Stock Market - Ben Graham's comments on the market appropriate today

It's worth a read. And, might give you some nuances to your "funny story" about how Graham's thinking evolved.

Perhaps. I'm not familiar with the criteria for determining "value" in a value index, but it is certainly possible based on that interview.

Do you have any value index, or low-cost value funds you prefer or recommend? I would like to check them out for my personal portfolio.

Haha - YES! As I read the interview, I thought about the magic formula. I wonder if Graham would like it. It has a value component. And it is simple. I'd guess the magic formula takes Graham's value (earnings yield), and maybe Fisher/Buffet's "great business" (return on capital). I'm not familiar with FNSAX, but I like Greenblatt's magic formula.

Agreed. Greenblatt said he thinks his magic formula approach will continue to work - because many people will give up on it after a year or two of "not working", or underperforming.

Despite the tendency of the human mind, it's possible for a person to overcome it.

There are a lot of observations & data that lead me to that conclusion. Some are subjective and impossible to quantify, others are more objective.

One example of the later is Earnings yield.

. It seems the last 15 or so years was an anomoly. That is my entire investing lifetime, and I think it has distored our general view about what is cheap and expensive. The graph show that prior to the late 90s, our current 5.39% was consistenly terrible.

Another is the 10-year PE. Here:

Again, our current valuation is market top territory (perfectly matching the 1966/67 period in Graham's quote) for the past 140 years... with the 1998-2008 period distorting our perception.

An example of the subjective (impossible to quantify) is observing the average middle-class person today (friends, family, LetsRun posters, etc) that "invests" in the stock market... usually in their 401k or IRA. There is no thought at all what they are buying, or the price they are paying. They mimic many of Flagpole's comments about stocks always "eventually going up", stock/bond allocation based mostly on age rather than relative value, etc. That Graham quote resonated with me because that is what I perceive today. You and I both know that due to the weaknesses of human psychology, the average person would not hold that belief if stocks were cheap - they would be frustrated with or fearful of stocks... essentially giving up at exactly the wrong time.

*Some are starting to give up on stocks, but again, that is relative to the distorted last 15 or so years. I think we're at best halfway to "cheap". Historically (past century), we're expensive.

You mentioned earlier that most people never get around to investing (due to psychological reasons). I see it differently. I feel that most people DO own stocks. Up until last year, over 50% of people owned stocks in some form. That's 50% of the entire US popluation. That is huge percentage of the people that a) have a regular income (or are legitimately retired) and b) save any of that income.

Agip, if it wasn't clear in what just wrote, this is the quote that I think you need to revise after reading the entire Graham interview:

"funny story - toward the end of his life Graham changed his mind on security analysis and very possibly on value investing in general (although that last is debatable).

No way is the second part of that statement debatable.

well normally I would point you to indexed, low cost balanced funds, but the problem there is bonds - a balanced fund will have 30-50% bonds, which normally would reduce your risk...but as we are seeing now, bonds are very nearly as risky as stocks at this point in time.

So - just thinking aloud here - take the 60% you might invest in stocks and put that in a diverse portfolio of index funds. Keep the 40% meant for bonds out for now.

I can't recommend specific funds w/o knowing where you live and more about you than is possible on a message board.

But I can point you to

http://www.ricedelman.com/cs/invest_with_edelman/determining_the_right_portfolio_for_you#.Uc869vmkqBs

Ric Edelman is pretty good at what he does, and he has an online portfolio selector based on your inputs.

I like ETFs, but index funds are just as good.

And if you want, and trust yourself, use the 'don't own stocks if they are below the 200 day moving average' rule.

Bonds are a puzzle right now - no good solution there.

gasser wrote:

You argue that equities in general are over valued right now, which is true. But even Ben Graham would agree that there are sectors that carry attractive long term valuations. Are old people not going to need medicine and healthcare over the next 20yrs? No. When they figure out how to ship all this natural gas you think foreign demand will clear out some of the current supply? Yes. There's plenty of examples of value out there, particularly in American companies. Resist the urge to simplify Graham solely in an effort to needle Flagpole.

I never replied to this.

What you describe as value doesn't match my understanding of what Graham describes as value.

In fact, I think Graham recommends against your examples:

(From Agip's interview):

A: ...They spend a large part of their time trying, valiantly and ineffectively, to do things they can't do well.

Q: What sort of things, for example?

