# Those waiting for a correction/crash.... what's exactly your strategy?



## SkyFall (Jun 19, 2012)

Those of you waiting for a crash/correction in the market what's your strategy? What I mean is, you guys are probably sitting on a good amount of cash or cash equivalent waiting for the market to correct itself (here let's pretend there will have a correction/crash.... just let's pretend that the bear is coming....or let's say those waiting for the next downturn). 

We don't know how bad the correction/crash will be, but once it has start what is your strategy? after a 10% downturn will you deploy all your cash to buy or you only put lets say half? and wait for a further correction/crash?

I am asking this question because still I am young I want to prepare myself for the next downturn (not saying it's coming or not) but I want to get your point of view since you guys saw more cycles than me, is there any signals you guys look at? I don't want to use all my powder when the market has only gone down 1/4 of the downturn....

*** I am not asking for forecasting the future, I am asking what you the key element that let you guys believe a downturn is not yet done. ***


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## Nemo2 (Mar 1, 2012)

I believe some people will choose (what they think is) a good entry point for a particular stock, some will hold off until there appear to be indications of a rebound, while others will just (attempt to) ride it out.......one size doesn't fit all.


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## Canadian (Sep 19, 2013)

I'm continuing to invest in companies that I believe are under-valued. If a correction happens, I don't think that _all_ stocks will go down - mostly the "momentum" stocks that have been bid up the last year or two. I have a very long time horizon as well so I believe I will be in a better position if I remain invested, rather than missing out on current growth and dividends. If my stocks happen to correct, I am happy to add to them at lower valuations.


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## the_apprentice (Jan 31, 2013)

^ My strategy is very similar.

We all have the advantage of having time on our side since we are young. That being said, your risk tolerance should be much higher than investors who are older and have much more to lose. Don't worry so much about the short-term market; instead invest in what you can afford to lose because the long-run is more important.

I've been adding to lower the ACB of my previous purchases, and investing in what I think will be a good hold for me (whether short-term or long-term). Staying out of the market is like being a bench player waiting for his turn to play... Now is always the best time to play. #optimist


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## SkyFall (Jun 19, 2012)

I totally agree with you guys, I have a very long investment horizon. I just thought about the fact that if i am invested 100% in the market I wont have money to invest when stocks are on sale.....


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## Time4earlyretirement (Feb 21, 2014)

SkyFall said:


> I totally agree with you guys, I have a very long investment horizon. I just thought about the fact that if i am invested 100% in the market I wont have money to invest when stocks are on sale.....



I don't think its a good idea, at least IMO, to be fully invested. I'd treat a huge correction the same way I'd treat smaller corrections, which I'd treat the same as unexpected dips on bad news: Find a universe of good companies that you like, doesn't matter if its on value or growth, as long as it fits to your riskiness and investment style, and just buy on dips. Obviously if the market drops for X amount of consecutive days, the buying on dip spreads. It's good to always have some cash to buy on these opportunities. Money can be made 2 ways...an absolute buy, where you watch the price go either above/below your entry price, or averaging down your cost to the average stock price.


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## Canadian (Sep 19, 2013)

In my experience so far I have found that there is always something "on sale," whether I have money or not. I have learned not to be too bothered by it when I'm in cash-saving phases.


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## the_apprentice (Jan 31, 2013)

SkyFall said:


> I totally agree with you guys, I have a very long investment horizon. I just thought about the fact that if i am invested 100% in the market I wont have money to invest when stocks are on sale.....


If that's the case then leave 20% of your total equity as CASH for a correction. I never keep CASH in my TFSA. All Dividends are DRIP'd or reinvested in ETF's and any contributions to that account are invested immediately as well. My RRSP is where I am more cautious where I will invest 50% of my equity and have the other 50% on the sidelines waiting for a "correction" so to speak or to add to the ACB of my holdings when the stock is considered to be "on-sale".


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## Pluto (Sep 12, 2013)

My strategy centers on an evaluation of "appreciation potential". If the appreciation potential of stocks in general is low, I get cautious. Unless a stunning opportunity comes along, I don't buy. When the appreciation potential of stocks is high, I buy and buy big. I go all in, and in some cases buy on margin. I get off margin in 1 to 2 years. 

