June 4, 2007 Letters to the Editor

Updated: June 4, 2007.

Evidence-Based Technical Analysis (EBTA)

I received a letter from Professor David Aronson. He thanked me for my review of EBTA. He drew my attention to an obvious error in my write up, for which I am grateful. I have made a correction.

I recommend Evidence-Based Technical Analysis. It is a quality publication.

Evidence-Based Technical Analysis

Non-S&P Indexes

I received this letter from Rob Bennett.

Thanks for all the work you do for those of us seeking to develop a better informed understanding of how long-term investing really works. As I have said before, I think your site is the most exciting site on Planet Internet today.

I would like to understand better the extent to which today's investor could realistically expect to improve his long-term returns by moving money from an S&P index to either a value index or a small-cap index. I know that you have addressed this topic on occasion. I have had a hard incorporating the findings into my investing mindset, perhaps for the same sorts of reasons that others have accepting the findings re valuations that I subscribe to so strongly (that what I am hearing is not entirely what I expected to hear).

Here are some words from an article of yours entitled "Switching with S&P500 Slices:"

"In every case, varying stock allocations with Professor Shiller's P/E10 would have improved 30-year Historical Surviving Withdrawal Rates substantially.

1) Switching allocations improved Large Cap Growth Historical Surviving Withdrawal Rates from 3.8% to 5.1%, a total improvement of 1.3%.
2) Switching allocations improved Large Cap Value Historical Surviving Withdrawal Rates from 4.6% to 6.5%, a total improvement of 1.9%.
3) Switching allocations improved Small Cap Growth Historical Surviving Withdrawal Rates from 4.1% to 5.3%, a total improvement of 1.2%.
4) Switching allocations improved Small Cap Value Historical Surviving Withdrawal Rates from 5.1% to 8.0%, a total improvement of 2.9%.
5) Switching allocations improved the S&P500 itself Historical Surviving Withdrawal Rates from 4.1% to 5.3%, a total improvement of 1.2%.

"Professor Shiller's P/E10 measure of stock valuations tells us about the market as a whole. It is applicable to wide segments of the market. It is most useful with Value stocks."

Are you able to say whether the five indexes examined are all (roughly) equally overvalued today, or are there benefits to making a shift of money from the S&P index to the others? Which of the others present the best prospects? Or do none of them present good prospects at today's prices?

HERE IS MY RESPONSE

All five indexes are overvalued today. I am not able to assign numbers beyond what you have already written.

The relationships that you see are stable over long periods of time. The relative performance of each category varies over time. But there are some details that I find bothersome.

Large Capitalization and Small Capitalization stocks alternate leadership. Growth and Value alternate leadership as well. Large Capitalization Growth dominated the run-up to the bubble. This suggests that Small Capitalization stocks and Value stocks should do well throughout the next decade.

But the Small Capitalization and Value stories are well known.

Almost all mutual funds claim to have a Value tilt. You can find a large number of small capitalization and micro-capitalization funds as well.

The Small Capitalization data may be contaminated by a serious error. David Dreman points to an unrealistic treatment of bid-ask spreads and large volume transactions within the available data. Liquidity is an important issue.

Regardless of such concerns, it makes sense to underweight yesterday’s winners, Large Capitalization Growth stocks.

My best guess is that none of the other slices will do any worse than the S&P500 as a whole over the next decade or two. If Small Capitalization stocks and if Value stocks underperform, it will that they failed to deliver an extra benefit.

Again, this is my guess. I make it because the “best choices” are widely known.

In terms of absolute performance, none of the choices are attractive. All of them feel the weight of lofty valuations. All of the switching programs have a minimal stock allocation at this time, for all slices.

Letters to the Editor in 2007

Letters to the Editor in 2006

Letters to the Editor in 2005