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The Death of Portfolio Theory

 
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mannfm11
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PostPosted: Wed Apr 28, 2004 8:49 pm    Post subject: The Death of Portfolio Theory Reply with quote

Now for what brought me here, Robs response to a post I wrote about the death of portfolio theory being of use in todays valuations. I will preface my previous comments with the fact I haven't studied SWR at all, but I have my own dabbling with numbers in looking at the hazards of stock market returns being used to sustain retirement. As rates have moderated, being an insurance agent, I can see and share my appreciation of insurance and annuities in relationship to this matter. I will also state that any withdrawals that invade the principal of an investment are not sustainable, even if the asset continues to go up in value. In that regard, one must have an idea as to what the principal of an investment is and that is for another discussion.

I have done my own work with Dr. Shillers figures he posted on his site. In fact, I have written him and questioned some of his techniques for valuation, including the idea about increasing dividend values by 25% to reflect stock buybacks. But, in sum I have been able to confirm some of my own suspicions by reading his stuff, articles I have read and my own finance education at a major university where they taught the formula for market valuation, but didn't tell you how to get the values. It seems it was an article in Fortune or Forbes last summer that mentioned the risk premium that allowed me to fill in the blanks for valuing the market.

Owning a portfolio of stocks and reaping a return has become an academic fact taught in every university and pushed by every financial planner without any basis of proof other than that stocks have averaged so and so over the last million years. What is neglected in this matter is that there have been long periods of overperformance and long periods of underperformance in stocks. There was what was known as the random walk theory, which in so many ways said, you don't know what to buy or when to buy it, but history show something so just buy and hold. I don't know what can be proved that can be accepted in principal, but this isn't a valid theory, though one might be able to make a case for it. Bear markets, in almost every case were either due to bad economic times or were periods when stocks went from vast overvaluations to simular undervaluations. The opposite hold true about bull markets and the public always gets out or slows down investing during the undervaluation portions of both markets and overinvests in the overvaluation periods. I think random walk came out of the idea that from 1959 to the early 1970's stocks were continually overvalued and thus, the market cannot be timed. I think if one looks at the 1959-1990 period in sum, the opposite would have to be proved out, that the market can be timed, even if for a good period of time the fools continue to pile in and make money. Something tells me the academic nonsense that has been pushed over the past 30 years will run into difficulty when we are not in a bull market and are instead in a bear market and then the proof will be stated as the opposite, that people would be foolish to get involved in stocks.

I wasn't a hard working student in college, but I was on the verge of brilliance in how I could grasp and develop what I saw to be simple ideas. I can assure you that they never told us what capitalization rate to put in the valuation formula for stocks. Nor was I told what to put in the growth portion. Once stocks got so overvalued, I began to think that instead of dividends, they must have been talking about earnings, as I knew stocks needed to be priced a couple of percent above the risk free rate of return. What they did teach me was the risk free rate of interest was 3% and that there was a difference between a capital instrument and a money instrument, something else that seems lost on the modern financial world. I also knew there was a yield curve that assigned a greater amount of risk to a greater amount of time.

Where else they touched was portfolio theory, which I didn't quite understand because I didn't understand what they were putting into the formula. I did understand the principal that you could reap a real return of maybe 5% with a 3.5% risk by combining risky assets, knowing that statistically the group would perform at the expected return. I believe the late 1970's gave birth to a load of financial factors that were used in the 1980's and became the norm in the 1990's and among them was portfolio theory. I think it was always assumed that risk could be diversified away, but I doubt there were many valid formulas for this diversification before modern times.

Now, I think portfolio theory is okay and for that matter very valid, as long as it is used with assets that have been evaluated. But, this has been a total failure, in that with portfolio theory has come a group of theories, most notably random walk and the widely accepted falsehood that stocks return 10%. Stocks return 10% when they are priced to return 10%, not when they are bought at any price and held. There is no mix of portfolio that is going to make a group of stocks 300% overvalued return the historic return.

The best view of this happens when someone buys a bond and risk or interest rates change. If one buys a bond at 10% and rates decline to 6%, the price of his bond goes up, allowing him to realize a significant capital gain or hold what it is valued now for a 6% return over its remaining life. If he makes a decision to hold the bond, he makes both 6% and 10%. 6% from that time forward and 10% from the date he bought the bond. But, since he has so far made much more than 10% by holding the bond, he might assume that holding bonds makes 17%, while instead speculating in bonds makes 17%. This confusion can go even farther as the move back to par would result in a lower percentage loss than it did a gain going up.

