Tuesday 16 February 2010

A History of Severe Real S&P 500 Stock Bear Markets – February Update

Looking at the first chart which shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market I have identified three historic severe stock bear markets. These I am defining as stock markets where from the stock market reaching a new high, they then proceeded to lose in excess of 60% of their real (inflation adjusted) value. These are best demonstrated by the second chart which shows each of these stock bear markets and the fall in percentage terms from the peak. So briefly what were these bear markets (full details here).

The first severe stock bear (marked in purple on the chart) market started with a new real high being reached in September 1906 and incorporated the 1907 Bankers Panic. From the high it took until January 1920 for the stock market to reach a real loss of 60.9% and then until December 1920 to reach its real low of -70.0%. That’s a period of 14 years and 3 months.

The second severe stock bear (marked in blue on the chart) market started with a new real high being reached in September 1929 and is obviously the period of the Great Depression. The markets passed through -60% on a number of occasions. In June 1932 the market reached its real low of -80.6%. That’s only a relatively short period of time however it really wasn’t over then as the market never really recovered and kept dipping back below -60% in real terms. 20 years later the market was still below the real -60% mark.

The third severe stock bear (marked in olive on the chart) market started with a new real high being reached in December 1968, incorporated the stock market crash of 1973 to 1974 and the 1973 Oil Crisis. From the market high it took until March 1982 for the stock market to reach a real loss of -60.9% and then until July 1982 to reach its real low of -62.6%. That’s a period of 13 years and 7 months.

So that brings me, as always, to the last line on the chart marked in red which shows the real bear market that we are currently in. This period began in August 2000 with the Dot Com Crash however we were unable to reach a new real high before the Global Financial Crisis took hold. In this real bear stock market we have been unable to break through -60% ‘only’ reaching -58.6% in March 2009. That is a period of only 8 years and 7 months.

As the second chart clearly shows we have now dipped back below the -40% line to be at -41.9% from -39.4% last month. We are now 9 years and 6 months into this severe bear market which is a relatively short period of time compared with the other severe bears shown. The previous bears all went below -60% in the years to come and at this point were:
- in 1916 at -25.4% and over the next year heading to -33.8%.
- in 1939 at -50.7% and over the next year pretty much standing still in real terms to reach -52.0%.
- in 1978 at -50.1% and over the next year heading to -53.1%.

I’m going to keep watching this comparison as I think it could be just starting to get interesting. Governments around the world are fast running out of borrowing capacity as Greece has aptly demonstrated. Closer to home the Bank of England has stated that more quantitative easing (QE) could be just around the corner. What will that do to inflation? The best growth that can be ‘created’ in the UK even with QE, bank bailouts and “cash for clunkers” is a miserly 0.1%. Finally, despite the big bonuses, I don’t see any evidence that the banking sector has repaired itself. I don’t see other developed economies being a whole lot better. Could we yet see that real -60% bear? History suggests there is still plenty of time for it to occur.

Assumptions include:
- Inflation data from the Bureau of Labor Statistics. January and February ‘10 inflation is extrapolated.
- Prices are month averages except February ‘10 which is the 12 February ’10 S&P 500 stock market close.
- Historic data provided from Professor Shiller website.

Monday 15 February 2010

Guest post – alternate investing strategy

Today is a guest post from a reader of Retirement Investing Today. Two elements of their investing strategy have inspired me. Firstly, they are in their early twenties and have already clearly accepted full responsibility for their own actions with respect to their own economic well being. I certainly wasn’t at that point at that age. Secondly, rather than just following the herd mentality with regards to investing they have adopted an investing strategy which includes a very interesting asset class – whisky. As with all Retirement Investing Strategy readers I wish them much success and I hope you enjoy reading their story. I know I did.

I am fairly new to the investment game, this being my second financial year as an investor. I decided against joining a pension scheme as I do not like the idea of saving for all of my working life and planning my retirement on the faith (that is very low) of an annuity company providing me with a good income. I want to plan my retirement and manage my own investments. I am in my early twenties and my plan is to accumulate enough capital by the time I am in my mid-fifties to provide an acceptable income that can be enjoyed for the rest of my life. When I have finished retiring, the income from my capital will then be able to be enjoyed by my successor(s), rather than an annuity company. Following the recommendation on this blog, I have purchased a copy of “Smarter Investing - Simpler Decisions for Better Results” by Tim Hale. I cannot recommend this book enough.