For an overview of "appreciation potential" a good source is the ValueLine Investment survey, available at most city libraries. I also pay a lot of attention to Buffett's favourate value indicator. One can get an overview of that here:

http://www.gurufocus.com/stock-market-valuations.php

The last peak in over valuation was about Sept 2007. Buyers of a TSX etf at that time @ 14000 would have about a 0% gain by today. Contrast that with buying the same etf when undervaluation was at its maximum in march 2009. Buying then at about 8000 would give one a 75% gain by today. Clearly, paying attention to value is wise. When the market is overvalued, and appreciation potential is low, it pays to wait even if it means waiting one or two years. 

Right now the % I have in cash is greater than I have in stocks. I'll be happy to spend that and buy on margin when the appreciation potential is much better than it is now.


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## Canadian (Sep 19, 2013)

I suppose I should elaborate a bit on my point. My thoughts are somewhat similar to Time4's. I always have a watch list of my current stocks and ones I would like to own. I concern myself with price fluctuations in only those stocks. Many stocks are not perfectly correlated with the index - so I can expect a correction in some of my "watch stocks" while the overall index continues higher. Similarly, if I wait for a x% correction in the index, my watch stocks may not have fallen to my "buy" prices yet. That is why I remain invested in the stocks I want to hold and deploy the cash I have saved in my "watch" stocks when I feel they are undervalued.


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## james4beach (Nov 15, 2012)

I'm not waiting for a crash (so perhaps I shouldn't be answering your question) but I wanted to reiterate this point that there's usually something that's out of favour. Even if we're talking broad sectors instead of individual stocks.

The broad strategy over the long term is to keep adding assets of different kinds. Aiming to maintain your target allocations naturally makes you add money to things that are low, so it all kind of works out.

For example, right now it's commodities including gold. Contrary to stocks which keep hitting new all time highs, broad commodity indices and gold are bouncing around multi-year lows


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## Canadian (Sep 19, 2013)

^ +1


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## cainvest (May 1, 2013)

james4beach said:


> The broad strategy over the long term is to keep adding assets of different kinds. Aiming to maintain your target allocations naturally makes you add money to things that are low, so it all kind of works out.


^^ This.

However, I do admit to shifting my asset allocations (new money only) more towards fixed income lately in hopes of a value buy within the year but that's about it.


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## SkyFall (Jun 19, 2012)

well that's what I am doing, I am passing in review the entire S&P 500 looking for undervalued/out of favor stocks and I put them in a watch list where I monitor them closely. Whenever they drop, I jump in. But I also have the pillars of my portfolio (bluechips) where I buy whether the market is up or down (that's the portion of my portfolio I am ''dollar cost averaging'' and plus those ''pillars'' are stocks I am comfortable with in any kind of market.


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## Canadian (Sep 19, 2013)

It sounds like you are on a good track with your strategy. The key - which I find can be hard at times - is patience. I have a habit of tracking newer purchases a lot closer than the rest of my portfolio - sometimes kicking myself if I feel like I pulled the trigger a bit early or late. After a while I tend to forget about it and things work out for the better - patience + time seem to work well with due diligence in stock selection.


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## Jaberwock (Aug 22, 2012)

Stay invested in quality dividend paying stocks. We have been hearing stories of this upcoming correction for over a year now. Meanwhile, those who cashed out have lost about 20% in capital appreciation and dividends while waiting for a correction that hasn't happened.

When the correction does happen, don't worry about it. Just collect the dividends and wait.


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## hboy43 (May 10, 2009)

Hi:

I don't wait for corrections, either in general, or on specific stocks or industries. However, one can get a sense that an interesting price is afoot and buy. I am often early and am often waiting years for things to turn out, but turn out they often do. I even do margin extensively so I don't concern myself with having the cash to act, I just act.

An example:

Had been a shareholder in MX for about a decade when 2008 hit. So the price went from mid 30s down under 20 in a matter of months. At that point, my weighting was about halved, and surely almost 50% on sale is an interesting number. so I purchased at $19 500 more shares IIRC. A few weeks/months later it continued on down, so 700 more at $17. A few weeks/months later I had the opportunity to pay less than the price of my initial tranche a decade prior, another 1500 at $8. Now the first two 2008 buys were upside down for what 1-2 years or so. Can't be helped. I cannot predict the future and hit the bottom every time, but one has to play if one wants to win. Here we are 6 years later and MX has been a spectacular investment.

