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WisdomTree LargeCap Funds: Indices Set Them Apart

Summary This is the second in my series of articles examining the field of large-cap ETFs. WisdomTree Investments’ ETFs are distinguished by their proprietary indices which are nuanced to fit specific aims. I describe the general nature of WisdomTree’s four large-cap ETFs, providing detailed information about the performance of these funds. WisdomTree Investments, Inc. (NASDAQ: WETF ) issues four large-cap ETFs under the WisdomTree Trust header: WisdomTree LargeCap Dividend Fund (NYSEARCA: DLN ) 1 WisdomTree ex-Financials Fund (NYSEARCA: DTN ) 2 WisdomTree Earnings 500 Fund (NYSEARCA: EPS ) 3 WisdomTree LargeCap Value Fund (NYSEARCA: EZY ) 4 What sets these funds apart from other large-cap ETFs are their indices; WisdomTree manages its own, proprietary, indices, assuring the funds of guidelines relevant to their purposes and hopefully structured to maximize the funds’ values. The ETFs All four funds require holdings to have a minimum of $100 million in market capitalization. 5 DLN and DTN take their holdings from the 300 largest companies in the WisdomTree Dividend Index that have paid dividends for the 12 months prior to screening; the two funds also require a $100,000 daily trading volume (average for the three months preceding screening). 6 EPS and EZY are drawn from larger universes of large-cap companies ( 500 and 1 , 000 , respectively), and both require a $200,000 daily trading average for the six months – and a price-to-earnings ratio of at least 2 – preceding screening. Eligibility for the index is determined by earnings over the four quarters preceding screening. The funds differ in two important respects: 1) specific eligibility criteria per index; 2) weighting. One thing I like very much about these funds is that their eligibility criteria are precise, even if I do not always find the criteria to be what I would like to see, but that’s my issue. The weighting systems speak directly to the focus of each fund – they do not simply go to the “default” cap-weighted system or to some other quick and easy but essentially meaningless measure. I will describe the general nature of the weighting systems as I describe each fund. 7 The average market cap in this fund is $49.5 billion, and Apple Inc. (NASDAQ: AAPL ) is the most-weighted holding in the fund. The holdings are weighted according to the company’s projected dividends for the coming year, with weighting determined by dividing a holding’s dividend by the aggregate dividends paid by all holdings – the company that pays the most cash gets the greater weight. DLN ‘s yield of 2.76% does exceed the average yield for the S&P 500 , but there should be no illusion that this is a fund that pays large dividends; all the same, just shy of $2.00 per share is very nice, and it is likely to be a steady (and steadily growing ) dividend. Expenses reported in the most recent Annual Report were a little higher than the expense ratio would indicate, and this may account for the somewhat low distribution ratio. During the most recent fiscal year the fund’s turnover rate was 12% of its average portfolio value; the larger a fund’s turnover rate, the more expenses the fund encounters. 8 DTN ‘s expense efficiency ratio (EER) of 77.40% tells a story here: the fund overran its expense ratio due to a very large turnover rate of 32% of the average value of its portfolio. 9 Nevertheless, DTN paid out a whopping yield of 3.49% ($2.45 per share). The eligibility criteria for DTN are the same as for DLN , except that DTN takes its holdings from the top-ten dividend-yielding companies in each sector except the financials. It strikes me as more effective to focus on yield rather than on cash dividends paid, as DLN does. Weighting is determined by dividing each holding’s yield by the sum of the yields of all holdings in the portfolio. This is a clever scheme, as the fund’s bias is towards those companies paying the highest yield – no doubt a substantial factor in supporting DTN ‘s excellent yield. DTN also has holdings in DLN and the WisdomTree MidCap Dividend Fund (NYSEARCA: DON ). 10 The EPS portfolio is comprised of large-cap companies chosen on the basis of their earnings ; to qualify, a company must have “generated positive cumulative earnings over their most recent four … quarters.” 11 The companies are among the 500 largest companies in the U.S., as determined by market cap. 12 Companies in the index are weighted according to their earnings in proportion to the aggregate earnings of all companies included in the portfolio. Earnings are computed using Standard & Poor’s -developed Core Earnings , which includes expenses, incomes and activities reflecting the profitability of a company’s ongoing operations. 13 EPS puts up rather nice figures: both its distribution ratio and expense efficiency rating are greater than 100%, indicating that it is minimizing its expenses and maximizing the distribution of net income. 