Category: Asset Allocation

Market Timing and Share Market Valuation … and June 2022 – End of Month Update

Trying to time the market is a losing game

In addition to the trading … and mostly holding onto individual companies, Slack Investor has been running an experiment on market timing for Index funds in the Australian, UK and US markets. The Index funds have been doing OK .. but Slack Investor is generally just finding that timing markets is just too hard and is hinting at an end to the timing experiment in 2024.

As a recap on the experiment so far, I am still outperforming the “Buy and Hold” investor in all followed markets – but the advantage is slim. Per annum outperformance is 1.4%, 1.9% and 0.6% for the ASX, UK and US markets respectively. Not really fantastic results when you consider that I am missing out on the dividends that “buy and holder’s” receive when I am “timed” out of the markets.

The Slack Index “timing the market” method was devised with a lot of back-testing on 30-years of market performances and does really well when sustained bear markets occur as it gets out of the market at a hopefully early stage in the price downturn. Ideally, the Slack method should stay in the market for the smaller fluctuations (corrections <~10%) and get out of stocks before it becomes a full bear market. The problem with my current strategy is that I am getting “whipsawed” out of the market in these smaller downturns – and the big swings seem to happen so quickly that the damage is done before I can get off the couch.

Things were much easier in the accumulation stage – I had set amounts of money coming out of my pay each month that would be automatically invested into my trading account. With dollar cost averaging, if the market went down, it would just mean that I would be able to buy a greater number of shares – all good.

It is different in retirement mode … as, I am not a net buyer of shares now and, as I am usually am fully invested, it is difficult to take advantage of a lower-priced market. These days, the stock market downturns are just something to be endured.

A chart that caught my eye from Current Market Valuation is shown below. They have a developed a method to try to see if a market is over, or under, valued using the cyclically adjusted price-to-earnings ratio (CAPE). This is very similar to the way that Slack Investor has previously tried to work out the valuation of the Australian, UK and US markets.

S&P CAPE data showing the 1950-2022 average (mean) P/E value of 19.8 (baselined as 0%), as well as horizontal bands showing standard deviation bands. As of June 24, 2022, the S&P500 P/E ratio is 47% higher than the 1950-2022 average – From Current Market Evaluation.

Current Market Valuation define the market as “Fairly Valued” if the CAPE Ratio is between between -1 and 1 standard deviation from the “average”. If the CAPE distribution is “Normal”, then the CAPE should be ranked as “Fairly Valued” about 70% of the time. 

Slack Investor has developed similar charts – but only since 1982. I have used only a short time frame for this analysis as there are good arguments as to why the CAPE should actually rise over time – and a small time range will tend to stop this distortion. The Green shaded areas correspond to the limits of one standard deviation of the CAPE from the 40-yr average values.

Slack Investor S&P 500 CAPE data showing the 1982-2022 average (arithmetic mean) P/E value of 24.3 at the end of May 2022 -“Fair Value” is represented by the green shaded area. Despite recent price drops, the S&P 500 CAPE is still well above average (28%) but at least in the broad “Fairly Valued” range now- Data from Barclays
Slack Investor FTSE 100 CAPE data showing the 1982-2022 average (arithmetic mean) P/E value of 17.5 at the end of May 2022 -“Fair Value” is represented by the green shaded area. The FTSE 100 CAPE is close to its 40-yr mean and well into the “Fairly Valued “range – Data from Barclays
Slack Investor ASX 200 CAPE data showing the 1982-2022 average (arithmetic mean) P/E value of 20.4 at the end of May 2022 -“Fair Value “is represented by the green shaded area – Data from Barclays

Slack Investor gets very nervous when the CAPE charts are well above the green “Fair Value” range. and would love to be a buyer when any of these markets show CAPE values below their 40-year averages.

However, as my “time the market” skills are limited, and my Stable Income pile is still producing, I am prepared to strap in and “enjoy”(not really!) the ride.

June 2022 – End of Month Update

The financial year closes and looking at the 12-month charts for FY 2022 – An official “Bear Market” for the US (>20% fall from a recent high) and big drops in the UK and Australian markets. The “blood in the streets” trend in world index prices have moved the ASX 200 below my stop loss of 6917 – This triggers a sell response.

