP over the longer term for valuation purposes? This figure is useful for long term estimates of market returns.

Professor Robert Shiller (Irrational Exuberance, http://www.econ.yale.edu/~shiller/ ) worked on the "Cyclically adjusted price-to-earnings ratio or CAPE" ( http://en.wikipedia.org/wiki/Cyclically_adjusted_price-to-earnings_ratio "Shiller later popularized the 10-year version of Graham and Dodd's P/E as a way to value the stock market.[2][6] Shiller would share the Nobel prize in 2013 for his work in the empirical analysis of asset prices." )

"The Schiller P/E is a more reasonable market valuation indicator than the P/E ratio because it eliminates fluctuation of the ratio caused by the variation of profit margins during business cycles. This is similar to market valuation based on the ratio of total market cap over GDP, where the variation of profit margins does not play a role either." - http://www.gurufocus.com/shiller-PE.php

This site http://www.gurufocus.com/global-market-valuation.php includes Shiller P/E among other things " to provide an overview of the stock market valuations of the 18 largest economies in the world. The indicator we use is still the percentages of the total market caps of these countries over their own GDPs."

This site http://www.philosophicaleconomics.com/2014/08/capehigh/ analyses relationships between Shiller CAPE and EPS (among other things) " . . . I’m going to introduce a schematic that intuitively illustrates why high real EPS growth produces a high Shiller CAPE.".

 

[DeepState]

Professor Robert Shiller...Cyclically adjusted price-to-earnings ratio or CAPE...

Thanks Artist. I do have a lot of affinity for the Shiller CAPE and its variants.

To complete an assessment of expected forward looking return, I need to inflate the adjusted EPS figure by some growth rate that makes sense. In the long run, the upper bound of this figure should not reasonably exceed the expected nominal growth rate of GDP (at least for the domestic component). Usually, it is a margin below this. I was wondering if anyone knows of work done to figure out what a reasonable relationship might be. I have my own beliefs, but I'd prefer stronger data.

 

[DeepState]

Does anyone happen to have a document which explains the construction of the Citigroup Economic Surprise Index in detail?

 

[DeepState]

RBA-speak for "get the hell out of bonds".

Debelle (RBA):

 

[luutzu]

Thanks Artist. I do have a lot of affinity for the Shiller CAPE and its variants.

To complete an assessment of expected forward looking return, I need to inflate the adjusted EPS figure by some growth rate that makes sense. In the long run, the upper bound of this figure should not reasonably exceed the expected nominal growth rate of GDP (at least for the domestic component). Usually, it is a margin below this. I was wondering if anyone knows of work done to figure out what a reasonable relationship might be. I have my own beliefs, but I'd prefer stronger data.

It obviously is beyond me but why are you looking to predict long term market returns based on the relationship between GDP and EPS growth? Why not just look at the market EPS itself instead of going from EPS to GDP then from GDP back to market return, which is essentially what EPS will give you, doesn't it?

EPS is earning per share I take it? So to use GDP to predict market growth, you are thinking of finding the link between market's earnings to GDP, then use GDP forecasts (I'm guessing) to then predict market earnings/returns.

And why earnings per share? Wouldn't earnings alone be better? Say CorpX represents half the market and it splits its shares 5x but still earn the same... wouldn't the EPS be greatly diluted but actually earning is still the same? Earnings figure would control for such non-economic changes while EPS in such cases would give wrong impression.

Ignore me if I don't make sense, just thought I'd asked.

 

[DeepState]

El-Erian, PIMCO, Sept 2014




Pichette, Google, March 2015




....way to go guys. I hear you.

 

[qldfrog]

definitively, just renewing my 1 day per week contract today for a couple of month;
life is good and so interesting.....So much to discover, learn and enjoy

that was my 2c feel good moment, let's share.

 

[DeepState]

Does anyone happen to have a document which explains the construction of the Citigroup Economic Surprise Index in detail?

Sourced elsewhere. Thanks anyway.

 

[galumay]

....way to go guys. I hear you.

