US high valuations impact on your stock porfolio mix?

Investing / Portfolios
39

This.

People in 2013 were predicting a market crash based on valuations. A CAPE value of 25 back then was considered by some as dangerously high for the S&P500: Be Prepared for Stocks to Crash

CAPE for the S&P500 in late 1996 was also at 25, a level until then only ever reached in 1928-1929. It was dangerously high. Yet, despite the dotcom and subprime loans crashes, with dividends reinvested, the S&P500 never went lower again than where it was back then: https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&sl=7J1fCZP8ciweJDThzSfLV

In order to time overvaluations efficiently, one has to:

  • leave the market not too early (while there are already plenty of articles around calling stocks overvalued and due for a crash) and not too late.

  • for the market to experience a crash rather than it going sideways for quite some time.

  • to be confident enough to re-enter the market early enough once things get calmer, and not too early because fake bottoms do happen.

I do think US stocks are overvalued and am willing to do something about it (though to be fair, my marbles are all off the table right now due to buying a house and planning renovations) but I’m pretty confident that if doing so can lessen the bluntness of a potential crash, it is not likely to lead to better returns.

Edit: maybe worth mentioning: not timing valuations (that is, riding the market through its highs and lows at market valuations), means being invested and fully taking the blow when (not if) market crashes happen. It takes a calm and clear mind as well as fortitude to do so. Reducing stock exposure is a way to help with that if the idea of watching stocks loosing 80% of their value (which can happen) without panic selling and while still sleeping decently enough at night seems difficult (as it probably is).

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40

I’d add that shareholder value is king, shareholders drive companies, who buy and sell politicians, who implement policy for their benefit. Many people living paycheck to paycheck, up to their eyeballs in debt, one missclick away from ruin. Not a system I’d love to live in, but will happily participate from civilised Europe.

Yeah, the issue is waiting for 6 years to come back from under water from Aug 2000 to Sep 2006, I wasn’t there but imagine the fortitude required not to say “fuck it” is immense, no matter what the data tell us. There’s a 50% drop between Aug 2000 to Sep 2003, and then another 50% drop from Oct 2007 to Feb 2009. As you know - I’ve played with the same data - there’s negative return from 2000-2009. Of course if you add a market cap weighted international (say ex-US developed) to the mix the blow softens quite a bit, and there’s a little bit of upside too.

That’s a very long time for a normal human to have a sizeable amount of money locked up not only doing nothing (but continuing incurring fees) but also to come out with a bit less than going in.
I know I tell myself “Yeah great, buying at a discount”, but 9 years is a long time. I am barely married for 10 years, but what 10 years they’ve been. Changed 2 jobs, moved countries, had 2 kids… The point I am trying to make is that this is a LONG time. Perhaps going forward there are fewer big life-changing events like these left, but who knows.

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41

Agree (on the amounts dumped in before “the crash”),
but we usually don’t “buy once and never again”, at least in the accumulation phase.

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42

but the effect is similar towards the end of the accumulation phase where the last years of new funds contributed is a tiny fraction of existing funds. being <5 years away from potential RE, I’m facing this very issue.

43

But why this scenario is more valid than the following? (When you do a lamp-sum in high valuations period):
“Starting from 10, climbing up to 11, a 50% drop will leave me with 5.5, which is WORSE than starting from 10, climbing to 10.5, where a 20% drop will leave me with 8.5”

Of course we cannot predict the future! The main point is that there is evidence that High Valuations are negatively correlated with Lower Expected returns (although there is much noise).
Now if we want or can address this somehow is the controversial topic :grinning:

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44

Your scenario is just as valid as mine, just the timing and rate of growth are different! Guess we need to be optimistic, disciplined, and lucky. Lump sums (and staying in the market) are shown to beat DCA 2/3 of the time.

That’s totally true too, I think the answer is not controversial, complicated, or easy!

  • we can’t time the market
  • time in the market beats timing the market
  • selling at a loss makes paper losses real
  • having an exit strategy is as important as entering

You can see it is not easy to do either, even for people like those in this forum who’re quite a few clicks above the average when it comes to personal finance: Are you retired? Did you struggle to leave money on the table?

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45

Depends where you are in your journey

  • if you are at 100k by putting in 25-50k yearly for the last 2-4 years and you get a major (30-50%) drop, that’s a great buying oppty
  • If you’re in 1M+ and lose (unrealized) a 500k chunk and are still putting in 25-50k a year, you just lost 10+ years of your contribution amount for sticking to your strategy.
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46

And, this is why a 70/30 or 60/40 portfolio makes sense at that point in your life (with rebalancing, you would even be “buying the dip”)

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47

60:40 was leaving a LOT of money on the table on the :40 end these last 15 years.
The :40 was not even generating positive returns. Simply holding cash was better.

Now we might return to normality, yes. But losing half of your 60: is also very painful if you’re 50+ yo, cause chances are that you’re never getting it back.