However, I will not sell against the overall trend. Given that the ASX 200 is bouncing up a little today (01 Jul 2022), this means that I will go to a weekly watch on the ASX 200 – I will now wait till the end of next week to see if the ASX 200 continues to drop – or recovers. I have developed this “soft sell” approach when I gauge that the market is not too overvalued (see above ASX 200 CAPE chart).

Slack Investor remains IN the FTSE 100, TENTATIVELY OUT for the ASX 200, but OUT for the US Index S&P 500 due to a sell in January 2022.

All markets down for the month. The FTSE 100 (-5.8%), the S&P 500 (-8.4%) and the ASX 200 (-8.9%).

All Index pages and charts  have been updated to reflect the monthly changes – (ASX Index, UK Index, US Index). The quarterly updates to the Slack Portfolio have also been completed.

Spurious Correlations … and April 2022 – End of Month Update

Cheese Before Bed Will Not Give You Nightmares

Slack Investor is a lover … of cheese. He follows all cheese related literature and was shocked by the revelation that “Death by Bedsheet Entanglement” is highly correlated (0.95 Pearson R correlation) with cheese consumption. The thought that over 800 people died in the US in 2008 at the hand of their sleeping equipment is terrifying.

A quick explainer on the correlation coefficient, it is just a way to measure how strong the relationship is between two variables. The correlation coefficient ranges between +1.00 (perfect positive correlation) through zero (no correlation) to -1.00 (negative corrrelation)

The close association between cheese and bedsheet deaths – Click Image for more detail – Data sources: U.S. Office of Management and Budget and Centers for Disease Control & Prevention – From tylervigen.com

Slack Investor salutes Tyler Vigen here – a bloke who wrote a program that crawls through unrelated government data sets to find spurious correlations. The above chart is one of these random pairs of data that were thrown together by his program. Almost 50 000 of these graphs that show unlikely correlations have been found so far – and one more is produce every minute! Hats Off Tyler.

Correlation does not mean causation

First lecture in Statistics 101

In the cheese consumption case, it is hard to think that eating cheese actually causes bedsheet entanglement. The first step when trying to establish a link between two variables is correlation. Then, most importantly, experiments must be done to show that A actually causes B – Is there a reason that makes sense? Some people link cheese to nightmares, but there is no scientific evidence linking cheese to death by bedsheet … so, this high correlation is probably just due to chance and a limited data set (10-yr). There is likely to be a missing other variable that’s the true driver that causes the correlation. I would speculate that both variables might be linked to general population trends – but this would have to be tested.

Using Sector Correlations in Investing

Slack Investor has been banging on a bit about “Sectors” lately. and despite not feeling the need to match his portfolio with the sectors of the S&P 500 (Or ASX 200), sector analysis can be useful.

My Investments portfolio consists mostly of “growth stocks” in the Technology and Healthcare sectors. The table below shows a high correlation of these sectors with the total market – they will tend to move with the general market during an occasional downturn. The Nasdaq Composite is down about 23% from its November 2021 high – the Slack growth portfolio is down about 7 % so far this financial year – Not fun, but I do expect the occasional down year.

Sector correlations with the US stock Market – A Sector that would exactly move up and down with the US stocks would have a correlation of 1.00. Low scores ie Utilities do not move up and down the same way as stocks. – From Morningstar 2000-2018 data

However, I want my Stable Income pile, 30% of non-house wealth, to be much more conservative. It holds annuities, fixed interest products and some shares. The shares in the Stable pile need to have a low correlation with the general stock market – as, when the stock market does poorly, I want this pile to be OK.

For my Stable pile, I choose stock sectors that are not highly correlated with stock market fluctuations (circled in red below). I already have some REITS (Listed Real Estate – Correlation 0.59), and some Consumer Staples (Correlation 0.57) which Perhaps I should buy some more Utilities and REITS (real estate). When I get an opportunity, I would like to buy some Utilities (Correlation 0.40) for the Stable pile.

I am always on the lookout for spurious correlations and the 19-year data set, in the above table seems sufficient (would like longer!). Do the correlations make sense? For example, it seems reasonable that Utilities would have a low correlation with the general market. It is a sector that would be able to keep its earnings and maintain its stock price – even during a market downturn.

