Welcome to The Investor Coaching Show, a podcast to help you get an insider’s view of the financial world and escape common investment drafts. We look at the financial news of the day and help you make sense of it so you can relax about money, and here’s your host, Paul Winkler along with Jim Wood, talking about money investing.
Is the Market Overpriced?
Paul Winkler: You know, so one of the topics that we were talking about this week, quite a bit, you know, a lot of people talking about like, Oh, the market is, so the price is so high and, and stock prices are so high. And I said, well, you know, some areas of the market. Yeah. I would agree with you there, but, well, it’s overpriced, you know, I kept hearing, and I said, well, yeah, if you look at certain areas of markets and if you were just in a vacuum, look at them, you’d say, yeah, I’m pretty high. And you’d get a lot of people. And I’ve said it many, many times people come into the office, Jim, and I think you find this as well.
Jim Wood: Yeah. People talked about the lost decade or the dead decade. That’s what they’re referring to is large US stocks. Because if you had a diversified portfolio and we’re talking 2000 to 2010, if you had a diversified portfolio over that time, then you still wouldn’t do it.
Paul Winkler: You’re doing fine. Yeah. You know, especially, you know, some of these international markets, small companies and things like that. So what’s going on now is if we look at larger companies like the S&P 500, if you look at Morningstar the database, what price are those companies selling for, for every dollar of earnings and you look at and go, Whoa, it’s like $29. The S&P 500 right now, 28, 87 is the most recent number that I have on that area of the market, which is normally 16. Right. And you go, wow, that’s overpriced. Not so fast, not so fast to say, it’s overpriced. Is it, is it fairly high yet? It’s fairly high compared historical earnings. But remember, it’s looking at one year of earnings.
I have to remind people this, you’re only looking at most current earnings data. And even if you’re looking at forward earnings, you’re only looking at one year and it, it just forgets to, or it doesn’t take into account the growth in earnings that can happen as we come back from this shutdown that we basically went through now. But that would be, maybe I ought to use it as a wake up call and go, yeah, yeah, yeah. It’s really overpriced. Y’all to get out. But, you know, that would be me just trying to just save people from themselves because they have a tendency to chase returns and really get focused. But is it, is it overpriced?
I would say, no, don’t look at it as necessarily overpriced, but yes, certainly take it as a wake up call that you really shouldn’t have all your money in one asset category or be focused all on that.
Jim Wood: There’s no consistent way to invest poorly. That is probably better than looking in the rearview mirror. Oh yeah.
Don’t Look in the Rearview Mirror
Paul Winkler: Is it likely to repeat that performance? Well, it’d be hard-pressed to say that, because right now it’s selling, like I said, for four times book value, whereas the other area of the market I just named. And you know, if you look at small value, it’s $1.30. So it’s, you know, literally one-third, the price. And if you go to international markets, you’re basically looking at somewhere in the neighborhood of, you know, less than one-quarter.
So yeah, you’re really asking for it if you’re not diversified in other areas, which leads me to an article in the Wall Street Journal, as the economy roars back life in many poor countries gets worse. How does that relate, Paul? What are you talking about? Why is it that many of these markets are selling for so much less than US markets? It’s because of this. If we look at what’s going on in US markets right now, it is nothing but nothing short of stunning. What’s really happening powered by US and China. The global economy is set to make a huge stunning comeback this year from its deepest contraction since the great depression economists say.
But the harsh reality is that for the poorest countries, they’re not, they’re not looking at vaccines being delivered to them until well into the next year, which means slower economic recoveries, and more painful for the poor. We can open up everything here. So hence when we look at our earnings and we look at our multiples, that’s why our earnings margin multiple would be higher because we weren’t going to have an advantage on the rest of the world. But remember, the market is a leading economic indicator, which makes you go, okay, well, wait a minute. As some point, this does start to filter into other economies.
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Vaccines and Economies
And the one article Jim we were talking about, which was that one, you know, I saw in the journal related is as, as US vaccines, millions for COVID-19, most Canadians are still waiting really want to go and socialize our Medicare and our medical system. Doesn’t it? Oh, among other reasons. Yeah. Let’s, that’s great. Us. Economy’s opening up. COVID-19 vaccines are increasingly available while its neighbor to the North has one of the slowest vaccine amongst developed economies. And they’re imposing new lockdowns to STEM the surgeon in FactSet infections so that, you know, there, there’s a good idea.
