Steve LeCompte writes the CXO Advisory Group blog. I sent Steve an e-mail re The Stock-Return Predictor and Steve sent me an e-mail in return offering his reactions. I asked if it would be okay with him for me to post his comments as a guest blog entry here and he said that that would be fine. I will post a response to Steve’s comments as tomorrow’s blog entry.
Here are Steve’s words:
Thanks for your note.
On a personal level, I am largely in sync with your emphasis on saving and conservative investing. Research such as that summarized at http://www.cxoadvisory.com/blog/external/blog2-1-05/ and http://www.cxoadvisory.com/blog/external/blog11-06-06/ supports your equity return expectations and PE-based approach. However, here are some reservations I have regarding your approach:
– Changes in market participation, regulations, financial services industry offerings and communications technology may have substantially modified the distribution of equity returns over the past century (e.g., decreasing volatility of returns). Sample segmentation helps expose any such trends.
– Simplistically, there is always a reasonably diversified subset of the market with below-average PEs. If PE is reasonably prescriptive for future returns, then an investor could expect to outperform your calculator by continuously restricting investment to such a subset (e.g., “value” funds).
– There are other asset classes besides U.S. stocks and bonds. These other classes may provide attractive (even conservative) alternatives with respect to return distributions.
– There is evidence that financial returns follow power law rather than normal distributions (as argued by Mandelbrot and Taleb — see http://www.cxoadvisory.com/blog/reviews/blog12-17-07/). Power law distributions are “wilder” than normal distributions and offer hardly any confidence for regression-type forecasting. I expect the regressions you use assume a normal distribution for equity market returns.
CXO Advisory Group LLC
Today’s Passion: Karthik Narayanaswamy said of the Predictor: “What’s nice about the Passion Saving website is that it uses a much simpler way to bring the valuation issue to focus.”