Tuesday, October 15, 2013

What does the Nobel Prize mean for investors?

Two of the three winners of this year’s Nobel Prize in economics have developed investment approaches that are critical to investment success.

Let’s look at the work of Eugene Fama and Robert Shiller, and figure out what the implications are for individual investors.

Eugene Fama
Overall, I take away two main points from Fama’s work: 

  1. Buy value versus growth stocks. These are stocks that may not be the Wall Street darlings you hear the pundits discussing, but they have a lower price-to-earnings ratio. This may be less exciting, but they may make more money in the long run.
  2. “Size matters.” Smaller companies tend to be more profitable.
 One company has pioneered investing with this approach: Dimensional Fund Advisors (DFA). They only work with Registered Investment Advisors (RIAs), not individual investors. If you’re an individual investor, I recommend that you work with an RIA like Wade Financial Group to get access to these funds.

Robert Shiller
If you follow my blog, you’ll know that one of the tools I use is the Shiller Price-to-Earnings ratio, known as the Shiller P/E ratio. This compares stock prices with company earnings. What does this mean for you?

Currently, the Shiller P/E ratio is very high—which suggests to me that the market is overvalued and we could see a drop, as I wrote about last week. Shiller P/E suggests that now is the time to lighten up on U.S. stocks…if you want to avoid buying high and selling low, that is!

Bringing it all together...

Looking at the work of these two economists together, here's where I'm seeing opportunities:
Currently, I’m looking at small, value stocks outside the U.S. (Brazil and India are where I’m seeing the opportunities). These have a low Shiller P/E.
I don’t want to buy into U.S. stocks any further right now, given the high Shiller P/E. Where's the market going to go? We can only guess, but I want to avoid getting caught in the “market buzzsaw” by buying high, and selling low!

--Jerry Wade, CFP®, CFS
Chief Investment Officer
Chief Wealth Advocate


No comments:

Post a Comment