Rory Gillen's free book: "A guide to sound investing"

[Fella]

How can people give out about a free book! I read loads of books sometimes I don't like them but you might pick up one or two bits of information you didn't know.
I read this book and it was very much as the title suggested it would be so no complaints here.

 

[PMU]

The difference between 1999 and now (because now is what's relevant) is valuation. Why was the investor in 1999 condemned to poor returns? Because he overpaid.

Correct. This was evidenced by Prof Shiller's 10 year cyclically adjusted P/E ratio (CAPE), which for the S&P in 1999 was 40.57 (and higher again at 43.77 in 2000). Shiller's theses is that the lower the CAPE, the higher the likely return in over the subsequent 20 years, and vice versa. The average CAPE value for the S&P is about 15.21 and this value provided an average annual return over the next 20 years of about 6.6%.

And where are valuations now? Pretty average ex US and a little higher in the US. Therefore the investor is very unlikely to be condemned to poor returns for the next 17 years. But if he chops and changes in response to macro events, he will be, because he will miss the upswings.

I disagree. The current S&P CAPE ratio is 26.09, its highest since 2009 and higher than its long term average. This implies low(ish) returns. Ex-US, it's difficult to find CAPE ratios for other markets, but with a bit of rooting around I found this research by StarCapital Germany http://www.starcapital.de/research/CAPE_Stock_Market_Expectations on stock market forecasts based on the current CAPE and price/book ratios. To prevent being condemned to poor returns it might be prudent to take this research into account in making investment decisions. Ireland, for example, has a CAPE of 28.2, higher that the US.
Not that average.

 

[dub_nerd]

Interesting post, but it ignores the main point which is that, once invested, one shouldn't leave and then re-enter the market again based on noise. That's where the individual misses out. The same argument holds for the period 1999 to date where missing the 10 best days for markets would also have damaged one's prospects.

Ok, so I ran those numbers, and you're right -- the top 10 best days gave a multiplier of 2.00. If you stayed in the market the whole time you'd have made a profit of 348% (total multiplier 4.48). If you missed the top ten days your profit would be 124% (total multiplier 2.24). (I had to ignore dividend yields as a matter of practicality, not because I don't think they matter).

But then I also looked at the 10 worst days. They gave a divisor of 2.15. So even if you randomly skipped days you'd probably do better by missing the best days because the bad ones you'd miss would more than compensate. If you managed to miss all of the ten worst days, your profit would be a massive 864%! In fact, that's much more important than hitting the ten best days. If you leave out the ten best days and the ten worst days, you make 382%, still better than just staying in the market the whole time.

None of this tells us how to predict market swings, but it does imply if you can find a strategy that even slightly improves your odds, the potential gains are great -- greater, in fact, that just staying in the market to make sure you benefit from the ten best days.

Your anecdote is still interesting, it has to be said. It's instructive to see just what a large difference a vanishingly small number of outliers makes (extended up to 2016 in the following graph):

The difference between 1999 and now (because now is what's relevant) is valuation. Why was the investor in 1999 condemned to poor returns? Because he overpaid. And where are valuations now? Pretty average ex US and a little higher in the US. Therefore the investor is very unlikely to be condemned to poor returns for the next 17 years. But if he chops and changes in response to macro events, he will be, because he will miss the upswings.

Does that imply, then, that you need to time your market entry right? And if so, why can't you use the same approach to skip in and out subsequently?

...The long-term returns from equities are mostly determined by the initial dividend yield and the subsequent growth in that dividend income stream. Share prices will follow the growth in earnings (and dividend) so that an investor's total return is the dividend income plus the capital appreciation as determined by the earnings (and dividend) growth. The tables on page 6 & 7 of the Booklet prove this point over a period long enough to iron out short-term anomalies. Of course, in the short-term, we know that markets rarely reflect this long-term truth, which makes it tricky to predict what returns are likely to be over shorter intervals. For example, a market can be valued at 10x earnings in one period and 20x in the next, boosting returns for a period. As 1999 was used in examples above as a starting point, investors in the US index were investing at a time when the US equity market was trading on a multiple of earnings at least double the long-term average, and quite possibly more. So, to an investor in 1999, future returns were compromised. While earnings in the US continued to grow thereafter, the multiple investors were prepared to pay quite rightly reverted to more normal levels leaving an index like, say, the S&P 500 flat from 1999 to about 2013 (not sure of exact dates). On page 36 of the booklet, this danger that we might describe as 'valuation risk' is highlighted in the Coca-Cola chart. As they say, a chart can paint a thousand words.

