Notes starting from June 25, 2009

Updated: July 17, 2009.

Statistical Sameness

Statistical tests show differences. So how can they show sameness? By a clever technique called the power of a test. It reports the probability that a test would have reported a difference if a specified difference actually exists.

Early researchers showed that mutual fund managers produced the same returns. They should have reported that it would have taken an advantage of 5% per year for more than a decade to show a difference. Even that was only 50%-50% likely. If they had done so, the Efficient Market Hypothesis would not have gained traction. Investors would have been much better off.

Rob Bennett on ABC

Here is a link to Rob Bennett’s interview on ABC news.

Rob Bennett on ABC

Lesson From Switching C

Compare the Graphs from Switching A and B (see the Switching Graphs) with that of Switching C. Notice the region around 100E10/P=6.0% and above. This corresponds to today’s valuations at P/E10=16.

You will notice that Switching C has generated a hole in this region. It is optimized for mid-range valuations in a long lasting (secular) Bear Market. The worst case 30-year Historical Surviving Withdrawal Rates are 6% (plus inflation) and higher.

It took the Investment Strategy Tester to identify these better settings.

Switching Graphs A and B
Switching C

Understanding Switching D

I optimized Switching D for the next ten years. I would expect a turning point from today’s long lasting (secular) Bear Market within this amount of time. I did not optimize it for a full 30-year period.

I have plotted the Switching D 30-year Historical Surviving Withdrawal Rates. It is similar to Switching A and Switching B. It is a little better at today’s valuations (P/E10=16 in a Bear Market) and worse at very high valuations (P/E10 above 20).

Switching Graphs A and B
Switching D

DVY Continues to Disappoint

The 6/24/2009 DVY quarterly dividend amount was $0.3969 per share. The one year distribution yield has fallen from a peak of 2.5323 to 1.9445. The current distribution yield is 77% of the peak.

This is a 23% reduction (nominal dividends). The worst case nominal dividend amount for the S&P500 was 17% between 1940 and 2000. The worst case real drop was 25%.

As of March, the S&P500 itself had lost only 5% to 6% (real and nominal).

The preferred shares of PFF continue to hold up well. My Retirement Practice portfolio consists of equal initial holdings of DVY and PFF.

Opaque

We still don’t know what caused the Great Depression. My impression is that recovery after recovery got squashed via Governmental missteps.

The reporting was atrocious then as it is now. Reporters had their lessons learned. But it was false learning. The 1987 stock market price drop brought out television file footage that we were entering another Great Depression. A few months later, we all knew better.

We cannot be sure that last year’s liquidity crisis was anywhere nearly as bad as advertised. In fact, we don’t know what happened to the money, just that it meandered in strange directions. It was supposed to handle troubled mortgages. It did not.

Dr. John Hussman reports that the money simply went to bailing out bank bondholders. He calls this unethical. I would use the word “typical.” If I am correct (and I am not at all certain that I am), bank bonds are treated as high quality reserves for making new loans. If so, the Federal Reserve did today exactly what it did in the Great Depression. It protected itself. Banks own the bonds of other banks.

We are seeing higher taxes and Government growth that will crowd out the private sector. We are seeing more and more regulation.

I expect this recession to be much worse than normal.

Take 6%

This is what happens at Year 20 if you withdraw 6% of your portfolio’s CURRENT balance each year.

Take 6%

Take 6% with Valuation Informed Indexing

This is what happens at Year 20 if you withdraw 6% of your portfolio’s CURRENT balance each year and adjust allocations according to P/E10.

Take 6% with Valuation Informed Indexing

Continuing Withdrawal Rates (July 2009)

Today’s valuations are much more favorable than those of a year ago. P/E10=16 and 100E10/P=6.25%. Continuing Withdrawal Rates have improved dramatically.

Continuing Withdrawal Rates (July 2009)

Looking at DVY

DVY is the oldest dividend oriented Exchange Traded index Fund. It has disappointed. It was over weighted in financial services. Those holdings have shrunk. Because of this, DVY has become well diversified.

Its dividend has been cut twice in a row. I believe that this will be close to a bottom. Using its most recent quarterly dividend amount (and multiplying by four) and its current price, DVY is now yielding 4.56%.

This makes an attractive stand alone investment.

