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This is from John Murphy’s book, intermarket analysis.

He states that when you have had a long bull market, it is followed by a long period of under performance, or even negative real returns.

Now note that he is a famous technician, so he has a bias towards that school of thought.

What he states is that in a steady bull market, like 1982 – 2000, buying an index fund and holding it is a great strategy.

In the ten years that are to follow the great bull market we have had over the last 9 years, it will take more skill to make money.

Things like market timing, trend following, sector rotation, and investing in foreign markets that have lower CAPE’s will be necessary to make money.

I may do some automatic sector rotation, when a certain Morningstar category falls out of favor. I will also allocate money to European, Pacific Rim, and emerging markets. If I can learn how to use trend following, I may do that.

I don’t imagine I will use market timing.
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What he states is that in a steady bull market, like 1982 – 2000, buying an index fund and holding it is a great strategy.
In the ten years that are to follow the great bull market we have had over the last 9 years, it will take more skill to make money.
Things like market timing, trend following, sector rotation, and investing in foreign markets that have lower CAPE’s will be necessary to make money.


This is a very good overview.

A couple of quick notes:

Another alternative is to pick things that are themselves not manifestly overvalued, in the US or elsewhere.
(they'll still drop in price in a bear market, but they'll come all the way back, whereas overvalued stuff won't)
The level of the broad US market matters only to people who are holding it.
If you want to combine the two (ex-US and not-the-broad-market) I recommend checking out the FT.com global equity screener.

Yet another alternative is simply to live with the very low returns on offer.
I don't recommend this, as I'm greedy, but it's an option.


In other news---
There are two "gotchas" in the notion of investing in foreign markets that have lower CAPEs.
First, only very large markets are diversified enough to be predictive of their own mean reversion.
When Nokia's earnings disappeared, the Finnish stock market didn't revert to the old mean, since Nokia *was* the market.
If you look at the weighting and concentration, most single-country markets are largely just a small number of specific firms, often in just a couple of industries.
Things like the historical GDP-to-market-cap ratio has theoretical problems in the US, but it really doesn't work in most markets because of this.
Better to look at CAPE-to-historical-CAPE for regions rather than countries.

And second, be aware that most markets mean revert to roughly their own historically typical CAPE, not the historically typical CAPE in the US.
The US at a CAPE of 20 might be a much better deal than Russia at a CAPE of 12.

So, the "CAPE ex-US" thing can work well, but watch out for the common pitfalls.

Jim
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"In the ten years that are to follow the great bull market we have had over the last 9 years, it will take more skill to make money."

If my MI didn't fare well in a 9 year bull market, how's it going to survive a bear???

"...foreign markets that have lower CAPE’s will be necessary to make money..."

With globalization, everything's coupled. If the US goes down, so will foreign markets, even if their CAPE is much lower to begin with, just my opinion.

DoesMIWork
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"...foreign markets that have lower CAPE’s will be necessary to make money..."
...
With globalization, everything's coupled. If the US goes down, so will foreign markets, even if their CAPE is much lower to begin with, just my opinion.


Sure, in a bad market the price of everything goes down.
Picking cheap stuff won't save you from that. Some stuff will fall less, perhaps.

But valuation can still matter, depending.
The distinction here is primarily one of holding period.

If you are doing a style which involve a long(ish) hold, anything that wasn't overvalued when you bought it will come all the way back.
(minus the odd company-specific adverse events, of course, but that can happen to any firm).
Conversely stuff that's overvalued tends not to do so well from top-to-bottom-to-normal, since the exuberance for that stock often never recovers.
People who bought (say) banks or house builders in 2006-2007 took a long time to break even.
This is true even of firms doing very well for years to come: it was a bad idea to buy Walmart or Microsoft in 1999 simply because of the price.
There are some firms at nosebleed valuations these days that are held only by optimists who think
their wonderful futures are a done deal. Those are probably not good "long hold" candidates.

If your holds are shorter, then your concern is primarily about the quality and reliability of your timing system and/or your security selection system.
Valuation isn't your primary concern except to the extent that it affects that quality.
I suppose it also gives some level of back stop in case the music stops suddenly.
Sometimes a short hold turns into a long hold. Historically speaking, most stock markets close.

Jim
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Here are some wise choices about what to do in a low return environment given by one of my favorite writers, James Montier with GMO. He wrote this back in 2013 in a pretty famous piece called "The Purgatory of Low Returns"

https://www.advisorperspectives.com/commentaries/2013/07/22/...

(i) Concentrate.
Simply invest in the highest-returning assets. This is obviously risky as you become dependent upon the accuracy of your forecasts, and right now nothing is outstandingly cheap so you are “locking in,” at best, fair returns (assuming you wanted to have a portfolio that was 100% invested and split between, say, European value and emerging market equities). You are, however, giving up the ability to rebalance.