So again, same question, are you saying that you should time your market entry? And if you've committed the (apparently) cardinal sin of market timing once, why not more than once?

 

[Rory T Gillen]

As I'm struggling to use the 'Quote & Reply Facility', this reply is to Dub_Nerd above:

I made no direct reference to 'timing the market', but by inference if a market is overvalued relative to history it is at least a yellow flag. But as the booklet highlights, overvaluation is not so much a danger to the 'Regular Investor' as it is to the 'Lump-sum' investor. The latter doesn't get to go again, so valuation is extremely important at the point of commitment. The Regular Investor and Lump-sum Investor have different issues to deal with. In 1999, it was not particularly important to the Regular Investor that the S&P 500 - or markets in general - were overvalued then, as he/she was not committing all their monies at that time, but investing over time.

However, if history is to be a guide in terms of valuation then there's more to it than has been argued above. For example, in 1999, the US stock market was trading at a very high multiple of earnings relative to history. If we take it that the S&P 500 was trading at 30 times earnings in late 1999 (I don't have the exact multiple), then that's the same as an earnings yield of 3.3% (100/30 expressed as a percentage). It's easier to use the earnings yield as it can be compared to bank deposits, rental yields on property or the yield to redemption on government or corporate bonds. At the time in late 1999, that 3.3% earnings yield could be compared to the risk-free 10-year US government bond yield of circa 6.3%. So, not only had you overvaluation in US equities when compared to history, but you were being offered much better value in the risk-free alternative.

So, yes, in this context you might choose to 'time the market' by investing where the value was better. It may be market timing, but it is so on the basis of values. In other words, value can be a market timer for an investor. And market timing this way is not speculating, it is the very essence of sound investing, which should be on the basis of value. If the Irish had any understanding about 'value' they would not have been buying Irish property post 2002, if not before. But not only were we piling in, but we were doing so with debt. It did not take a genius to work out that it made little investment sense. Hence, my opening para in the booklet 'learning how to save and invest is not a luxury in life; it is a crucial part of our lives and we need to be more informed'.

Today, in my view, it's not so clear cut that the key US equity market is significantly overvalued. Yes, we have the S&P 500 trading on circa 21 times earnings for an earnings yield of 4.7%. Yes, this earnings yield is well below the long-term average, which is a yellow flag, but perhaps not a red flag. Today, unlike 1999, the yield from a risk-free 10-year US government bond is 2.55% (when I last checked), which is well below (not above) the S&P 500 earnings yield. Today, it's tricky. It's not always necessary to have a definitive view. I don't have one at present. I neither feel the key US equity market is overvalued nor undervalued. I appears fairly valued relative to the alternatives. After all, how do you price an asset when interest rates are so low. If you believe long-term interest rates are going to be this low for several years then it is right equities are valued higher than was the case historically. In 1999, the bubble was in equities. In the mid-2000s the bubble was in property, and no more so than Irish property. We Irish do go to extremes! Today, I'd venture, the bubble is in developed world government bonds unless you believe in deflation. The 35-year old bond bull market in the developed world, that started as long ago as 1981, most likely ended last July. As they say, long bull markets rarely end softly!

These principles are all outlined in the booklet. I believe the more one reads the booklet, the more you will get from it. I am on my third read of 'Money, the Unauthorised Biography'. A superb piece of work by Felix Martin in the UK on the history of money. But if you follow my lead and buy this book, be forwarned that's it demands good initial insight to get the value.

I, like others, can see the remarks on this thread. I'm encouraged to see some saner voices making an appearance of late. In the booklet, there's 30 years' experience in 56 pages written in easy-to-follow language. Lord John Lee, columnist with the Financial Times, recognised that and hence the 'Foreword'.

However, it's a decent guide, not gospel...we might leave that to Warren Buffett. So, anyone is entitled to argue with points in the booklet and make their own points. That's debate. But before you add to the debate, have the common curtesy to read it first, as I will not engage with those who see a need for argument without facts to back it up.

 

[dub_nerd]

Thanks for the comments. This jumped out:

So, yes, in this context you might choose to 'time the market' by investing where the value was better. It may be market timing, but it is so on the basis value. In other words, value can be a market timer for an investor. And market timing this way is not speculating, it is the very essence of sound investing, which should be on the basis of value.

Maybe I've been missing something all along. Is there some other version of "timing the market" than waiting for value to appear? That's certainly what I've meant by it. Indeed, I'm a bit stumped as to what else it could mean.

 

[Rory T Gillen]

Yes, I was assuming most people refer to timing the market 'by way of the price action (also referred to technical analysis)' as opposed to 'fundamental values'.