14 Dividends, however, are a secondary concern here, as the fund is designed to hold companies that are most likely to maintain solid earnings and growth . These companies are (presumably) also likely to experience smaller losses during economic downturn. Besides the criteria mentioned at the beginning of this section, EZY holdings’ earnings per share, book value per share and sales per share must be positive . WisdomTree Investments creates a ” value score ” for each company based on EPS , BVS , sales-to-share and one-year change in stock price ; of the 1,000 largest-capped companies those with scores in the top 30% were selected for the index. 15 Weighting is based on earnings, which are computed on the basis of the companies’ adjusted net income. This is the smallest of the four large-cap WisdomTree funds and – after more than eight years on the market – it does not seem to be quite as virile as its brethren. Average daily volume is only $155K, just less than one-fifth the volume of next-in-line EPS. EZY’s holdings are not the sort to inspire a lot of confidence. A full 35% are in consumer goods, the bulk of that (22%) being consumer-discretionary industries. The following chart shows the breakdown of EZY’s portfolio: (click to enlarge) Comparative Performances The following chart shows the performances of the WisdomTree funds since their inceptions: (click to enlarge) Performance for the four funds since inception has been on the modest side, particularly if compared to the Guggenheim funds I examined in my last article. 16 In particular, the Guggenheim Russell Top 50 ETF (NYSEARCA: XLG ) had the lowest performance over this period of 55.77% – about 1100bps more than the highest-performing WisdomTree fund, DLN . The funds’ post-recession performance has been somewhat more impressive, but only marginally: (click to enlarge) While performance over the past five years has been better for these funds, the best two ( EPS and EZY ) only marginally outperform the worse of the five Guggenheims. 17 The Recession In the Guggenheim discussion I found it interesting to look at how those funds performed through the recession of 2007-2009. As I looked at the data for the WisdomTree funds, I began thinking more about the significance of a fund’s performance during the recession (and, as I discuss below, during the correction of 2015). I am formulating some thoughts about an ETF’s recession data and what it might say about the make-up of a fund; I will have more to say about this in the near future, as I collect more data. In the meantime, the following chart gives the specifics for the WisdomTree funds from 2007 through 2013: (click to enlarge) This chart traces the performance of the funds from their highest pre-recession point to their lowest recession point and then tracks how long it took each fund to reach or exceed the pre-recession high. It took two years or less for prices to collapse, but more than four years to recover. 18 Looking at the data above, it would seem that the funds based primarily on earnings and valuation seem to do a bit better than the funds focused on dividends . It will be interesting to see if this is a generalizable observation as the series continues. A curious note: EZY hit its recession low on November 20, 2008 – almost five months before the day the market as a whole bottomed. This drop seems to have been a “flash crash” of sorts, as EZY rose back up the next day, and then followed the rest of the market to the March 9 lows. It just happened that EZY ‘s November 20 low was lower than that of March 9. The WisdomTree funds compare fairly well with the S&P 500 during this period. The S&P dropped from a high of 1565.15 (October 9, 2007) to a low of 676.83 on March 9, 2009 – a drop of – 57.76% , just slightly less than the average drop for the WisdomTree funds. The 2015 “Correction” As with the 2007 – 2009 recession, the “correction” experienced in late summer, 2015, provides an opportunity to examine the nature of an ETF’s structure: (click to enlarge) There is less to go on here than was available with the recession, primarily because there has not been enough time to fully recover from the drop on August 25. However, some of the data does seem to correlate with data from the recession, with regard to the length of time from pre-correction high to correction low. During the recession, EPS suffered the least losses of the set, DLN was second, EZY third, and DTN lost the most value, at -65.11% . By August 25 (or, for EPS , September 29) EPS saw a decrease of nearly -13%, DLN was down -13.92% and DTN again dropped the most value – this time with -15.45%; the only change was with EZY , which dropped by only 10.38%. It is quite possible that, since EZY ‘s portfolio consisted of companies that presumably were experiencing suppressed valuations , that fund was less damaged by a market turn that would, in principle, have been motivated by (perceived) excess valuation. Compound Annual Growth Rate I am beginning to wonder if each group of large-cap funds will have in it a “sleeper” – a fund that seems unimpressive on the face of things, but which ends up doing quite well by itself. The following chart shows the total returns for each of the funds since inception and over the past five years: 19 (click to enlarge) Only one of the WisdomTree funds has performed consistently since inception – DLN . Since first being issued, DLN has returned 87.86% – perhaps not an “incredible” amount, but not bad. Over the past five