Thursday, August 30, 2018

Valuation vs. Momentum Investing

Bill Spitz (who is known to the readers of this blog for his prescient calls in the past, As Risk Increases, Spreads Widen) has written another gem documenting the "manias" leading up to the current market.  Students will learn something about about two strategies for investing:  Valuation (long run) vs. Momentum (short run).  Here is the bottom line advice:
  • There are widely accepted and time tested methods of forecasting returns on various asset classes. 
  • While we work very hard at refining the inputs to the process, you should understand that they vary considerably over time rendering the forecasts subject to error. 
  • These forecasts do actually have pretty good predictive value over 7-12 year time horizons but provide little or no insight into near term returns. 

Of course, everyone will want to know what he thinks of the current market, and here it is:
The Shiller P/E has risen from 13.3 to 32 since 2009. Note that the long term average is 17 although it is important to remember that it hit 44 during the Dot.Com bubble. An additional mitigant might be that the combination of strong earnings and a relatively flat stock market in 2018 has reduced the P/E somewhat based on current earnings. Most other asset classes are similarly expensive as compared to their historic norms. The Federal Reserve has made its intention clear to raise short term interest rates and we are already close to an inverted yield curve which has historically been an accurate predictor of recession. Finally, there is a great deal of noise on the political front with continuing discussion of Brexit, the prospect of trade conflicts, and active shouting matches with North Korea and Iran.

UPDATE FROM A VALUE INVESTOR:’s actually easier, or at least more fun, to define growth and value by caricature of the kind of people who buy each type of stock. Growth investors wear nice suits, and are charming. They are by nature optimistic and typically do not read the footnotes, because, no one else does, right? If they go to a conference, they fly first class or in a private jet. Value investors are rumpled and not as much fun to talk to. They are overly analytical and obsessed with missing something in the footnotes. They fly coach. 

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