Being on a 'gap year' with my little family has been a strong reinforcement of the importance of getting the life balance right!

 

[DeepState]

FOMC release.

GDP downgrade despite oil price decline impact on PCE and limited change to the employment outlook.



Interesting that the dots for longer term equilibrium yield are declining...

From Dec 2014:


To Mar 2015:

 

[DeepState]

I am rethinking my approach to gaining equity exposure. One aspect which is unchanged is that I don't like to be exposed to explosion risk on large asset class exposures.

Any views on stops vs options as a means to protect downside? I am aware that a stop is an option, but you know what I mean.

 

[skyQuake]

I am rethinking my approach to gaining equity exposure. One aspect which is unchanged is that I don't like to be exposed to explosion risk on large asset class exposures.

Any views on stops vs options as a means to protect downside? I am aware that a stop is an option, but you know what I mean.

Care to elaborate on 'explosion risk'?

Do you mean stock gaps eg. SRX AU/GTAT US
And what timeframes?

 

[DeepState]

Care to elaborate on 'explosion risk'?

Do you mean stock gaps eg. SRX AU/GTAT US
And what timeframes?

I'm all over the place on this. Would be great to have a sounding board.

On asset allocation to equities, I think the best I can do is to say that it is not ridiculous to hold an asset on a long term basis. That is, I can see a risk premium in there and that makes it alright to hold the asset class with a long horizon in mind.

Somehow, judgment gets clouded when your view suffers a massive drawdown or gets eroded over time. In either case, the argument in favour of "you know jack-s##t" improves relative to feeling comfortable that you have some notion of what is going on. Data speaks...what is it saying?

On near term events, if the market gaps 20%+ in a couple of days, something has happened. I think it might be a good idea to circuit break and re-group with a cool head. The risk is missing out on some rebound shortly afterwards. Other questions....should that ~20% be relative to high water mark, recent average, last night...

If the position is slowly eroded, it could be that my original idea was stuffed, that it is becoming more valuable (getting cheaper), or that random bad news has been tilting towards the ugly side for a while. Is some form of circuit breaker helpful to initiate a revisit with as fresh eyes as possible from the perspective of no risk on? Is this a good idea? Should you force an exit? Or should you just say...I need to look again...because some price point was reached?

In theory, we would be disciplined and able to stand aside from the position every day and think fresh. Experience tells me that this is a pretty high standard of dispassion that is at odds with being a regular human. It's ok for small positions like individual stocks (taking a bath on VET-AU in percentage terms is no problem and I can stand back and take a fresh look as the dollar amount was small in my case). However, if the losses are truly large in dollar terms (equivalent to a decade of savings etc.) I suspect I'd act a little less dispassionately. I accept my humanity. What is a suitable threshold of progressive drawdown (dollar, percentage, time frame...) to trigger a re-set? Relative to what?

What should I do? What instruments should I use to help implement this? I have asked about stops and options, but it could well be an issue of ongoing management too.

---

Right now, I use a funky option replication concept which has elements of the above embedded into it. If this exchange gets going I'll expand if interested. I have been screwing up the implementation and this has been costly in terms of foregone benefit recently (markets ran and I did not rebuild positions as fully from market low points as would be ideal). It could be readily solved by improving a few coding things that would only take an hour or so which would lead to different contingent trades being added upon rebalances (ie. stop BUY orders added as well. At the moment, I only have stop SELLs in place...and did not refresh positions quickly enough).

I am taking the opportunity to throw the question open again. Could do with some additional perspectives or lessons from your experience.

 

[skyQuake]

Wow where to start? This is a very broad topic

I am firmly of the opinion if your position size allows for stops, use them. If not... well that's a different kettle of fish
Have toyed with option + futs - sector ETF/CFDs smorgasbord in the past but could never get it to be effective after accounting for slippage and spreads. Structured products with cap guarantees, installment warrants, minis (eg SRXKOC) can have their uses in certain circumstances.

As for equity drawdowns, I guess that depends on its relativity to the market, previous drawdowns etc. I don't believe you can significant remove 'explosion risk' without removing a good chunk of the upside too.

