November 20, 2007 Letters to the Editor

Updated: December 20, 2007.

International Dimension

I received this letter from Elizabeth.

I am very new to this, starting to read the site, and not very knowledgeable. I wonder--how does this approach address the globalization of markets. I think in the past (maybe last 15 years), European and Pacific Rim index results often showed different results from the US index, all three potentially moving differently (but presumably not wholly unrelatedly). I have NO idea what the PE/10 would be for them, nor how to find out (and I apologize if it is in your site information).

Looking ahead a decade, my guess is that those markets and the US will be more interconnected, and emerging markets will be more important and maybe more of a wild card. Any pointers would be very welcome.

Many thanks.

HERE IS MY RESPONSE

Many thanks to you too.

I wish that I could provide you more. I will give you what little information I have.

To get an idea of how foreign markets behave, I recommend “Valuation Ratios and the Long-Run Stock Market Outlook” by John Campbell and Robert Shiller. It is the report that they gave to the Board of Governors of the Federal Reserve System back in 1996. (They wrote the paper in 1997.) It is available for download from Professor Robert Shiller’s web site:

Professor Shiller’s Web Site
Professor Shiller’s Online Papers

My conclusion is that you can use an equivalent of P/E10 in most cases, but with caution. There is a lot of uncertainty.

My recommendation is for you to use dividend yield, preferably using the average of 5 to 10 years of real dividend amounts (if such information is available) divided by the current price. Otherwise, use single year dividend yields. They do almost as well. After all, dividend amounts vary slowly.

You should be able to get this kind of information. Finding a direct equivalent to P/E10 is likely to be much more difficult.

In my own research, I have found that dividend yield has been better than earnings in the United States since (just before) 1950. Both smoothed earnings and smoothed dividends make good choices. Refer to my article E10 or D10?

E10 or D10?
Edited: E10 or D10?

More regarding the International Dimension

Rob Bennett of www.PassionSaving.com sent me this:

I wanted to add a comment re Elizabeth's question about the international dimension of your research into the U.S. market and the effects of valuations on long-term returns. I agree with you that it is an important question and one re which we do not today have enough information.

There is reason to believe that Robert Shiller (author of "Irrational Exuberance") believes that it is possible at least to some extent to avoid the risks of overvaluation in the U.S. market by moving funds to non-U.S. markets. There are two articles that I have seen that indicate (while providing few details) that Shiller now has a stock allocation of something in the neighborhood of 60 percent, with little of it in the U.S. market. That obviously suggests that Shiller believes that there are better prospects elsewhere.

People need to be cautious. As a general rule, I would say that investing in foreign markets is more risky for U.S. investors just because we are not as familiar with these markets. Those investing internationally should spend more time on research. For those willing to put in the time, I believe that moving at least a portion of a portfolio to foreign markets can make sense. It certainly appears that over time more and more people will be adopting a global perspective.

Retirement Portfolio

I received this letter from Lisa.

I've come across your website, which is packed with interesting information. I'm an artist, not a numbers person. Do you evaluate portfolios, for a fee?

I have enough savings to carry me through the next thirty years, but I may be making unwise assumptions/investments. Most of my investments are in bonds, cash, and DFA funds. If you would evaluate the portfolio, and make recommendations, I would sleep better at night!

Thank you.

HERE IS MY RESPONSE

Thank you too.

No. I do not evaluate portfolios. I investigate overall strategies. I leave individual investment advice to others.

Rob Bennett has a great web site for those who are not numbers oriented. It covers many subjects. Among them, he translates much of what I write into plain English. You will enjoy his site. It will help.

Rob Bennett’s Web Site

Rob calls himself a “numbers dunce.” But he gets the important things right. He is a great motivator. He has a lot of fresh ideas.

The Rule of 20-20

I received this letter from Rob Bennett.

I understand your point. I believe that the Multiply-by-25 Rule is out-of-date.

I think you may be underestimating the improvement we have achieved in recent years.

Your Rule of 20-20 is based on a worst-case scenario. What if someone retires at a time when the P/E10 value is 8? That retiree can realistically count on something better than a 5 percent withdrawal. The Rule of 20-20 is what applies for retirements beginning at times of high valuations (when the worst-case scenario is a realistic possibility).

The question that immediately comes to mind is -- Why are those who retire at times of low valuations so lucky? The obvious answer is that they are not luckier than other investors; it's just that they happened to be born at a time when their best investment scenarios came up at retirement age rather than sometime earlier in their lives. We all get a mix of good investing scenarios and bad investing scenarios.

So those who get to use only the Rule of 20-20 get compensation for that "bad luck" earlier in their lives. They get to enjoy higher returns in the years leading up to retirement. They are able to accumulate the amount needed for a safe retirement at a 5 percent withdrawal in less time while those born at a different time accumulate funds at a slower rate and then are able to take a higher withdrawal.

The point that I am getting at is that it may be a bit of a mistake to focus so much on safety at the retirement date. There's obvious value in doing that. But there's also value in looking at these questions from different perspectives. If people could be trained to look at retirement planning as a lifetime activity, there would be less focus on short-term news developments, which would be a good thing. And what we would see is that we all experience sometime in our investing lives the sorts of markets in which the primary goal is accumulating wealth and the types of markets in which the primary goal is holding on to wealth already accumulated.

Lots of strategic implications follow from this different way of looking at things. The usual advice is that a young person should not care too much about valuations because he has lots of time to recover from a big price drop. I question this idea. If the young person views the investing game as a lifetime game, he sees that time periods in which losses dominate are followed by time periods in which huge gains over short periods of time are possible. The young person's big opportunity is that time period in which big gains are possible. He should be planning for that in the time when big losses are likely rather than comforting himself with talk that the losses aren't so bad because he has time to recover.

He does indeed have time to recover from the losses. But he will never be able to regain that opportunity to get huge returns on his money that he passes up when he mindlessly permits himself to lose a big portion of his capital in the big-losses time-period.

These are not fully formed thoughts. I think there is something here, though. I think that people need to take more of a lifetime perspective to investing as the differences in the nature of stock investing from one time to another are so dramatic. I agree that the Multiply-by-25 Rule is too conservative. I think that it is possible that, when we have explored things further, it may be that even the Rule of 20-20 may look a bit conservative.

HERE IS MY RESPONSE

Well said.

You are right. The Rule of 20-20 is a rule for today and today’s sky high valuations, not a rule for all markets.

I refer you to the “I Don’t Want to Wait” and “The Delayed Purchase Concept” articles as examples of what happens in more favorable times.

It is interesting to see what happens at other valuations when using the Year 30 SWR Retirement Risk Evaluator and the Scenario Surfer. The improvement is dramatic.

I Don’t Want to Wait
The Delayed Purchase Concept

Letters to the Editor in 2007

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