Stocks are rallying, posting a second day of solid gains on Thursday (so far). The Dow Jones Industrial Average (^DJI -0.11%) and the benchmark S&P 500 (^GSPC 0.02%) are up 2.05% and 2.24%, respectively at 1:40 p.m. EDT.
Yesterday, I referred to one of the smartest, most rigorous finance bloggers out there. He blogs anonymously at Philosophical Economics (and tweets from @Jesse_Livermore), but I'd put his work up against that of any overpaid Wall Street strategist.
Today, I want to draw your attention to the work of another expert blogger, Prof. Aswath Damodaran of New York University, who blogs at Musings on Markets. If you're passionate about investing, you'll be doing yourself a huge favor by following both of them. If you're an investment professional, you'd be penalizing yourself if you aren't already doing so.
Source: What is the euro crisis? Re-published under a Creative Commons license.
Yesterday's column laid out 5 Rules to Achieve Happiness in a Bear Market, including "Nobody knows what the market will do next" and "Don't change investment tack in response to a "trading opinion."
In his latest blog post, Prof. Damodaran points out his own set of four rules to cope with a market crisis and they are very pragmatic, including:
Rediscover your faith: In my book (and class) on investment philosophies, I argue that there is no "best' investment philosophy that works for all investors but that there is one for you, that best fits what you believe about markets and your personality. My investment philosophy is built on faith in two premises, that every business has a value that I can estimate, and that the market price will move toward that value over time. During a crisis, I find myself returning to the core of that philosophy, to make sense of what is going on.
This is extremely sensible. One of the most dangerous aspects of a financial crisis is not the fall in asset prices per se, but rather the emotional toll this takes on investors. Fear perverts our ability to think rationally; when we are under emotional duress, we are much more likely to sabotage ourselves by acting in a manner that we would otherwise find ludicrous. Reminding yourself of your investment philosophy is a good way to break that cycle.
And speaking of value and market prices, I contacted Livermore to get his estimate of fair value for the S&P 500. He responded:
I think FV is 1700. By my estimates, SPX will post a 10 year total return of 6% nominal, 4% real [annualized], from that level. That's an appropriate premium over the returns on bonds and cash to compensate for the increased volatility and likelihood of a meaningful drawdown at some point..
At 1,980, the S&P 500 is now roughly 16% above that fair value estimate. As such, to obtain the expected 10-year annualized total return from current prices, you need to dock roughly one-and-half percentage points from the above estimates, leaving just 4.5% nominal/2.5% real. I imagine those figures are quite a bit lower than most investors' expectations.
Of course, the historical volatility of 10-year returns is significant, so investors could end up earning much better returns over the next 10 years. However, it seems unwise to count on that "positive volatility" to achieve your financial goals.