A: To forecast short- and long-term changes in the economy, and in the price level of common stocks, to select the most promising industry groups and individual issues--generally for the near-term future. "

And here:

"...we must express some serious reservations and perhaps prejudices that we hold about the basic utility of industry analysis as it is practiced in Wall Street and as its results are exhibited in typical brokerage-house studies. Industry analysis relates to the past and the future. Insofar as it relates to the past, the elements dealt with have already influenced the results of the companies in the industry and the average market price of their shares. ...When industry analysis addresses itself to the future it generally assumes that past characteristics and trends will continue. We find these forward projections of the past to be misleading at least as often as they are useful."

"If we could assume that the price of each of the leading issues already reflects the expectable developments of the next year or two, then a random selection should work out as well as one confined to those with the best near-term outlook."

Thanks agip! Will pursue your advice. And for those of you that don't think you can sometimes get decent recommendations on LR, these words of wisdom are as good if not better than I've gotten from several investment professionals.

marijuologist wrote:

If every investor and money manager implimented Ben Graham's basic principles, there would be no bubbles.

Seems reasonable to me.

Once again, you seem to be missing the nuances of the headlines. The key to Buffett's bet was the costs of the hedge funds. He felt the fees would outweigh the outperformance.

Buffett felt they could outperform, and specifically said so. But, not enough to overcome the typcial 2%, net 20% hedge fund fee structure.

I incur no such fees.

Disagree. At least if thinking is coupled with discipline.

It can lead to underperformance.

I reject the idea that it doesn't pay to think in investing. Graham does too.

Similar to Buffett's bet, the lag is due to the fees incurred with actively managed funds. John Bogle of Vanguard has spoken about this. Again, it involves digging into the details, asking "why", and not just swallowing the headline statement. Thinking, in a way.

so...you think you can beat an index over the next 10 years? Would you take that bet?

Very good article! Thank you for posting it.

Since 2000:

(Would love to see one with older data)

Here is an article from 2002. I don't know if it's reliable, but he claims the historical average is 0.9. We are at 1.47 today.

0.9 would be 983 S&P, or a 39% drop.

Good point on earnings changing over time.

I would guess the opposite - that earnings reporting has gotten looser. Do you have any links that support your claim?

The article below (not sure if it's right) claims the opposite as well, at least as of 2002.

I'd like to see a historical chart showing Price relative to dividends + stock buybacks. (since buybacks seem more common now than back in Graham's time).

agip wrote:

so...you think you can beat an index over the next 10 years? Would you take that bet?

I am taking that bet with some of my investment funds.

wait a second... wrote:

agip wrote:

so...you think you can beat an index over the next 10 years? Would you take that bet?

I am taking that bet with some of my investment funds.

__

yeah, so am I. call me a hypocrite, accurately.

I have about 20% of my stock money in funds I believe will beat the market. I have had one fund (HFCGX) since 1997 - it is similar to the magic formula funds - a quant fund that buys cheap stocks on the mend. It uses research from James O'Shaughnessy, who wrote one of my favorite books, 'What Works on Wall Street.'

It has beaten the Sp500 over 15 years, but trailed the small cap indices that are a better benchmark. So I win and lose, sort of.

But the core of my stock money is in plain vanilla index funds.

I did hear a recent article with Siegel, who has challenge the shiller 10 year PE as inaccurate because of different defintions of profit. And according to siegel, shiller has agreed that there is some problem with the data, that makes the ratio seem artifically higher today.

So...that suggests two things:

1) profits have become harder to come by than before

2) the shiller 10 year PE may not be accurate over decades.

I wish I had that in writing, but it was in an interview.

more to come - good thread.

This has been an interesting thread, thanks for all the info and reads.

I love how when the big boys show up to talk shop, the self-anointed investing expert clears out his "buy and hold, brother!" quacking.

wait a second... wrote:

As a result, I suspect Graham would not have a large allocation to stocks at today's valuation levels.

Maybe I'm misunderstanding, but when you say "valuation", I think "PE". Is that not what you mean? If it is what you mean, then why wouldn't Graham be highly invested in stocks with today's below average valuations?

Pokil wrote:

wait a second... wrote:

As a result, I suspect Graham would not have a large allocation to stocks at today's valuation levels.

Maybe I'm misunderstanding, but when you say "valuation", I think "PE". Is that not what you mean? If it is what you mean, then why wouldn't Graham be highly invested in stocks with today's below average valuations?

Using PE, US big caps are at over average valuations. Not by much, but by a little. If average is 14, it is now at around 17.

Some links above show this graphically.

