Shiller PE10 nearing nosebleed territory?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Browser
Posts: 4857
Joined: Wed Sep 05, 2012 4:54 pm

Shiller PE10 nearing nosebleed territory?

Post by Browser » Fri Mar 08, 2013 11:28 am

Shiller PE10 now at 23.8. Every time it's gotten this high in the past, things didn't turn out well for stocks going forward -- except for the nutty nineties when it just kept on trucking up to the 40s somewhere. Doubt we'll see that again. I hate to be a party pooper, but it might be time to double-check your risko-meter to see if it's set to your correct risk tolerance level.
We don't know where we are, or where we're going -- but we're making good time.

wesleymouch
Posts: 237
Joined: Wed Dec 05, 2012 2:24 pm

Re: Shiller PE10 nearing nosebleed territory?

Post by wesleymouch » Fri Mar 08, 2013 11:36 am

Much better valuations exist in International markets. I think they will outperform the US

User avatar
nisiprius
Advisory Board
Posts: 35874
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Shiller PE10 nearing nosebleed territory?

Post by nisiprius » Fri Mar 08, 2013 11:44 am

I'm not sure what you mean by "nosebleed territory," but it doesn't look alarming to me:

Image

I think of statistics like that as being like the distance of a car from the median strip. Just because it isn't in the center of the lane doesn't mean a collision is imminent. There's a very broad range of fluctuation that is normal, and within that range, just being farther to the left than normal isn't even an indication of danger. And then, of course, there's the car that's "weaving" and does represent a danger--but how often do you see a car weaving, with no crash?

That doesn't mean I would rule out a crash. I'm just saying yeah, in 2000 I think it actually was possible to say "sooner or later a crash is coming and it may be terrific" (quoting Roger Babson's famous words of September, 1929). I don't think you can say anything for sure today. As for risk, stocks are always risky. They were risky in 1990, they were risky in 2000, they were risky in 2008, and they are risky now. Stocks can always crash. The obvious protection is not to have such a high stock allocation that a crash is going to be more than you can tolerate. It's easy, it's obvious, and it works. Thinking you can see it coming and dodge it is tempting, but all the evidence is that nobody can do it. You're just as likely to dodge into a bullet.

An example of dodging into a bullet would be the advice proffered in February, 2011--just two years ago!--by one of the authors of Dow 36,000 who said it was time to consider but "buying hedges such as 'bear funds,' whose prices go up if the market goes down." Here's how that would have worked out (blue line).
Image
Last edited by nisiprius on Fri Mar 08, 2013 11:54 am, edited 1 time in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

User avatar
midareff
Posts: 5563
Joined: Mon Nov 29, 2010 10:43 am
Location: Biscayne Bay, South Florida

Re: Shiller PE10 nearing nosebleed territory?

Post by midareff » Fri Mar 08, 2013 11:47 am

Yeah, the market is going to get clobbered. Europe's economy is in trouble so overseas markets will stink. Bonds will get clobbered and money markets pay nothing. Yawn, wake me when it's over.

larryswedroe
Posts: 15625
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Re: Shiller PE10 nearing nosebleed territory?

Post by larryswedroe » Fri Mar 08, 2013 12:01 pm

First, valuations matter and they matter a lot. But to show you how wide the potential dispersion of returns is: when the Shiller PE 10 is 21-25 the AVERAGE real return for next 10 years was 0.9%. The range was -4.4 to +8.3.
Lesson, your plan should incorporate both those possibilities. If you cannot stomach the -4.4 move to another playground

Larry

User avatar
grayfox
Posts: 4860
Joined: Sat Sep 15, 2007 4:30 am

Re: Shiller PE10 nearing nosebleed territory?

Post by grayfox » Fri Mar 08, 2013 12:04 pm

Well the last time someone called Irrational Exuberance, it went up for 3 years before crashing. Right now, the market has positive momentum going for it. See 200-day SMA.

And VIX is a low 12.54. I don't see the storm clouds on the horizon just yet.

CAPE is not even up to 2007 levels yet.

Image

BTW, earnings yield 1/23.32 = 4.288% is not bad for a real return, considering many bonds have negative expected real return.

allsop
Posts: 1046
Joined: Sun Jun 15, 2008 7:08 am

Re: Shiller PE10 nearing nosebleed territory?

