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Aug 09 2011

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Why Do People Think The Markets Are So Cheap?





What is it about our brains, ensuring that most people see the stock market through such a hazy short term window?

Let’s take the recent stock market level.  

Many people have emailed me, asking me whether they should sell off some bonds, or throw some money into the stock markets because the markets have fallen so far.

They have the right idea, but the wrong strategy…at least at this point.

When asked if I think people should sell bonds to buy into the stock market right now, I respond with this:

“Were you enthusiastically selling off bonds to buy stocks one year ago?”

The answer, of course, is typically no.

Then I ask the follow-up question:

“With U.S. stocks, for example, 7 percent higher today than they were one year ago, what makes you think stocks represent a better deal now, than they did 12 months ago?”




That’s when I get a blank stare.

The markets are still 7 percent higher than they were last August.

Rebalance, if you must, when your portfolio is significantly out of alignment.  

But if you weren’t excited about market levels last August, it doesn’t make sense for you to be excited about them now.

If a real market decline occurs, I’ll be rebalancing my portfolio.  And I’ll be rubbing my hands with glee.  But my portfolio is barely out of the aligned asset allocation I set for it.

The last time I sold bonds to buy stocks was in June of 2010.  And the markets still have a long way to fall before hitting those levels.

I hope that happens, but until it does… pardon my bluntness, but the markets haven’t fallen at all – yet.

Let’s hope they do.





About the author

andrew hallam

I'm a freelance finance writer, lucky enough to have been nominated as a finalist for two Canadian National Publishing Awards. I'm also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School, a book explaining how I became a millionaire on a teacher's salary, while still in my 30s. Working to empower people financially, I'm available to motivate and inspire people on basic retirement planning and index investing. I'm happy to comment on your questions, first, please read the Terms of Use.

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22 comments

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  1. avatar
    Financial Uproar

    Nice post Andrew. Just because the markets are down a little doesn't mean they're cheap.

    I bought some muni bonds today, right before the market closed. They got hammered with the downgrade. I was sitting on a little cash, so I'm slowly starting to deploy it. Like you, I'm hoping for lower markets so I can keep nibbling on the way down, since nobody can time the bottom.

  2. avatar
    The Dividend Ninja

    Andrew,

    Great post and timely advice. I just wrote a piece yesterday on how people should slow down before they "backup the truck." Too many people are in a hurry to buy stocks!

    While I had enertained the though of swapping some of my bonds to buy equities, I quickly realized that would not be prudent at all. Right now bonds are the place to be, and I will be keeping those puppies thank you :) I will also be topping-up my index funds and equities over the next while as I have the capital to do so, and keeping my asset allocation in check.

    Cheers

    The Dividend Ninja

  3. avatar
    Dividend Monk

    Rather than comparing stocks to August 20th, I'd prefer to compare them to what I believe their fundamental value is. If I analyzed a company a month or two ago, and determined it's worth $X, and it has since fallen to well below $X based not on fundamentals, but on European debt worries or US treasury panic, then it is potentially a great value. The subset of available businesses that I consider attractively priced has increased based on this 15% sell-off.

    I'm finding good values in the MLP space right now, in particular. Based on my current asset allocation and how it is shifting, I'll be buying stocks as long as they keep falling. Probably not selling bonds, though (unless it continues dramatically).

    1. avatar
      Andrew Hallam

      Hey Dividend Monk,

      I couldn't agree more with you Dividend Monk. With fresh money, I am also adding to stocks (indexes) at these levels. But because I don't own individual stocks, I rely simply on my allocation model. Currently, I have 44% in bonds. That's higher than usual; my allocation is normally about 40%. So I'll add to my stock indexes with fresh money from my wife's salary (I have the semester off!)

      And if I can't keep my allocation of stocks close to 60% of my total, I'll be forced to sell some bonds to buy stocks, just to keep the portfolio close to the allocation model I set for it.

      In one sense, I'm driving an automatic, and you're driving a 5 speed. But in the end, we'll both get where we want to go because we've learned to think dispassionately about the markets. I'm convinced (more and more) that being dispassionate and having a consistent plan, through good times and bad, is a greater key to wealth building than the actual products we invest it. However, by combining aptitude with investment products that make sense (low cost diversified products/well selected stocks)…..that's when we really set a precedent for great future returns.

      1. avatar
        Dividend Monk

        Definitely.