I would not buy DVY today. In my opinion, today’s Government policies are making the recession worse. I expect the stock market to fall much farther. I expect P/E10 to drop in half. If so, DVY will become a compelling investment.

Failed Already

Those who took the traditional advice in the Year 2000 already face busted retirements. That advice was to withdraw 4% of their original balance (plus inflation) from a portfolio with a high stock allocation. The Year 30 SWR Retirement Risk Evaluator [button on left] clearly shows that Failure was Likely.

The fatal flaw was that the earlier studies failed to take valuations into account.

Balances from Year 2000 are already below 50% of their starting levels. From an old article, we see that this means almost certain failure.

Portfolio Safety Insights

Lessons from the SWR Translator

You can read about the SWR Translator by accessing my Archives [button on left]. It has never gained a great amount of popularity. But there are several lessons to be learned.

The most important is that a stock market’s total return at Year 30 has little to do with the Historical Surviving Withdrawal Rate. But if you look at the total return of the stock market at Year 10 or 14, you can make an excellent estimate of the how well the portfolio will do. R-squared ranges between 74% and 90%.

This brings me back to an important point. Portfolio survival is determined by how well the stock market holds up in the first 10 to 15 years.

An Overview of the SWR Translator

Year 2000 Investments

This picture shows what happens to 30-year Historical Surviving Withdrawal Rates with a high stock allocation. Back in Year 2000, P/E10 was 44 and 100E10/P was 2.3%. Slap some confidence limits about the graph and you find that the Safe Withdrawal Rate was 2% of the original balance (plus inflation). Withdrawing 4% was reckless. Yet, that was the standard advice at the time.

HSWR80T2 Graph

Now look at the TIPS table. The mathematics is similar to that of a mortgage as a lender. Back then you could get 3.5% to 4.0% from TIPS. You could have a Government guaranteed 30-year Safe Withdrawal Rate in excess of 5%.

TIPS Table

The wise investor went with an all-TIPS portfolio back then.

Year 2000 Return Sequence

Historical Surviving Withdrawal Rates depend on both the total return and the sequence of returns. The sequence of returns from Year 2000 has been gentle. The October 2008 meltdown was delayed eight years. Earlier withdrawals have had a less severe affect on balances than if the meltdown had occurred earlier.

Permission Granted

I grant full reprint permission for anything at this site as long as you mention your source.

I thank Elizabeth for bringing this up.

Benjamin Graham on Timing

From page 95 of The Intelligent Investor (fourth revised edition): “Since common stocks..are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings. There are two possible ways by which he may try to do this: the way of timing and the way of pricing….

Benjamin Graham would not have called Valuation Informed Indexing a form of timing. He would have called it pricing.

Computers and Timing

Studies of stock market timing no longer distinguish among differing rationales. It is just too hard to do when using a computer and analyzing huge amounts of data. Every shift in allocations is credited to timing, regardless of the reason. This is why we see cautions against stock market timing applied recklessly. Seldom do we see a distinction between pricing and timing. Even less often do we see a distinction between the short term and the long term.

Exciting Conversation

Rob Bennett and Arty are engaged in a fascinating conversation over at Rob Bennett’s “A Rich Life Blog.” It is based on the July 7, 2009 article entitled “Passive Investing is for Extremists: The Critique.”

A Rich Life Blog July 7, 2009

Index Fund Comparisons

An active manager should have the ability to move holdings in and out of the stock market and the bond market. An active manager should be able to shift among sectors.

You can only make limited comparisons with index funds. You can compare sector funds and a few other stock only or bond only selections, but little else.

Index Universe Selections

From the SWR Translator Graphs

Look carefully at the Year 14 SWR Translator Graphs. You can see the effect of overlapping sequences at the extremes. The real, annualized, total return of the portfolio (return0) at the extremes occurred in the same time periods. The 30-year Historical Surviving Withdrawal Rates were not quite independent, but they came close. You can see a small oscillation about the trendline.

SWR Translator Graphs
SWR Translator Graph with Lines

Finite Liquidation Strategies

I tend to treat all liquidation strategies alike. These are strategies in which you sell shares to generate retirement income. They are in danger of running out of money.

But this is not always true.

A portfolio can grow enough that dividends cover withdrawals before too long. The selling period is finite. Such a portfolio will generate a continuing income stream.

There are other exceptions. As a rule, however, it is better to leave the original investment untouched except for improving the quality of holdings.