Probability: Should It Play A Part In Your Asset Allocation?

We live in the moment. We have short attention spans (and shorter memories). For the most part, we want to know how stocks will perform over the next few weeks or months.

2026? 2027? Few “long-term” investors have the fortitude to regard today’s equity market decisions the way that a red wine vintner treats a Cabernet.

Nevertheless, Meb Faber, Chief Investment Office of Cambria Investment Management, recently posted an insightful piece on probable investment outcomes over long time frames. He looked at the three best rolling 10-year outcomes in U.S. stock history and he looked at the three worst rolling 10-year periods.

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The first thing that jumps out at you on the thee phenomenal 10-year periods are the sizable dividend yields and the modest stock market valuations (i.e., cyclically adjusted price-earnings ratio or “CAPE” or “PE10″) at the starting gate. 17.5%-20% annual appreciation? Remarkable.

In contrast, consider the three dismal 10-year returns that occurred in the 2nd chart above. The dividend yields at inception were far less inspiring, on average. And the valuations? The starting PE10 or CAPE for the three worst 10-year periods averaged in the high 20s. The consequence? Flat to 0% annual returns.

Meb Faber later simplified the storyline as follows: Higher starting dividend yields coupled with lower starting valuations tend to produce enhanced 10-year outcomes. Meanwhile, lower starting dividend yields alongside higher starting valuations tend to offer abysmal 10-year results.

How might that matter here in late September of 2016? The chart below shows that U.S. stocks, at present, are far more similar to the average of the three worst 10-year sequences. A starting dividend yield of 2% combined with a CAPE of 26, then, may be detrimental for wealth-seekers going forward.

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Naturally, an analysis along these lines excludes a wide variety of other factors that may or may not be pertinent in today’s world. Yet that hardly implies that investors should ignore expected probabilities.

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Disclosure: ETF Expert is a web log (”blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered ...

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Kurt Benson 4 years ago Member's comment

#DeutscheBank is likely another case of too big to fail. $DB