Post by allsop » Fri Mar 08, 2013 12:08 pm

larryswedroe wrote:First, valuations matter and they matter a lot. But to show you how wide the potential dispersion of returns is: when the Shiller PE 10 is 21-25 the AVERAGE real return for next 10 years was 0.9%. The range was -4.4 to +8.3.
Lesson, your plan should incorporate both those possibilities. If you cannot stomach the -4.4 move to another playground

Larry
+1

KyleAAA
Posts: 6515
Joined: Wed Jul 01, 2009 5:35 pm
Contact:

Re: Shiller PE10 nearing nosebleed territory?

Post by KyleAAA » Fri Mar 08, 2013 12:14 pm

I'm not expecting 10%+ returns over the next decade or so but I doubt we'll see -5% returns, either. I think Larry's numbers sound about right. Could the huge recession and corresponding sharp drop in real earnings have skewed PE10? I mean, real earnings REALLY dropped for a while there. That could be skewing the entire number. PE10 isn't magic. Just a thought.

Browser
Posts: 4857
Joined: Wed Sep 05, 2012 4:54 pm

Re: Shiller PE10 nearing nosebleed territory?

Post by Browser » Fri Mar 08, 2013 12:38 pm

larryswedroe wrote:First, valuations matter and they matter a lot. But to show you how wide the potential dispersion of returns is: when the Shiller PE 10 is 21-25 the AVERAGE real return for next 10 years was 0.9%. The range was -4.4 to +8.3.
Lesson, your plan should incorporate both those possibilities. If you cannot stomach the -4.4 move to another playground

Larry
That's the way I'd look at it. Are those figures average annual real returns; e.g., the lower bound would be an average annual real return of -4.4% over the next 10 years?
We don't know where we are, or where we're going -- but we're making good time.

User avatar
ThePrune
Posts: 897
Joined: Wed Nov 10, 2010 9:38 am
Location: Midland, MI

Re: Shiller PE10 nearing nosebleed territory?

Post by ThePrune » Fri Mar 08, 2013 12:52 pm

Browser wrote:Shiller PE10 now at 23.8. Every time it's gotten this high in the past, things didn't turn out well for stocks going forward -- except for the nutty nineties when it just kept on trucking up to the 40s somewhere. Doubt we'll see that again. I hate to be a party pooper, but it might be time to double-check your risko-meter to see if it's set to your correct risk tolerance level.
I'm happy with my target asset allocation regardless of which way the market moves! Of course as a retiree my target asset allocaton to equities & real estate (45%) is probably a lot lower than that of others on this Forum.

That said, I am rebalancing (selling equities) back to my target regularly. I'm putting the money from equity sales into my short-term living expenses account for this and next year.
Investment skill is often just luck in sheep's clothing.

User avatar
Random Musings
Posts: 5209
Joined: Thu Feb 22, 2007 4:24 pm
Location: Pennsylvania

Re: Shiller PE10 nearing nosebleed territory?

Post by Random Musings » Fri Mar 08, 2013 1:03 pm

0.9% real avg next 10 years says to me that int'l equities are looking a little better, although their are no guarantees. Never are, anyway.

RM
I figure the odds be fifty-fifty I just might have something to say. FZ

larryswedroe
Posts: 15625
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Re: Shiller PE10 nearing nosebleed territory?

Post by larryswedroe » Fri Mar 08, 2013 2:38 pm

Browser REAL returns, so say add 2.5% for estimated inflation
Note any positive equity premium though would be better than bonds!!!
Larry

bargainhuntingking
Posts: 177
Joined: Wed May 14, 2008 3:48 am

Re: Shiller PE10 nearing nosebleed territory?

Post by bargainhuntingking » Fri Mar 08, 2013 3:51 pm

I rebalanced today based on my IPS. Being a new (late bloomer) investor just before the 2008 crash, I learned directly how markets can plummet in just a few days. This valuable experience enabled me to obtain an asset allocation that was not just theoretically comfortable, but empirically comfortable based further market drops in 2009. I am greatful for the informative discussions that take place on this forum and share pride with the other members who have achieved or are confidently progressing toward reaching their "number."