Example of why it is, you know, that and markets have priced us in. So that’s why these markets are selling for a lot less, but realize it’s going to change and it’s going to change. The new information is going to come out just like it did in the United States. When that information came out, that we had a vaccine and we were going to roll it out at the speed. We were going to roll it out. If you were not in US markets at the time that that information came out, you were late to the party. It was like, I was having stationed with a guy this week and I said, he and I were talking. And he goes, well, you know, well, don’t you look at trends in the economy.
And I said, no, let me give you a little, a piece of data that you might just find interesting. And I said, if you look at the stock market, large US stocks, for example. And I gave him that piece of data that we have in Jim and the first workshop that we teach. And instead said, if you look at markets going back, what you’ll notice is that large US stocks have averaged 10% return going back to the 1920s until now. And I said if you look at how many days per year that all of that return came from, if you removed, it was, was 2.2, 2.3 days per year.
I think it is responsible for 100% of the positive returns. So you better, you know, that trend lasted a full 24 hours and you better read it. And he was like, Oh my gosh, I had no clue. I had no idea that it was that much. And you know, it’s the same thing with months. I mean, literally 4% of months, isn’t it remember? Remember
Jim Wood: It was like 4% of, I know you’ve, you’ve done different studies or referred to different studies that have been anything from less than 1% of days to maybe 2% of days amounting to massive amounts. And most of the actual return in the stock market, you remove those days and you get the return of cash or maybe even worse.
Paul Winkler: Yeah. So it’s literally news that drives and the big, big moves in the market. You know, we can sit there and talk about, well, you know, over the past two years, the highest returning asset category was this. And you can be fooled really quickly in the thinking that that was a long trend that it took it to get there. And the reality of is no, it’s pretty doggone quick.
Trends are Inconsistent
Jim Wood: Hey, you were going to follow the trends and we’re going to get in and out of the market and we’re going to capture this information. Well, there are people there have been, people trying to do this for long, long periods of time. And if you look at the evidence and it’s been studied from every angle, the evidence of somebody’s ability to consistently do that is not existent.
Paul Winkler: Or even inconsistent. Yeah. And it’s just like, or just blind, random luck is really what it gets down. When you see somebody that has outperformed the market.
Jim Wood: And certainly fewer people do it than wouldn’t be expected just by random chance. And the longer that they try to do that fewer and fewer actually get lucky
Paul Winkler: Because of the expense. Yeah. There there’s expense involved in trying to do it. And the reality of it is you may hear about somebody that says, “I did it.” And you know, the reality of it is they only tell you about their wins. They never tell you about their losses. It’s, we’re really good at remembering when we’re terrible at remembering when we lose. Yeah. Another thing that came up this week in a meeting that I haven’t talked about in a while, and I think it’s worth talking about it’s, there’s an old study that was done in 1986, repeated in 1991 by a few academics.
You know, which companies are better than others, which are more poised, are better poised to be successful in the future and that type of thing. But, you know, really what drives your investment performance? According to this study that was done in 1986, repeat in 1991, same exact result. And every time it’s ever been done is your asset mix. Your asset allocation and asset allocation is going to be, how much do I have in large companies? How much do I have in small companies? How much in large value companies, small value companies, international and making sure that you have these areas covered because when that new information comes out, like we were talking about, I mean, literally, you know, you have a day that will be new information will come out that tells you that this is the segment of the market, is that is really going to benefit from this brand new information, brand new information that has just come out well, once that information is out that area, the market jumps right away.
And then most of the other stuff that happens the rest of the year is, if you ask academics about it, they refer to it as noise. I mean, cause you’ll have a hundred, 200, 300, 400 point moves in the Dow, for example. And you think, Oh, that’s a big deal. And no, and they’ll say, well, that’s just noise. It’s nothing compared to what really will drive when you’ll have a 1000-point day, 2000-point day or something like that. That’s the real stuff.
Jim Wood: I always tell people when we’re looking at that, it’s just the, how, what, how you choose to include something in the portfolio is one, it has to have the right long-term expected return. And then it comes down to how it interacts with other assets in the portfolio. So, you know, is it correlated or specifically, you want things that aren’t completely correlated.
Paul Winkler: Right. They don’t act the same, so they don’t move the same. So that helps with the reduction risk. As it says, I had a conversation with somebody this week and we got to talking about, you know, when you choose things, when you add things to the portfolio that you want to have, that non-correlation to reduce the overall risk cases. How do we maximize expected return for a given level of risk? And it’s a science, there’s a lot of data behind it. There’s a lot of academic research behind it, but it just gets ignored because the industry is so focused on selling stuff, selling you the latest, greatest thing, an investment that had the best return over the past period of time, or has the best story as they say.
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