years, its total return has been essentially the same – 88.36% . No matter whether one has held shares since inception, nine years ago, or only for the past five years, one has received 88% return on one’s investment. DTN has fared the worst, although “worst” is relative, here – DTN has offered the lowest return of the four funds over the past five years. Since inception, the fund has returned more than 102% , but over the past five years has returned 84.56% . EPS has returned only 70.13% since inception, but had an investor purchased shares five years ago, they would have seen a total return of 88.25% on their investment. With the recession behind it, this fund has started to come into its own. If any of the WisdomTree large-cap ETFs qualifies as a sleeper , however, it is EZY . Since inception, this fund has returned only 53.55% – I think that qualifies as fairly low. However, over the past five years, EZY has returned nearly 90% over its initial value in December, 2010. The following graph shows the CAGRs for the four funds over the two periods being considered: (click to enlarge) All things considered, these four funds have been fairly indistinct over the past five years. Assessment While EZY looks fairly intriguing when considered from the five-year perspective, when all is said and done, DTN pulls clearly ahead of the pack, with DLN and EPS not too far behind, in that order. EZY does not score well in many of my criteria, and ends up quite a distance in the back. If I were looking for dividend income , DTN would be high on my list (of the funds discussed here); if growth were the aim, I believe EPS would have to get the nod. All things considered, however, I would likely turn to the Guggenheim funds before I would choose one of the WisdomTree funds – at least, as it stands for now. Disclaimers This article is for informational use only. It is not intended as a recommendation or inducement to purchase or sell any financial instrument issued by or pertaining to any company or fund mentioned or described herein. All data contained herein is accurate to the best of my ability to ascertain, and is drawn from the Company’s Prospectus, Statement of Additional Information, and fact sheets. All tables, charts and graphs are produced by me using data acquired from pertinent documents; historical price data from Yahoo! Finance . Data from any other sources (if used) is cited as such. All opinions contained herein are mine unless otherwise indicated. The opinions of others that may be included are identified as such and do not necessarily reflect my own views. Before investing, readers are reminded that they are responsible for performing their own due diligence; they are also reminded that it is possible to lose part or all of their invested money. Please invest carefully. ——————————- 1 DLN homepage. 2 DTN homepage. 3 EPS homepage. 4 EZY homepage. 5 WisdomTree Trust Prospectu s , August 1, 2015. The $100 million figure is apparently generalized to take into account all of WisdomTree’s funds. In general, the large-cap funds seem to have holdings with capitalization of more than $1.6 billion each. 6 Prospectus , pp. 10 & 14. 7 The Prospectus for the funds goes into great detail in explaining how the weighting process is executed. 8 WisdomTree Trust Annual Report , March 31, 2015. Distribution ratio compares the actual distributions made to those that would be projected on the basis of net income as reported in the Annual Report. Some deviation may be expected, since my figures reflect yield ttm, which may extend beyond the period covered by the Annual Report. 9 See Prospectus (5, above), p. 10. 10 However, holdings in DLN and DON are small, at 0.03% each of DTN ‘s NAV. 11 Prospectus , p. 38 12 According to the WisdomTree Earnings Index . Prospectus , p. 38. 13 Prospectus , p. 39. 14 I calculate the “expense efficiency rating” by dividing actual expenses paid into the product of the fund’s NAV and its expense ratio. “Distribution ratio” is determined by dividing the actual dividends paid by net income per share. If a manager is keeping expenses down, and making large distributions, both figures represent results exceeding expectations. Any figure over 100% should be considered very favorable. 15 Prospectus , p. 50. 16 ” Changes Coming For Guggenheim Large-Cap ETFs .” Coincidentally, a chart for the Guggenheim funds is shown there covering essentially the same period as the one above – 2006 – present. 17 A five-year performance chart was not presented in the Guggenheim article, but has been made available here . 18 I can see why an investor might find it hard to hold onto stocks when going into a recession, since the recovery seems to be protracted (and, according to then-Treasury Secretary Tim Geithner, the recovery from this last recession was quicker than usual). Cutting one’s losses early, then re-investing once the bottom is neared, may seem to be an effective way to avoid extended losses. But the devil’s in the details: when is it “official” that the economy is entering a recession, and when has the economy bottomed out? I don’t think there are any hard and fast answers to either of those questions. 19 Share prices reflected in the graph have been adjusted to reflect dividend payments.