Having confidence in one's asset allocation allows one to enjoy the gains during positive market trends and relish in the buying opportunities during downturns, a win-win situation.
Last edited by bargainhuntingking on Fri Mar 08, 2013 5:39 pm, edited 1 time in total.

Grt2bOutdoors
Posts: 18433
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: Shiller PE10 nearing nosebleed territory?

Post by Grt2bOutdoors » Fri Mar 08, 2013 4:51 pm

I hit a band and re-balanced out of equities as well. Rebalancing does not prevent one from missing out on additional gains, it may prevent you from losing your shirt though.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

wesleymouch
Posts: 237
Joined: Wed Dec 05, 2012 2:24 pm

Re: Shiller PE10 nearing nosebleed territory?

Post by wesleymouch » Fri Mar 08, 2013 5:46 pm

About 1% real over the next 10 yrs for the S and P. Cash should yield 0-1% for the next 10 yrs. Hmmm

User avatar
Rick Ferri
Posts: 8360
Joined: Mon Feb 26, 2007 11:40 am
Location: Austin, TX. Twitter: @Rick_Ferri
Contact:

Re: Shiller PE10 nearing nosebleed territory?

Post by Rick Ferri » Fri Mar 08, 2013 6:16 pm

Browser wrote:Shiller PE10 now at 23.8. Every time it's gotten this high in the past, things didn't turn out well for stocks going forward -- except for the nutty nineties when it just kept on trucking up to the 40s somewhere. Doubt we'll see that again. I hate to be a party pooper, but it might be time to double-check your risko-meter to see if it's set to your correct risk tolerance level.
Shiller PE10 is a poor indication of market valuation when earnings are increasing. Do you really want to look back at earnings from ten years ago and use that to make a prediction about prices in 2013? Not me. It's like saying the average interest rate on 10-year T-notes is 4% so bonds are cheap today.

Use PeakPE for a useful valuation fix, not Shiller PE10.

Rick Ferri
The Education of an Index Investor: starts in darkness, finds enlightenment, overcomplicates everything, embraces simplicity.

User avatar
bogleblitz
Posts: 435
Joined: Mon Oct 01, 2012 2:51 pm

Re: Shiller PE10 nearing nosebleed territory?

Post by bogleblitz » Fri Mar 08, 2013 8:16 pm

Rick Ferri wrote:
Browser wrote: Use PeakPE for a useful valuation fix, not Shiller PE10.

Rick Ferri
Is there a website that shows the PeakPE or trailing 12 month PE? What is it currently? I don't know how to calculate these myself, and I usually visit the PE10 website to see the number for PE10.

User avatar
Rick Ferri
Posts: 8360
Joined: Mon Feb 26, 2007 11:40 am
Location: Austin, TX. Twitter: @Rick_Ferri
Contact:

Re: Shiller PE10 nearing nosebleed territory?

Post by Rick Ferri » Fri Mar 08, 2013 8:36 pm

Peak PE is very close to actual PE. It's at 17.5 now. Not low, but not high either given low interest rates and inflation.

Rick Ferri
The Education of an Index Investor: starts in darkness, finds enlightenment, overcomplicates everything, embraces simplicity.

User avatar
Watty
Posts: 13439
Joined: Wed Oct 10, 2007 3:55 pm

Re: Shiller PE10 nearing nosebleed territory?

Post by Watty » Fri Mar 08, 2013 11:22 pm

larryswedroe wrote:First, valuations matter and they matter a lot. But to show you how wide the potential dispersion of returns is: when the Shiller PE 10 is 21-25 the AVERAGE real return for next 10 years was 0.9%. The range was -4.4 to +8.3.
Lesson, your plan should incorporate both those possibilities. If you cannot stomach the -4.4 move to another playground

Larry

The problem is that the other playground pretty much means bonds and I would not bet a lot on them being any safer.

User avatar
nisiprius
Advisory Board
Posts: 35874
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Shiller PE10 nearing nosebleed territory?

Post by nisiprius » Sat Mar 09, 2013 8:16 am

Watty wrote:The problem is that the other playground pretty much means bonds and I would not bet a lot on them being any safer.
Please define what you mean by "safer" and then we can discuss it.