My target portfolio at the moment is:
Cash - 65%
UK Equities - 25%
Gold - 5%
Whisky - 5%

The large percentage that is allocated to cash is not because I am cautious but because I have a short term goal to save enough to use as a deposit to fund a home within three years, which is too short to invest.

My contribution to this blog today will be about whisky as there is a noticeable lack of information on the Internet about this asset class. Whisky currently makes up approximately 5% of my portfolio.

Whisky is a spirit that is enjoyed all over the world. Recently, we have witnessed a very large growth in the demand of Scottish whisky due mainly to the rapidly growing middle classes in developing countries. Supply has not been expanding nearly as fast (I can tell you this personally as I live in Moray, which has the largest concentration of single-malt distilleries anywhere in Scotland). My reason for allocating 5% of my portfolio to single-malt Scottish whisky is that I aim to profit from the expanding ratio between supply and demand. Historically also, whisky collecting has generally been a very profitable pursuit, although a certain level of knowledge on the subject is essential.

There are essentially three ways to invest in whisky:
1 – Buy shares in a company that makes profit from the whisky industry
2 – Buy young whisky casks en primeur and hold them until that have matured
3 – Buy bottles of whisky and hold them in order to take advantage of dwindling supply.

I am concerned with the third option.

It is important to point out at this point that bottled whisky does not mature further and will not change in character if it is stored correctly (more on this later). It is also important to select bottles from iconic well established distilleries, as these are the ones that will be most in demand. The main distilleries that I am interested in are Ardbeg, MacAllan, Balvenie, Talisker, Glenfiddich and Port Ellen. These are all very well respected and are in high demand all over the world. The last one that I mentioned has closed so it goes without saying that demand for their expressions are going to increase.

Most of these distilleries have an online committee/club that is free to join. Quite often, special limited edition expressions are offered only to member. The last committee exclusive that Ardbeg offered (Ardbeg Supernova) was ranked as the world’s second finest whisky and now sells for 150% of the price less than one year on. In years to come as more of these limited bottles are consumed I expect the value to increase.

The ideal bottle of whisky for investment purposes will be (in order of preference):
1 – From an iconic distillery (and if it has closed even better).
2 – Part of a very limited release
3 – Aged beyond 30 years (although younger expressions are also worth considering if they meet the rest of these requirements)
4 – Mostly unavailable to the open marker (i.e., committee releases or distillery exclusives)
5 – Taste good (I use the latest edition of Jim Murray’s whisky bible for this).

Take note that bottles are also produced by external bottling companies who buy casks en-primeur and bottle them much later. Often this is the only way to buy expressions from closed distilleries. Some external bottling companies to consider include Duncan Taylor & Co and Douglas Laing & Co.

I recently acquired a 30 year old bottle of MacAllan, bottled by Douglas Laing & Co. This particular expression was bottled after the whisky has matured in a rum cask and is one of just under two hundred bottles. I believe that this expression has a very high chance of increasing in value significantly.

There are also quite a few rare bottles that are only available by visiting the distillery. This can be very costly if you do not live near them (this is where I have an advantage). If you are able to visit a distillery at a small cost, it is definitely worth having a look to see what exclusives are available.

Whisky bottles are not as sensitive to wine as they have a high alcohol content. They can be stored anywhere that is not subject to major temperature fluctuations, however they must be stored within their tube or box, to prevent light from oxidising the whisky.

As far as taxes is concerned, duty is obviously paid when you purchase the bottles (unless you buy them from an airport), however I believe that like wine, whisky is exempt from capital gains tax.

I am very optimistic that my ever growing whisky collection will generate a good return for my portfolio however there is the possibility that some bottles will not increase in value as much as I hope they will. If this is the case I might even enjoy a nice dram of scotch when I retire!

Please do your own research.

Sunday 14 February 2010

US (S&P 500) Stock Market – February 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a Cyclically Adjusted Price / Average 10 Year Earnings (PE10 or CAPE) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller. Background information here.

Chart 1 plots the Shiller PE10. Key points this month are:

Shiller PE10 = 19.9 which is down from 20.6 last month. My UK Equities target asset allocation therefore increases from 18.6% to 18.8%. Additionally my International Equities target asset allocation increases from 13.3% to 13.4%.

Shiller PE10 Average (1881 to Present) = 16.4. This means we are currently still 21% higher than the long run average since 1881.

Shiller PE10 20 Percentile (1881 to Present) = 11.0

Shiller PE10 80 Percentile (1881 to Present) = 20.6. The Shiller PE10 has now fallen back through the 80 Percentile.