GDXJ – Limited Downside And Great Upside Potential In A Rising Gold And Silver Price Scenario

A potential long term investment with limited downside and great upside potential. Diversity of holdings mitigates the downside risk. Virtually every component of the index would be on many people’s list of junior precious metals stocks to buy to take advantage of a rising price scenario. There are few sectors which have such a huge potential for massive gains as resource sector juniors, but to achieve these one not only has to pick a company which on its own has enormous potential in what is one of the riskiest sectors for any investor to dabble in, but also any gains may be doubly enhanced should the resource sector in which the chosen company operates also move from being extremely depressed into a strong recovery phase. Pick the right resource, and virtually any surviving junior will serve you well but, as was seen following the 2008 resource market crash, if you pick well gains could be massive – 1,000 percent or more. Arguably, now could be a really good time to buy into resource stocks. They have seldom been more depressed, particularly the precious metals, and industrial metals copper and iron ore. However the writer does not see any kind of sharp recovery ahead for either copper or iron ore in 2016, although looking further ahead one would still have to consider survivors in the industrial metals sector as being potentially very strong investments, but the fallout between now and then could be perhaps a risk too far. That leaves us with precious metals – perhaps the riskiest sector of all. However the collapse in prices has seen precious metals stocks come down dramatically over the past three years, since gold reached its top of around $1920 an ounce in 2012. Gold for example has fallen by 44% since, and has dragged the other precious metals down with it. Is now the time to climb back in? If one reads the mainstream media one could be forgiven for assuming that the gold price fall had been far greater – but a much bigger drop has been suffered by most precious metals mining stocks – and by the junior sector in particular – ‘so here there be bargains galore’ one would think. And so there most definitely are, but the risks in buying junior precious metals stocks can be enormous. Any prolonged continuation of gold’s fall, and that of the other precious metals could yet see some serious casualties in terms of corporate shutdowns, and/or sales at hugely below potential valuations, even for juniors who, on the face of things, have some really good potential projects, but do not have the wherewithal to progress them. Now we see the fundamentals for gold in particular on a supply/demand basis as being extremely strong, but it may still take time for the investment sector to come to terms with this. Demand for physical metal has been growing – particularly in Asia and the Middle East – and central banks have been net buyers further increasing demand for physical metal. Meanwhile gold inventories in the West have been declining drastically. Sales out of the Precious Metals ETFs, which kept the market well supplied particularly in 2013 when the price began to dive, are dwindling with the weaker holders already having exited. Low gold prices are beginning to see new mined production starting to fall back, while the same low prices keep the incentive for scrap sales low – so these have been dropping too. So here the prospects for junior gold and other precious metals miners look potentially strong. If there is a supply crunch coming ahead – see 2016 a crunch year for physical gold supply as we suggest – then precious metals, and precious metals juniors in particular should be a major beneficiary and we could see some dramatic stock price gains even on comparatively small upwards movements in the metals prices. The high risk investor is poised to climb back in given many feel the gold juniors are bumping along the bottom. So how does one mitigate the very serious risk element here. It’s all very well jumping into a junior stock, however good it seems on paper, but then some external black swan factor comes into play which completely wipes you out. This could be political, geological, financial, weather related, fire, flood, earthquake etc. – any number of things could bring an under- or tightly-funded project (the nature of most juniors) to a grinding halt. There is a way, though, of investing in this sector in a much safer manner, but still with phenomenal growth potential. As we noted above, if the metals prices rise the whole sector will accelerate – except perhaps a few players who get left in the wake. Consider here investing in an ETF which follows a major junior precious metals index. The diversity in the stocks followed helps mitigate the downside risk, but virtually all the individual holdings in