If we define "safer" as "chance that a holding of X, dividends reinvested, will show a larger number five years from today than it does today," I think it is higher for bonds. For example, my 2010 SBBI yearbook--the handy chart I'm looking at only show long term government bonds--show positive returns 74 times in 80 five-year periods, losses 7.5% of the time. For stocks, the numbers are 69 times in 80, i.e. losses 23% of the time.

If we define "safer" as "chance of being the best-performing," then the same yearbook shows that, of seven different mixes ranging from 100% (long-term government) bonds to 100% (large-company U.S.) stocks, 100% stocks was the highest-performing portfolio 54 times in 80 = 67% of the time, bonds 19/80 only 23.7% of the time (and no mix was highest-performing more than 3.75% of the time. So much for diversification :!: :D )

In the end, it is really important to decide for yourself, independently, how you personally define risk or safety, and only then go exploring to see how investments measure by your criteria. Do not let anyone else use the work "risk" without defining it, and do not let anyone else tell you that you are using a "wrong" definition of risk. You can prove that anything is safe or risky by playing with the definitions of the words--and people who are trying to sell you risky investment usually do.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

larryswedroe
Posts: 15625
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Re: Shiller PE10 nearing nosebleed territory?

Post by larryswedroe » Sat Mar 09, 2013 9:08 am

Watty
This is issue of risk tolerance and you get a 2008 and stocks will drop 50-60%, think short term high quality bonds will drop by anything close to that in any interest rate environment you can foresee?
If you cannot take the risks then you should lower your equity allocation and then alter your plan in other ways if that creates an issue of too low an expected return to meet your goals. So save more, plan on spending less, work longer, etc. But don't take the risks because if they show up you might blow up
Larry

YDNAL
Posts: 13774
Joined: Tue Apr 10, 2007 4:04 pm
Location: Biscayne Bay

Re: Shiller PE10 nearing nosebleed territory?

Post by YDNAL » Sat Mar 09, 2013 9:36 am

larryswedroe wrote:...So save more, plan on spending less, work longer, etc. But don't take the risks because if they show up you might blow up
Larry
This quote above goes to the heart of the issue(s) because the response is not generic, IMO.
1. A decumulator (retired) usually can not save more or work longer, so the questions are mostly... how much (%) am I consuming, how much risk do I need to consume YY years in retirement and meet all goals?
2. An accumulator... what is my goal, how much am I saving, how long do I work, how much risk do I need for XX years then YY years in retirement?

Two completely different scenarios. So, Browser (OP), when P/Es are high(er) and risk increases, the answers you get in various posts depends on #1 and #2.
Browser wrote:Shiller PE10 now at 23.8. Every time it's gotten this high in the past, things didn't turn out well for stocks going forward -- except for the nutty nineties when it just kept on trucking up to the 40s somewhere. Doubt we'll see that again. I hate to be a party pooper, but it might be time to double-check your risko-meter to see if it's set to your correct risk tolerance level.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

User avatar
jeffyscott
Posts: 6866
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: Shiller PE10 nearing nosebleed territory?

Post by jeffyscott » Sat Mar 09, 2013 10:29 am

larryswedroe wrote:Browser REAL returns, so say add 2.5% for estimated inflation
Note any positive equity premium though would be better than bonds!!!
Larry
30 year TIPS are at +0.67% real.

Vanguard long term investment grade has SEC yield of 4.32%, so expected return is perhaps 1-2% real.

If held exactly 20 years, EE bonds will yield about 3.5% nominal, so expected real return is, perhaps, as much as 1%.
press on, regardless - John C. Bogle

mindbogle
Posts: 130
Joined: Sun Feb 10, 2013 11:28 am

Re: Shiller PE10 nearing nosebleed territory?

Post by mindbogle » Sat Mar 09, 2013 11:23 am

A warning... Different versions of PE-related valuation measures are not directly comparable without first normalizing each to their average over some large enough (and equal) time window. For example, because the long-term trend of earnings growth is positive and PE10 uses a 10-year trailing averaging window, the resulting average earnings will be biased lower relative to present-day earnings, which in turn will bias PE10 numbers to be higher than PE1. Similarly, Price to Peak earnings has a bias lower, due to peak earnings in the denominator. These statistical biases don’t invalidate the valuation measure, but require them to be normalized. So a particular PE10 number is not directly comparable to a PE1, PE20, or P-to-Peak measures. Rather, we should compare PE10/PE10historical to PE/PEhistorical, P2P/P2Phistorical using the same long time window for the historical average.