When most have a holding that is showing a loss, they see a mistake they have made. "Why didn't I sell at $35?" or "Why did I buy more at $19, then $17". I see it as a signal to pay attention as maybe a good opportunity is there. The initial purchases may well have been a mistake, but that is not mutually exclusive with buying more now being a spectacularly good move. I have made a stunning amount of money on companies with a success ratio under 50% because backing up the truck at really low prices covers it all and then some.

The last couple of years, it in general has not been obvious that a good buy is out there. So I have been mostly paying down debt. I have only purchased more BBD.B when it swooned recently to the mid 3s, and I initiated a new position in TCK.B as I had no miner and it is in the dog house these days. Neither of these buys is doing much for me yet. I am sure that there are plenty of buys out there now as there always is, but it takes time to pay attention to the entire universe of stocks and I would rather work on my boats and go sailing.

So I am mostly in investor hibernation waiting for, no looking forward to, the next time the world becomes really interesting like back in 2008. A 10% fall or correction in the market is just not very interesting frankly. It is neither something to fear, nor celebrate. It is just the regular wind and waves of the investing experience.

hboy43


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## tygrus (Mar 13, 2012)

If you have a significant investment in the market and it shaves off 10-30% in some 'correction' you are going to have a really hard time pulling the trigger on anything. Only the most hardened investors bought on the 2009 dip. When the rest of your investments have lost ground, its hard to throw in more. Nortel and Blackberry have been on sale too.

Save yourself some headaches, buy a couple good ETFs drip them and leave them alone for 30 years. Thats the only way investing works for the little guy.


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## Canadian (Sep 19, 2013)

tygrus said:


> If you have a significant investment in the market and it shaves off 10-30% in some 'correction' you are going to have a really hard time pulling the trigger on anything.


Maybe for some, not all. Dips like this can be a shock for new investors - but it's a valuable learning lesson for those who have time to recover (longer time horizon). When I first started investing I had a hard time stomaching the volatility. I once had a stock drop ~50% over a couple months and the experience I had holding onto it, averaging down, and recovering to make a gain helped me harden my nerves. Patience in the markets isn't something that can be taught, but rather must be experienced.



tygrus said:


> Save yourself some headaches, buy a couple good ETFs drip them and leave them alone for 30 years. Thats the *only* way investing works for the little guy.


I disagree. ETFs are great for a core holding for a core-and-explore strategy, or for those who don't have the knowledge/time/interest in managing a portfolio of stocks. But many have done themselves well by selecting quality stocks. One could even model their portfolio of individual stocks after an ETF to receive the distributions directly and save on the MER.


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## gt_23 (Jan 18, 2014)

Pluto said:


> The last peak in over valuation was about Sept 2007. Buyers of a TSX etf at that time @ 14000 would have about a 0% gain by today. Contrast that with buying the same etf when undervaluation was at its maximum in march 2009. Buying then at about 8000 would give one a 75% gain by today. Clearly, paying attention to value is wise. When the market is overvalued, and appreciation potential is low, it pays to wait even if it means waiting one or two years.


How do you know corporate earnings won't continue to increase and drive markets higher?


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## Canadian (Sep 19, 2013)

gt_23 said:


> How do you know corporate earnings won't continue to increase and drive markets higher?


The rate at which the markets have grown in the past 5 years is much higher than the rate of corporate earnings growth. While corporate earnings can continue to grow and drive the market higher, a lot of stocks that continue to trade at higher multiples may pull back or slow down until earnings catch up and valuations normalize - especially with Fed tapering.

Of course, when we refer to the markets we should distinguish between the TSX, the S&P 500, and the DJIA. The TSX has experienced 47% growth in the past 5 years while the latter 2 have grown 114% and 100%, respectively. Canada wasn't hit as hard during the recession and we seemed to recover faster - I doubt that companies south of the border had twice the corporate earnings growth. In short, I don't think the TSX as a whole looks as frothy as other indices - but like I said, I tend to focus my attention on specific holdings, rather than an entire index.


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## cainvest (May 1, 2013)

tygrus said:


> Only the most hardened investors bought on the 2009 dip. When the rest of your investments have lost ground, its hard to throw in more.


