Why I Am Now a Bear

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On August 1, 2012, I wrote "Why My Retirement Savings Accounts are Currently 100% in the Stock Market." (This was the post that Mitra Kalita noticed and motivated her to invite me to write for Quartz when it started up.) Today's post is an update on "Why My Retirement Savings Accounts are Currently 100% in the Stock Market."

John Hussman had the office next to me at the University of Michigan in the 1990's. By at least 1998, he was saying that the stock market was quite overvalued. Thanks to him, I was out of the market in 2000. I pulled out of the market a couple of years before the 2000 peak. The techniques John is using can't time market peaks exactly, they simply tell if the market is overvalued or undervalued.

On March 6, 2017, John put up a blog post entitled "The Most Broadly Overvalued Moment in Market History." Take a look at his first graph, of the expected 12-year stock-market return his equation predicts. In the graph, you can see the low expected stock returns that caused me to pull out of the stock market in about 1998. You can also see the low expected stock returns in the 12-year period beginning now. Of course, those returns need to be compared to what one could get in the bond market or other available investments.  For clarity in thinking, I like John's approach of first determining expected return on stocks, then comparing with bonds.

I read John's post last Wednesday morning (March 8), and found it convincing. So I changed my main account (my University of Michigan defined contribution pension)


  • 58.07% US Index Fund (FID TOT MKT IDX INS)
  • 26.65% International Index Fund (FID INTL INDEX INS)
  •  9.05% Real Estate Investment Trust Fund (VANG REIT IDX INST)
  •  6.24% Emerging Market Index Fund (VAN EM MKT ST IDX IST)


  • 50% Money Market Fund (VANG TREASURY MM)
  • 50% Real Estate Investment Trust Fund (VANG REIT IDX INST)

(I was careful to choose a money market fund with a low expense ratio. There were high-expense money market funds available from Fidelity that I avoided.) For me, this was a very conservative portfolio. I didn't have time that morning to change a couple of smaller accounts (my NBER defined contribution pension and my new University of Colorado Boulder defined contribution pension) that combined would only be a fraction as large. 

I reported the action I had taken with that retirement account on Facebook and received some useful feedback. Reminding everyone that everything on my Facebook page is totally public, let me share some of that feedback with you. The best advice was from Einer Richard Elhauge, who wrote:

Terrific article and great analysis of the problem. But a few questions on the remedy. Vanguard Reit PE is 26. Isn't that just as overvalued and likely to collapse? The yield for Vanguard Treasury MM is 0.5% -- even less than the 1% yield this article predicts for US stock market. Why isn't a better remedy switching to foreign stocks?

I replied:

I am worried that border adjustment will cause the dollar to appreciate and hurt the dollar value of foreign stocks. Long-run Treasuries I am worried will come down when QE is unwound. Obviously, I need the market to come down in a lot less than 12 years for having money in T-bills to make any sense. Does anything have a below normal P/E?

I am very much a devotee of international diversification, as you can see in "Why My Retirement Savings Accounts are Currently 100% in the Stock Market." But I figure I don't need to take on the risk of whether border adjustment goes through or not—a risk that should be resolved within a 6 months time, I hope. You can see more of my thinking about border adjustment in my post "Border Adjustment vs. Dollar Depreciation." (Also see Olivier Blanchard and Jason Furman's post  "Who Pays for Border Adjustment? Sooner or Later, Americans Do," which addresses a question I have been thinking about in a way similar to my thinking:)

Many people scolded me for trying to do market timing. My response to that is a bit subtle. As I wrote in "Robert Shiller: Against the Efficient Markets Theory":

