If, as you say, “real GDP growth has been one of the most consistent economic statistics throughout the past 100 years,” why do you object to a buy-and-hold strategy on the S&P 500?
If you hold a traditional index fund, like the S&P 500, and the market remains range-bound – a very high probability at this point - you’ll likely experience the range-bound market hell: plenty of volatility and no returns (miniscule dividends and zero price appreciation). I believe you can do a lot better in the current environment.
Given your preference (in range-bound markets) for high dividend yield, high cash flow, lower P/E stocks, what US funds or fund categories are best positioned for the current market?
As I note above, it is important to look at normalized earnings at the sector and company level. I believe Energy, Materials, and Industrials face a very real threat of operating margins contraction. If you believe the global economy will slow down, Materials and Industrials will get hit very hard. Unfortunately, this risk is not priced into stock valuations. I would underweight these sectors.
In the last range-bound market, from 1966-1982, value stocks (those with low P/E ratios) outperformed growth (high P/E) stocks. Their P/Es were lower so they experienced less P/E compression. "If you decide to take a passive investing route, at least pick index funds with a value bias and above average dividend yield..." They also have higher dividends, and this is responsible for a large portion of their return.
If you decide to take a passive investing route, at least pick index funds with a value bias and above average dividend yield, and you’ll do better than a broad market index that has a high valuation and pays a skimpy dividend.
One fund family offering a value and high dividend yield strategy is Wisdom Tree. You can take this strategy further and buy value-tilted ETFs of sectors which are likely to face less profit margin pressure.
In October of last year, you argued the Fed should hold interest rates steady, and let free market forces work out the liquidity problems on their own. Do you still hold to this opinion? What is your view of the fiscal stimulus package just passed by Congress? Are there other government actions that should be taken to stimulate the economy?
The Fed is equipped to fight cyclical problems. The problems we face are structural. Risk was underpriced for a long time, so investors became risk seekers. The risk of the system and the financial markets as a whole increased. It is now unwinding. The market should work itself out on its own. Fed intervention lessens pain in short run but increases pain in the long run.
In Japan they had a structural problem in late 1980s. The government intervened, and did not let companies go bankrupt. The problem did not work itself out - their economy went into a prolonged recession as a consequence. In the past, in the U.S., we let the free markets do their magic even if it caused us more pain the in short run. However, this all changed in 2001, when the Fed intervened and kept rates at extremely low levels for a long time. It led to housing bubble and the problems we have today.
"The further we postpone the recession the longer it is going to last."
The further we postpone the recession the longer it is going to last. Fed actions may create bubbles in other (often unexpected) asset classes. Stimulus package make for great political speeches but do not accomplish much. I told my mother-in-law she should deposit the check she’ll get from the government in my kids’ accounts. After all, they’ll be the ones paying for it.
Lastly, you are forecasting the range-bound market (which started in 2000) will last until 2020. What overall asset allocation recommendations would you make now?
Assuming you are a long term investor, there are two things I recommend.
First, the traditional wisdom that 90% of returns come from asset allocation is only true for secular bull markets, when stocks outperform bonds and T-bills by a great margin. However, in range-bound markets returns from stocks don’t differ substantially from bonds or T-bills. I approach this question by asking another question -”What is cost of being wrong?” I would err by overweighting stocks (and underweighting bonds), in case inflation picks up (or the market offers returns higher than I expect). Stocks are a better asset class than bonds. But you must be in the right stocks. "I would err by overweighting stocks (and underweighting bonds), in case inflation picks up (or the market offers returns higher than I expect). Stocks are a better asset class than bonds."
Instead of buying a broad market index, investors should be in a portfolio of individual stocks that meets the Quality, Valuation and Growth criteria I describe in the second part of my book. This is the approach we use at Investment Management Associates.
Choose funds with a value bias. Value may come in and out of favor, but it does better in range-bound and bull markets.
Second, it is very important to look at what I am saying about range-bound markets, even if you disagree. If history is a guide, there is a high (80%) probability (which you should not dismiss) we will be in a range-bound market and a 20% probability we will be in a bear market. (By the way, Active Value Investing will do better in a bear market, too, because you own high quality companies paying above average dividends, or growing earnings with attractive valuations.) Active Value Investing has the lowest possibility doing harm if you are wrong, which is how you should evaluate any strategy. If the stars are perfectly aligned in a weird way and we experience a spectacular bull market, you might slightly underperform. It is like taking out a very small insurance policy.
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