Anyone who adjusted their asset allocations during that period, topped up their RRSP or TFSA in the beginning of 2009 would have bought in on that dip so I wouldn't say it's just hardened investors who got in.


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## doctrine (Sep 30, 2011)

You need to have cash on hand at all times if you are preparing for the next big correction, which of course will inevitably arrive but who knows when. 2008-09 was a big crash, but even better news is that most stocks stayed 20% or more below the 2007 peaks until essentially the end of 2011. You had 3 full years to deploy cash in plenty of undervalued and growing companies, small and large cap.

I see the next few years as a time to raise cash. That doesn't mean selling - to me, it means being restrictive about investing new money (building cash) and letting the market run where it will with my current holdings (taking advantage of a bull run).


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## gt_23 (Jan 18, 2014)

Canadian said:


> While corporate earnings can continue to grow and drive the market higher, a lot of stocks that continue to trade at higher multiples may pull back or slow down until earnings catch up and valuations normalize - especially with Fed tapering.


What do you consider a normalized valuation? Avg. sector P/E? (10, 20, 30 years?)...There seems to be a lot of capital in the financial markets - equity and debt - for the last few years chasing returns and I'm not sure higher multiples won't persist.


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## Canadian (Sep 19, 2013)

Normalized valuations being common indicators, such as historical average P/E or P/CF for respective sectors - adjusted for growth and inflation. If you graph corporate earnings, most tend to be linear or logarithmic, but valuations over the past year or two have been increasing in more of a linear or exponential manner. Stocks that have valuations increasing at a rate higher than actual growth will likely see a slow down or correction.

This is not to say that _all_ higher multiples won't go away, but I doubt that all will continue like they have. There is a lot of capital in the financial markets - but there is also a lot of _leveraged_ capital. As tapering continues and people eventually cover their margin, the liquidity injection in the market will slow and stocks trading at premiums for no apparent reason will likely be the first to be affected.


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## Jon_Snow (May 20, 2009)

I always keep a fair bit of cash ready for quick deployment. I've never really experienced a market crash, as I started investing seriously in late 2009, after the crash had reached bottom. What I do like is pouncing on individual stocks that have mini crashes/corrections and then buy them at a relative bargain. I've talked about this a bit in the past.

Not sure what I might do if a market wide crashed occurred - hopefully I have learned enough around here that I wouldn't panic and do something stupid. :stupid:


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## Pluto (Sep 12, 2013)

hboy43 said:


> Hi:
> 
> I don't wait for corrections, either in general, or on specific stocks or industries. However, one can get a sense that an interesting price is afoot and buy. I am often early and am often waiting years for things to turn out, but turn out they often do. I even do margin extensively so I don't concern myself with having the cash to act, I just act.
> 
> ...


I like your post. You don't wait for corrections, but when they happen you back up the truck and load up on stock. That's one of the best ways to do it. And obviously you don't buy into all the negative sentiment during serious downturns. Way to go.


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## Pluto (Sep 12, 2013)

gt_23 said:


> How do you know corporate earnings won't continue to increase and drive markets higher?


How do I know? 

1. Experience. 
2. Reading books by those who know more than I do. 
3. A core idea is when the economy gets good, central banks withdraw stimulation, and then actually try to slow the economy mostly by rising rates. They do that to contain inflation. Higher rates is an impediment to increasing corporate profits. 
4. Another core idea is value. When the price of stocks is too high relative to their earnings, sales, and median book value their appreciation potential is low. It is unwise to load up on stocks when appreciation potential is low. 
5. Last year S&P earnings increased about 1% while the market went up about 33%. Basically the 33% increase is air. Its going to come out; exactly when, is unknown, but it won't be an eternity. The 33% increase was not in response to earnings increases, its a matter of money managers not having any other place to put the money. To me that wasn't a bad time to give them some of my stock. Nothing I sold last year has gone above it's previous highs. 
6. Financial and economic history. I'm unaware of anytime that an over valued market was addressed by sudden large increases in corporate profits. Typically over valuation gets dealt with by severe corrections. Once they start, they feed on themselves. Margin calls. Mutual fund managers not having the cash to deal with redemptions so they have to sell some. then more margin calls. Then more redemptions. At some point the big money managers get panicked and huge volumes of stock get dumped on the market, and prices take a sharp fall. Bargain hunters come in and prices rise sharply, but not enough to match previous highs as the pessimistic see the bounce as an opportunity to unload. 

