Asset allocation in a US stock market bubble

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It’s simple really; do you want to own the biggest and best companies in the world in the biggest economy in the world from which most innovation originates?

What’s the masterplan, to try and time the US market by exiting it now in the hope of re-entering at some future point when you perceive it to be ‘cheaper’ (whatever that means)?
 
Gordon Gekko said:
We’ve been listening to this spoof about the US market being expensive for years.

A very expensive mistake if someone had listened to it.
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Two apparently conflicting statements can simultaneously be true.

Irish house prices were expensive in 2007. But 17 years later, buying a house in 2007 was the right decision for most people. Even though it seemed like a terrible decision to many people for several years.
 
Comparing the S&P500 and the biggest companies in the world with a property bubble on a relatively small rock on the western edge of Europe doesn’t really make sense.
 
Gordon Gekko said:
Comparing the S&P500 and the biggest companies in the world with a property bubble on a relatively small rock on the western edge of Europe doesn’t really make sense.
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I mean the fact that us markets currently appear (and in my opinion are) expensive isn't of itself a reason not to buy into those markets. There are other elements in the equation which produce a different answer.
 
Gordon Gekko said:
Comparing the S&P500 and the biggest companies in the world with a property bubble on a relatively small rock on the western edge of Europe doesn’t really make sense.
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S&P500 equities are historically expensive relative to earnings, earnings which are in turn significantly propped up by increasingly parabolic US sovereign debt issuance.

It makes zero sense to blindly have faith in it tbh.

That said, what folks need to remember when they hear that Warren Buffet is moving to cash is that Buffet has a plan and a track record of picking winners from the carnage, most of us don’t! There are two stages to his strategy, easy to follow stage one (move to cash), not so easy to follow stage two (cherry-pick winners!). That’s what makes that strategy unsuitable for retail investors.
 
Gordon Gekko said:
Trying to time the market is mad. Even if a correction happens, you’ll exit too early and miss some further growth and then the recovery will start before you’ve re-entered.
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But participation isn’t just an in-v-out, cash-v-equities decision. We do have other markets that we (those of us who aren’t named Warren Buffett) can choose to participate in, ie. to de-risk through diversification. It’s still a worthwhile discussion tbh.
 
There's no such thing as de-risking. At best there's risk diversification which reduces the likelihood of getting hit with negatives everywhere all at once (which also also reduces the risk of getting hit with positives everywhere all at once), but I wouldn't call that de-risking.

Everyone has their own personal risk matrix in their head. There's divergent views on how to estimate likelihood, and impact is going to be very personal. Certain risks can be eliminated/avoided entirely (eg losses on equities can be avoided entirely by dropping all your equities) but that just shifts the risk (ie to inflation by holding cash & the risk attached to the opportunity cost).

Risk can only be managed, never eliminated.
 
I'm just looking at the dimensional returns book Marc referred me to.

For the Nasdaq generally, someone who invested in 2000 would have taken until 2014 to get back into the black, so Microsoft isn't that far off the index.

But someone who invested in 1998 would have positive annualised returns every single year since except for 2002. There's no negative returns over 15 or 20 year periods, only 2 over 10 year periods, but lots over 5 year periods. The S&P 500 is basically the same.

  • 20 year annualised returns on the S&P 500 range from 5.5% to 17.7%.
  • 40 year annualised returns range from 8.9% to 12.3%
  • From 1926 to 2000 it was 11%
  • 2000 to 2023 it was 6.2%
All of which suggests that US stocks remain an excellent proposition over the longer term, ie 10 years plus. And all the more so if your dollar cost averaging into them.

Hypothetically though, if I'd started investing in the S&P 500 in 1980 and retired in 2000 I would have gotten annualised returns of 16.4% up to my retirement, while in the 20 years to 2020 I would have been getting much lower annualised returns at 6.1%. The overall annualised returns from 1980 to 2020 would have been 11.8%.
  • If I partied like it was 1999, ie in the expectation that my annualised returns would have continued in the mid teens I'd have been in serious financial trouble in my dotage.
  • But if I'd assumed that the long term annualised return from aged 40 to aged 80 would line up with the previous expected 40 year range and spent accordingly, then I would have been totally fine.
I still haven't heard a convincing argument for using anything other than long term averages to estimate future growth.
 