Though the valuation formula for stocks is a little different, they are a lot closer to bonds than one many think. There are differences, mainly that the outcome is more volatile and there is no corpus for stocks. That means a change in the return on stocks creates a much larger price impact than bonds. But, there is a well kept secret about stock returns that it takes insight to see. That is that stocks aren't guaged by inflation plus for a return, but instead are directly related to the real or risk free rate of interest by measuring the growth above inflation and dividends. Knowing stocks represent a significant market risk and are prone to bad economies and bankruptcy, then it reasons that an instrument that promises no return of profit or principal must also carry with it a significant risk premium. The risk premium of the market as a whole should show up in the price of an index such as the SPX, a return that should be reaped by managing the risk of such a large portfolio.

Well, the dividend rate is 1.61% and the historical growth rate over inflation is 1.11%. Currently, the trend growth is 1.22% above inflation, but 2 years ago, it was zero. So, the number fluctuates over time, but for 133 years, the average has been 1.11%. What this means is the SPX is priced to yield 2.72% if you use history and 2.83% if you use the current trend growth over inflation. The risk free rate on debt instruments is reputed to be 3%, so the SPX, as a group of stocks is now priced to yield under the risk free rate and for that matter is not getting a risk premium for the extreme length of time holding stocks might represent. Like the bond example I presented above, one is now buying stocks at a portfolio return of less than the rate of inflation and holding them because they don't understand that what they are holding now will hold true for evermore.

Thus, when I say that portfolio theory is dead, I don't mean the theory is invalid, but when followed as a religion, with no regard to risk and return, it cannot work. When the portfolio proves out to be priced to yield less than the risk free rate of interest, based on generations of returns, then the theory cannot work to provide a greater return. The best it can do is hedge inflation and given the risk forgone in the present market is much greater than the risk of inflation, this isn't a good hedge. The return on stocks isn't based on some long term generality, but instead in reverse is based on the risk of holding stocks over the generations. Because the theory of portfolio reduced the risk to a managable level, the risk associated with the individual assets also disappeared and the assets ceased to be priced to reflect the risk they all have as individual assets. What a 10% return for stocks really means is inflation, plus dividends plus the risk premium should equal 10% and be offset by inflation plus dividends plus growth, which should also equal 10%. Trend inflation is in the 2.5% range and despite speculation to the contrary, must be recognized as such. Historical growth is 1.1% above the long term rate of inflation. That gives 3.6%. Add the 1.61% trailing dividend yield (forward dividends from year to year don't count because they are implied in the growth rate) and you arrive at a return of 5.21% on an asset that has no call other than bankruptcy or liquidation.

In my answer to Rob on the Prudent Bear Fund Chat board, I noted that our posts were related, but not exact. The subject of this board revolves around how much can you draw from your assets and not run out of money in retirement. There is a relationship because academia and assumptions made with portfolio theory have given people the impression they can use stocks as a retirement vehicle. They likely can if they have plenty of cash to back themselves up, but in having an entire retirement portfolio based on stocks or even a 50% mix between stocks on one side and bonds and cash or near cash on the other side still presents a dilemma under this form of valuation. There is absolutely no valuation assumption that is valid that can be used on stocks other than the dividends they pay, due to the fact they no longer represent the risk and return values they have historically represented. Even in the mid 1960's, when dividends reached historically low levels at the time, we had in place a trend where growth above inflation was over 2% and dividends were over 3%. Even that led to a period where the CPI adjusted value of stocks in 1966 weren't exceeded on a permanent basis until the early 1990's. Reaping inflation as a return out of an asset represents nothing but a taxable liquidation of something that has not actually sustained a real gain.

I have seen a lot of talk about the Shiller data on this board so I will reveal something I have gathered out of this data. If you take a spreadsheet or a financial calculator, you can find the IRR of the rate of inflation from 1966 to the last date, 2002. That is done by entering the formula (P-2002/P-1966)^36, calculating the inverse 36th power. If you do that with the dividends paid in 2002, you will come up with literally the exact same figure. What this says about the market is that corporate America, as represented by the SPX, did nothing to outperform inflation. Being the SPX was around 100 in 1966, which led to a bear market where values were not CPI exceeded for 26 years, then peak valuations based on this factor should be no more than roughly 570, which bear in mind could very well lead to another bear market where after a time, the PV of SPX 570 may not be exceeded for some 26 years. Since we are not down to this value yet, one might report that I am full of nonsense and that stocks are poised for even higher values. A new paradigm, as they might say. Well, if that be the case, then the idea of holding a portfolio of stocks to achieve an above risk gain is a thing of the past and chronic low returns is all that can be expected from stocks. At SPX 575, we are looking at a market today that is priced a little cheaper than the one in 1966 and priced to yield inflation plus about 4.35. Those type returns are available on AAA bonds in the present time, assets quite superior in risk to the underlying stocks. Being there is no excess return to reap out of the portfolio as priced, the theory is all but dead.