There is no reason why a DIY individual investor needs to stay in front of that train and console themselves by saying at least they still get the dividends. Us small folks can be totally out in some minutes. It is a great advantage over big money managers, who have so much, they can't get out. I'm into preserving capital and making it grow. Staying fully invested in an over valued market is not the best way to preserve capital.


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## gt_23 (Jan 18, 2014)

Pluto said:


> How do I know?
> 
> 1. Experience.
> 2. Reading books by those who know more than I do.
> ...


OK #3 is a good answer that I hadn't considered.

Wrt to #4, how do you justify that different sectors have different 'normals' for value (i.e. P/E, P/B, etc.). If there were some measure of each that defined over-valued, why does it differ so much by sector, and even industry or firm, what is considered a normal P/E, P/B, etc.

Where does a DIY investor put his capital, when equity, debt, and real estate markets are overvalued? There must be a negative correlation out there somewhere!


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## Pluto (Sep 12, 2013)

tygrus said:


> If you have a significant investment in the market and it shaves off 10-30% in some 'correction' you are going to have a really hard time pulling the trigger on anything. Only the most hardened investors bought on the 2009 dip. When the rest of your investments have lost ground, its hard to throw in more. Nortel and Blackberry have been on sale too.
> 
> Save yourself some headaches, buy a couple good ETFs drip them and leave them alone for 30 years. Thats the only way investing works for the little guy.


Hardened investors might have seen it coming by keeping an eye on value and raised cash by locking in some profits during the period of over valuation. Then, in the inevitable bear market, they are not shocked and stunned by paper losses. Instead they are delighted to have some cash and buy back in at bargain prices. 

The tsx topped out in June 2008, and lost about 44% by the following March, even though the whole thing was basically precipitated by US financial events. We are not immune. A panic south of the border will drag out stocks down with them. (If your life boat is too close to the Titanic, you are going down too.) And it took the tsx until this year to recover what it lost in only 9 months back in 2008-9. Stocks go down way faster than they go up.


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## GoldStone (Mar 6, 2011)

Pluto said:


> 3. A core idea is when the economy gets good, central banks withdraw stimulation, and then actually try to slow the economy mostly by rising rates. They do that to contain inflation. Higher rates is an impediment to increasing corporate profits.


We are nowhere near close to central bank tightening.

1. Improving economy lowers unemployment rate.
2. Tight labour market improves wages.
3. Higher wages lead to inflation AND shrink profit margins.
4. Central banks start raising rates.

We are stuck at #1. Unemployment rates remain elevated, despite unprecedented stimulation.

Also take a look at the attached graph. Rising rates are not that bad for stock returns, until rates reach certain point.


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## Pluto (Sep 12, 2013)

gt_23 said:


> OK #3 is a good answer that I hadn't considered.
> 
> Wrt to #4, how do you justify that different sectors have different 'normals' for value (i.e. P/E, P/B, etc.). If there were some measure of each that defined over-valued, why does it differ so much by sector, and even industry or firm, what is considered a normal P/E, P/B, etc.
> 
> Where does a DIY investor put his capital, when equity, debt, and real estate markets are overvalued? There must be a negative correlation out there somewhere!


1. You can put your capital in a short bond etf while waiting for bargains. Even though you only get like 2.5%, and you feel you are losing out on 3.5% to 5% dividends, you get it back in spades when the market tanks. You end up with more stock and higher dividends, plus you get appreciation as the market recovers. So the main thing one loses is grief, and too much risk. 
2. I don't justify that different sectors have different normals. To me, they justify themselves, and I just accept the normal for each industry. Typically growth stocks get a higher p/e as normal and higher price/book. A growth stock is defined as earnings growing at a 20% annual rate or greater, and expected to grow at that rate for many years. Their p/e's can go very high based on the assumption that the future is going to be rosy. Other stocks in cyclical industries (mining, autos, paper, manufacturing etc) will have different norms compared to growth stocks. That's because, defined as cyclical, they are not expected to have unimpeded revenue and earnings growth. Cyclicals are not buy and hold stocks, they are trades, and as such, they are valued differently by the market. Sometimes, when economic times are bad, and these stocks are not making money, the share price is low, but does not go as low as one might expect because the market starts to value them on their assets and on anticipation of future earnings when the economy improves. (Some of these cyclical monsters might be eking out a small profit during bad times, and the p/e can be 200, give or take a hundred or so. The market price does not drop to get the p/e lower primarily because of the assets, and anticipation of a recovery. If one insists on owning them, that's probably a good time to buy. Later, when the economy is cooking, and these monsters have recovered and are raking in dough, their p/e's can be around 5 - 10. That's a good time to think about selling them.) 