Firms may have economic moats but this doesn’t make them monopolies, or necessarily facilitate supernormal profits. Both the USA and the EU fine companies that infringe competition law. However, many would regard the fines imposed by European competition law on American tech companies operating in Europe as more akin to a tax for access to the market. It will be interesting to see how the incoming administration in the USA responds to this issue.

SquirrelChaser said:
Second, around 60% of American adults own stocks while around 15% of Europeans do. Ignoring cross border investment, there's just far more money going into the US stock markets which inevitably inflates them more than US stocks.
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Money goes into stocks only when companies provide the return required by investors. Otherwise they don’t invest. And as I pointed out in post # 47 above, US firms have higher operational efficiency than Europeans. This allows them to provide a greater return to their investors while still retaining income for reinvestment, lowering debt, etc. This is why people invest in them.

If stock prices were inflated for reasons unrelated to firms’ operational efficiency, short-sellers will just pile in and force prices down.

SquirrelChaser said:
Europeans tend to keep their money in the bank not the stock market- it's a problem which has been attracting a bit more attention recently.
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On Europeans tending to keep money in the bank, you are correct. But this may be due to European firms not providing adequate returns to investors, i.e. the're are just better firms in the USA and a better fiscal and public policy environment for investors. A recent statement by Mario Draghi on the EU Capital Markets Union covered this point. Draghi urges reform, investment drive to revive EU . But Mr Draghi also pointed out a GDP gap has opened up between the US and Europe thanks to a slowdown in productivity, which to me implies that, inter alia, American firms are just better than European ones, i.e. more productive, higher returns on investment, etc., and therefore will attract more investment.

joe sod said:
a bit more sober reading regarding the S&P 500 , between year 2000 and 2010 the S&P500 had a lost decade and investors actually lost money in real terms.
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In the year 2000, Shiller CAPE ratio for the S&P 500 reached a peak of around 44.2, which implies lower future returns. A prudent investor would not have invested in eh S&P 500 index at that time, or would have invested but expected lower returns.

Today’s Schiller CAPE ratio for the S&P500 is 38.5. Historically, the average annualized growth rate for the S&P 500 when the CAPE ratio is around 38.5 has been approximately 1.01% . So, invest in the S&P500 today and you can expect this return, but you are investing in better run firms that operate in a better public policy and taxation environment.
 
But 1998 was before the huge peak so you were effectively buying us stocks at good valuations, 2 years later the market was 2 and a half times more expensive. Its easy to pick points on a graph afterwards and say oh well if I invested in 1998 I wouldn't have had any down years.
The reason why the UK and European markets are doing relatively badly is because everyone wants to get it on the US market action, money has been taken out of UK and European markets to invest in the US, so its like a positive feedback loop. Even the global indices are now heavily weighted to US markets and more specifically to a few mega cap tech stocks. If you want to join that party and add more fizz, you are welcome to it
 
I think we differ on personal definitions of de-risk, I see it as a verb to reduce/mitigate risk, not eliminate. But agree with you beyond that distinction.
 

Well yes, but it's equally easy to pick a point on the graph afterwards and say oh well if I'd invested in 2000 I would have gone totally broke.

And you're still not suggesting any alternatives to using long term averages to predict future performance of investments based on the S&P 500 or anything else. It's all very well saying the US markets are bubbly (and I agree, both about the fizz and the positive feedback loop) but I'm not going to just follow my heart and switch my pension funds non-US funds without numbers to back up that decision. There's a big difference between providing numbers which support the conclusion that US based funds are too expensive and providing evidence that some alternative can be expected to do the same or better in the long term

** correction to my earlier post** It's hard to analyse a table in a PDF so I extracted it to Excel and had another look. The lowest annualised returns over a 20 year period would have been if you invested in the S&P 500 between 1928-1930, the worst of which years was 3.1% in 1930. After that you have to wait until 1999 to invest when you would have gotten an annualised return of 5.6%.

Based on annualised inflation just under 3% since 1926 in the US, the worst ever real return over 20 years was still slightly positive.
  • The median annualised return over a 20 year period was 11.2%.
  • The average was 10.8%
  • 95% of 20 year periods had annualised returns over 6%
  • Over a 40 year period the lowest annualised return was 8.9%, and the median was 11%
But relatively few people go all in to anything at one specific point in time: people pay into their homes, their pensions, and other major investments over the course of 20 years or more.