Shiller PE10 Correlation with Real (ie after inflation) S&P 500 Price = 0.78

Chart 2 further reinforces why I am using this method. While the R^2 is low there appears to be a trend suggesting that the return in the following year is dependent on the Shiller PE10 value. Using the trend line with a PE10 of 19.9 results in a 1 year expected real (after inflation) earnings projection of 5.2%.

Chart 3 plots Real (after inflation) Earnings and Real Dividends for the S&P 500. Real Dividends are still falling however they are still above their long term trend. Real Earnings have a roller coaster ride continually, particularly since about 1990. If the Standard and Poors forecast earnings are to be believed however we continue to be above the long term earnings trend and climbing.

Assumptions include:
- Q4 ’09 & Q1 ’10 earnings are estimates from Standard & Poors.
- Inflation data from the Bureau of Labor Statistics. January & February ‘10 inflation is extrapolated.
- January & February ‘10 dividends are estimated as December ‘09 dividend.
- Prices are month averages except February ‘10 which is the 11 February ’10 S&P 500 stock market at 1430.
- Historic data provided from Professor Shiller website.

As always DYOR.

Saturday 13 February 2010

My allocation to emerging market equities

Tim Hale in his book ‘Smarter Investing : Simpler Decisions For Better Results’ provides some tips for investing in emerging markets. These are:

- do so in moderation;
- Own a diversified pool of markets, rather than putting all your eggs in one basket, such as China, despite what the Sunday papers may say;
- be prepared for the times when returns diverge substantially from UK and developed markets on the downside;
- don’t be overly optimistic about the degree to which a free lunch is on offer

Additionally he suggests that the correlation between emerging markets and developed markets is 0.6 although he also states that this could be generous. I have also considered that “from 1987 to 2004 emerging market equities only beat US equities by 1 percent ... but with around twice the level of volatility...”

With all this in mind plus knowing that I want to minimise fees and taxes I have positioned my retirement investing emerging markets equities as follows:

- Investing in moderation with a desired allocation of only 5%.

- The ETF owns a diversified pool of markets which I detail below.

- I am prepared for times when returns diverge substantially which should help me to buy low and sell high as I have described in previous posts.

- I am not being overly optimistic about the free lunch.

- I am buying the ETF’s within my ISA. I have done this as picking up on the high volatility point means that I may have to buy and sell often which is in my opinion best done in a tax wrapper to prevent capital gains tax ever becoming payable.

- I have minimised fees by buying an emerging markets exchange traded fund (ETF)

My Emerging Markets Equity ETF asset allocation is as follows:
- 16.9% China
- 15.7% Brazil
- 12.2% South Korea
- 11.0% Taiwan
- 8.7% India
- 6.9% South Africa
- 6.6% Russia
- 4.3% Mexico
- 2.7% Malaysia
- 14.9% Other

As always DYOR.

Thursday 11 February 2010

Buying Gilts, Property, International Equities and UK Equities

As an employee of a company I have the option to contribute to a pension scheme. I have made the choice as part of my retirement investing strategy to contribute to the pension scheme as the company matches my contributions up to a limit, plus as I salary sacrifice into the pension, they also generously contribute the 12.8% employers national insurance that they would have otherwise paid to HMRC. I will complete a blog on pensions hopefully in the near future.

This is new money that enters every month and is currently the equivalent of about 0.5% of my total retirement investing assets. Another months worth of contribution has just been made. This is currently automated to occur each month and will be invested as follows:

- 4% to Index Linked Gilts. This adds up to be a very small contribution but I want to just keep nibbling a little.

- 60% to UK Commercial Property. A big contribution is made here as my desired low charge portfolio requires 10% asset allocation and my current low charge portfolio is only at 8.1%.

- 21% to International Equities. My desired low charge portfolio currently requires 13.3% asset allocation and my current low charge portfolio is only at 13.1%. This is the only input to International Equities that I am currently exploiting.

- 15% to UK Equities. This is one that requires a little explaining. My desired UK Equities is 18.6% and my current UK Equities is 18.6% so I am where I need to be. Where I am underweight heavily is Emerging Markets Equities by 2.3% and my total Equities exposure is also underweight by 2% at 54%. In an ideal world I would be buying Emerging Markets however my company based pension is inflexible (like a lot of company based schemes I would guess) and the lowest cost Emerging Markets Equity fund that I can buy has fees of 2%. Now I refuse to pay anyone 2% in fees and so the compromise I have made is to try and bolster my Equities allocation while acknowledging I am underweight Emerging Markets. Not ideal I know but fits with strategy to minimise fees.

As always DYOR.