What does "the market is overvalued" actually mean?

[disneysteve]

The other point I was making EEinNJ is that the herd largely sold off their holdings when the market tanked, thus missing that 19% recovery so far this year. Instead of joining the exodus, those of us who hung in recovered at least a decent chunk of what we had lost.

[Scanner]

I agreee with the assessment on the S&P 500 - it's been a dog. My soon-to-be ex-wife's T. Rowe Price Blue Chip fund has barely broken even since 1997.

That being said, I would be happy to concede the point that there has been a "herd"mentality on the precious metals. I think I was on hte lead part of that herd but now it's running strong and I am merely in the pack. I have considered putting a bottom on it.

I also have to consider also that if I really beleive commodities (and precious metals) will rule in the next 20 years because of the increasing population and competition for resources, that companies that deal in commodities directly (oil, mining, farming) would have to indirectly benefit also.

Not sure if they have "commodity companies" or an index or basket of companies like that.

YOu always need human capital to get to the commodity.

[Scanner]

A true diversified portfolio to me would be 20% bonds, 20% stocks, 20% REIT and 20% precious metals and 20% commodity index.

Of course, I am sure that's an oversimplification of risk and reward (some saying it's stil too much of a bet on precious metals).

Well, I certainly didn't sell my Janus at the "top" - I sold it at $39.75 and it was 41 and some change today. My REZ is up a little though.

[elessar78]

From your experiences, is it true that most actively managed mutual funds have trouble beating the SP500?

[disneysteve]

From your experiences, is it true that most actively managed mutual funds have trouble beating the SP500?

Keep in mind that not all actively managed funds should be compared to the S&P 500 index, so let me reword your question:

Is it true that most actively managed funds have trouble beating their respective index?

The answer is a resounding YES. I don't have any stats in front of me but I believe that something like 80-90% of the time, the index fund wins. Plus the index fund typically has lower expenses giving them even more of an edge.

[disneysteve]

I also have to consider also that if I really beleive commodities (and precious metals) will rule in the next 20 years because of the increasing population and competition for resources, that companies that deal in commodities directly (oil, mining, farming) would have to indirectly benefit also.

Not sure if they have "commodity companies" or an index or basket of companies like that.

YOu always need human capital to get to the commodity.

There are certainly commodity funds. We own OPGSX in my wife's 403b which invests in companies involved in gold and precious metals, mining, etc. That fund is up 73.15% YTD.

Oppenheimer also has QRAAX, a broad commodity fund, but that is not doing so well, with negative 1 yr, 3 yr and 5 yr returns. We don't own that one.

I'm sure other fund companies have commodity funds, too, both sector specific and general.

[mtsen]

not sure how this thread turns into a fund allocation discussion, but back to TS,

when I think market X is worth $ Y but the price now is more than $Y then I would think the market is over value. There may be many stories but the really fundamental is just buyers and buyers' thoughts.

[Broken Arrow]

I agreee with the assessment on the S&P 500 - it's been a dog. My soon-to-be ex-wife's T. Rowe Price Blue Chip fund has barely broken even since 1997.

Past performance is no guarantee of future performance. Plus, S&P 500 funds can also return an annual dividend to offset some of the flatness.

A true diversified portfolio to me would be 20% bonds, 20% stocks, 20% REIT and 20% precious metals and 20% commodity index.

True diversification is only possible with non-correlated asset classes. So, a total bond index fund, for example, already has some exposure to REIT, and a commodity index fund or ETF will also have precious metal exposure.

I would get rid of either "precious metals" or "commodity index", maybe slim down REIT, and replace that with international stocks and TIPS.

Well, I certainly didn't sell my Janus at the "top" - I sold it at $39.75 and it was 41 and some change today. My REZ is up a little though.

I wouldn't feel bad at all for not being able to somehow time the tops or bottoms of a fund. Market timing is only clear in hindsight. However, I also hope that you will realize the same situation is true when talking about the stock market for the past decade.

[Broken Arrow]

The answer is a resounding YES. I don't have any stats in front of me but I believe that something like 80-90% of the time, the index fund wins. Plus the index fund typically has lower expenses giving them even more of an edge.

Lucky for you, I do. The link is a PDF though.

Here's a reformatted quote from the first page:

Over the five year market cycle from 2004 to 2008:

* S&P 500 outperformed 71.9% of actively managed large cap funds.
* S&P MidCap 400 outperformed 79.1% of mid cap funds.
* S&P SmallCap 600 outperformed 85.5% of small cap funds.

These results are similar to that of the previous five year cycle from 1999 to 2003.

And yes, I've heard criticisms against the source and the study, but I don't think they hold. For example, S&P500 doesn't sell mutual funds, so they don't have anything to gain with any particular leaning on the conclusion of this study. If anything, as a company that does sell market analysis and benchmark data, they would hurt their credibility and business a lot more with a biased conclusion of some kind.

Also, while the past 10 years may not have been a shining moment for the stock market, what this study shows is that you're likely to do even worse with the majority of actively-managed stock mutual funds. And that's before you consider the expense ratio and loads/sale charges one may have paid on top of that....

I've heard of a reasonable rebuttal that another way to interpret this is to do your homework, pick top quality actively-managed funds, and keep an eagle eye on how your funds are being managed. I can agree with that, but that doesn't invalidate the competitive net returns of a no-hassle, low cost, index-equivalent fund....