 

[galumay]

I am taking the opportunity to throw the question open again. Could do with some additional perspectives or lessons from your experience.

Just jumping in, it sounds to me from the details of that post you are trying to develop a strategy to essentially time the market. It seems to me you might benefit more from understanding and dealing with your emotional responses to the market rather than trying to time it.

On the other hand I suppose if you truly believe you will become victim to emotional over rides to your core strategy then maybe engaging with a different strategy is a better option even if it has some opportunity cost.

Its certainly not something I have fully resolved in my world either, I am stuck at the point for having a clear strategy of when I might sell a company in a strategy that is essentially buy and hold. (eg price rises well above the intrinsic value i had calculated.)

 

[tech/a]

Think He's trying to mitigate risk.
Outlives are the hardest.

Don't know that its a metal issue.

I don't believe you can significant remove 'explosion risk' without removing a good chunk of the upside too.

Tend to have some agreement on this.

Other than individual stock explosions to the downside which get everyone broader portfolios are generally hit by GFC type tsunamis

For the Lucky Duck my system stopped generating new trades
I personally stopped trading the system when draw down reached below that shown in testing and as 100s of people had tried to break it I had a good set of Blueprint figures to go by.

So while I was 27% down from Peak to Valley I was out around 6 mths before the GFC--something was clearly wrong as pretty well all top 200 stocks were displaying similar patterns.

Long Momentum signals just didn't occur.
As it turned out had you continued to trade the system all trades would have been closed from exit triggers before the crash.

New signals started to emerge many months later.
Had you continued to trade it---I didn't choosing Futures for Long and Short short term
The system made new equity highs (Thats above the Peak to Valley Drawdown I mentioned)
About 14 mths ago.

Don't know if this is helpful
But I try to keep things as simple as possible.
Trying to time options type hedge strategies must be like Brain surgery!

 

[craft]

I am taking the opportunity to throw the question open again. Could do with some additional perspectives or lessons from your experience.

This was penned just recently, and whilst the author may not be in the same league as our forum guru's, I will post it anyway as it is a perspective that I agree with and implement.

I think there is scope in the implementation of what he has to say in a range between purposeful selection and portfolio concentration, to broad diversification and inter portfolio rebalancing dependent on your appetite for volatility and inclination for taking on stock selection risk. Personally I'm at the stock selection end of the range - so suffer larger effects from individual stock explosions - but the blow-ups are relative to the gains. Correlation bombs where everything goes down in sync are bigger issues - but the purchasing power concept puts these declines into perspective and what looks like lemons for a while turns out to be lemonade as you cycle the dividend liquidity into cheaper purchases.

Our investment results have been helped by a terrific tailwind. During the 1964-2014 period, the S&P 500 rose from 84 to 2,059, which, with reinvested dividends, generated the overall return of 11,196% shown on page 2.Concurrently, the purchasing power of the dollar declined a staggering 87%. That decrease means that it now takes $1 to buy what could be bought for 13 ¢ in 1965 (as measured by the Consumer Price Index)

There is an important message for investors in that disparate performance between stocks and dollars. Think back to our 2011 annual report, in which we defined investing as “the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future.”

The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.

Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.

It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.

For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.

If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement. (The S&P 500 was then below 700; now it is about 2,100.) If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).

Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.

The commission of the investment sins listed above is not limited to “the little guy.” Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool’s game.

There are a few investment managers, of course, who are very good – though in the short run, it’s difficult to determine whether a great record is due to luck or talent. Most advisors, however, are far better at generating high fees than they are at generating high returns. In truth, their core competence is salesmanship. Rather than listen to their siren songs, investors – large and small – should instead read Jack Bogle’s The Little Book of Common Sense Investing.

Decades ago, Ben Graham pinpointed the blame for investment failure, using a quote from Shkespeare: “The fault, dear Brutus, is not in our stars, but in ourselves.”

 

[DeepState]

Japan:

Where the heck is that third arrow when you need it?