(ii) Seek out alternatives.
This meme had been popular until the GFC revealed for all to see that many alternatives were anything but alternatives. True alternatives may be fine, but they are likely to be few and far between.

(iii) Use leverage.
This is the answer from the fans of risk parity. Our concerns about risk parity have been well documented. As a solution to a low-return environment, leverage seems like an odd choice. Remember that leverage can never turn a bad investment into a good one, but it can turn a good investment into a bad one (by forcing you to sell at just the wrong point in time).

(iv) Be Patient.
This is the approach we favour. It combines the mindset of the concentration “solution” – we are simply looking for the best risk-adjusted returns available, with a willingness to acknowledge that the opportunity set is far from compelling and thus one shouldn’t be fully invested. Ergo, you should keep some “powder dry” to allow you to take advantage of shifts in the opportunity set over time. Holding cash has the advantage that as it moves to “fair value” it doesn’t impair your capital at all.
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"I may do some automatic sector rotation, when a certain Morningstar category falls out of favor. I will also allocate money to European, Pacific Rim, and emerging markets. If I can learn how to use trend following, I may do that."

Trend following doesn't work. James Simons mentioned in a talk that it worked in the 70s and marginally in the 80s, but not after that. It makes sense, because if there was any advantage in trend-following, it would be acted on by the quants too quickly for the average investor to profit (excepting small cap/thinly traded).

In addition to emerging markets which you mentioned, I would consider international real estate. Question some allocation to gold but it is more of a timing play. If there was a big US recession because of high valuations, debt, or some other reason, I would expect gold to increase, but no way to know when that would happen. What about latin america? Valuations seem fair.
Not sure about Europe based on its debt, political turmoil, and currency issues, although CAPEs lower than the US.
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"...Valuations seem fair.
Not sure about Europe based on its debt, political turmoil, and currency issues, although CAPEs lower than the US..."

I hold a lot of leveraged (I'm greedy) Emerging Markets(EM) through an asset allocation section in my MI. Each time the S&P gets hammered, so does my EM. I'm pretty sure the valuations on the EM are much lower than SPY. Because of globalization, I think everything is coupled. I think all the other markets follow the S&P. When it falls because of high CAPE, threat of recession, or threat by the Fed, the other stock markets will follow, regardless of whether it is cheaper than the US or not.

Back to crypto, anyone??? Highly uncorrelated...

DoesMIWork
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Sure, it is known that international bear markets are correlated on the downside; we saw that in 2008. As mungofitch mentioned above ("perhaps.."), EM will probably fall less during a US bear market and rise more in the succeeding bull market. And international equity markets are not as correlated during a bull market. Since the timing of the next recession is not known, EM could do better in the next 1-2 years.

I would not buy crypto now; it's not that well used/accepted, so if there was a major (equity) recession I expect that ppl would sell crypto and the price would fall.

I would almost consider a 50% gold/50% EM portfolio, then return to MI after the next recession.
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As mungofitch mentioned above ("perhaps.."), EM will probably fall less during a US bear market and rise more in the succeeding bull market.

FWIW, that's not my belief. I commented that some stuff will fall less than other stuff in a big bad bear, but I wasn't thinking of EM stocks.
I doubt they are likely to be in that club.
(I was thinking more of traditional defensives)

Things with US revenues and listed on US exchanges have a huge advantage, as big panics generally
lead to rises in the US dollar as people sell stuff and park the proceeds in dollars.
EM stocks are very volatile: they tend to go down more than other things in down markets, without any respect to valuation.

And bear in mind that EM stocks are not nearly as cheap as they appear.
Compare each region to its own historical average level, not the historically average levels in the rich world.
Russian stocks, for example, tend to stay cheap for a reason, giving a long run average P/E of around 8, IIRC.
Check out these people http://siblisresearch.com/data/cape-ratios-by-country/


If you want to go international and have an expectation of doing well, I recommend a shotgun approach that does not involve any cap-weight funds.
Fire up the FT.com global equity screener and find some good companies without regards to where they are located.
Not too much debt, meaningful dividend, high five year average ROE, and a business with control of its own pricing and not subject to too much change.
Then to the MI thing: buy equal dollar amounts of (say) 25 or 30 of them. No need to trade regularly though, a hold of two years is probably fine.
I've found some nice investment opportunities this way.
These two from 2011 have returned 16.4%/yr and 18.3%/yr since then, plus dividends.
http://boards.fool.com/id-like-to-thank-the-folks-who-offere...
Here's a description of the sort of criteria I use.
http://boards.fool.com/in-consideration-of-your-thinking-the...
After finding some candidates, I look at what they actually do for a living.
I usually avoid banks, utilities, materials, insurance, most retail, automotive, tobacco, telecoms.
I try to guess the firms least likely to have head-to-head competition, and least likely to have a fundamental change in their business economics.
The last one I was looking at was a pencil maker in Turkey, though I haven't pulled the trigger on that.
The price is about where it was a year and a half ago, but the Turkish lira has just tanked, down a quarter since then.
Too many tanks, I guess.
Still, as long as the factory doesn't get burned down by accident, an exporting pencil maker is unlikely to get targeted by anybody, right?

