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Models for Market Valuation Jan 8, 2011 Leigh Anderson Presentation at

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1 Models for Market Valuation Jan 8, 2011 Leigh Anderson Presentation at

2 Houston Investors Association /Evidence-Based Investing SIG / Leigh Anderson 2 Models Robert Shiller Robert Shiller John Hussman John Hussman Fed Model Fed Model CXO Advisory CXO Advisory Bonus: Timing with Bollinger Bands Bonus: Timing with Bollinger Bands

3 Houston Investors Association /Evidence-Based Investing SIG / Leigh Anderson 3 Robert Shiller P/E10 = price / avg 10 years earnings

4 Houston Investors Association /Evidence-Based Investing SIG / Leigh Anderson 4 Applying Shiller P/E10 a strategy at the end of January 1921 of buying (selling) the S&P Composite Index when P/E10 crosses below (above) its 40-year lagged average not obvious that the P/E10 threshold strategy can earn a large enough return on cash while out of stocks to materially best a buy-and-hold benchmark P/E10 has some predictive power for long-term future returns, but this predictive power does not convincingly translate into an outperforming investment strategy.

5 Houston Investors Association /Evidence-Based Investing SIG / Leigh Anderson 5 John Hussman The key elements: valuations and market action. approach is to align our investment position with the prevailing Market Climate and shift that position when sufficient evidence of a Climate shift emerges. Evidence … does not convincingly support a belief that John Hussman successfully times the stock market via hedging adjustments based on his assessments of market valuation and market action.

6 Houston Investors Association /Evidence-Based Investing SIG / Leigh Anderson 6 The Fed Model Compare forecast Earnings Yield (E/P) to T-Bill rate Compare forecast Earnings Yield (E/P) to T-Bill rate Hold (sell) if E/P greater (less than) T-Bill Hold (sell) if E/P greater (less than) T-Bill evidence … does not support a belief that the Fed Model usefully predicts stock market returns over the past two decades. evidence … does not support a belief that the Fed Model usefully predicts stock market returns over the past two decades.

7 Houston Investors Association /Evidence-Based Investing SIG / Leigh Anderson 7 CXO Advisory Real Earnings Yield Akin to the Fed Model Akin to the Fed Model Substitutes forecasted inflation rate for T-Bill rate Substitutes forecasted inflation rate for T-Bill rate REY = E (forecast) / P – Inflation (forecast) REY = E (forecast) / P – Inflation (forecast) Investors require the expected (12-month forward) stock market earnings yield to exceed the expected (12-month forward) inflation rate as evidence that equities have the potential to generate a positive real return. Investors require the expected (12-month forward) stock market earnings yield to exceed the expected (12-month forward) inflation rate as evidence that equities have the potential to generate a positive real return. Note: earnings and inflation forecasts obtained from simple trend-following mechanical rule Note: earnings and inflation forecasts obtained from simple trend-following mechanical rule

8 Houston Investors Association /Evidence-Based Investing SIG / Leigh Anderson 8 REY REY Model appears to offer some information about S&P 500 Index returns over the next few quarters REY Model appears to offer some information about S&P 500 Index returns over the next few quarters

9 Houston Investors Association /Evidence-Based Investing SIG / Leigh Anderson 9 Timing with Bolinger Bands can an investor beat a buy-and- hold strategy by buying (selling) when the market crosses below (above) the lower (upper) Bollinger Band? can an investor beat a buy-and- hold strategy by buying (selling) when the market crosses below (above) the lower (upper) Bollinger Band? evidence from simple tests over the past 17.5 years does not support a belief that investors (especially those with small accounts) can beat a buy-and- hold strategy by using Bollinger Bands to buy low and sell high for the broad U.S. stock market. evidence from simple tests over the past 17.5 years does not support a belief that investors (especially those with small accounts) can beat a buy-and- hold strategy by using Bollinger Bands to buy low and sell high for the broad U.S. stock market.


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