The problem with these indicators is that, although they may indicate over- or undervaluation, they tell you nothing about when a mean reversion will happen.
As Keynes famously said: "The market can stay irrational longer than you can stay solvent."
An indicator that does a pretty good job of signaling the "when" of a recession, and by extension the likely "when" of large market corrections, is yield curve inversion. It predicted the recession of early 2020 quite well, even with the external shock of the pandemic.
From the perspective that somehow a reset of the business cycle has happened through government transfers (not exactly a sound assumption), watch interest rates, and in particular the relationship between the 2 and 10 year.
Should we start to see a rise in short-term rates, without a similar rise in long rates, watch out. You'll no doubt see a multitude of articles explaining how "this time is different." It won't be. And on top of all of that, we'll head into it with the most overvalued market in history.
Fed Fund Rate vs 30YT since 1970(only cherry picking this year because the data on fred is poor before this period, and end of gold standard is significant) is a perfect 8/8[0].
And how many degrees of freedom went into the choice of metrics to compare? Just because something went 8/8 doesn't mean it will predict the future crashes.
I'm not super knowledgeable in this area, but one possibility is that the "9 of the 5" only gives the number of times that it predicted that there would be a recession. There could be many more times that it accurately predicted that there would not be a recession.
So you are saying that a plausible mechanism leads to a ~50% prediction accuracy?
I'm curious how this stacks up to the accuracy of other prediction methods? Off the cuff, this one doesn't seem too bad. esp given the stochastic nature of the variable being predicted.
This "9 out of the last 5" quote is the deadest of beaten horses on HN. It shows up at least once a week here, and it is written with such smugness and unoriginality that it makes even dad jokes funny by comparison.
Let's cut to the chase and make a bot that posts "9 out of the last 5 recessions, hyuk!" on every post remotely related to finance and be done with it. It is the furthest thing from a substantive comment; it is a recycled low-effort joke in the style of reddit.
I agree that it's amusing the first time one reads it. But it is posted here a lot and has become very trite; it probably competes with Hanlon's razor in terms of frequency. After just a cursory search, here are some other examples:
It's not an indicator problem, it's a problem of people trying to time markets. Also, there are two ways to use the Buffet Indicator - right and wrong. The wrong way is to say 'it's overvalued, I should do something - short the market'. The right way is 'it's overvalues, I should avoid doing something - buying overvalued stocks'.
Buffett has been sitting on piles of cash in the past for years and years, avoiding buying securities when they are overvalued. He never tried timing the market, simply waiting for the right moment. Nor did he sell stocks when they were overvalued in order to try to buy them back at a lower cost at least AFAIK from reading his biographies. So, for a value investor, it's a useful tool.
> sitting on piles of cash in the past for years and years, avoiding buying securities when they are overvalued. He never tried timing the market, simply waiting for the right moment.
It’s not quite clear what you’re trying to say here, because if you popped into a newbie investment forum and said you were sitting on a pile of cash that you were avoiding investing because the market was overvalued, you’d be told that is the literal classic “trying to time the market” move.
Buffett obviously is a sophisticated investor who knows what he’s doing but if your description is right this is absolutely still him timing the market. Timing the market isn’t just when you try to pick the day that’s lowest, it’s still timing the market if you are picking the month or year that is lowest.
One note about idolising Buffet in modern times is that it seems to me any strategy Buffet used to employ is outdated.
Any simple metrics, or indicators you can think of are already priced in by algorithms so the only possibility to gain an edge would be to have some very specific niche knowledge or inside information, or you must have even better algorithm that considers more variables.
Any success not stemming from those things can't really be attributed to anything else than luck.
I'd argue, Buffet even if young, couldn't do the same today, that he did in the past.
If there's a successful pattern discovered it will be used until there won't be any more profits available from being able to read this pattern. And these patterns get more and more complicated as time goes on, for an hobbyist investor there's absolutely no way, to do some technical analysis and find a profitable idea.
The denizens of the investor forum would be wrong; it isn't trying to time the market. This strategy is simply valuing the stocks.
The problem with the plan is that holding piles of cash is a game for losers; you need the money to be in some sort of asset - it matters not what - to avoid the printers of the central banks. There is a real chance that stock prices never come down as much as everything else goes up.
As a sole investor you can't in modern day value stocks more accurately than their current market cap.
Any difference in valuation you come up with compared to the market cap would simply mean that there's something missing in your calculations that makes up the difference, as the stock and its market cap is coming from thousands of times more complicated methods for valuing the stock than whatever few metrics you were able to consider.
Essentially by using some sort of method to value a stock, you can only fool yourself to think that you know what you are doing and are skilled beyond luck. Because you are competing against institutions with state of the art tools, researchers and experience.
> Any difference in valuation you come up with compared to the market cap would simply mean that there's something missing in your calculations that makes up the difference
Not necessarily, can also mean that your circumstances are different from the large traders. Value is relative to your net worth, status RE the tax system, risk tolerance and current allocation. So it is not only possible but likely that the large traders have a valuation that is correct for them and wrong for you as a small market participant.
