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If you're looking for The Single Greatest Predictor of Future Stock Market Returns[1], here it is: http://www.philosophicaleconomics.com/2013/12/the-single-grea

by pdog 9y ago

If you're looking for The Single Greatest Predictor of Future Stock Market Returns[1], here it is: http://www.philosophicaleconomics.com/2013/12/the-single-greatest-predictor-of-future-stock-market-returns/ http://www.philosophicaleconomics.com/2013/12/the-single-gre... This is a long read, but it's worth it. The metric can be calculated in FRED[2], and as a predictor of future returns, it outperforms all of the most common stock market valuation metrics, including cyclically-adjusted price-earnings (CAPE) ratio[3]. (Basically, the average investor portfolio allocation to equities versus bonds and cash is inversely correlated with future returns over the long-term. This works better than pure valuation models because it accounts for supply and demand dynamics.) [1]: http://www.philosophicaleconomics.com/2013/12/the-single-greatest-predictor-of-future-stock-market-returns/ http://www.philosophicaleconomics.com/2013/12/the-single-gre... [2]: http://research.stlouisfed.org/fred2/graph/?g=qis http://research.stlouisfed.org/fred2/graph/?g=qis [3]: http://www.multpl.com/shiller-pe/ http://www.multpl.com/shiller-pe/