Academia has come with some new nonsense about portfolios. Being the SPX and the Nasdaq are cap weighted indexes, they are now recommending that more stocks be added to the mix. What this means is the rest of the stocks on the market are also going to near a return that results in a risk free, before expense return out of stocks. Nonsense begats more nonsense and as long as there is a premium being paid for stocks, there will be more stocks issued to draw more money at premium prices. Mal investment will continue and the return out of capital investment will be destroyed, the asset to not be visited again until the next bull market is well under way. Academias excuse this time was the high caps were required to be bought and that brought on the overvaluation, when in fact, the random walk theory, the long term hold theory and portfolio theory just don't wash together. Portfolio theory has to be combined with intelligent financial analysis of the risk associated with a specific group of assets and nothing else. Hence, we have stocks valued today that bear no resemblance to what they represent as potential returns in the future.

Lastly, I believe there is a real hole in the long term return on stocks, as the academias only rate the surviving stocks. As recently as 1997, Woolworth and Bethleham Steel were in the Dow Industrials and the went out of the index and straight into bankruptcy. I think Johns Manville was in the index in the early 1980's and suffered a similar fate. Recently we saw AT&T taken out of the index and the yields I have seen on their bonds is an indicator they too are headed for the scrapheap. We are looking at the evidence salmon exist, in that these are the fish that made it while thousands of fry died between birth and their return to the stream of their birth. If you check the SPX data, there were massive additional investments that were required to be made to make up an SPX point on the top of the market and the losses are much greater than the index shows. But the real point is the SPX and its various entities no longer represents a long term gain potential at its current price. It won't until the flaws of the current investment intelligencia have been exposed and accepted. I don't know about you, but I don't want to be holding these assets when the world figures this out.


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BenSolar
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PostPosted: Thu Apr 29, 2004 5:27 am    Post subject: Reply with quote

Greetings, mannfm11 Smile

That was an interesting read.

The main point that I got out of it was that at today's valuation the S&P 500 is priced so that there is basically no risk premium over expected returns from quality long bonds. I think this seems about right. Sad

mannfm11 wrote:
I have seen a lot of talk about the Shiller data on this board so I will reveal something I have gathered out of this data. If you take a spreadsheet or a financial calculator, you can find the IRR of the rate of inflation from 1966 to the last date, 2002. That is done by entering the formula (P-2002/P-1966)^36, calculating the inverse 36th power. If you do that with the dividends paid in 2002, you will come up with literally the exact same figure. What this says about the market is that corporate America, as represented by the SPX, did nothing to outperform inflation.

Earnings, however, have continued to grow faster than inflation, while percentage of earnings paid out as dividends has declined. I agree that dividend payout is where a shareholder gets most of his value from a stock, but I can't ignore cases such as Microsoft where there is clearly a large value to that company, despite paying practically no dividend. I think the trend of lower dividend payouts is bad for the investor in general, however, as most companies will tend to waste a lot of excess cash that they could have paid out. Where does that leave us on valuation? I think you have to give some consideration to PE-10 as well as some to dividend yield.

Regards,



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mannfm11
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PostPosted: Thu Apr 29, 2004 11:59 am    Post subject: I think you missed my point Reply with quote

I think if you examine what I write and begin to comprehend where I have been trying to go with this idea, you will begin to realize there is no shortcut to owning stocks and using them to retire. What I wrote was that today, holding a portfolio of SPX stocks returns less than holding 30 year treasuries. Plus, only 1.61%, based on trailing dividends at the end of March, are paid to shareholders, making the cashflow from holding stocks 1/3 of what you would receive holding the bond. To get more, one would have to liquidate their stocks little by little and hope growth pulled them out.

There is no assured return out of holding a financial asset other than what it pays the holder. To say it doesn't matter if a stock doesn't pay a dividend is absolute absurdity, as it is a financial asset. The value of a stock is the PV of all the income stream it is to provide the holder in the future under assumed expectation. The idea of holding any asset for appreciation purposes only is a great mistake, even if it has worked for years. The paper asset has to have a financial value and the value is either its assets in liquidation, at some undefined future date or the flow of dividends or interest from the asset to the holder. There is no other method of valuation outside of some absurd imagination to place on these assets.

