One of the biggest problems with value is the time it takes to work itself out. Over, and under valued securities and markets can stay stubbornly mispriced for years, or even decades. My favorite grandaddy of all bubbles, Japan, took about 20 years to get back to normal valuation. And even now the stock market is down 30% from all time real highs (including dividends).
One popular criticism of the valuation models that Hussman, Gray, Buffett, Shiller, Grantham, and Philbrick et all propose is that they tend to work over 5-15 years. Many conclude that they are then worthless as most people are trading on shorter time frames etc. It doesn’t matter if it is PE, CAPE, Tobin’s Q, dividend yield or mkt cap to GDP, most don’t work that great in the short term.
(Note: Our Global Value paper introduces another element, and that is relative valuation, which was shown to work great on much shorter time frames.)
So what is a simple answer to this criticism? Simple: hold the position longer.
Below we set out to test a very simple system. The goal is to have a maximum allocation at cheap secular lows, and a minimum allocation at secular, expensive highs.
We divide the portfolio into five buckets of 20% each. Each bucket can be anywhere from 0-100% invested in stocks, and the remainder is in 10 year bonds. Therefore, the entire portfolio can be 0-100% invested in stocks or bonds.