Jim
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FWIW, that's not my belief. I commented that some stuff will fall less than other stuff in a big bad bear, but I wasn't thinking of EM stocks.
I doubt they are likely to be in that club.
(I was thinking more of traditional defensives)


Yes, I did not mean that you meant that EM would fall less, but the rationale that even though there are correlations (which DoesMIWork referred to as a reason against diversification), does not mean that the extent of the fall/rise would be the same.


Things with US revenues and listed on US exchanges have a huge advantage, as big panics generally
lead to rises in the US dollar as people sell stuff and park the proceeds in dollars.


My concern was that there would be a US recession, for the following reasons:
- compared to 2008, there is now more auto, student loan, and credit card debt today
- banks have a high amount of debt
- federal debt as percentage of GDP is close to historical highs. from ken rogoff's work countries with high debt to GDP levels are more prone to financial crises
- historically low interest rates and quantitative easing may have propped up equity prices (note the low inflation when considering the extent of quantitative easing). this could be the reason for high P/Es in the US market
- corporate debt is higher now than before the 2008 crisis
- individual state debt is very high

So if there is a loss of confidence in the USD (which lost around 10% of its value in the past year compared to other currencies; China is lowering their holdings in US debt), then the USD could decline.


EM stocks are very volatile: they tend to go down more than other things in down markets, without any respect to valuation.


Do we know that this is the case? At least they did rebound much more strongly than US stocks after the 2008 crisis.


And bear in mind that EM stocks are not nearly as cheap as they appear.
Compare each region to its own historical average level, not the historically average levels in the rich world.
Russian stocks, for example, tend to stay cheap for a reason, giving a long run average P/E of around 8, IIRC.
Check out these people http://siblisresearch.com/data/cape-ratios-by-country/


Is it correct to compare to historical levels? Yes, we know that Russian stocks are going to be cheap (the state can seize any company it wants at any time, possibility of more sanctions, etc), and the argument can be made for other specific regions, but it is harder to make for the EM class as a whole, especially because there is the concern that US stocks are overvalued. Most academic projections are that EM stocks are going to outperform US stocks in the medium-term. Also P/E is related to expectations and expectations tend to be more often over-inflated than under-inflated.


The last one I was looking at was a pencil maker in Turkey, though I haven't pulled the trigger on that.
The price is about where it was a year and a half ago, but the Turkish lira has just tanked, down a quarter since then.
Too many tanks, I guess.
Still, as long as the factory doesn't get burned down by accident, an exporting pencil maker is unlikely to get targeted by anybody, right?


I have a good friend in Turkey, I could get his opinion on the company.
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"My concern was that there would be a US recession, for the following reasons:
- compared to 2008, there is now more auto, student loan, and credit card debt today
- banks have a high amount of debt
- federal debt as percentage of GDP is close to historical highs. from ken rogoff's work countries with high debt to GDP levels are more prone to financial crises
- historically low interest rates and quantitative easing may have propped up equity prices (note the low inflation when considering the extent of quantitative easing). this could be the reason for high P/Es in the US market
- corporate debt is higher now than before the 2008 crisis
- individual state debt is very high"

You are not the only one who is rightfully concerned with the debt issue. I just don't see how things can't blow up. I hate to keep harping on the point, (just trying to help) but Satoshi Nakamoto created Bitcoin in direct response to government ineptitude in handling the 2008 debt driven crisis.

Although crypto is very risky, it's covariance actually HELPS reduce risk. This is the only free lunch out there.

DoesMIWork
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You are not the only one who is rightfully concerned with the debt issue. I just don't see how things can't blow up. I hate to keep harping on the point, (just trying to help) but Satoshi Nakamoto created Bitcoin in direct response to government ineptitude in handling the 2008 debt driven crisis.

Although crypto is very risky, it's covariance actually HELPS reduce risk. This is the only free lunch out there.


I'm bullish on crypto in the long run, but the volatility is extreme. I recently calculated that it was 8x more volatile (bitcoin) than the S&P500. So the position size would have to be small. But besides that, there is significant fraud and manipulation in the market which I believe is propping up the price of bitcoin, even at this level. I anticipate there will be a major correction. And besides that, probably most of the market is speculators. They are going to get cold feet in an equity recession and sell. Maybe in future recessions it will do well, but I think the price will tank in the next recession, in favor of hard assets.
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