I don't know what P/E10 is or what it represents, but if you are holding stocks waiting for it to happen, the chances of it happening are going to come from a great reduction in stock prices and not from growth. At the current 3.5% growth rate of dividend payments, the value of stocks will double every 20 to 21 years and most of that will be inflation. If we go back to the norm, a historical dividend rate of 4.8% on the Dow and about the same on the SPX, then we are probably looking at a depression and dividends are going to drop farther. The assumed 8% to 10% out of stocks at current prices just don't exist.

This is the core idea of portfolio theory, that one can hold a group of 8% to 10% assets and reduce the risk on the group to 5% to 8%. As I have diagrammed, stocks no longer, as a portfolio yield 8% to 10%, but 5% and THERE IS NO MAGIC WAND THAT IS GOING TO MAKE THEM TURN FROM THIS POINT FORWARD BACK INTO ASSETS THAT RETURN 8% TO 10%. If you are trying to retire off stocks, you might as well be trying to piss up a rope. I have been studying this idea with my own financial knowledge for several years and I have found no way to extract money out of stocks that holds up to produce any appreciable income.

So, we are at a point where the excessive use of portfolio theory, combined with the false belief that if you just own an asset it is going to provide an excessive return, no longer works. Portfolio theory works when you buy assets that can be expected individually to earn 10% and as a group represent a 6% risk. Remember, the yield and risk march hand in hand and a 10% yield represents a 10% risk also. When it doesn't, it is an exercise in arbitrage, grabbing a 10% return on a 7% risk. There are mispriced assets all over the world, but few have the capacity to discern what they are.

Take a look at the SPX. We have a 1 5/8% dividend and a 3.5% growth rate. You take a portfolio out of that group of stocks and your portfolio is going to yield, not right now, but forever, 2 3/4% above inflation. Your only ally in such a deal is higher inflation and that really isn't an ally, as the advantage moves to owning bonds at a higher rate, realizing that something will be done to slow inflation.

I think what I wrote in the last paragraph just cannot sink into the mind of the people involved in the stock market. Times might get better, but in all of history, we have never had a 3% growth rate in dividends over inflation sustained for more than a few years. That would get the risk premium on stocks to 4.5% above inflation and 1.5% above the risk free rate. Those type of yields can be found now on AAA bonds, a group of instruments much safer than the underlying stocks. Realizing the cost of maintaining a portfolio of stocks would reduce that return, one would still own the bond. At the current dividend yield, a scenario like that would not support the risk of stocks and instead of going forward the price of stocks would still have to go backwards.

I am going back to the idea of dividends. I think John realizes that stocks can only be held when dividends are high. I don't know that he grasps that idea because we have all been sold the idea of appreciating stocks, but all these years listed in that group are low price years, not high price years. If you check the dividends offered on stocks during those years and the amount of appreciation that followed, one will realize that it was the dividends and the growth in dividends that attracted the appreciation. A 4% dividend supports a 5% withdrawal rate, using the rule of thumb. A 1% dividend supports a 2% withdrawal rate. The extra 1% is the historical real rate of growth you can see generated by Shiller on the bottom of the mentioned spreadsheet. I have done those numbers myself.

When one can come to realize that without dividends, stocks offer absolutely no support to the holder of them, then one realizes the only reason to hold and own stocks is to get the dividend. Your example of MSFT is absolutely absurd. How big do you think MSFT will have to get before it can pay a 3% return on its share price? I think that is a payment of some $7.5 billion a year in place of the $1.6 billion they are now making. MSFT keeps having stock babies and they have 20 billion shares authorized. They are either spending their income to maintain proportional ownership or they are creating more shares to pay dividends on, leaving the holder of the stock running in place. How many more times do you think MSFT is going to multiply itself and what will it be worth when it runs its course? This is a stock that though listed at something like 25X is selling for closer to 50X what it is really making for the shareholders of record at the beginning of the year. Their 2/3% dividend does little to add to what is likely a growth rate of 6% above inflation that will not go on forever, but likely peter out in 10 years or less. They lose their monopoly position in the OS industry and they are a cooked goose.

I don't believe it has sunk in that stocks are like bonds, the only difference is that the return on a stock is divided between what it pays the shareholder and the appreciation in the stock due to the amount it pays the shareholder being increased from year to year. True, MSFT could pay a 50 cent dividend and thus pay 2%.

