"New global research on Graham / Shiller..."

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solonseneca
Posts: 100
Joined: Sun Feb 19, 2012 10:01 pm

"New global research on Graham / Shiller..."

Post by solonseneca »

Has anybody reviewed this? Opinions?

http://greenbackd.com/2012/07/30/new-gl ... ape-ratio/

"The second paper, Does the Shiller-PE Work in Emerging Markets? by Joachim Klement examines the reliability of CAPE as a forecasting and valuation tool for 35 countries including emerging markets. Klement finds that CAPE is a reliable long-term valuation indicator for developed and emerging markets. Klement uses the indicator to predict real returns on local equity markets over the next five to ten years (shown in Exhibits 11 and 12 extracted below):"
....

"Klement makes some interesting observations about developed markets:

Looking at the forecasts for different markets the following observations stand out:

• For all developed equity markets the expected real return in local currencies is positive and the probability of negative real returns after ten years is generally low.

• The market with the lowest expected future return is the United States which together with Canada and Denmark promises real returns that are quite a bit lower than developed markets overall.

• Because of the low expected returns for US stock markets, an equal weighted portfolio of developed market equities is expected to perform significantly better than a typical value weighted portfolio. The current debate about optimal sector and country weights in a stock market index is still ongoing and there are many different rivaling approaches like equal weighting, fundamental weighting, GDP-weighting or equal risk contribution or minimum variance. The jury is still out which one of these approaches is the best for long-term investors, but our calculations indicate that an equal weighted portfolio should outperform a value weighted one.

• Looking at individual markets again, we see that the most attractive markets are generally the crisis-ridden European equity markets and in particular Greece which currently has such low valuations that real returns over the next five years could come close to 100%. But more stable markets like Finland, France or Germany also offer attractive long-term return possibilities."

Question: Is this stuff valid?
BYUvol
Posts: 120
Joined: Sat Mar 24, 2012 3:06 pm
Location: KY

Re: "New global research on Graham / Shiller..."

Post by BYUvol »

solonseneca wrote: Question: Is this stuff valid?
Sure, it has some Face Validity.

The major problem I have, is even if CAPE does have some reliability with LONG TERM, using that to predict "real returns on local equity markets over the next five to ten years" seems silly. Over a period of 5 to 10 years, the market can easily defy expectations through changes in multiples. Like Buffet says, short term the market is a beauty contest, long term it is a weighing scale.

I enjoy reading other peoples opinions, but I don't think there is anything actionable here.
Rodc
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Joined: Tue Jun 26, 2007 9:46 am

Re: "New global research on Graham / Shiller..."

Post by Rodc »

and in particular Greece which currently has such low valuations that real returns over the next five years could come close to 100%
That totally ignores risk. Of course expected returns are high because real returns might well be horrendously low.

To be useful any prediction of returns has to have a prediction of risk.

Of course errors in predictions then compound because what matters is expected return/expected risk and you really know neither numerator or denominator.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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grap0013
Posts: 1885
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Re: "New global research on Graham / Shiller..."

Post by grap0013 »

From a nuts and bolts perspective, I agree that's about how stuff looks. My eyeball test says their data look like about 4% real annualized for US and 5-6% for developed/emerging markets. You'd have to change your allocations pretty significantly to make any meaningful difference on portfolio returns. That might get you into market timing territory and most know how that story ends. Plus you have to deal with higher expense ratios and potentially higher frictional costs internationally.

I ran some data with some estimates on my own portfolio of:

Current
50% US
25% developed ex US
25% emerging markets

vs.

40% US
30% developed ex US
30% emerging markets

For example, if you assume an additional 2% premium annualized for all international, the 10% "shift" only improves overall portfolio returns by about 15 basis points. I don't think chasing those basis points is worth altering allocations for. Nothing is certain. US could outperform for several more years and a shift could lose you money.

However, for someone who is 80:20 or 70:30 US:international and you have been considering increasing your international allocation to 50:50 or cap weighted global 40:60, now would be the time to do it if there ever was one. You might be able to add 50-100 basis points to your long term annualized returns. Maybe not. As usual, staying the course is very very likely to be the most prudent action.
There are no guarantees, only probabilities.
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