KasianFranks 9y ago
When the yield curve begins to dip, a flight to quality will begin into crypto's.
- deleted 9y ago
  [deleted]
- matt_wulfeck 9y ago
  Good luck with that. Usually there's a exodus from speculation the minute things get hairy in the market. Nobody speculated in crypto right?
  - KasianFranks 9y ago
    Like there was in 2008/09 when most people in the world lost confidence in banking systems followed by the bailouts and Quantitative Easing.
    - JumpCrisscross 9y ago
      > in 2008/09...most people in the world lost confidence in banking systems You mean when everyone sold securities, moved to cash, and bought Treasuries, CDs and bank deposits?
      - KasianFranks 9y ago
        And Bitcoin Ref: http://www.wealthdaily.com/articles/eurozone-turning-to-bitcoins/4102 http://www.wealthdaily.com/articles/eurozone-turning-to-bitc...
        JumpCrisscross 9y ago
        > And Bitcoin Given Bitcoin's "capitalisation" failed to hit even $10bn until well after the crisis [1], it's safe to say that more capital moved, in almost any single U.S. state, from stocks to corporate bonds, than from anything to Bitcoin. Being optimistic about the future of a technology is fine. Being delusional about its history is not. [1] https://blockchain.info/charts/market-cap https://blockchain.info/charts/market-cap
        KasianFranks 9y ago
        Ignoring correlations to market downturns and ignoring the data is delusional https://www.google.com/search?site=&tbm=isch&source=hp&biw=1805&bih=1310&q=bitcoin+2009&oq=bitcoin+2009&gs_l=img.3..0l3j0i8i30k1l2j0i24k1l2.2107.5386.0.5795.14.14.0.0.0.0.92.888.12.12.0....0...1.1.64.img..2.12.882.0.vNYA7BPPSCU https://www.google.com/search?site=&tbm=isch&source=hp&biw=1...
        JumpCrisscross 9y ago
        Bitcoin came into existence in 2009. Nobody was buying Bitcoin in 2008 because it did not exist in 2008. We don't have data to support the claim that people would rush Bitcoin amidst stock market crashes. We do have data supporting the claim that they rush into traditionally safe assets, i.e. insured bank deposits and Treasuries. Regarding Cyprus, wealthy Cypriots--by and large--bought German and Greek government bonds, not Bitcoin.
PDoyle 9y ago
Wow, really interesting read. Thanks for the link. Only trouble is that once people find patterns like this, they have a habit of disappearing. Hopefully this one is based on solid enough fundamental market forces that it persists after its publication. It was published in 2013 so we won't know for sure until after 2023.
- wyager 9y ago
  > Hopefully this one is based on solid enough fundamental market forces that it persists after its publication. If you can find any way to predict the future price of things, you can make money by performing arbitrage across time (instead of space, which is how people usually think of arbitrage). This (nominally) describes all types of model-informed time-based investment. The thing with arbitrage is that there's a finite amount of money you can make. If there's a price difference on some cross-listed stock between HKEx and SZSE, you can make money by buying on the cheap one and selling on the pricier one. But, as a side effect of doing so, the price goes up on the cheap one and goes down on the pricier one. There is only a finite amount of stock you can exchange before the price difference approaches zero and you can't make money. The price information has been communicated, and the market has served its function. The same is true for arbitrage across time. There's only so much money you can spend before the "prices" (more complicated than spacial price differences, because you have to worry about some more complex utility theory to find the expectation value of something in the future) equilibrate and market information has been propagated "through time". This is why these things "have a habit of disappearing"; every single way of making money via models corresponds to a market inefficiency. Model-based traders are eliminating market inefficiencies and making a cut off the benefit, just like any other good business. The inefficiencies are just more abstract than usual. So if a model is good, there's no way for it to persist. If it actually predicts something we didn't expect, that corresponds to some inneficiency in the market that some trader can eliminate in exchange for a nice fee.
  - kbenson 9y ago
    Which is all just another way of saying (albeit more interestingly and in more detail), that when new information becomes available, the market adjusts to better reflect the true value of things.
sambe 9y ago
From eye-balling the chart, it seems to consistently lag. Am I mis-reading it, or is this not actually a predictor?
- PDoyle 9y ago
  You're mis-reading it. The blue line is subsequent 10-year performance, so it's already shifted back (left) several years from its natural alignment on the chart.
aphextron 9y ago
Pure astrology
- matthewbauer 9y ago
  Not nearly as bad as some of the "Technical Analysis" I've seen. From what I gather, "Technical Analysis" just amounts to this is what the stock has done in the past, maybe it will do that in the future?
  - module0000 9y ago
    Yes and no. It depends what type of technical analysis you are doing... If your technical analysis has no other inputs except the price(over any period(s) of time), then you may as well go buy a lottery ticket. If you are wondering which category you are in, if at any point during your "analysis" you find yourself looking for things with names like "evening star", "bullish engulfing", "head and shoulders", etc.... save yourself some time and money, and go buy that lottery ticket. Day trading is not for you. If your technical analysis is looking at volume/price/depth-changes, then congratulations, you are on the right track. Next you have to overcome the largest and most devastating hurdle, which is your own psychology.
    - rocho 9y ago
      Could you suggest books that go deeper in the second type of technical analysis? Most of what I find online fits well in the first type you described.
      - module0000 9y ago
        The best resource I know is John Grady's "No BS Day Trading" book. It's part of his basic course at http://www.nobsdaytrading.com/courses/basic-course/ http://www.nobsdaytrading.com/courses/basic-course/ Reading that and applying it was a huge turning point for me in my trading.
        9y ago
frankosaurus 9y ago
Thanks, it would be interesting to see how this has trended throughout this year. The FRED chart is only current to January 1 2017, despite the terms being updated quarterly.
rudyl313 9y ago
One thing to keep in mind is that predicting a downturn in the short-term is different than predicting long-run performance over 10, 20 or 30 years. I think the website is trying to do the former and your article is talking about the latter.
indescions_2017 9y ago
If I'm reading this correctly, the indicator is currently at 0.42? Somewhat above the lifetime average of 0.35, and well below the 0.50 mark which would indicate stocks are overvalued relative to other assets? I believe that corresponds quite accurately with the assessment we are currently at the early to mid stages of a secular bull market in equities analogous to the runs during the 1950s and 1980s. But as others have pointed out, it doesn't say anything about the possibility of a correction in the near term. Be careful out there!
- deleted 9y ago
  [deleted]
randyrand 9y ago
I personally don't think the past 100 years are going to look anything like the next 100 as far as the stock market is concerned. But we will see.
harryh 9y ago
In the same blog as your reference [1] you can find one of the more thought provoking essays I have read in the last little while. It's a discussion about how easier stock market diversification should lead to permanently higher multiples on earnings. http://www.philosophicaleconomics.com/2017/04/diversification-adaptation-and-stock-market-valuation/ http://www.philosophicaleconomics.com/2017/04/diversificatio... Highly recommended.
- eyraudj 9y ago
  "Unfortunately, when we flip the point around, and say that the universe of risk assets should grow more expensive in response to improvements, people get concerned, even though the exact same thing is being said." Discredited the article to me.. Improvements of a market reduce its friction and make it more efficient: transaction costs disappear for instance. Cost and price aren't the same thing. The latter includes the former. Price can be seen as formed by a supply-demand process. In this process investors and capital seekers are BOTH subject to the cost of an inefficient market. They're not two sides of a coin. Maybe not so recommended.
  - harryh 9y ago
    Nothing he says is contradictory to the point you are making here. As markets grow more efficient it become easier for buyers to enter the market which increases demand which causes asset prices to rise.
    - eyraudj 9y ago
      You are right in saying he doesn't contradict me as I am giving precision and I am trying to contradict him. :-) Basically you say that the decrease in friction in a market drives the demand up: as markets grow efficient it become easier for buyers to enter. However I see that it become easier for seller to enter as well! So it is not necessarily a driver of demand.. This argument can be correct in an asymmetrical market like the ones for bonds, equities, real estate, commodities but it doesn't hold in FX markets for instance (perhaps the money market as well) or other derivative markets where there is not so much bias in being a buyer rather than a seller. Although, I might say this argument can be available in a world were investors are in majority of the 'buy and hold' type. Which is the world we live in actually! So I can agree with him that new market opportunities and improvements in market efficiency can be an explanation for the flow of cash, and thus inflated prices... even bubble genesis! The venture capital markets or the crypto-currency ones are perfect examples. To conclude you made me think twice about that and I kind of agree with him but I still don't think it is a universal argument.
coliveira 9y ago
The idea definitely makes sense, but what is the use of this graph? It only shows past returns based on information we already know. Far more interesting is the realization, which is not news for people who observe these things, that prices cannot go down until there is a crunch on the money supply. After all, the allocation of stocks usually remains constant or goes up when prices are going up, so only money supply can change the dynamic of price escalation. The same happens on the way down, because prices are decreasing, the allocation naturally reduces, even if investors want to keep it constant. Only new money supply can reverse the trend of equity price declines.
pishpash 9y ago
After being receptive to this article at the outset, I've become much more skeptical after thinking about it some more, to wit: 1. Why 10 years as the forward return period -- would be nice to see the situation for other return periods, even close to 10 years. Granted, it is a round number and doesn't appear to be cherry-picked, but still. 2. Why 1952 as the starting point -- presumably because the data from FRED starts there, but can this not be extended further back? 3. Why an implausibly linear relationship between the equity allocation percentage, which is bounded (0%-100%) vs. the returns, which is unbounded on either side, over such a large range of values? What is the mechanism to explain this? In other words, what is the proposed model that transmits allocation percentage into a return, even if the directionality of correlation is at least likely? What happens around 0% and 100% allocation -- do the extreme cases make sense? I'd like to run my own data before I believe this.
ata6187 9y ago
That "predictor" or monetary stock and flow theory that blog post describes is well over 100 years old now and very well known (pre-Keynesian and going back to at least Irving Fisher). It has also been studied in detail in academia for decades if anyone wants to look up proper research studies about it. The blog author maybe should have mentioned that this is already a well known and tested predictor, and if the author hadn't heard of before writing that blog post I would question that entire site. There are also several companies that specialize in providing this exact cash/equity data research to financial firms to help them manage their trading strategies and offering more practical details in their data than FRED data offers. For example TrimTabs [1] (no affiliation) has been around since 1990 according to their website [1] trimtabs.com