 

[dub_nerd]

Ah, ok. I presume that's what these so-called "chartists" that I've been reading about are doing. That has always struck me as about as scientific as reading chicken entrails. I hadn't thought of it as "timing the market" so much as predicting movements based on supposed recurring patterns. But yeah, I guess that's the same thing. Those people should be locked up for their own safety.

 

[Dan Murray]

Ah, ok. I presume that's what these so-called "chartists" that I've been reading about are doing. That has always struck me as about as scientific as reading chicken entrails. I hadn't thought of it as "timing the market" so much as predicting movements based on supposed recurring patterns. But yeah, I guess that's the same thing. Those people should be locked up for their own safety.

Dub nerd,

My understanding is that Rory is not averse to a bit of chartism. I am sure he will qualify the extent he subscribes to such methods and how he reconciles this practice with post 22?!

 

[RobFer]

Not at all. It can mean many other things. Value based based investing can be rule based. In contrast timing the market can mean an approach that is haphazard and not rule based. Timing the market could mean trying to harvest the trend rather than capture an undervalued stock.

 

[RobFer]

Ah, ok. I presume that's what these so-called "chartists" that I've been reading about are doing. That has always struck me as about as scientific as reading chicken entrails. I hadn't thought of it as "timing the market" so much as predicting movements based on supposed recurring patterns. But yeah, I guess that's the same thing. Those people should be locked up for their own safety.

Despite what you say there is a lot of academic evidence that value based investing has historically worked.

 

[Rory T Gillen]

Yes, I pay attention to a number of technical indicators that I understand and find useful.

• Dow Theory for the 21st Century - complex, but fully explained in the book of the same name written by Jack Schannep. Dow Theory, as a technical indicator, has been around since 1900 and Jack Schannep's is just one version of it.
• The Coppock Indicator - very helpful at highlighting the move from bear to bull market, excellent track record.
• Capitulation indicators - basically measure when the pace of decline accelerates, and usually signal a bottom or the start of a bottoming process.

I did not include any reference to them in the booklet, as the aim was to keep the booklet as simple as possible. But the above three indicators are all outlined in detail in the other book 3 Steps to Investment Success. These indicators are also followed in the members' area of our website gillenmarkets.com.

I don't tend to base any of my own investment decisions on them. But I do find that they are very helpful in understanding what the market is saying. Capitulation, for example, is characterised as a frenzy of selling with prices cascading downwards at speed. It's a scary time in markets. But it can be measured, and as it signifies a time in markets when everyone is selling together it is a sort of contrarian indicator.

I don't think it is necessary to use such indicators for sound investing. I simply find them interesting, so each to their own.

 

[Dan Murray]

I don't tend to base any of my own investment decisions on them.

I am trying to understand your investment decision making process. I'm not at home, right now, so don't have your book or booklet to hand.

So just to be clear - are you saying that you don't base investment decisions on technical indicators (i.e. you rely on other forms of analysis) or are you saying that after your fundamental analysis you will adjust your buy/sell decisions based on such indicators? If the latter applies, how influential are the technical indicators or put another way, are they occasionally followed, invariably followed or somewhere in between and what determines when the technical indicators are followed or otherwise? Also, how do you reconcile the two approaches (fundamental analysis v. technical indicators.)?

The reason for asking is that I believe it is critical to understand the thought process of an investment adviser in order to be able to judge whether it's a philosophy with which one is comfortable.

 

[dub_nerd]

Yes, I pay attention to a number of technical indicators that I understand and find useful...

• The Coppock Indicator - very helpful at highlighting the move from bear to bull market, excellent track record.

...I don't think it is necessary to use such indicators for sound investing. I simply find them interesting, so each to their own.

Wikipedia cites a claim that the Coppock Indicator is useful in bear markets less than half the time. In general, isn't the use (or even existence) of technical analysis at odds with the efficient market hypothesis? (i.e. any advantage that could be gained through its use would already be priced in).

 

[Duke of Marmalade]

This thread has been an interesting read this Christmas Eve

A few observations. I bought the original book, Three Steps and I got the booklet free through the post, from Davys I presume. I didn't read the booklet but I kept it on the shelf beside Three Steps. I think there was an AAM thread one time on Three Steps itself and I seem to remember being a strong critic of several aspects. In particular I was skeptical of the "Buy The Cheapest 15 (by PE) and Rebalance Each Year" system to beat the market; that it historically appeared to deliver proved nothing IMHO. I also in general have no time for chartist type predictors like Coppock. This thread made me give the booklet a quick skim and it doesn't seem to suffer from these pretentions.