Can You Succeed at Contrarian Market Timing? The one thing I would add here to what Bob says is this about market timing. Some of Bob’s work, some of it joint with John Campbell, suggests that contrarian market-timing can be a good idea. In particular, their work suggests increasing one’s stock holdings when the price/dividend ratio is low and reducing one’s stock holdings when the price/dividend ratio is high. (Bob has also used the ratio of price to cyclically adjusted earnings or smoothed earnings as a way of gauging if the market is high and likely to fall or low and likely to rise.) I believe this works and try to do it myself. But it is hard to do without a contrarian personality. What makes the market too high is that some story is making people optimistic about the market–a story that is likely to infect you as well; what makes the market too low is that some story is making people pessimistic about the market–again a story likely to infect you as well. So doing any market timing subjects you to the danger of succumbing to the stories out there that, because most other people are succumbing to them at the same time, will make you likely to buy high and sell low. It is only if you naturally like stories other people don’t like and dislike stories that they like that you can be a contrarian investor without great intellectual and emotional self-discipline.

In other words, if the market is not fully efficient, it is because a mass of traders—whom I will call "noise traders"—are pushing it away from efficiency in a way that necessarily involves them buying high and selling low. So if the market is not efficient a lot of money has to be doing things exactly wrong. Therefore, anyone who is going to follow the herd will lose by trying to time the market. And unavoidably, most people who time the market must be following the herd—otherwise there wouldn't be a herd generally going one way. So it is absolutely right that it is generally good advice not to time the market. However, if one has a contrarian personality and finds it easy to go against the herd, then it should be a good idea for one to do some market timing, at least to go against serious mispricing. I consider myself to have a contrarian personality that finds it easy to go against the herd, so I am not worried in general about doing some market timing.

Consciously in response to Einer's arguments, and perhaps unconsciously in response to some of the scolding about market timing (which I don't rationally agree with), I decided I had overreacted and changed my portfolio allocation in my main account to

  • 35% Real Estate Investment Trust (VANG REIT IDX INST)
  • 33% Money Market Fund (VANG TREASURY MM)
  • 30% US Index Fund (FID TOT MKT IDX INS)
  • 1% International Index Fund (FID INTL INDEX INS)
  •  1% Emerging Market Index Fund (VAN EM MKT ST IDX IST)

(Revising my real estate investment holdings again so soon got me a scolding from the Fidelity computer for making a "roundtrip" on those real estate investment trusts.) My other much smaller accounts are mostly in that emerging market index fund. Despite the danger of a loss there because of border adjustment pushing the dollar up, I have always liked to have some in emerging market funds for diversification, and that fund has been flat for so long, it seems less likely to be overvalued. The 1% holdings are to help me remember the names of the funds I want to get back into once the uncertainty about border adjustment is resolved. 

I don't want to stay in Treasury bills very long (the money market fund), but these early months of the Trump administration seem like a time of yuge policy uncertainty. (People talked a lot about policy uncertainty under Barack Obama, but get real—isn't there more policy uncertainty right now?) So I am willing to accept a very low return on almost 1/3 of my visible portfolio until we see a little better what the Trump administration will do in economic policy. And the Fed will raise rates enough that the insurance premium I am implicitly paying will go down somewhat. 

Despite its relatively high valuation, I am still hoping that a diversified real estate investment trust will act a bit like a bond that hasn't been pushed up as much in price as the bonds the Fed has been buying in QE. Indeed, I expect a real estate investment trust to owe some money in the form of long-term bonds, so I hope there is an aspect that is a little like shorting long-term bonds. I could be doing my analysis wrong, but that is where I am coming from.

Also, I have some hopes that (a) real estate investment trusts are a bit safer than most stocks and so deserve a higher valuation than most stocks and (b) that the lingering psychological after-effects of the end of the house price bubble are still pulling down real estate investment trust valuations somewhat, so that I am not overpaying too much compared to other available investments. In any case, some substantial holdings of real estate seem sensible from the point of view of diversification.  

In any case, things in general are at high enough valuations that it is not easy finding investments with the expected real rate of return that I would like to find. As usual in life, nothing is perfect. But you can see how I am muddling along in my portfolio decisions. 

I would be glad for more feedback, especially from those who have gotten this far in reading this post.