An asset that has an even lower correlation to the S&P 500 is Gold – and is often seen as a “hedge” to to the stock market. Over a 20-yr period (2000-2020), Gold has a correlation of -0.28 with Australian Equities and -0.12 with Global Equities

Gold has a low (and at times, negative) correlation to other assets

ETF Securities

Smarter people than Slack Investor provide compelling reasons for including Gold in your portfolio – to improve long term returns. But the pig-headed Slack Investor has not yet overcome his old fashioned view that Gold is a speculative investment that does not earn a dividend or interest.

April 2022 – End of Month Update

Slack Investor remains IN for Australian index shares and the FTSE 100 but OUT for the US Index S&P 500 due to a sell – back in January 2022.

Despite some big daily fluctuations, the FTSE 100 (+0.4%) and The ASX 200 (-0.9%) ended relatively flat this month. All is not well in the USA where inflation fears and some mixed results from the Tech sector allowed the S&P 500 to fall -8.8%.

All Index pages and charts have been updated to reflect the monthly changes – (ASX Index, UK Index, US Index).

Diversification … It’s a good thing … up to a point

This collection of herbs and spices makes me hungry – From Systematic Risk Systematic Value

Slack Investor tries to diversify his investment risk by keep a 70% growth oriented investments portfolio with a 30% stable income portion. So far this financial year, my Investments portfolio performance has been a bit lacklustre – so I have gone to the “hall of mirrors” and had a long, hard look at myself. I decided to do a sector analysis of my investments portfolio. The biggest revelation is the large proportion of Investments in the Information Technology (INFT) and Healthcare (HLTH) sectors.

A breakup of the Slack investments portfolio by sector. Dominated by Information Technology (INFT) and Healthcare (HLTH) – but a scattering of Financials (FINL), Broad Index-type funds (INDX), Consumer Discretionary (COND), Communication Services (COMS/TELS), and Consumer Staples (CONS)

Both of my main sectors have had a rough time these last few months – as can be seen by the monthly sector performance chart below. Materials (Resources) and Energy have done well – But these are sectors that I do not own.

Monthly Sectors heatmap for S&P 500 Sectors – Click on Image for better resolution – From Livewire

Slack Investor is not too old to learn new tricks … or, at least, evolve a little. so I was interested to see how my sector analysis compared with the US S&P 500 (below). I chose the S&P 500 f0r comparison as it not dominated by Financials and Resources like the ASX 200. My weightings are very different to the S&P 500.

Dow Jones 30,000: Here's Why It's Still Underperforming the S&P 500 and the Nasdaq | The Motley Fool
S&P 500 Sector analysis – From The Motley Fool

Annual performance for each sector in the S&P 500

I came across a great graphic showing how each sector of the S&P 500 performs annually

10 yr excerpt from the annual S&P 500 Sector Performance ranking – Click on the Chart to get the full interactive experience – From Novel Investor

Some explanation of this beautifully coloured quilt is in order. The vertical columns represent each of the last 10 years performance of each sector of the S&P 500 in ranked order. The right hand column is for 2021. The 2021 sector leader was Energy (ENRS) after a long period in the doldrums. Next is Real Estate (REAL), Financials (FINL), Information Technology (INFT), S&P 500 (S&P), Materials (MATR), Health (HLTH), Consumer Discretionary (COND), Communication Services (TELS), Industrials (INDU), Consumer Staples (CONS) and Utilities (UTIL). The full glory of this graphic is found on the Novel Investor website with a bit of interactivity.

Some things that I have gleaned from this graphic

  • Every dog has its day – Depending on the year, each sector can have it’s day in the sunshine.
  • If you want neither the best of returns or the worst sector returns – buy the S&P 500 Index.
  • Often … if a sector tops the rankings in one year, it usually performs much worse in the next year.
  • The Information Technology (INFT) sector, to which Slack Investor is heavily exposed, is in the top four rankings for performance for 7 of the last 10 years. This year is not one of them.

Should I change my sector allocation?