        And I partially index too, so I'm in a similar boat as you. My retirement accounts are indexed, and even my primary taxable account which holds my dividend stocks utilizes index ETFs for some of the other asset classes, like bonds and international exposure (I rarely stock pick internationally, but still want exposure of course). I'm noticing international indexes are falling a bit faster than even the US indexes in this correction, including many outside of Europe.

        I like indexing as a core strategy, but I enjoy stock-picking because a) even dividend indexes don't have the consistent dividend growth of individual dividend champions, b) I don't like giving up my shareholder voting rights (Vanguard abstains from 92% of social and corporate shareholder proposals), c) I like looking balance sheets squarely in the eye, and d) I like certain asset classes such as MLPs that lose some of their "juice" if they are indexed.

        It should all work out in the end, though, with pure indexing or partial indexing. The rebalancing part is key, as you know. All too often, I see people avoiding lower-returning asset classes because they want the high returns, but a balanced portfolio offers greater returns than simply the sum of its parts, so a bond allocation, if appropriately sized, may not drag on total returns too much, or may even boost total returns in certain markets. Typically rebalancing works simply by adding cash, but if this wicked sell-off continues, manual rebalancing may be in order.

        Perhaps appropriately, my article "Step 9: Asset Allocation" is coming up this week, which some readers may find particularly relevant if they wish they had a bit of a war-chest of non-equity capital right about now.

        1. avatar
          Andrew Hallam

          Hey Dividend Monk,

          It's interesting what you say about rebalancing. It's especially powerful in volatile markets. My bond allocation is still roughly 41% of my total, so despite the dropping markets, I'm not rebalancing until its much further from my target allocation.

          Something you said about rebalancing also made me think about yields. I was asked, by an investor over the weekend, what the yield was on my Canadian government bonds. Ironically, he doesn't own bonds (he's in his 50s) but I own a low fee, Canadian bond index, and frankly, I don't even think about the yield. I suppose it's about 3% per year, but more importantly, the bonds add rocket fuel to my portfolio when the markets tanks. They usually rise a little in value when stock markets drop, and I get a chance to rebalance, selling some of my bond index to buy stock indexes at lower prices (which increases my long term returns by quite a bit). Volatile markets are great for that. Interestingly, the price of my bond index, today, is higher than I've ever seen it. That said, I chuckle when people talk about high bond prices. My bond index, moving from $27 to $29 is considered a huge move!

  4. avatar
    Dividend Monk

    ^I meant August 2010, not August 20th. :)

  5. avatar
    Andrew Hallam

    Well Ninja and Uproar,

    I'm enjoying this indeed! Since writing this post, the markets fell another chunk. One more drop should tempt me to take a nibble. Further drops will tempt me to bite. And if there's a total freefall, I'll enjoy selling off large chunks of bonds all the way down, to buy into my stock indexes. I'll be keeping my bond allocation at no less than 35% of my portfolio's total though, no matter what. I'm a wimpy investor, but having a strategy that's sound, and sticking to it, ensures that the markets don't lead you by the gonads. I don't usually watch the markets much. But public fear has definitely been my friend, in terms of solidifying future profits. Let us hope for some huge future drops my friends!

  6. avatar
    The Wealthy Canadian

    I think the serious investor has to stick to his or her game plan when we witness sizable dips in the markets, as we have seen over the past several days.

    But I agree with you Andrew, we are nowhere near the lows that we could easily be facing.

    But how does one know how to precisely time the market from an entry point perspective? Everyone would have loved to have a boat load of cash ready to plow into equities in March 2009 when the TSX hit a low of 7,500 points, as Ninja clearly pointed out in one of his threads from earlier this week.

    The challenge is knowing when we have reached that point. In fact, I think it's more of an impossibility than a challenge.

    From a personal standpoint, I maintain confidence in my personal policy statement. I think it's a good practice for all investors to do one so they don't deviate too far. Since I sat down and literally wrote down my policy statement, I have been comfortable with my investment decisions and haven't looked back.

    I've been nibbling a bit in recent days. I purchased CM at roughly 5% yield and WMT at roughly 3% yield. I too will be buying stocks for as long as they are falling and looking for bargains along the way.

    Nice post!

    1. avatar
      Andrew Hallam

      Hey Wealthy Canadian,

      Yeah, you're right. Speculating a bottom is tough to do. My allocation is 40% bonds and 60% stocks. If the markets drop, and I end up with 50% in bonds, then it's time to do something. I'll sell some bonds to buy stocks. If I never get to that point (ie. if the markets don't drop that far) then I don't care. When I rebalance, I want it to be worth it.