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48

If you want a secure income for the rest of your life, you have a few options:

  1. An annuity - perfect, but very expensive recently due to low interest rates. Takes care of longevity risk.
  2. Government bonds. You can ladder your bonds. Again, was expensive recently due to low interest rates.
  3. Real estate. Has benefits of inflation protection.
  4. Dividend stock portfolio (tax inefficient in Switzerland)
  5. Speculative/Growth portfolio. Too volatile on its own but if you tamper down the volatility with 1-3, then you can offset the low returns of 1-3 and mitigate the sequence/volatility of a growth portfolio.

I’m not sure if I’ve missed anything, but I’m personally going for a bit of everything.

49

I’m doing point 2 (2nd pillar) involuntarily.
I’m actively doing 3-4-5 with a 50-10-40% split for now (roughly), that will slowly turn 60-30-10% by the time I’m 55-ish, for the exit strategy.

At least that’s the plan now. :smiley: Going into real estate has left a LOT of money on the table since my first deal in 2005, but at least I had a place to sleep :wink:

50

I haven’t check annuities much but as you mentioned they seem to be too expensive. More than the second pillar.
Isn’t second Pillar a “form” of Government bonds?

Does it? better than stocks?
And are you talking about REITs or real :slight_smile: real estate?

In what way dividend stocks are different from the non-dividend ones? Dividends are not free money. They reduce the stock price when they are paid. + You are being taxed on marginal rate!

I don’t see the reason behind focusing on Growth stocks (vs market cap or factor tilt)

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51

Not really.

If you only consider return and risk on the surface, kind of. But inside the investment strategy is RE, bonds, stocks etc. During accumulation phase, it is basically a mixed asset fund, with a guarantee (not sure however what happens if a fund really goes down the drain)

If you check it out as a pension (instead of capital withdrawal), it would turn into an annuity.

52

Yep, this what I meant. From return and risk point of view it is kind of a government Bond. If you do not cash it then it will turn into annuity.

I checked the underlined assets: a mixture of domestic and international Bonds, Stocks, Real estate, gold and Private Markets!
The not so funny “fun fact” is that the last 5 years it under-performed VT by a factor 3+. And at the end it provided only half of that performance to the owners! (something like 1-1.5% per year)

So I think it make sense not to bother at all with the underline investments of the 2 pillar fund and just consider it as a safe government bond…

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53

It’s not quite as bad. The performance of VT between end of 2018 and end of 2023 was 8.36% p.a. in CHF. The average pension fund performance was 3.56% p.a. according to Pensionskassen-Performance | UBS Focus. Could certainly have been better¹ but they obviously can’t invest it all in the stock market. And the negative interest era (+ the interest rate increase to move back to positive interest rates) hurt pension funds with their bond allocations. Hopefully, that era is over.

¹ E.g., the Pictet LPP 2015-60 index (60% stocks) averaged 5.07% p.a. in the same time span.

54

First, a strategy doesn’t need to be fixed in terms of asset allocation. Personally I plan to steadily reduce my stock allocation and move it to cash/bonds at one point.

Second, I believe that if the US market crashes by 30-50%, most other markets will crash as well due to the interconnectedness of our world, maybe not as hard, but they will for sure be hit as well.

Third, by changing your strategy you might as well miss an unseen 20 years bull market in the US or you could change into a market that crashes hard, while the US still performs good or any other of 1000s of scenarios.

Fourth, your strategy should fit your risk profile, if you can’t stomach such a massive crash, you need to adjust your strategy.

55

My main concern is not so much about the underperformance due to the asset allocation but about not passing the full performance to my personal assets.
I am not an expert about what happens in the backend but I think part of my money is used to finance existing pensioners’ relatively high and locked conversion rate.

Combine that with the chance of FIRING/retiring abroad with 40+% tax rate and you understand why 2nd pillar doesn’t seem the greatest option for me…

56

Yes, that misappropriation is really bad. The pending BVG reform will at least slightly improve it by reducing the BVG conversion rate from 6.8% to 6.0%, however, I suspect the majority will vote against it.

57

There are infinite scenarios and we all agree that we cannot predict the future.
What we know empirically - though with some noise - is that:

High Valuations → Low Expected Returns and in some cases big crashes
Common US Cap weighted indexes → Currently Very High evaluations

So the logical question emerges: By accepting the above, is there something we can do to probabilistically improve things?
e.g. tilt towards lower evaluations (Lower US part %, tilt towards Value, use home bias, something else …)

As very clearly some noted, the problem is higher when you have less than 10-15 years to Fire/Retire and your already invested capital if far bigger than the one that will be invested the next years.

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59

Another way how you can mitigate both the US Tech MegaCap Risk as well as the current, excessive weight of US Shares in current Market Cap:

The return is slightly below Market Cap return. If you scaled this Portfolio down and augmented it with an equal Nasdaq 100 ETF, this to get the US back to 60% weight - you would probably get the same return than the world - but withouth the current mega cap risk we face right now and as well at a much lower PE valuation.