There are good arguments for passive investing and, if I did not enjoy investing in individual companies, and my 5-yr results were not OK), then that is what I would do. To completely diversify my investment portfolio to match the S&P 500 would mean that I would be investing solely in an S&P 500 Index fund. This has been an excellent idea for the past 50 years.

Berkshire Hathaway has tracked S&P 500 data back to 1965. According to the company’s data, the compounded annual gain in the S&P 500 between 1965 and 2020 was 10.2%

From businessinsider.com

However, Slack Investor still thinks that the S&P 500 is over valued. Regardless of the current cycle, to invest in the whole index would be lumbering my portfolio with some cyclical and low growth companies.

I will continue to skew my investments portfolio with growing businesses – regardless of which sector they are in. I will not always get the company selection right – and will suffer the occasional whack. That’s fine, as long as I get it “mostly right”.

At the moment, many of the high P/E, growing businesses that Slack Investor owns are being sold down as analysts adjust down future earnings because of anticipated inflation. But the companies I own were usually selected for their ability to set their own prices and increase their earnings … these are the qualities of businesses that will prevail – regardless of short-term fluctuations.

Asset Decisions … and March 2022 – End of Month Update

Between Wealth and Love – by William-Adolphe Bouguereau– From Arthive.com (Private Collection)

Slack Investor doesn’t face such vexed issues as this poor young woman. In this sad, but beautifully painted, scene from the 16th Century there are two suitors – the old bearded one offering wealth in a jewellery box, while the young musician offers only love. Her gaze is turned away from both men and she has a despondent expression that suggests that the decision may not be hers alone.

My decisions seem feeble in comparison to the young girl depicted by Bouguereau. Looking at this painting just reinforces to me that men must do a better job of recognizing some of the often horrible decisions that women have to make. Sure, things have improved for women since the 16th Century – but there is still plenty of inequalities. It is the duty of all men to “lean in” and try to make things better.

Asset Allocation Decisions before the end of the financial year

Slack Investor likes to have a look at my income producing piles at this time of year – The Stable Income pile and the Investments pile. I have to decide how to allocate money for living expenses and how to allocate the amounts in my investment asset mix before financial year end to get it ready for next year.

Lets just back track a bit here and remember that Slack Investor finances were thrown into three piles before retirement– a House, Stable Income, and Investments. Now that I am retired and fortunately have my house paid off, there are only two piles that really concern me – The Stable Income pile (30 %) consists of Annuities, Bonds, Term Deposits and Fixed Interest. I have recently added some shares to this pile that I think won’t be too affected by a share market downturn. This share tranche consisting of a small amount of property trusts, consumer staples and infrastructure shares.

The other pile is Investments (70%)- consists of mostly growth shares (high Return on Equity, historical and forward earnings growth).

Despite the tough recent times for growth shares, after extracting living expenses, the total of the piles has grown slightly so far this financial year (0.2%). With 70% growth shares, positive pile growth will not always be the case. But my asset allocation strategy should help be ride out the bad times.

Dividend season is almost over and throughout the financial year I have taken out most of my living expenses from both piles using income from annuities, interest payments, distributions and dividends. At this stage, my current allocation is 29% Stable Income and 71% Investments. In order to maintain my 30%:70% asset allocation, if I need anymore living expenses I will take it out of my over-allocated Investments pile. I will make final adjustments at the end of the financial year – so that the initial allocations are roughly intact (30%:70%) – ready for the next year.

The decisions I make on asset allocation are to keep my nest egg in good shape – so that it continues to provide income. In a good year for investments most of my living expenses can be withdrawn from the Investments pile. In a bad year for investments, then I dip more into the Stable Income pile. Also, in a bad investments year, I might cut back on my discretionary expenses eg. Travel.

March 2022 – End of Month Update

Slack Investor remains IN for Australian index shares and the FTSE 100 but OUT for the US Index S&P 500 due to a sell in January 2022.

The FTSE 100 was flat this month (+0.4%). There were substantial rises for the ASX 200 (+6.4%) and the S&P 500 (+3.6%).

All Index pages and charts  have been updated to reflect the monthly changes – (ASX Index, UK Index, US Index). The quarterly updates to the Slack Portfolio have also been completed.