      Plus, if I do rebalance, and if the markets drop further, I'm going to be happy—and not sad that I haven't "timed" the bottom. If the stock market kept falling, I would just sell off some more bonds, to bring my portfolio back to alignment: 60% stocks, 40% bonds. People who think too much end up pulling their hearts into their brains. It's great to hear that you have such a great strategy. That must be why you're the wealthy Canadian. I love it!

  7. avatar
    chris

    Howdy Andrew, I like this Post also…..Maby my strategy is wrong but during the last couple of days I have been buying VTI on the way down…just a couple shares here and there…nothing outragious or as Dividend Ninja puts it "don't backup the truck" My question is: Shouldn't we nibble a little bit on the way DOWN at different price points as sort of an insurance policy since nobody can time the Bottom? I mean as quick as they Fall they can start rising again! And what if President Obama shocks the world by announcing something comepletely opposite of his Economic Thinking like cutting all corporate taxes for a year……then the Markets would shoot up like hell to 16000 or something crazy like that! Cheers- Chris the Truck Driver

    1. avatar
      Andrew Hallam

      Hey Chris,

      Your strategy is an excellent one. If the broad stock market index drops, keep buying it. Most people don't realize that (for long term investors) the stock market is far safer when it's falling (or when it's low) because it's cheaper, and has a higher likelihood of providing higher returns over the next 20 years—if you can buy shares at low levels. Well done Chris! By the way, how many miles do you drive each day?

      And another question, if you don't mind. Do you notice a recent shift between goods that are shipped by truck versus by train today? Is truck shipping increasing? Or are train shipments taking some of the business?

      I'm curious, of course, because Warren Buffett bought Burlington Northern, and he feels that more goods can be shipped economically by train. You're the expert Chris! What are you seeing?

      1. avatar
        Chris The Truck Driv

        Saludos Amigos….Hi Andrew…Thanks for your response to my Questions? Here is a link: Ceridian-Pulse of Commerce Index- I'm not a real tech guy but this Index measures Diesel consumption for long haul trucking and serves as an indicator of where the US Economy is heading! PLease Check it out….I learned of it by listening to Bloomburg Financial Radio on Sirius Satellite Radio. As far as how much I drive every day…..about 500 everyday! I haul the US Mail from Sacramento, CA to Lost Hills, Ca or BarkersField, Ca and then back to Sacramento>Bakesfield is closer to 570 round trip though! Do I notice a recent shift between goods that are shipped by Truck vs Train? Well it looks to me that both are very steady! However…as you mentioned Mr. Buffet did indeed purchase Burlington Northern….and I have noticed that many of the BIG TRUCKING COMPANYS such as Swift or Schneider are shipping their own empty trailers back to where ever they want them via TRAIN! An empty Trailer being shipped by a Driver is referred to as Deadheading! This is not efficient! Your an educated man on the Markets and I know you know the famous Oklahoman Boone Pickens! Well his big idea is to switch all Big Rigs to Natural Gas….it's not only cleaner than Diesel and Gas but much more economical as well….the question is though… Do the Politicians here in America have the will to have a decent energy policy? I hope so for all of our sakes! Thanks again Andrew and Blessings to EveryBody! P.S. I'm sucking on a couple of cold Tecate Cervesas with Lime…UMMMM…Delicious! Bye Everyone- Bye Andrew…Sincerely Chris the Truck Driver

  8. avatar
    Andrew Hallam

    Hey Wealthy Canadian,

    Like you, I don't think trying to time a bottom is a good idea. I just try to keep my portfolio in the same allocation of stocks and bonds. I don't think about whether the markets will keep dropping or not, (no predictions, anyway, just hopes). I simply look at my portfolio's allocation, and if it's out of whack, and purchasing the laggards isn't helping, then I rebalance. I used to think about what percentage the markets dropped (using a 20% drop as a trigger to rebalance). And I guess that's not a bad measurement to use. The markets could drop 15% from their previous point, and then rise–ensuring that I miss the opportunity. But over the long haul, having a set and disciplined strategy, I think, is a pretty sound option. Either way, it's nice to know that if the markets keep falling, you can just keep buying bonds along the way down, while just keeping your portfolio in the same asset allocation balance you had before the drop. What do you think?

  9. avatar
    the cynical investor

    Andrew,

    Only if I had read this

    “That’s when I get a blank stare.