Anyway, I thought this was very thought-provoking, because it's intuitive to believe that fund managers should somehow understand the economic climate we are in and be able to steer their funds to safer shores. But in the vast majority of the case though, that appears to not be so.... (edit: They do, by the way, but a lot of things are beyond their control, be it market fluctuations, government regulations, or clients simply not understanding the situation and forcing their hand. I'm supportive of a fund manager's plight, even if I do not always support the funds they offer. )

[disneysteve]

not sure how this thread turns into a fund allocation discussion, but back to TS,

when I think market X is worth $ Y but the price now is more than $Y then I would think the market is over value. There may be many stories but the really fundamental is just buyers and buyers' thoughts.

Thanks for getting back to the original question. Still, though, how can you (or anyone) say that the "market" is overvalued? The "market" is made up of hundreds or thousands of stocks in many different sectors and industries. Some of those individual companies might be overvalued. Others might be undervalued. Still others might be priced pretty fairly based on their performance prospects. It just seems like a tremendous and inaccurate oversimplification to say "the market" is overvalued.

I do think certain sectors are probably overvalued. As I mentioned above, our precious metals fund is up over 73% YTD. I certainly don't expect it to maintain that kind of performance. It needs to drop back to earth at some point. Now might be a good time to lock in some of those profits. Other sectors, though, have been beaten down in the recession and are probably poised for a recovery as things pick up and spending increases again. Lumping all of those companies together as "the market" just doesn't make any sense to me.

[disneysteve]

Anyway, I thought this was very thought-provoking, because it's intuitive to believe that fund managers should somehow understand the economic climate we are in and be able to steer their funds to safer shores. But in the vast majority of the case though, that appears to not be so....

Just like all of us, fund managers are human. They get greedy. They think they see patterns where none really exist. They overestimate or underestimate the significance of certain events.

That said, I have heard that in certain sectors, indexing doesn't work as well. International funds, for example, are harder to index because there are so many factors at play like currency issues, political instability, etc. That is where a well-trained management team may be better than a blind index.

[mtsen]

Interesting video/article, Scanner. Personally, I don't think I follow the herd. I've lived through the tech bubble and the real estate bubble and quite intentionally avoided both. As I said, I did a little speculating with some "play" money during the tech bubble but I knew that the values couldn't possibly hold up. Same with real estate. I saw people paying crazy high prices for properties. I saw people with zero real estate experience buying properties to flip and thought they were insane. At one point a few years ago, I actually looked into buying a rental property in Florida but I ran the numbers, spoke to several owners in the area, spoke with a couple of property managers and decided that the deal just didn't make sense.

Where are we now? We're in a situation where lots of investors lost a ton of money in 2008 and sold off all their stock near the bottom of the market. Since then, the major indices have gone up what, 30% or something like that? Now, some of those same folks are starting to think that it might be time to start getting back in. It makes no sense. Sell low. Buy high. That is the herd mentality, something I've never followed.

I do own less stock today than I did a few years ago. That is partly due to the market drop and partly due to me intentionally adjusting my allocation, particularly in my daughter's college savings, since she is older and closer to college age now.

I'm not trying to convert anyone. I just think the average investor follows the herd in the wrong direction, getting out when the market is down and poised for a rebound and buying in when times are great and prices are riding high.

I, for one, am in the same shoe as steve. except that I need cash flow now so I am jumping back to stock market, knowing the risk I am facing ..

[mtsen]

Just like all of us, fund managers are human. They get greedy. They think they see patterns where none really exist. They overestimate or underestimate the significance of certain events.

That said, I have heard that in certain sectors, indexing doesn't work as well. International funds, for example, are harder to index because there are so many factors at play like currency issues, political instability, etc. That is where a well-trained management team may be better than a blind index.

some other time it is not just greed, complexity does increase simply because the size is big. this article talks about that;

Fund Managers Are Lousy ! | Malaysia Personal Finance

Basically when size increase, the problem quality is the same but quantity is different. Although the root of the challenge is the same, but the required solution is totally different. that is why fund managers do have some tied hands.

I for one, also support active index funds vs passive index funds. Because in comparison to passive index fund, choosing a blue chip that can out perform passive index is relatively quite an easy task.

[disneysteve]

I, for one, am in the same shoe as steve. except that I need cash flow now so I am jumping back to stock market, knowing the risk I am facing ..

How does buying stocks help your cash flow? Are you focusing on dividends?

[Broken Arrow]

Still, though, how can you (or anyone) say that the "market" is overvalued? The "market" is made up of hundreds or thousands of stocks in many different sectors and industries.

Well, it can depending on the context of the conversation.... For example, if we are talking about a total stock market mutual fund, since its performance is market-wide, I don't see anything wrong with talking about it on a market-wide level.

Also, when we talk about certain top level things... such as the Federal Reserve for example, then the impact of their actions is also going to be market-wide.

But as I've also said before, the stock market is vast and full of different varieties of securities that zigs and zags all over the place. So, when we start to narrow down the conversation to specific sectors, industries, and even individual securities and commodities, then the macro-economic view starts to become less and less directly applicable.

I think part of what made it so confusing is that, in the last thread, the market-wide view was used incorrectly to justify decisions in individual investments. That was a problem I did notice but didn't point out....

That said, I have heard that in certain sectors, indexing doesn't work as well. International funds, for example, are harder to index because there are so many factors at play like currency issues, political instability, etc. That is where a well-trained management team may be better than a blind index.

That's true!

How does buying stocks help your cash flow? Are you focusing on dividends?

Maybe he means gambling on the stock market.

I for one, also support active index funds vs passive index funds. Because in comparison to passive index fund, choosing a blue chip that can out perform passive index is relatively quite an easy task.

This part doesn' t make sense....