by pdog 9y ago

KasianFranks 9y ago

When the yield curve begins to dip, a flight to quality will begin into crypto's.

deleted 9y ago
[deleted]
matt_wulfeck 9y ago
Good luck with that. Usually there's a exodus from speculation the minute things get hairy in the market. Nobody speculated in crypto right?
- KasianFranks 9y ago
  Like there was in 2008/09 when most people in the world lost confidence in banking systems followed by the bailouts and Quantitative Easing.
  - JumpCrisscross 9y ago
    > in 2008/09...most people in the world lost confidence in banking systems You mean when everyone sold securities, moved to cash, and bought Treasuries, CDs and bank deposits?
    - KasianFranks 9y ago
      And Bitcoin Ref: http://www.wealthdaily.com/articles/eurozone-turning-to-bitcoins/4102 http://www.wealthdaily.com/articles/eurozone-turning-to-bitc...
      - JumpCrisscross 9y ago
        > And Bitcoin Given Bitcoin's "capitalisation" failed to hit even $10bn until well after the crisis [1], it's safe to say that more capital moved, in almost any single U.S. state, from stocks to corporate bonds, than from anything to Bitcoin. Being optimistic about the future of a technology is fine. Being delusional about its history is not. [1] https://blockchain.info/charts/market-cap https://blockchain.info/charts/market-cap
        KasianFranks 9y ago
        Ignoring correlations to market downturns and ignoring the data is delusional https://www.google.com/search?site=&tbm=isch&source=hp&biw=1805&bih=1310&q=bitcoin+2009&oq=bitcoin+2009&gs_l=img.3..0l3j0i8i30k1l2j0i24k1l2.2107.5386.0.5795.14.14.0.0.0.0.92.888.12.12.0....0...1.1.64.img..2.12.882.0.vNYA7BPPSCU https://www.google.com/search?site=&tbm=isch&source=hp&biw=1...
        JumpCrisscross 9y ago
        Bitcoin came into existence in 2009. Nobody was buying Bitcoin in 2008 because it did not exist in 2008. We don't have data to support the claim that people would rush Bitcoin amidst stock market crashes. We do have data supporting the claim that they rush into traditionally safe assets, i.e. insured bank deposits and Treasuries. Regarding Cyprus, wealthy Cypriots--by and large--bought German and Greek government bonds, not Bitcoin.