    The markets are still 7 percent higher than they were last August.

    Rebalance, if you must, when your portfolio is significantly out of alignment.

    But if you weren’t excited about market levels last August, it doesn’t make sense for you to be excited about them now.”

    I am hopeless, I need treatment and fast. I bought stocks on this Black (as the background of my blog) Monday. And on leverage even if in 2008 I said I would not do this again (still vivid the nights when I could not sleep and saw my portfolio losing more and more of its value). I think in a few months I got 5 year older.

    And I would daily receive automated e-mails from my brokerage account saying how much money in my margin account I have until I get a margin call. I would get the paycheque and transfer most of it almost immediately to my brokerage account, that seemed like a bottomless pit. I hadn't received a margin call but I was a few times dangerously close.

    1. avatar
      Andrew Hallam

      Hey Cynical,

      I noticed that the markets dropped another 4% or so yesterday. But it's interesting. They are still higher than they were one year ago. We never see that in the senstational news, which is pretty funny.

  10. avatar
    john

    Hey Andrew,

    I know you're an index guy…but can't allot be said for picking up big companies such as Canadian banks, Insurance companies and some of the big higher yielding energy companies and enrolling them in a drip then sit back? Yields are between 4.5-6% for some big companies that aren’t going anywhere. Agreed don’t back up the truck at anytime…just nibble when it everyone is selling.

    I’ve enjoyed your blog for a while and look forward to getting my hands on your book!

    Cheers!

    1. avatar
      Andrew Hallam

      You're absolutely right John. A lot can be said for that kind of strategy. If you're disciplined, and you don't move money around, you can make a killing.

      Here's a good one for you. If you had bought the AVERAGE U.S. stock, 30 years ago (I'm not talking about Microsoft or Apple, I'm talking average) and if you had reinvested the dividends, you could have turned $10,000 into more than $200,000.

      The average global stock would have given you something close to that as well.

      Few people realize that, and very few people who were investing 30 years ago made those kinds of returns, because they were messing around, trading, paying high fees to brokers, etc. No—your strategy is a great one. Just keep the discipline, and you'll rock over your lifetime John.

  11. avatar
    Value Indexer

    These moves definitely don't make the market cheap by any means. But it could also reverse itself at any time since the average investor doesn't seem to be content with driving the market up to fair value and stopping there :)

    I was perfectly happy with my allocation last weekend, then yesterday my US index fund fell 5.42% and my bond fund rose 0.78%. With a small transfer (bonds to equities) I improved the outlook for that portion of my capital by over 6%. This puts my bond fund slightly underweight though. If the decline continues that puts my allocations back in line. If it reverses itself then I need to trade back to avoid being really overweight in stocks and make a profit along the way. Should I accidentally get 6% coming and going I won't complain. I was happy with my portfolio last week, I'm happy with it today, and I'll be happy with it next week/month/year no matter what happens.

    I'm just doing small trades here so it won't change my life. But the stock markets will run out of sellers before I run out of bonds doing this, which would leave me buying at some very attractive prices and scraping together all the cash I can spare. Since I don't know the future the best I can do is buy gradually as prices improve and sell gradually as they get excessively high. Rebalancing does the same thing with less work, and if I could only look at my portfolio once a year I wouldn't be worried about it.

    1. avatar
      Andrew Hallam

      I have one word for you, Value Indexer:

      BRILLIANT!!!!!!

  12. avatar
    My Own Advisor

    Good post Andrew, love it.

    Yeah, I was thinking the same thing the other day:

    Aug. 8, 2010, TSX = 11,469.

    Aug. 9, 2011, TSX = 11,670.

    Aug. 8, 2010, DJIA = 10,700.

    Aug. 9, 2011, DJIA = 10,809.

    Like my favourite (Dividend) Monk, my registered accounts/retirement accounts are mostly indexed, with about 30% bonds. I love the cushion that bonds provide in this environment. A few U.S. dividend-paying stocks don't hurt either :)

    Even still, I don't see these times as a huge fire sale of equities, although they are certainly cheaper than before. If I had some cash, I would be buying. But, I don't. I feel this is a good time to aggressively pay down our LOC while interest rates remain low.

    If the TSX, and DJIA drops another 2,000 pts. each, well, that's a different story. Will it "get there", I really don't know. What I do know is, I love buying my equities and bonds, cheaply :)

    1. avatar
      Andrew Hallam

      We'll throw an overseas party if we get another crash Mark! Skype it baby!

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