I was particularly interested in the "discussion" between Wollie and Rory. As seems to be inevitable online it got a bit tetchy but I think it would be unfair to accuse either of overstepping the mark into abuse. I think the fact that the REITs stand at a discount to NAV is a comfort to buyers though I note that Wollie has had personal experience that it by no means guarantees you are getting good value.

I am firmly bought into the narrative that we are sitting on a massive asset bubble inflated by QE. Thus, for example, I have maxed out on Prize Bonds yielding 85bp tax free. However, Rory's reminder that dividend yields are 2.5% p.a. and that there could be a reasonable expectation of future growth of say 3.5% p.a., shows that there is still quite a bit of headroom over 2% bond yields. The problem is Rory seems to accept that a correction is likely so on a, say, five year view its hard to be confident on equities.

 

[Rory T Gillen]

Wikipedia cites a claim that the Coppock Indicator is useful in bear markets less than half the time. In general, isn't the use (or even existence) of technical analysis at odds with the efficient market hypothesis? (i.e. any advantage that could be gained through its use would already be priced in).

Since 1970, if one had bought the S&P 500, for example, on each Coppock signal, the average 1-year returns were 19%, 3-year returns 42% and 5-year returns 91%. These returns were before dividend income which, of course, would be material over the 5-year horizon. There have been just 12 signals since 1970; that's 12 signals in 46 years. That can hardly be classed as trading or speculating in markets.

I am not saying using Coppock beats a 'Buy & Hold' approach, which I favour, but they are solid facts on which to base a decision should you follow such an indicator. You could, for example, add to a position at such a time. In a bear market, it is impossible to know where the bottom will be put in. Better, perhaps, to wait for the turn and the 'Coppock Indicator' has proven itself to be a useful indicator in that regard. Not perfect, but useful.

In March, April and May 2009, the Coppock Indicator gave a serious of 'Buy' signals when most in the investors were shell-shocked. What it actually signaled was that the (professional) buyers had returned despite the media headlines, which were still universally apocalyptic at the time. And this is the most important point....such indicators can assist you to see clearly through the fog to what the market is 'doing', not what everyone is 'saying'. They assist you deal with the biggest bogey of all in markets, your emotional responses to poor media headlines.

In March, April and May 2009, professional fund managers were buying not selling and the 'Coppock' indicator strongly hinted that a turn was in. The same occurred this summer (2016) with a series of 'Coppock' buy signals first in the emerging markets, then the UK FTSE 100, then Asia Pacific, the S&P 500 and so on. Reading the media heading would have led you to different conclusions perhaps, but it was fairly clear from 'Coppock' that the average investor was buying not selling.

You can ignore such information and buy only when you see solid value in easy-to-understand companies or funds. But I find 'Coppock' and other such medium-term technical indicators useful tools in the investment bag.

How you calculate the 'Coppock Indicator' is in an Appendix in 3 Steps to Investment Success. So, it's open to anyone to check those 'facts'. There's also a fascinating history behind 'Coppock' for anyone with an interest in stock market history.

 

[Rory T Gillen]

This thread has been an interesting read this Christmas Eve

A few observations. I bought the original book, Three Steps and I got the booklet free through the post, from Davys I presume. I didn't read the booklet but I kept it on the shelf beside Three Steps. I think there was an AAM thread one time on Three Steps itself and I seem to remember being a strong critic of several aspects. In particular I was skeptical of the "Buy The Cheapest 15 (by PE) and Rebalance Each Year" system to beat the market; that it historically appeared to deliver proved nothing IMHO. I also in general have no time for chartist type predictors like Coppock. This thread made me give the booklet a quick skim and it doesn't seem to suffer from these pretentious.

Yes, we understand your opinions, but it would be nice if you did not mix them up with the facts, which is one of my basic criticisms of many on this website. In the above response to 'dub-nerd', there are facts provided on Coppock. In addition, these same facts were initially outlined in 3 Steps to Investment Success, published in late 2012. A different approach perhaps, but hardly 'pretentious' simply because you don't accept the facts!

 

[Duke of Marmalade]

Yes, we understand your opinions, but it would be nice if you did not mix them up with the facts, which is one of my basic criticisms of many on this website. In the above response to 'dub-nerd', there are facts provided on Coppock. In addition, these same facts were initially outlined in 3 Steps to Investment Success, published in late 2012. A different approach perhaps, but hardly 'pretentious' simply because you don't accept the facts!

It is a FACT that on each occasion that Saturn has been aligned with Jupiter the Fiji stockmarket has shown a bounce, so what?

I think AAM contributors can decide whether the Coppock Indicator is pretentious based on the following explanation.