As Larry Swedroe says, valuations have been shown to matter in a statistical sense. Vanguard recently put out a very balanced piece on valuation measures and stock market return here.

As Rick Ferri explains in his article, the basic motivation behind adjusting the denominator in a price to earnings valuation measure is to remove the oscillating effects of business cycle from the calculation. Much of the shorter-term fluctuation in earnings can be attributed to margin fluctuation (E=margins*sales). As has been quoted by Jeremy Grantham, margins are one of the most mean reverting time series in finance. The way he explains the underlying cause and effect: profit margins fluctuate with the waning and waxing of the business cycle. High margins invite competition, and competition has the general effect of lowering margins. Hence the cyclic mean-reversion in margins and thus earnings. Of course, sales are affected by the business cycle as well, but the effect is not nearly as large as the effect on margins.

One of the often cited critiques of PE-type valuation metrics is that they implicitly assume a time-stationary trend margin, and a time-stationary price that investors are willing to pay for long-term future earnings. But could trend margins (efficiency) be increasing over time due to technological innovation? Are the record high margins of today a reflection of this? What is the impact of globalization on these assumptions? So there is plenty to holes to poke - user-exercised caution is recommended.

John Hussman was the first author that I have read that promoted the peak earnings method (he used reported rather than operated earnings). For some reason, which I won’t speculate on here (but I do have a speculation!), John has stopped promoting his price-to-peak earnings method of valuing the stock market. I should also note that he has been very vocal about the dangers of using operating earnings as a valuation measure (as Rick used in his article) because they can be manipulated by companies for unscrupulous purposes. Years ago I compared John's price-to-peak reported earnings with PE10 and other variants and found that his method faired a little worse than PE10 in terms of foretelling future stock returns, although the differences were arguably not statistically significant.

I have studied many of the different methods of valuing the stock market based on price and earnings, and my take-away is that these are useful as very soft indicators. If one or more get way out of wack, then that should set off a cautionary alarm for investors. But you get different numbers depending on the method and parameters used (e.g. what is so special about 10 years for smoothing, should we use real prices and earnings, or nominal prices and earnings, etc.?). And a danger is that if a person has an a prior motivation (think stock broker or money manager), he/she can select a method that best supports their predisposed viewpoint.

PS: my favorite valuation ratio is S&P500 price/sales. I formed this view while digging deeply into Jeremy Grantham's work on valuation. The idea is this - assume margins are responsible for all of the business cycle fluctuations in earnings. Then replace the oscillating actual margin with an assumed historical trend margin - say 6%. This in effect smooths out the business cycle fluctuations in earnings. Also assume some long-term trend PE multiple that reflects the price that investors are willing to pay for future earnings. Say 16. Then PE=P/.06*sales = 16. Or after rearranging, P (fair market value) = .96*sales. So for instance, these assumptions would result in a current S&P fair market value of about 1000! After normalization, I get very similar numbers using this method as I do PE10. I like it because it is simple and transparent - the input parameters, which can be deduced from historical data are user decisions (that's right - you are responsible!). The user can test a range of foward looking input parameters to address parameter uncertainty. And because there is no lagged window averaging, the resulting unnormalized numbers are more comparable directly to PE1 numbers. One caveat - the history for S&P500 margins does not go back very far. Also, the assumption that margin fluctuations account for all of the shorter term earnings fluctuations is only satisfied to a degree - sales are affected too.
Last edited by mindbogle on Sat Mar 09, 2013 3:46 pm, edited 4 times in total.

User avatar
grayfox
Posts: 4860
Joined: Sat Sep 15, 2007 4:30 am

Re: Shiller PE10 nearing nosebleed territory?

Post by grayfox » Sat Mar 09, 2013 11:51 am

mindbogle wrote:
As Rick Ferri explains in his article, the basic motivation behind adjusting the denominator in a price to earnings valuation measure is to remove the oscillating effects of business cycle from the calculation. Much of the shorter-term fluctuation in earnings can be attributed to margin fluctuation (E=margins*sales). As has been quoted by Jerremy Grantham, margins are one of the most mean reverting time series in finance. The way he explains the underlying cause and effect: profit margins fluctuate with the waning and waxing of the business cycle. High margins invite competition, and competition has the general effect of lowering margins. Hence the cyclic mean-reversion in margins and thus earnings. Of course, sales are affected by the business cycle as well, but the effect is not nearly as large as the effect on margins.
I am skeptical of the certainty for mean reversion in net profit margin (NPM).

