Prudent diversification – a market discussion

 

Measuring the Market

Have you ever wondered what stock market professionals and equity analysts talk about in their spare time?  Recently, the Bloomberg website featured a debate about something that is getting a lot of attention recently: the historically high, and still-rising U.S. stock market valuations.  People have been willing to pay more, and more, and more for a dollar of corporate earnings.  What does that mean about future returns?

Let’s look over the shoulders and see how two professionals approach the question of how to look at today’s markets.

Bloomberg Gadfly columnist Nir Kaissar starts by noting that the Standard & Poor’s 500 Index has beaten both the MSCI EAFE Index — a collection of developed market stocks outside the U.S. — and the MSCI Emerging Markets Index by 6 percentage points a year since March 2009, when the market hit bottom, through May, including dividends.  Whether you measure market prices by price-to-earnings ratio, price-to-book or price-to-cash flow, U.S. stocks are now more expensive than their foreign counterparts.

To Kaissar, that suggests that investors should consider moving at least some of their money out of American companies and into companies domiciled elsewhere.

Bloomberg View columnist Barry Ritholtz countered that valuation is largely driven by psychology.  We are experiencing a bull market in American stocks, which can be defined (in psychological terms) as a period when investors become willing to pay more and more for a dollar of earnings.  Eventually this will turn around, and the regional performance gap between the U.S. and Europe will reverse.

But for Ritholtz, the important issue is timing.  You could have used Kaissar’s argument four or five years ago, gotten out of U.S. equities, and you would have missed a nice runup while foreign stocks were going nowhere.  Is it possible that the same will be true over the next few years?  (Hint: it is definitely possible.)

Kaissar responded with a definition of risk vs. valuations—the idea that investors are generally willing to pay more for less risky stocks.  So can we make an argument that the S&P 500—with a price-to-book ratio about twice as high as the EAFE basket of stocks—is half as risky as stocks trading in the rest of the world?  He doesn’t think so, and the conclusion is that American stocks are mispriced.

Ritholtz says that rather than trying to time which part of the world is going to do better or worse, it’s better to own it all.  Instead of U.S. stocks vs. world stocks, own a portfolio that includes all of them in proportion.

Aha! says Kaissar.  U.S. investors commonly allocate 70 percent to 80 percent of their stocks to the U.S., even though U.S. stocks represent only 50 percent of global market capitalization.  He says that if you believe in true diversification, it would make more sense to create portfolios with a U.S. stock allocation that’s closer to 45 percent, tilting slightly toward the global stocks that are currently trading on sale.

Ritholtz makes a final argument, saying that sometimes cheap stocks get cheaper and continue to fall; other times expensive stocks get more expensive and keep going up.  He doesn’t want to abandon U.S. equities, but he finds common ground with Kaissar when he recommends that people with U.S.-heavy portfolios consider diversifying into MSCI EAFE and MSCI EM indexes—not for timing purposes, but because it’s prudent diversification.  You can see exactly how boring the cocktail conversations of stock analysts can be by viewing the entire discussion here:

https://www.bloomberg.com/view/articles/2017-06-26/how-to-know-when-stocks-are-properly-valued-a-debate#596235f3a911d

 

 

Source:

 

https://www.bloomberg.com/view/articles/2017-06-26/how-to-know-when-stocks-are-properly-valued-a-debate#596235f3a911d

About Objectively Speaking

Tom Batterman, founder of Vigil Trust & Financial Advocacy and Financial Fiduciaries, LLC is in the business of representing the best financial interests of his clients. Having provided objective, fee-only financial management services for over two decades, he specializes in managing the investment and related financial affairs of individuals and mutual insurance companies who do not have the time, interest or expertise to manage such matters on their own. As an objective, unbiased professional who takes on a fiduciary responsibility to his clients, he guides clients to the financial decisions they would make themselves if they had years of training and experience and the time and expertise to fully research and understand all of their options. Founded in 2010 as an outgrowth of Vigil Trust & Financial Advocacy, Financial Fiduciaries, LLC is a financial management solution for individuals and mutual insurance companies who recognize they do not have the time, interest or expertise to properly attend to their financial matters on their own. While there are many financial “advisors”, most of them have investment products to sell and the “advice” they provide is geared toward getting their clients to engage in a purchase. As one of the rare subset of advisors known as “fiduciary advisors”, Financial Fiduciaries does not sell any investment product so its guidance is not compromised by conflicts of interest which plague ordinary advisors. Prior to his employment in the financial industry in financial advocacy and trust positions, he worked at a private law practice in the Wausau area in the areas of estate planning, tax, retirement planning, corporate organizations and real estate. He is a graduate of the University of Wisconsin-Madison and the UW-Madison Law School and has during his career held Series 7, 24 and 65 securities licenses. A longtime resident of the Wausau, Wisconsin Area, Tom is active in the community. He enjoys golf, curling, skiing, fishing, traveling and spending time with his family.
This entry was posted in Uncategorized. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s