PDoyle 9y ago

Wow, really interesting read. Thanks for the link. Only trouble is that once people find patterns like this, they have a habit of disappearing. Hopefully this one is based on solid enough fundamental market forces that it persists after its publication. It was published in 2013 so we won't know for sure until after 2023.

wyager 9y ago
> Hopefully this one is based on solid enough fundamental market forces that it persists after its publication. If you can find any way to predict the future price of things, you can make money by performing arbitrage across time (instead of space, which is how people usually think of arbitrage). This (nominally) describes all types of model-informed time-based investment. The thing with arbitrage is that there's a finite amount of money you can make. If there's a price difference on some cross-listed stock between HKEx and SZSE, you can make money by buying on the cheap one and selling on the pricier one. But, as a side effect of doing so, the price goes up on the cheap one and goes down on the pricier one. There is only a finite amount of stock you can exchange before the price difference approaches zero and you can't make money. The price information has been communicated, and the market has served its function. The same is true for arbitrage across time. There's only so much money you can spend before the "prices" (more complicated than spacial price differences, because you have to worry about some more complex utility theory to find the expectation value of something in the future) equilibrate and market information has been propagated "through time". This is why these things "have a habit of disappearing"; every single way of making money via models corresponds to a market inefficiency. Model-based traders are eliminating market inefficiencies and making a cut off the benefit, just like any other good business. The inefficiencies are just more abstract than usual. So if a model is good, there's no way for it to persist. If it actually predicts something we didn't expect, that corresponds to some inneficiency in the market that some trader can eliminate in exchange for a nice fee.
- kbenson 9y ago
  Which is all just another way of saying (albeit more interestingly and in more detail), that when new information becomes available, the market adjusts to better reflect the true value of things.

sambe 9y ago

From eye-balling the chart, it seems to consistently lag. Am I mis-reading it, or is this not actually a predictor?

PDoyle 9y ago
You're mis-reading it. The blue line is subsequent 10-year performance, so it's already shifted back (left) several years from its natural alignment on the chart.

aphextron 9y ago

Pure astrology

matthewbauer 9y ago
Not nearly as bad as some of the "Technical Analysis" I've seen. From what I gather, "Technical Analysis" just amounts to this is what the stock has done in the past, maybe it will do that in the future?
- module0000 9y ago
  Yes and no. It depends what type of technical analysis you are doing... If your technical analysis has no other inputs except the price(over any period(s) of time), then you may as well go buy a lottery ticket. If you are wondering which category you are in, if at any point during your "analysis" you find yourself looking for things with names like "evening star", "bullish engulfing", "head and shoulders", etc.... save yourself some time and money, and go buy that lottery ticket. Day trading is not for you. If your technical analysis is looking at volume/price/depth-changes, then congratulations, you are on the right track. Next you have to overcome the largest and most devastating hurdle, which is your own psychology.
  - rocho 9y ago
    Could you suggest books that go deeper in the second type of technical analysis? Most of what I find online fits well in the first type you described.
    - module0000 9y ago
      The best resource I know is John Grady's "No BS Day Trading" book. It's part of his basic course at http://www.nobsdaytrading.com/courses/basic-course/ http://www.nobsdaytrading.com/courses/basic-course/ Reading that and applying it was a huge turning point for me in my trading.
      - 9y ago

frankosaurus 9y ago

Thanks, it would be interesting to see how this has trended throughout this year. The FRED chart is only current to January 1 2017, despite the terms being updated quarterly.

rudyl313 9y ago

One thing to keep in mind is that predicting a downturn in the short-term is different than predicting long-run performance over 10, 20 or 30 years. I think the website is trying to do the former and your article is talking about the latter.