Now I would agree that there is mean reversion for NPM. For example, if NPM is high for software industry and low for auto industry, there will be more investment shifted to the higher profit margin industry. That makes sense.

But in the aggregate, NPM is the share of GDP that goes to the owners of capital. Another share goes to labor. Labor and capital are competing for their share of the output. If there are supply shocks, like the available pool of labor increases by 5x, wages will fall, the share of GDP going to labor will fall, and NPM will rise. A new equilibrium will be reached.

There will still be mean reversion, but it will be to the new equilibrium point.

Here is wages as a fraction of GDP. Down from 53% (1970) to 48% (2000) to 44% (2012). Probably due to globalization, i.e. outsourcing U.S. jobs to China and India, and automation, i.e. robots replacing workers.

Image

Here is Corporate Profits After Tax as a fraction of GDP, which is net profit margin. Except for the blip during the economic crisis, NPM has risen since 2000 from 5% to 11%. As labor lose, owners of capital win.

Image

Now this may seem wonderful for investors, but it's not. You have to remember that workers are also consumers. When wages go down, consumers have less money to spend. And what consumers spend is the revenue to the corporations. The result is low GDP growth, which is what we have seen since 2000.

User avatar
Rick Ferri
Posts: 8360
Joined: Mon Feb 26, 2007 11:40 am
Location: Austin, TX. Twitter: @Rick_Ferri
Contact:

Re: Shiller PE10 nearing nosebleed territory?

Post by Rick Ferri » Sat Mar 09, 2013 12:16 pm

Imagine what these figures would look like in the farming industry over the past 200 years? The number of people needed per 1000 bushels of corn has probably dropped from 100 to 1 due to technology advances. Despite the dwindling number of people working on farms, farm output skyrocketed along with demand for farm products.

[Economics policy comment removed by admin LadyGeek]

Rick Ferri
The Education of an Index Investor: starts in darkness, finds enlightenment, overcomplicates everything, embraces simplicity.

User avatar
Watty
Posts: 13439
Joined: Wed Oct 10, 2007 3:55 pm

Re: Shiller PE10 nearing nosebleed territory?

Post by Watty » Sat Mar 09, 2013 1:10 pm

nisiprius wrote:
Watty wrote:
larryswedroe wrote:First, valuations matter and they matter a lot. But to show you how wide the potential dispersion of returns is: when the Shiller PE 10 is 21-25 the AVERAGE real return for next 10 years was 0.9%. The range was -4.4 to +8.3.
Lesson, your plan should incorporate both those possibilities. If you cannot stomach the -4.4 move to another playground

Larry
The problem is that the other playground pretty much means bonds and I would not bet a lot on them being any safer.

Please define what you mean by "safer" and then we can discuss it.

What I was looking at was the low end of the range of the REAL return being -4.4 %

Even moderate inflation and interest rate increases could cause bond investments to have a lower REAL return than -4.4% at least over the short term.

Roy
Posts: 970
Joined: Wed Sep 10, 2008 9:34 am

Re: Shiller PE10 nearing nosebleed territory?

Post by Roy » Sat Mar 09, 2013 3:28 pm

mindbogle wrote: John Hussman was the first author that I have read that promoted the peak earnings method (he used reported rather than operated earnings). For some reason, which I won’t speculate on here (but I do have a speculation!), John has stopped promoting his price-to-peak earnings method of valuing the stock market. I should also note that he has been very vocal about the dangers of using operating earnings as a valuation measure (as Rick used in his artical) because they can be manipulated by companies for unscrupulous purposes. Years ago I compared John's price-to-peak reported earnings with PE10 and other variants and found that his method faired a little worse than PE10 in terms of foretelling future stock returns, although the differences were arguably not statistically significant.
Good post, Mindbogle.

I've read Hussman for years and he often mentions PE 10. Problem with Hussman is he uses a potpourri of ever-adjusting "ensemble" indicators, tweaks his funds weekly (hence higher costs), and these days he comes off as being too smart by half, judged by the butcher's bill of his recent returns.