Besides, if all assets are - in some sense - equal then any inane strategy that involves buying assets is equivalent to any other and just dumping all the cash into any basket of assets is workable. So people could probably buy just assets they like and expect an equivalent return to everyone else. If that logic holds.
> people could probably buy just assets they like and expect an equivalent return to everyone else
That's pretty much true. Although risk and volatility does differ from asset to asset. So as a lone investor you can decide how much you are willing to risk to get better returns.
I firmly believe that you should just invest on a fixed schedule. Every month, every year, whatever. And if you see a significant drawdown in between those periods you can buy in before the next scheduled buying time.
But never get scared from investing when stocks are too high - this strategy works one way because you should always be long the market.
> The denizens of the investor forum would be wrong; it isn't trying to time the market. This strategy is simply valuing the stocks.
trying to pick the stocks that are least overvalued is great and everyone should be doing it all the time. (assuming you are investing in individual stocks and not index funds)
the problem comes when you say "everything is overvalued so i'll sit in cash until the market is less overvalued" and yes that's timing the market.
> The problem with the plan is that holding piles of cash is a game for losers; you need the money to be in some sort of asset - it matters not what - to avoid the printers of the central banks. There is a real chance that stock prices never come down as much as everything else goes up.
yes, you've identified the central problem with timing the market, this is precisely why it's a bad idea in general.
As others are saying: if you accept the efficient market hypothesis then your guesses are inherently no better than random chance, unless you somehow have unique insight that nobody else in the market has. Otherwise if you've successfully identified a trading strategy that worked, it would be exploited until there was no longer any value there, and the market returns to "no better than random chance".
(there's the old joke: an economist and his friend are walking down the sidewalk. The friend spots a bill laying on the ground and says "look, a hundred dollar bill!" and bends down to pick it up. But the economist keeps walking, saying "of course it can't be, if it was then somebody would have picked it up already." It's a meme but in a macro sense it's true, there are small pockets of alpha that can be exploited on a small scale but in the macro sense the market is as efficient as it can be and everybody else is just as aware as you that "the market seems overvalued right now" too.)
Therefore the best strategy is to dollar-cost-average across some span of time and accept that you may have missed a percent here or there but that the market is generally going up by more than you missed - and that you also may have timed it poorly and cost yourself a percent or two as well.
Timing the market means you are predicting when something is going to happen, ie, has elements of time involved.
Valuing an asset and then not buying when it is expensive is a completely different activity. It involves no prediction on how long it will be before the price corrects relative to value.
> He never tried timing the market, simply waiting for the right moment.
That's the same thing. Whether you are staying out or buying in, both are trying to time markets. Avoiding doing something is also an action.
In fact historically by staying out because you think something is overvalued has been shown to be outperformed by constantly putting in to the market whatever you can.
Another way to think about this is that historically equity returns are so consistently high that even with an accurate predictor of returns it’s not worth not being exposed to stocks.
Even if you know the next ten years will be in the bottom decile of returns for the S&P 500, you’re still better off than with cash.
"Suppose I offer you a security that will pay $100 two days from today. You can buy as much of it as you like today at $50, or you can wait until tomorrow. Tomorrow, I’ll flip a coin. If it’s heads, I’ll sell you the security at $99. If it’s tails, I’ll sell you the security at $25. What should you do?
Clearly, if you buy the security today, you’ll double your money two days from now. That’s a 100% expected return for each dollar you invest, over that 2-day period. If you wait, you’ll earn nothing on the first day, but you’ll then have two possibilities. If heads, you’ll get just 1% on your invested money. If tails, you’ll get a 300% return, quadrupling your money. With a 50/50 chance at each, your expected return for every dollar you invest is 0.51% + 0.5300% = 150.5%. So waiting adds 50.5% to your expected return over that 2-day period."
Keynes also said “in the long run, we’re all dead”. But with these popular quips, Keynes wasn’t undermining macroeconomic theory, but certainly is communicating that policy outcomes are civilisational in both scale and timeframe.
Neither politicians, nor your investment advisor, use such a scoped time horizon.
As Keynes famously said: "The market can stay irrational longer than you can stay solvent."
An indicator that does a pretty good job of signaling the "when" of a recession, and by extension the likely "when" of large market corrections, is yield curve inversion. It predicted the recession of early 2020 quite well, even with the external shock of the pandemic.
https://www.forbes.com/sites/leonlabrecque/2020/02/26/anothe...
From the perspective that somehow a reset of the business cycle has happened through government transfers (not exactly a sound assumption), watch interest rates, and in particular the relationship between the 2 and 10 year.
Should we start to see a rise in short-term rates, without a similar rise in long rates, watch out. You'll no doubt see a multitude of articles explaining how "this time is different." It won't be. And on top of all of that, we'll head into it with the most overvalued market in history.