the ETF have great upside potential in a rising precious metals market environment. OK, it also will mean that the whole is perhaps not as profitable as some key elements within it, but the overall potential remains massive. Such an investment is the Market Vectors Junior Gold Miners ETF (NYSEARCA: GDXJ ) (listed on the NYSE Arca Exchange) which seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the Market Vectors Global Junior Gold Miners Index. It has been bouncing along what many see as the sector bottom of late. It peaked back in November 2010 at around 171.84 and those who invested in it at the time, and stayed with it, would have lost just short of 90 percent of their investment given it is now, at the time of writing at least, at 18.95. Many feel the chances of it falling lower are decidedly limited, while the potential for recovery, if precious metals prices pick up, is very large. If it gets halfway back to its former high that would mean a gain of around 350 percent from its current level. While this might be a tall order in 2016 it is certainly not outside the bounds of possibility should precious metals start to move. Interestingly trading volume has been high over the past year when the price has fluctuated from around 18.30 to 30.10 so it tends to be easily tradeable and there are obviously others out there aware of its potential. The Index on which the ETF is based is also not based on fly-by-night juniors with little or nothing to offer except hope and a prayer, but also includes some significant miners which are probably highly offended that they might even be classified as juniors, like Hecla Mining (NYSE: HL ), Pan American Silver (NASDAQ: PAAS ), Centerra Gold ( OTCPK:CAGDF ), Evolution Mining ( OTCPK:CAHPF ), Oceanagold ( OTCPK:OCANF ), Osisko Gold Royalties ( OTC:OKSKF ) etc. to name but a few. The top 10 companies held, which include all the above, account for 42.75 percent of the total holding. Note also these include some significant silver miners, and history tells us that if gold begins to move, silver moves too – but faster! Indeed running down the full list of holdings all of them would be on many people’s list of potentially strong performing juniors. They include Pretium Resources (NYSE: PVG ) (developing one of the world’s highest grade – underground gold mines), Detour Gold and Lake Shore Gold ( OTCPK:DRGDF ) – both Canadian junior gold high flyers, Silver Standard (NASDAQ: SSRI ), Coeur Mining (NYSE: CDE ), First Majestic (NYSE: AG ) (all three prominent in the silver space). So – do take a look at GDXJ as a long term punt on a turnaround in precious metals prices. It is a junior investment which nowadays offers what we see as very limited downside, but has great upside potential in a more favorable pricing environment.

No, Jesse Had It Right: Owning Stocks Today Has An Unattractive Risk/Reward Profile

My rebuttal to Terrier’s rebuttal. Terrier seems to believe that timing the market is not possible, but beating the market through stock picking is very much possible. Many bulls look at one market over one long stretch of time and believe they’re all clear for 10+ year periods… nope. Terrier Investing posted a rebuttal this morning to Jesse Felder’s original piece : “Owning Stocks Today is Risking Dollars to Make Pennies.” Terrier makes three points in his rebuttal. To quote: Well, according to Jesse, it means stocks are so wildly overvalued that your potential return over the next ten years is miniscule, and your potential downside is massive. I posit this is: A) alarmist and statistically inaccurate; B) overly narrow in its definition of risk; and C) treats “stocks” as some monolithic entity” Each of Terrier’s points are problematic; I’ll handle them one by one. Before I do, however, let me say that Terrier makes many sensible claims in his rebuttal. I dispute his line of reasoning here, mainly because he uses three arguments that I think undergird many bulls’ logic, whether they realize it or not. Someone like Terrier who explicitly makes assumptions is in my view on much firmer soil than the many bulls who are implicitly making the identical assumptions. If Terrier sees reason to modify his explicit a priori, he can. Bulls that are actually sheep have no such explicit framework against which they can base a reasonable shift to their investment thesis. With those disclaimers out of the way, I will now address the problems that I see with Terrier’s arguments. A) Alarmist and statistically inaccurate (sorry to quote so much of Terrier’s piece, but I want to address what he DID say, not what he didn’t): What is the actual likelihood of stocks resulting in a significantly negative 10-year return? Here’s a link to a nice document providing this data from 1926 through 2013 in both tabular and graphical format. Summarily, there were only a very few rolling 