indescions_2017 9y ago

If I'm reading this correctly, the indicator is currently at 0.42? Somewhat above the lifetime average of 0.35, and well below the 0.50 mark which would indicate stocks are overvalued relative to other assets? I believe that corresponds quite accurately with the assessment we are currently at the early to mid stages of a secular bull market in equities analogous to the runs during the 1950s and 1980s. But as others have pointed out, it doesn't say anything about the possibility of a correction in the near term. Be careful out there!

deleted 9y ago
[deleted]

randyrand 9y ago

I personally don't think the past 100 years are going to look anything like the next 100 as far as the stock market is concerned. But we will see.

harryh 9y ago

In the same blog as your reference [1] you can find one of the more thought provoking essays I have read in the last little while. It's a discussion about how easier stock market diversification should lead to permanently higher multiples on earnings. http://www.philosophicaleconomics.com/2017/04/diversification-adaptation-and-stock-market-valuation/ http://www.philosophicaleconomics.com/2017/04/diversificatio... Highly recommended.

eyraudj 9y ago
"Unfortunately, when we flip the point around, and say that the universe of risk assets should grow more expensive in response to improvements, people get concerned, even though the exact same thing is being said." Discredited the article to me.. Improvements of a market reduce its friction and make it more efficient: transaction costs disappear for instance. Cost and price aren't the same thing. The latter includes the former. Price can be seen as formed by a supply-demand process. In this process investors and capital seekers are BOTH subject to the cost of an inefficient market. They're not two sides of a coin. Maybe not so recommended.
- harryh 9y ago
  Nothing he says is contradictory to the point you are making here. As markets grow more efficient it become easier for buyers to enter the market which increases demand which causes asset prices to rise.
  - eyraudj 9y ago
    You are right in saying he doesn't contradict me as I am giving precision and I am trying to contradict him. :-) Basically you say that the decrease in friction in a market drives the demand up: as markets grow efficient it become easier for buyers to enter. However I see that it become easier for seller to enter as well! So it is not necessarily a driver of demand.. This argument can be correct in an asymmetrical market like the ones for bonds, equities, real estate, commodities but it doesn't hold in FX markets for instance (perhaps the money market as well) or other derivative markets where there is not so much bias in being a buyer rather than a seller. Although, I might say this argument can be available in a world were investors are in majority of the 'buy and hold' type. Which is the world we live in actually! So I can agree with him that new market opportunities and improvements in market efficiency can be an explanation for the flow of cash, and thus inflated prices... even bubble genesis! The venture capital markets or the crypto-currency ones are perfect examples. To conclude you made me think twice about that and I kind of agree with him but I still don't think it is a universal argument.

coliveira 9y ago

The idea definitely makes sense, but what is the use of this graph? It only shows past returns based on information we already know. Far more interesting is the realization, which is not news for people who observe these things, that prices cannot go down until there is a crunch on the money supply. After all, the allocation of stocks usually remains constant or goes up when prices are going up, so only money supply can change the dynamic of price escalation. The same happens on the way down, because prices are decreasing, the allocation naturally reduces, even if investors want to keep it constant. Only new money supply can reverse the trend of equity price declines.

pishpash 9y ago

After being receptive to this article at the outset, I've become much more skeptical after thinking about it some more, to wit: 1. Why 10 years as the forward return period -- would be nice to see the situation for other return periods, even close to 10 years. Granted, it is a round number and doesn't appear to be cherry-picked, but still. 2. Why 1952 as the starting point -- presumably because the data from FRED starts there, but can this not be extended further back? 3. Why an implausibly linear relationship between the equity allocation percentage, which is bounded (0%-100%) vs. the returns, which is unbounded on either side, over such a large range of values? What is the mechanism to explain this? In other words, what is the proposed model that transmits allocation percentage into a return, even if the directionality of correlation is at least likely? What happens around 0% and 100% allocation -- do the extreme cases make sense? I'd like to run my own data before I believe this.

ata6187 9y ago

That "predictor" or monetary stock and flow theory that blog post describes is well over 100 years old now and very well known (pre-Keynesian and going back to at least Irving Fisher). It has also been studied in detail in academia for decades if anyone wants to look up proper research studies about it. The blog author maybe should have mentioned that this is already a well known and tested predictor, and if the author hadn't heard of before writing that blog post I would question that entire site. There are also several companies that specialize in providing this exact cash/equity data research to financial firms to help them manage their trading strategies and offering more practical details in their data than FRED data offers. For example TrimTabs [1] (no affiliation) has been around since 1990 according to their website [1] trimtabs.com