Essentially the market decides what is an appropriate value under current circumstances. When they get to the high end of the range, it is not unreasonable to assume they will regress to the mean, or lower. That's because the economy is cyclical. Despite the best efforts of central banks to eradicate cycles, they have failed. I expect them to fail in the future. Every time they get into inflation fighting mode, they break the back of the bull market. If the market is already overvalued relative to its own historical mean, the correction is more severe. But even if central banks did not fight inflation overvalued stock markets would eventually crash anyway. Many people eventually realized that paying thousands for a single tulip bub was insane, and the market crashed all on its own. 

The recent correction in growth stocks (eg Russell 2000 leaders) is, I believe, big time money managers sensing that the main course of this 5+ year meal is over, and now we are in an uncertain pause before the actual end. There is a herd thing going on. No one of them wants to pull the trigger and raise a lot of cash out of fear of looking stupid if they are too early. They stay in, to keep their jobs, and the way to do that is for all of them to look pretty much the same as the other guy. Can't blame them. But individual investors don't have to play that game. They can raise a whack of cash, park it in short bonds, then relax until the inevitable bargain hunting season arrives.


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## Pluto (Sep 12, 2013)

GoldStone said:


> We are nowhere near close to central bank tightening.
> 
> 1. Improving economy lowers unemployment rate.
> 2. Tight labour market improves wages.
> ...


I agree. We are not close to tightening. Tightening, is not an essential factor in markets correcting or crashing. They can do that all by themselves without any intervention. 
A big worry is the current over valuation of stocks, regardless of no tightening. Stocks can regress to the mean or lower without any central bank tightening. And even without tightening, US S&P 500 stocks earnings had about 1% earnings growth in 2013, while the index went up 33%. There are not enough 30% growers to sustain further meaningful increases in these stocks. The pickings are very slim. And when the correction comes, the few decent growers will get caught in the downdraft.


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## GoldStone (Mar 6, 2011)

Pluto said:


> A big worry is the current over valuation of stocks, regardless of no tightening.


"Overvaluation" is the subject of a fierce debate. A few pockets of the stock markets are clearly overvalued: biotech, social internet stocks, US small caps.

Outside of these pockets? Valuations are actually quite reasonable. According to Joel Greenblatt (Magic Formula Investing), US large caps are in the 42nd percentile of historic valuations. Meaning that, historically, they've been more expensive 42% of the time and cheaper 58% of the time. International stocks are even cheaper.

Yes, a couple of macro metrics point to overvaluation. Total market cap to GNP is one. CAPE is the other. Neither one works as a market timing indicator. We can go a lot higher for a lot longer before we correct. Here's a very good summary of why CAPE is problematic:

http://www.thereformedbroker.com/2014/05/22/cape-forward-returns-and-you/



Pluto said:


> And even without tightening, US S&P 500 stocks earnings had about 1% earnings growth in 2013, while the index went up 33%.


One year comparison is not meaningful. Here's the chart of S&P 500 vs. its earnings, courtesy of Eddy Elfenbein. Where the lines cross, stock market P/E is 16.










As you can see, anything can happen short-term. The earnings can outpace the index. The index can outpace the earnings. 2013 was the year where the index caught up to earnings. The key question is, where do earnings go from here.


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## gt_23 (Jan 18, 2014)

Pluto said:


> 1. You can put your capital in a short bond etf while waiting for bargains. Even though you only get like 2.5%, and you feel you are losing out on 3.5% to 5% dividends, you get it back in spades when the market tanks. You end up with more stock and higher dividends, plus you get appreciation as the market recovers. So the main thing one loses is grief, and too much risk.


Yes I had thought of that, but I didn't think 2.5% was worth the risk of the value of the ETF dropping at even the slightest hint of higher interest rates. Granted that short won't move as much, they still dropped after last year's Bernanke speech in the spring.