10-year periods when investing in the S&P 500 would have resulted in losses in nominal terms. Specifically, you would have had to invest right before the Great Depression or in the late 1990s – two of the larger bubbles of all time. Looking at one market over one stretch of time, even a long stretch, does not give you a statistically robust sense of what that market can do over any 7-15 year timeframe. I’ll grant you that it’s better than a sharp stick in the eye, but the data can easily mislead. I wonder what the German stock market would have looked like over the first half of the twentieth century. After enduring two world wars, a bout of hyperinflation, and political dismemberment, I don’t believe that German stocks performed too well over that meaningfully long timeframe. The German stock market was at the time (and still is) a well-developed market. I wonder what fraction of those 10-year periods had sizeable losses. Whoever said that can’t be us? From an Investopedia article on history of stocks and bonds: At the same time, many other economies suffered great losses. For example, according to Phillipe Jorion and William N. Goetzmann in their article “Global Stock Markets In The Twentieth Century” (1999), the Japanese stock market saw a 95% decline in real returns between 1944 and 1949. The German market also suffered devastating losses. In this context, the U.S. market’s success seems to be an exception, which the previous lack of data for other countries may have obscured. (emphasis added) Japan 1986 to present?…let’s not look there I’m guessing. (click to enlarge) How about the US stock market from 1891-1974? There were many poor return stretches over that time frame, especially when viewed on a real return basis. That’s a long stretch in our own market; how do the total return statistics bear out? While I’ll grant that the percentage of positive ten-year returns would likely still be high, the final results would be substantially more lackluster, particularly for investors who did not reinvest all of the dividends over the entire horizon with no tax implications. In fact, depending on your starting and ending points, you can find periods of negative real returns over a fifty-year time frame if you don’t include complete dividend reinvestment over the entire 50+ horizon. To see that this is the case, check out Political Calculation’s S&P calculator . Enter some periods that end in 1974 or 1983 for instance. I’m not trying to cherry pick here; I am demonstrating that there certainly are periods for even the longest of practical time horizons where equity returns are quite unattractive. There are two other, larger reasons why past may not be prologue for S&P returns. And I’ll address these points alongside Terrier’s point B: B: Risk as volatility, not as permanent loss of capital Moreover, there is more than one definition of “risking dollars” – assuming you have a ten-year or greater time horizon and need to invest to fund long-term liabilities (kids’ college funds, retirement, etc.), then earning near-zero returns by investing exclusively in bonds is just as much of a risk as potential volatility from investing in stocks. Risk, in this context, means you won’t meet your financial goals – and if you don’t invest in any stocks, it’s very hard to see how you will generate sufficient returns with yields on fixed income where they are. Some clarification here first. Terrier goes on to say that he believes that the market as a whole is on the expensive side (which leads to his point C), so he’s not some brainless stock market cheerleader. To that same end, Felder never explicitly says that nobody should have any equity exposure. (As for me, I have plenty of equity exposure: I’m short SPX.) Terrier’s second point essentially makes an assumption: risk as volatility vs. risk as probability of permanent capital loss. If risk is merely volatility – stocks whipping around for short and maybe even violent bursts, only to recover over a reasonably quick timeframe and make new highs – then I believe that he is correct. In his defense, he doesn’t suggest going “all-in” on equities, and even recommends having a decent cash pile. The issue is that Terrier’s problematic analysis from his first point (stocks rarely have negative nominal 10-year returns) leads him to the next conclusion that equity risk is actually only volatility, not capital impairment. This is where Terrier and I truly part company. Many long-only investors believe that strong long-run SPX returns happen mostly as a simple function of time; they’re somehow owed these returns for weathering volatility. I find it amusing that these same long-only bulls don’t feel like Brazilian investors are owed strong long-run returns, or that Greek or Russian or Japanese or South African equity investors are owed long-run returns. This amounts to a personally