For that reason I would argue that the number which you should be using for planning purposes is the average of returns over rolling windows of 20 & 40 years
  • for 20 year windows, the lowest for the S&P 500 turns out to be 8.9%, and the median is 11.2%.
  • For 40 year windows, the lowest is 10.8% and the median is 11.2%
So for planning purposes (for a pension at least), if going all in on an S&P tracker) it seems safe to assume that your minimum long term annualised return will be 9%, while also treating any overall return above 11% as a debt you owe to the market rather than money you actually have.
 
But you can always pull out figures to back up a prognosis, by the figures the US markets have been phenomenal over the last 20 years so whatever long term figures are all going to be flattered by the level of the US markets now as everything is lifted up as I pointed out earlier even if you run the figures using 2022 as the reference year you get significantly lower returns.
By your analysis then investing in Europe or UK is never on because all the long term figures look terrible because of the relatively poor performance of those markets over the last 20 years. Therefore your figures will never give a positive outlook for investing in those markets so just as it produces positive feedback loop for US markets it produces negative feedback loop for european markets. Is that really credible ?
I mean the UK markets are trading at the same levels (excluding dividends) than they were at the beginning of the century does that mean that the UK should never receive anymore investment and that all your investment euros should still be ploughed into the US markets (effectively the big 7 tech stocks)?
 
joe sod said:
can you give any examples of those instruments that can easily be bought?
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Various bond issues from Irish banks (PTSB, BOI, AIB)....pick your duration risk........and then to bring the conversation full circle.......some European telecoms groups also have bonds in issue with some excellent YTM relative to my assessment of default/recovery risk.......VMO2, Telenet, Vodafone.....European regulators have killed equity returns for telecoms shareholders....but they remain and will remain consistent creditors....and where the underlying debt security (fixed & wireless networks) have real value in a bankruptcy with a mountain of capital sitting on the sidelines in infrastructure funds ready to pounce once the over-levered equity holders get in trouble.
 
Is that a case for not buying bonds, if you think inflation still has more to go (oil is going up again short term due to new sanctions on russian oil) well then interest rates have to rise more, also if there is so much government debt already out there in the form of bonds and if interest rates did go up more well then we are back in "financial crash" territory with governments unable to refinance their debt. Also Trump tarriffs would be inflationary pushing up prices but also decreasing demand not a good outcome.
Its really hard to know what to own in such a scenario just that I don't want to be buying bonds when the bond market is already massive with so much government and corporate debt already out there needing to be refinanced?
 
Inflation is terrible for bonds with short/medium term bond coupons often higher than longer term bonds meaning bond prices fall. If all the above comes to pass then the last place you want to be is in long term bonds.
 
Flybytheseat said:
Inflation is terrible for bonds with short/medium term bond coupons often higher than longer term bonds meaning bond prices fall. If all the above comes to pass then the last place you want to be is in long term bonds.
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yes I'm well aware of that but the consensus is that if the US tech market crashes like in 2001 the place to be is bonds, however the bond market was inflated from all those years of negative interest rates so its now massive since governments were able to refinance and issue new debt at negative interest rates for years.
I think we are still in an inflationary environment since production and flow of goods has never recovered since covid and has been severely affected by geopolitical changes, war in Ukraine etc. There won't be an oversupply of production that leads to deflation, even the Californian wildfires are going to suck up a huge amount of productive capacity in the US to rebuild etc, then there is the massive rebuild necessary in Ukraine. AI will have little affect on all that aswell
 
I agree - I think US inflation will continue over the coming years meaning US long term bonds are probably not that safe a haven and will not produce real returns. I believe the US will continue to print money leading you currency devaluation but as the US dollar is the reference currency this may not be apparent in foreign exchange rates. Asset prices will continue to rise so US stocks/Precious Metals/ Real Estate but how far can US stocks go if already in bubble territory ? The end game may be the dollar loosing its reference currency status to the Chinese RMB as the Amercian/Western/ European Empires wain and the East gains dominance. So chances are that an investment in BRIC stock markets makes sense in the medium to long term.
 
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