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## Pluto (Sep 12, 2013)

GoldStone said:


> "Overvaluation" is the subject of a fierce debate. A few pockets of the stock markets are clearly overvalued: biotech, social internet stocks, US small caps.
> 
> Outside of these pockets? Valuations are actually quite reasonable. According to Joel Greenblatt (Magic Formula Investing), US large caps are in the 42nd percentile of historic valuations. Meaning that, historically, they've been more expensive 42% of the time and cheaper 58% of the time. International stocks are even cheaper.
> 
> ...


1. Every time the market is over valued there is a fierce debate about what it means. Typically, I don't debate, I just state my perspective. 
2. Thank you for the information and charts. They support my view. 
a) For instance, the article on CAPE. Currently it indicates a 2.7% appreciation potential over 5 years. That is consistent with ValueLine which also see very low appreciation potential in the next 3-5 years. I simply don't buy into the assumption of the article that "there is no reason this (an elevated cape) couldn't continue". They don't provide any compelling reason why it will continue. The only valid reason for it to continue is increasing revenues and earnings. My experience is in a mature bull market, analyst expectations are overly optimistic. Essentially the extrapolate the past into the future often with no accounting for the cyclical nature of the economy and stock market. 
b) CAPE is not my preferred measure. Total market cape to GNP or GDP is, I think, more precise in terms of identifying a period of over valuation. 

2. The S&P 500 vs Earnings graph is telling. Your interpretation is that prices "caught up" to earnings. That's not quite accurate. In early 2013 they caught up. The S&P prices exceeded the earnings line. They still exceed the earnings line. that's consistent with my concerns. Too, the yellow earnings line is extrapolated into the future right out to 2016. Why? It's all assumption. There is no compelling reason why S&P earnings will be 140 by 2016. If this was 2007, and this graph was made in, say, January 2007, you wouldn't see the earnings line turn down in the future. Instead you would see it continue on up into 2008 and 9. So this graph is interesting historically, but it has no sound basis when it extrapolates into the future. Moreover, how long does the black line stay above the yellow line in an upward trend when total market cap exceeds GNP? For some thoughts on that, look back at 2007 when market cap exceeded GNP, and your graph shows prices exceeded the earnings line. The bull market ended. 

Here's how I interpret the S&P earnings graph:

2009 to mid 2010: This is the market surge anticipating a better economy. Then, ops, maybe we over did it, and a pull back below the earnings line. 
Mid 2010 - early 2013: this is the climbing a wall of worry phase. 
Then in 2013 the cross above the earnings line: This is leaving the wall of worry behind and moving into the latter stages of happiness, complacency, euphoria, arguing that its different this time, this can go on forever, no one knows when it will end, so buy anytime, new investors hearing from friends and relatives about how much money was made and jumping in before it is too late. 

Interest rates: prolonged low interest rates is not predictive of a higher market. The beginning of prolonged low interest rates is predictive of a rising market. But not years later. Many years of low rates usually means that virtually every cent available for stocks is in stocks. 

P/E's: in 1987 the Dow P/E was 16, some months before the 87 crash. So normal level p/e doesn't prove anything. 

I accept the fact that valuations don't prove when a market will crash. That's why I use an additional indicator, the 270 day or 54 week moving average. 
When the market is overvalued - ie its value exceeds US GNP, and the major indexes fall below the moving average, the odds are great that the party is over. 

Too, we have the huge Alibaba IPO coming up to add to all the other ipo's. Is there enough stock buy backs, mergers and acquisitions to reduce the supply of stock? When there is an over supply of anything, the price goes down. 

However, I accept the fact that I will not convince everyone.


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## doctrine (Sep 30, 2011)

Pluto, what do you propose? I take it you are selling positions and holding cash? How much %, and what is your strategy to get back in? Sell everything, half, a quarter, put it in short term GICs or HISA and wait for a 25% drop?


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## Pluto (Sep 12, 2013)

gt_23 said:


> Yes I had thought of that, but I didn't think 2.5% was worth the risk of the value of the ETF dropping at even the slightest hint of higher interest rates. Granted that short won't move as much, they still dropped after last year's Bernanke speech in the spring.