dangerous form of financial jingoism. Let me make it clear: IF sustained poor equity returns can happen to Brazil (the world’s seventh largest economy), then they can happen for the US. See, investors today aren’t looking at the Greek market and shrugging it off as a temporary bout of volatility. Ditto the other markets mentioned above. Investors correctly see these declines for what they are: semi-permanent capital loss. That is to say that even a strong bounce and even full dividend reinvestment will not bring a buy-and-hold index investor who purchased in, say 2010, back to even for years to come. Bears like Felder and myself believe that S&P balance sheets, investor margin positioning, GDP growth trends, and equity valuations in light of a slowing global economy put the S&P 500 at risk of a vigorous fall that will NOT be recovered anytime soon. (click to enlarge) (click to enlarge) Source: FactSet Why should we expect S&P returns that approximate history when a) GDP growth (global or US) is nothing like what it has been in the past, b) corporate balance sheets are not very healthy and c) valuations for the broad market are MORE expensive for almost every decile than at the March 2000 peak? To conclude, Terrier states: Risk, in this context, means you won’t meet your financial goals – and if you don’t invest in any stocks, it’s very hard to see how you will generate sufficient returns with yields on fixed income where they are. Well, what if the S&P falls – a LOT – and does not recover? Meeting one’s financial goals goes from being difficult to completely impossible. I believe such an outcome needs to be given a very meaningful weight. Terrier’s last point is that we don’t have a stock market, but a market of stocks: Finally, point C: I think it’s unfair to treat “stocks” as a monolithic entity – as if you either own the S&P 500 (NYSEARCA: SPY ) or you do not, and there’s no other alternative. Even if you believe the market as a whole is overvalued, like I do, that doesn’t mean every single component of the market is overvalued. Terrier goes on to say that one can do research and find a basket of stocks that will beat the market. Which is basically saying that Terrier doesn’t believe that investors can beat the market via market timing (“Not owning the market is risking dollars to make pennies”), but that they can beat the market through security selection. I completely disagree. Look at all the “smart beta” ETFs and actively managed mutual funds that are essentially continuously fully invested. How many of those pros beat the market? Not too many. I’m not saying that it cannot be done, but I see no reason – whatsoever – why market outperformance through the security selection channel is so much easier to consistently achieve than market outperformance via the market timing channel. But my objection to Terrier’s point C goes well beyond this first point: In 2013, the most heavily-shorted stocks were some of the best performers . It tends to be sophisticated investors that short companies. Full disclosure: I have never in my life shorted an individual name, and so I claim absolutely no expertise on this process. These securities specialists had their you-know-what’s handed to them, because it was a bad idea to be short any stock in the S&P during 2013. Similarly, it was a bad idea to be long any stock in the S&P between March 2008-March 2009. When “the market” gets crazy (up or down), security selection absolutely will not save you… period. At that point, the macro takes over, and the micro gets buried. That doesn’t mean that security selection cannot help you (assuming that you can in fact do it AND stick to your discipline): better to lose 33% than 40% or 60% instead of 75%… but you still won’t be happy with your strongly negative returns. In conclusion, Terrier states in his point A (in context of negative 10-year returns): Specifically, you would have had to invest right before the Great Depression or in the late 1990s – two of the larger bubbles of all time. My stance, and I believe Felder’s as well (though I’ll let him speak for himself), is precisely that today’s market IS one of those great bubbles. James Paulsen of Wells Capital Management produced the chart below to compare P/Es of the S&P for each 5-percentile increment for year-end 2014 vs. June 2000. The overvaluation of the broad markets is far more severe than it was in 2000, and so when the bottom falls out, there may not be too many great places to hide from the merciless reaping that ensues. Permanent capital impairment from any and all long US equity exposure needs to be treated not as a fringe case, but as THE base case. In that world, long investors really indeed are risking dollars that they won’t recover for years in order to pick up those juicy 3-5% yields or hope for the continuation of a stretched and tired bull.