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Your Favorite Investment and Stock Market Valuation Indicator

Last update on: Jun 18 2020

Investors continue to seek the economic or market indicator that tells them when to buy and sell stocks. I spend some time in my book Invest Like a Fox…Not Like a Hedgehog discussing this phenomenon and why it doesn’t work. At a minimum, you need to look at multiple indicators, not only one data point. Even then, nothing is going to work like a science experiment. Markets are composed of people. People both make mistakes and change. Vanguard provides an updated view of my position.

Vanguard looks at a dozen widely-used indicators investors try to use to anticipate market returns. I think the paper overstates the point a bit to try to convince investors to follow the Vanguard buy-and-hold approach to investing. But the point is well made that no single indicator can effectively forecast short-term market returns. Vanguard also spends some time in the paper touting its own method for market forecasting, which is a bit of a change from its historic position that investors shouldn’t try to shift their portfolios much.

We’ve shown that forecasting stock returns is a
difficult endeavor, and essentially impossible in the
short term. Even over longer time horizons, many
metrics and rough ‘rules of thumb’ commonly
assumed to have predictive ability have had little
or no power in explaining the long-run equity return
over inflation. Although valuations have been the
most useful measure in this regard, even they
have performed modestly, leaving nearly 60%
of the variation in long-term returns unexplained.
What predictive power valuations do have is
further clouded by our observation that different
valuations, although statistically equivalent, can
produce different ‘point forecasts’ for future
stock returns.

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