You can solve your problem by doing two things. One is realizing that stocks don't represent an asset at this time that will fund retirement and the other being that if you cannot find another plan that will allow you to retire and keep up with inflation, then you need to work another year and save more money. That does 2 things. It adds a year of savings to the pool and if you are aware you need the savings, you will save more and it takes another year off the time you need to have money to live. I wouldn't get too carried away with an idea that Buffett and others have told people is absurd, that stocks as a group are going to provide long term growth in excess of the growth in the GDP. Nominally, that is about 5% and the idea of productivity subtracts, not adds to that 5%. There is absolutely no difference in sum between a group of stocks that are going to return 5.25% and a bond that is going to do the same. The timing of the receipt of the cashflow is the only difference and a bird in hand is worth 2 in the bush. That makes a 6.4% yield on a 30 year AAA bond worth 8 times what the SPX is worth right now if you follow that philosophy. The only other game is to learn to speculate and trade in and out of swings.

Due to the weak financial valuation of stocks, when I mention the idea they are priced to yield 5.25%, I wouldn't bet on that good of a return out of stocks over the next 20 years. My guess is it will take a triple in dividends and at least a double before we will see a resumption in the upward march of stock prices. The prices you see on Shillers spreadsheet using a variety of valuation models are very accurate real values we could and probably will see on stocks before we break to the upside. If we do break from this point forward to the upside, I would plan on definitely having a depression. When instruments sell for 6 to 10 times book, a whole new industry of developing books of assets to sell in an organized fashion to the public develops. We will see nothing but a bunch of inflated assets that have no earning capacity and an investment boom that will pack no punch when it is done. Just a heap of junk will remain.


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JWR1945
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PostPosted: Thu Apr 29, 2004 12:31 pm    Post subject: Reply with quote

mannfm11, I think that you have written a great post that needs to be studied carefully. I think that most of your points will hold up very well even under the most intense scrutiny.

The kind of recommendations that have come out of my switching of stock allocations during retirement are consistent with most of your points. I have found that it will be best to be on the sidelines for about a decade.

I believe that we are in the early stages of a long-term (secular) bear market with some dramatic rallies along the way. It will take the kind of adjustments that you are talking about for the stock market as a whole to become attractive once again. There is no risk premium today. Or maybe there is but it is NEGATIVE. You pay extra for higher risk.

As a technical point, I am not concerned about survivorship in the S&P500 because it is capital weighted and has lots of issues. An S&P499 index or an S&P501 index would be almost identical to the S&P500 on a percentage basis. A prominent stock in the S&P500 that goes bankrupt in effect exits the index with a capitalization almost identical to that of the company with the lowest capitalization in the index. Similarly, a stock that rises out of nowhere to dominate the index might as well have been part of the index all along, just at the lowest level of capitalization.

Have fun.

John R.


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BenSolar
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PostPosted: Thu Apr 29, 2004 12:38 pm    Post subject: Reply with quote

mannfm11 wrote:
I think you missed my point

No, I didn't. Thanks for the analysis. I agree that the S&P 500 is grossly overpriced, and I wouldn't retire on a portfolio that rested mainly on that asset class at this time. Though long term bonds at a fixed nominal rate of 5.5-6.5% don't look good to me either, given a very likely (in my mind) increase in inflation in coming years.

We are in the land of low returns. Sad I will continue to work, save money, try to preserve the money I've saved through a defensive portfolio stance, and hope that we see better valuations sometime in the not too distant future.

Regards,



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JWR1945
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PostPosted: Fri Apr 30, 2004 9:29 am    Post subject: Reply with quote

mannfm11:
Quote:
I have seen a lot of talk about the Shiller data on this board so I will reveal something I have gathered out of this data. If you take a spreadsheet or a financial calculator, you can find the IRR of the rate of inflation from 1966 to the last date, 2002. That is done by entering the formula (P-2002/P-1966)^36, calculating the inverse 36th power. If you do that with the dividends paid in 2002, you will come up with literally the exact same figure. What this says about the market is that corporate America, as represented by the SPX, did nothing to outperform inflation. Being the SPX was around 100 in 1966, which led to a bear market where values were not CPI exceeded for 26 years, then peak valuations based on this factor should be no more than roughly 570, which bear in mind could very well lead to another bear market where after a time, the PV of SPX 570 may not be exceeded for some 26 years.