The indicator is designed for use on a monthly time scale. It is the sum of a 14-month rate of change and 11-month rate of change, smoothed by a 10-period weighted moving average.

Three Steps helpfully explains the theoetical basis for this formula. Apparently Mr. Coppock asked the church how long was the recovery time after bereavement. He was told between 11 and 14 months and naturally he concluded that 11 month and 14 month growth rates would be key inputs into his indicator. However, despite its impressive ecclesiastical origins I am not convinced of its infallibility.

 

[Duke of Marmalade]

Ok, Boss, I have read the booklet from cover to cover. Overall a good read and much sound advice/comment but and there is a but which I will come to later. First the good things.

At the end of the day one is left wondering just what to invest in and that is not a criticism, that is how it should be, there are no silver bullets in this booklet.

We are in absolutely unprecedented financial conditions. I for one can see no possible reason for investing in long government bonds at these yields even within a balanced fund. The booklet almost agrees with this.

I was nearly persuaded by the comments on REITs. I do like that these are openly traded and their tax treatment is attractive (especially if you have past bank share losses) - perhaps more emphasis should have been given to the taxation aspects.

The only definitive "advice" seems to be that anyone embarking on long term asset accumulation, say for a pension, should think equities and even I, the incurable equity skeptic, can't argue with that. Though he should have emphasised more the role of inflation in past statistics.

My favourite exhibit is the Coca Cola one. This is my hobby horse. The stockmarket is a second hand market. It is the price that will decide the value not the quality of the good. Coca Cola has been shown to be an excellent company but its inflated price meant that it was a poor value investment.

Of course he is right in advising investors to steer clear of Financial Spread Betting and CFDs.

He has a swipe at Guaranteed Tracker Bonds, are these still available at these interest rates?

For the But I will dedicate a separate post - why oh why did he include that ultimate pretension Euro Cost Averaging? 9 outa 10 without that but barely scrapes a pass with that included, I hope he drops it from future editions.

 

[Duke of Marmalade]

Euro Cost Averaging

Pound Cost Averaging was the ubiquitous tool of the early Unit Trust salesmen esp. in the UK. It served them in several ways:
1. It argued that regular savings systematically provided a "free lunch" in that when prices were down you picked up more "extra" units than the "shortfall" when prices were up.
2. It made a merit of falling prices - the main downside to the ordinary investor comparing with bank savings.
3. It made them sound clever.
I thought that in these days of high regulation this tool had been disgarded even by this constituency.

In academic circles Pound Cost Averaging was always dismissed as a mere demonstration of the arithmetic tautology that the Arithmetic Mean is greater than the Harmonic Mean (Google it). It conferred no economic substance whatsoever.

Rory will no doubt argue that Table 6.3 of the booklet is Fact. The Table demonstrates that over this time period and for this market a system of investing a regular money amount was 3.6% better than a system of investing a regular number of units (aggregate money investment equal). This will tend to be the case in rising markets because the former invests the money earlier than the latter.

 

[Rory T Gillen]

Euro Cost Averaging

Pound Cost Averaging was the ubiquitous tool of the early Unit Trust salesmen esp. in the UK. It served them in several ways:

I think the real strength of euro-cost averaging is the discipline it brings to the table. Volatility in markets can be scary at times and it can knock many a saver off course, but by pre-committing to a programme - like many do with their monthly pension contributions - it is somewhat easier to ensure that you don't just buy when things are on the up.

Of course, euro-cost averaging exclusively into equities is no use if a market is in a sustained decline (as opposed to a cyclical bear market i.e. temporary decline), like can occur in a deflationary environment, and did occur in Japan from 1990 to 2012 in both equities and property. So, for euro-cost averaging to assist, you need to make the assumption that equity markets will continue to make progress over the long-term. That's the glass-half-full attitude discussed in the booklet, and in that context, yes, Table 6.3 is fact. If an investor doesn't accept that equities are headed higher longer-term then he/she has the alternative choice of investing using a balanced approach - investing in both risk assets and non-risk assets alike or, indeed exclusively into non-risk assets.

Overall, however, good to see someone post a comprehensive review. I'm not sure why you favour opinion over fact regarding Coppock, but I've said my bit and I will leave it at that. On the FTSE 100 P/E approach, just to clarify, it's not simply the lowest 15 p/e stocks in the index, it's the lowest 30 P/E stocks from the top 75 stocks in the FTSE 100 Index, with a stock from each 'industry' selected from this basket of 30 to give a portfolio of somewhere between 12-15 stocks diversified across sectors or industries. But, enough said on that topic also!