Interesting New York Times article about the market valuation:

“Market valuations are another consideration. By almost every measure, stocks are far cheaper at Dow 10,000 today than at Dow 10,000 in March 1999.

Back then, the price-to-earnings ratio for domestic stocks stood at a very high 41.4. That’s based on 10-year average earnings, a conservative measure that smoothes out short-term swings in corporate profits. Since then, using the same measure, the market’s P/E has fallen to 18.9. While that’s not necessarily a screaming bargain — the market’s long-term average is closer to 16 — stocks are trading at a discount of more than 50 percent to their 1999 prices.”

That would seem to argue for the value player’s approach to investing. And over long periods of time (decades), the value approach is indeed valid.

However, academic studies have shown conclusively that it is your asset allocation strategy that is the greatest determiner of your returns. The best stockpickers out there got crushed if they were 100% long US equities in 2008; The worst bond mangers still did well relatively.

Consider:

“The return to 10,000 also serves as a bitter reminder that stocks have gone virtually nowhere, on balance, for more than a decade. It was in March 1999 that the Dow first climbed above 10,000, before soaring as high as 14,164 two years ago and plummeting as low as 6,547 this past March . . .

Look a bit deeper, though, and you’ll find that there have been some changes in the domestic market, too, in the last 10 years — and largely for the better. Some of them, however, are hard to see at first glance.

For example, a majority of sectors have actually posted positive returns since the end of 1999 — in some cases sizable gains. On average, including dividends, energy stocks have returned nearly 150 percent, shares of consumer staples companies (like Procter & Gamble and others that sell necessities) have gained nearly 65 percent and utility stocks have risen nearly 50 percent . . .” (emphasis added).”

What is also be worth looking at are other investable asset classes beyond US equities: How did emerging markets do? Convertible Bond Arbitrage? Private Equity? Real Estate? Commodities? Munis? Gold?

Even within the equity slug of your allocation, there are small cap value, big cap tech, alt.energy, etc. that may have outperformed the overall market over the same time period.

And when all of the above asset classes become correlated and start to head down, as they did last October, that is your signal to move aggressively to cash.

The overall conclusion of this article, which the Times did not explicitly state, is that most investors would be better off with an asset allocation strategy rather than sticking to the traditional stock picking or even index approaches so common amongst mom and pop . . .

Source:

10 Years Later, a Much Less Expensive Dow 10,000

PAUL J. LIM

NYT, November 14, 2009

http://www.nytimes.com/2009/11/15/business/economy/15fund.html