We are close, but we need to be on exactly the same page.

Here are my reference links:
Professor Shiller's Online Data, Stock Market Data, HTML file (table)
http://www.econ.yale.edu/~shiller/data.htm
http://www.econ.yale.edu/~shiller/data/ie_data.htm
CPI is 100 in July-August 1983.

Looking at January data, the real price of the S&P500 index was 495.35899 in 1966 and 1287.5748 in 2002. The real dividend amount was 14.544403 in 1966 and 15.299006 in 2002, which is virtually identical.

I read that the CPI was 31.8 in 1966 and 175.1 in 2002.

Our references to Professor Shiller's data differ somewhat, but the conclusions do not.

Have fun.

John R.


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JWR1945
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PostPosted: Sun May 02, 2004 9:14 am    Post subject: Reply with quote

I believe that mannfm11's post has a much wider range of applicability than many appreciate.

Here are some key points that I wish to draw attention to [emphasis added]:

Quote:
What they did teach me was the risk free rate of interest was 3% and that there was a difference between a capital instrument and a money instrument, something else that seems lost on the modern financial world. I also knew there was a yield curve that assigned a greater amount of risk to a greater amount of time.

Quote:
Where else they touched was portfolio theory, which I didn't quite understand because I didn't understand what they were putting into the formula. I did understand the principal that you could reap a real return of maybe 5% with a 3.5% risk by combining risky assets, knowing that statistically the group would perform at the expected return. I believe the late 1970's gave birth to a load of financial factors that were used in the 1980's and became the norm in the 1990's and among them was portfolio theory. I think it was always assumed that risk could be diversified away, but I doubt there were many valid formulas for this diversification before modern times.

Quote:
Now, I think portfolio theory is okay and for that matter very valid, as long as it is used with assets that have been [properly] evaluated. But, this has been a total failure, in that with portfolio theory has come a group of theories, most notably random walk and the widely accepted falsehood that stocks return 10%. Stocks return 10% when they are priced to return 10%, not when they are bought at any price and held. There is no mix of portfolio that is going to make a group of stocks 300% overvalued return the historic return. [The word properly has been added.]

Quote:
Thus, when I say that portfolio theory is dead, I don't mean the theory is invalid, but when followed as a religion, with no regard to risk and return, it cannot work. When the portfolio proves out to be priced to yield less than the risk free rate of interest, based on generations of returns, then the theory cannot work to provide a greater return.


I consider this the most important section. From this, I conclude that your comments have a great amount of generality. These comments extend well beyond the S&P500.

Quote:
Academia has come with some new nonsense about portfolios. Being the SPX and the Nasdaq are cap-weighted indexes, they are now recommending that more stocks be added to the mix. What this means is the rest of the stocks on the market are also going to near a return that results in a risk free, before expense return out of stocks. Nonsense begets more nonsense and as long as there is a premium being paid for stocks, there will be more stocks issued to draw more money at premium prices. Mal investment will continue and the return out of capital investment will be destroyed, the asset to not be visited again until the next bull market is well under way. Academics excuse this time was the high caps were required to be bought and that brought on the overvaluation, when in fact, the random walk theory, the long term hold theory and portfolio theory just don't wash together. Portfolio theory has to be combined with intelligent financial analysis of the risk associated with a specific group of assets and nothing else. Hence, we have stocks valued today that bear no resemblance to what they represent as potential returns in the future.


From this last paragraph, I conclude that many of our diversification/asset allocation approaches need to be reexamined. Simply slicing different sections of the stock market and/or adding other asset groups is not sufficient by itself. Most likely, people are misjudging the risk of their combined portfolios. Most likely, they are misjudging the potential for rewards from individual components as well.

Have fun.

John R.


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Mike
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PostPosted: Sun May 02, 2004 10:25 am    Post subject: Reply with quote

Quote:
Simply slicing different sections of the stock market and/or adding other asset groups is not sufficient by itself.

This depends upon the author's target audience. A small number of people can often find niches that are overlooked by the majority. It is self evident that if the cap weighted S&P cannot support the current number of equity investors, moving the majority to smaller issues such as REITs and SCV will only make the problem worse. The market cap of the entire REIT sector is less than that of Microsoft, and could not possible support 10% of the majority's assets. Slice and dice strategies depend upon finding asset classes that are relatively overlooked by the majority for their success. There is no hope for the majority of equity investors in any equity class if the S&P becomes over valued. The majority would have to seek investments outside of publicly traded companies to supplement their S&P or TSM holdings.


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