PE is tricky cause sometimes it is 'normalized,' sometimes is is trailing 12 months, sometimes it is forward looking 12 months, sometimes the 'average' is over the last 12 years, sometimes it is over the last 80 yrs...

So, you don't attempt to do it. But, you admit there is some value, at least at times (your observations in 1999 and 1982). You noticed it both times without even trying to tune in to it. Imgaine what you might notice if you paid attention.

I see value in observing. It's subjective. It's not foolproof. It would be tough to quantify for client presentations or not get sued. Yeah, yeah, all that. I would never reply solely on it. But it can be a valuable clue. It complements more objective measures of value.

It only makes sense that PE expansion & compression would be tied to investor emotions and participation. When "everybody"... ahem, "the vast majority" are doing something investment-related, like buying stocks, the prices tend to get bid up, and P/Es expand. Bid-up prices (high PEs) are negatively correlated with future returns.

Examples of clues that I've experienced:

My brother-in-law suggesting in 2006 that we should start flipping houses was a clue. I had already run the numbers and renting made more sense than buying... but his enthusiasm confirmed my decision to keep renting.

Hearing "Qualcomm" & "Cisco" repeatedly in the locker room at the gym in 1999/2000 was a clue.

My mom (having contibuted annually to IRA & 403b for 14 years, and never once mentioning it to me) asking me, in February of 2009, if she should put in her annual IRA contribution or hold off... was a clue. (She did contribute.) My guess is she won't contibute, or will be TOUGH to convince, the year we finally put in a secular bottom and 10-year PE ratios are single digits.

The only two friends I had ever discussed gold with, emailing within 2 days of each other, in Aug, 2011, "you were right" was a clue. I would guess those two will buy gold before gold's ultimate peak.... which I'd guess is still to come.

Today, every single one of my close friends (that I discuss investing with) have a decent chunk in stocks. Within the last few months, several of them have indicated they have an itchy finger on the sell button, and are waiting for the first sign of trouble. They are in their 30s/40s, have secure professional jobs, and have NEVER exibited fear of stocks, nor sold out. I think that is a clue. My guess: the next downturn will be faster & more severe than the last few. I'd guess that will be the one that takes us to single digit PEs.

I find the psychology of markets & market participants fascinating. I think it reflects what value investors see in the numbers.

Are you describing what I've done with Graham, or is this your sarcasm (not to be taken seriously) again? Serious question. It's hard to tell. It feels like a putdown. If it's sarcasm, it adds no value, and is very distracting.

Anyway, perhaps you don't study the best investors in history because you are not attempting to outperform the market?

I've found that studying the best is a great way to learn. In any endeavor.

Not alone, but if the large majority of ordinary people are blindly investing in stocks, AND p/e, p/s, etc ratios are high compared to historical averages, it implies stocks are not a great investment at that time.

Except... the two times you admit paying attention to sentiment and it was valuable. But - what you did was impossible, and god-like...

Are you a demigod? Nope, and neither am I. Your experiences and my own convince me there is opportunity beyond blind stock investing... for someone that can control their emotions and stay disciplined. Thinking can be good.

Your advice is good for most people. Absolutely. But that doesn't mean that paying attention to value to enhance performance is impossible. Nor does it take god-like ability.

I'm embarrassed by all the typos above, and apologize.

agip wrote:

yeah, so am I. call me a hypocrite, accurately.

Ha! No worries.

I did notice that you recommended someone tweak their bond allocation since bonds were expensive.

How do you reconcile doing that with bonds, yet you recommend buy & hold regardless of price with stocks?

Pokil wrote:

Maybe I'm misunderstanding, but when you say "valuation", I think "PE". Is that not what you mean? If it is what you mean, then why wouldn't Graham be highly invested in stocks with today's below average valuations?

Correct about valuation meaning PE, Price/Sales, etc.

How do you figure today's valuations are below average? Honest question - I'm curious about how you reached that conclusion.

My view: today's valuations, despite coming down over the past 13 years, are still significantly above average (even more than Agip described). The 1996-2008 anomoly has skewed our perception of what is normal.

Some examples:

10-year PE ratio: 23.49. Historical average: 16.47. Historical lows: mid single digits. (42% above average)

(Notice today's PE matches the peak in the 1960s, which Graham referred to in the original quote. Graham recommended a low stock allocation both in the late 1960s, and in 1972.)

Price to Sales Ratio: 1.47. Historical average: 0.9 (63% above average).