The general idea is that when a stock market debacle arrives in earnest rates drop, so your short bonds would have a little pop. Then you can sell them if you want, and start shopping for stocks. Money market funds are OK too. The other part of this is any capital loss in short bonds is tiny compared to probable losses in stocks.


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## Pluto (Sep 12, 2013)

doctrine said:


> Pluto, what do you propose? I take it you are selling positions and holding cash? How much %, and what is your strategy to get back in? Sell everything, half, a quarter, put it in short term GICs or HISA and wait for a 25% drop?


I'm not really proposing anything, I'm just stating my perspective, and generally what I do. I still have stocks but more than 50% cash. I'm not trying to advise people, I'm offering a perspective that they can evaluate and accept or reject as they see fit. I have no intention of buying any stock until this over valuation is resolved. I'm more likely to sell a little more, than buy. This isn't, strictly speaking, timing. Its a matter of probabilities. The odds of making money by buying in an over valued market is low. So I don't buy, and cut back a bit. Too, it is taking advantage of what individual investors have, that money managers with 2 billion to spend don't have: When the risks are high, I can cut back on stocks quickly. When the risks are low, I can be fully invested in less than 15 minutes. Plus I can concentrate in a small number of quality companies, most certainly less than 10 stocks. I don't need 20, 30, or 50 stocks, something that would almost certainly doom performance to mediocrity and force me to spend a lot of time keeping track of them. 

I find that the ValueLine Investment Survey is a good guide for appreciation potential of stocks. Anytime they believe appreciation potential over the next 3-5 years is 30% or less the odds of making money by buying at that time, unless one is Peter Lynch, is very slim. And speaking of Lynch, the main idea of his book One Up On Wall Street, is individual investors have advantages that big time money managers don't have so make use of the advantages. One advantage is I can concentrate on about 6-10 really good companies. Too, I can easily raise cash when the bull market is getting pricey and tired. Then I can buy back in when the price is right. In my view, individual investors should not try to emulate what professional money managers do, because they lose the advantages they have.


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## richard (Jun 20, 2013)

Skyfall, always remember that the market will go up until it can't go up anymore and then it will go down until it starts going up again. Got that?  Another good one is "buy low, sell high". If a strategy doesn't have that result it should be avoided. I follow a similar strategy of "choose well, buy whenever [based on asset allocation], sell never".

A correction or crash can happen at any time so the most important thing is being prepared at all times. Not ultra-defensive 100% cash, but just being able to wait it out if and when it happens without panicking or being forced to sell because you need the money right now. If you do that then you don't have to worry about anything.

As for not having money to invest when stocks are on sale, that is a much smaller concern to me than not investing enough in the first place. For most people that's like complaining about the color of the paint in their house when it has a risk of collapsing in the middle of the night and crushing them. If your portfolio happens to include things that are negatively correlated to stocks, like bonds, then you may be able to rebalance. But a few good deals now and then can't possibly make up for not investing enough in the first place.


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## richard (Jun 20, 2013)

gt_23 said:


> OK #3 is a good answer that I hadn't considered.
> 
> Wrt to #4, how do you justify that different sectors have different 'normals' for value (i.e. P/E, P/B, etc.). If there were some measure of each that defined over-valued, why does it differ so much by sector, and even industry or firm, what is considered a normal P/E, P/B, etc.
> 
> Where does a DIY investor put his capital, when equity, debt, and real estate markets are overvalued? There must be a negative correlation out there somewhere!


I don't know of any central banks that are talking about needing to slow down the economy any time soon. Of course when it does happen it will probably be faster than we expect at the time. It seems like a lot of things have stagnated for the last 10-15 years. They may have gone too high at the time but it could also mean that there is a lot of untapped potential now. Plus the US now has a large supply of cheap energy that will continue to grow, which is leading to manufacturing jobs coming back because of the cheap energy, shrinking wage gap, and the advantages of having it nearby. I don't know the future but I'll bet it's interesting.

The one thing that isn't good is that expected returns from today are lower than usual. There isn't much we can do about that. I'm sticking to the plan and if the returns get higher in the future I will happily accept that.

Why does P/E differ so much by sector? Because it's just an estimate that doesn't reflect all the business realities. Every industry has different needs for investment to get to those earnings so the earnings may be worth more or less. Every company can even have a different way of accounting for the earnings so they aren't strictly comparable.


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