Yesterday, some guy (Shilling, I think?) on CNBC also mentioned Shiller's PE 10 as being much superior to various 1-year methods (much like the operating earnings stuff mentioned above), and upbraided his opponent over the issue, when she said present equity (domestic) valuations looked good.

PE 10 is pretty good for what it is, regarding "valuations matter". The bigger questions always concerns what, if anything, to do about it, and to what degree if actually doing something. Of course, as Larry mentions, even that is only part of the answer in determining what any individual should do and why.

User avatar
ladders11
Posts: 795
Joined: Fri Nov 14, 2008 4:20 pm

Re: Shiller PE10 nearing nosebleed territory?

Post by ladders11 » Sat Mar 09, 2013 10:31 pm

Rick Ferri wrote:
Browser wrote:Shiller PE10 now at 23.8. Every time it's gotten this high in the past, things didn't turn out well for stocks going forward -- except for the nutty nineties when it just kept on trucking up to the 40s somewhere. Doubt we'll see that again. I hate to be a party pooper, but it might be time to double-check your risko-meter to see if it's set to your correct risk tolerance level.
Shiller PE10 is a poor indication of market valuation when earnings are increasing. Do you really want to look back at earnings from ten years ago and use that to make a prediction about prices in 2013? Not me. It's like saying the average interest rate on 10-year T-notes is 4% so bonds are cheap today.

Use PeakPE for a useful valuation fix, not Shiller PE10.

Rick Ferri
I am interested in what you mean by "when earnings are increasing". Over the long haul, earnings have always increased.

Chart here:
http://www.multpl.com/s-p-500-earnings/
(12-month real earnings per share — inflation adjusted, constant January 2013 dollars.)

The body of evidence supporting PE10 is certainly from a period when earnings increased.

Browser
Posts: 4857
Joined: Wed Sep 05, 2012 4:54 pm

Re: Shiller PE10 nearing nosebleed territory?

Post by Browser » Sun Mar 10, 2013 12:42 am

Thanks for these insightful posts. :thumbsup
We don't know where we are, or where we're going -- but we're making good time.

MoonOrb
Posts: 959
Joined: Thu Jan 24, 2013 6:58 pm

Re: Shiller PE10 nearing nosebleed territory?

Post by MoonOrb » Sun Mar 10, 2013 1:07 am

Why worry? Just stick to your plan. The index will go up sometimes and down sometimes over the period of time you hold your investments. Why try to guess when those times are?

User avatar
czeckers
Posts: 993
Joined: Thu May 17, 2007 3:49 pm
Location: Upstate NY

Re: Shiller PE10 nearing nosebleed territory?

Post by czeckers » Sun Mar 10, 2013 7:54 am

No idea about PE, but my current portfolio has been above my value averaging path for the last two months so new investments have been going into cash. The cash will be deployed once the portfolio value drops below the value path again.

That's the nifty thing about value averaging -- the portfolio self-regulates with respect to valuations.

-K
The Espresso portfolio: | | 16% LCV, 16% SCV, 16% EM, 8% Int'l Value, 8% Int'l Sm, 8% US REIT, 8% Int'l REIT, 20% Inter-term US Treas | | "A journey of a thousand miles begins with a single step."

yahoo
Posts: 65
Joined: Sun Jun 03, 2012 11:34 am

Re: Shiller PE10 nearing nosebleed territory?

Post by yahoo » Sun Mar 10, 2013 9:33 am

Can anyone give me an explanation of the Schiller PE 10? I don't know what it means exactly, other than it is some measure of stock valuations.

The level of the S&P 500 is now where it was in 1999. However earnings and dividends have basically doubled since that time.

It seems, therefore that the S&P 500 is half as expensive as is was in 1999. The yield on the S&P 500 is more than the 10 year treasury. It seems like the last time we were in this position, stocks out performed bonds.

TJSI
Posts: 332
Joined: Thu Jan 27, 2011 4:03 pm

Re: Shiller PE10 nearing nosebleed territory?

Post by TJSI » Sun Mar 10, 2013 10:57 am

So what does Mr Shiller say about all this? From today's NY Times (3/10) Business Section: " The CAPE has been high of late:it stands at 23, compared with a historical average of around 15. This suggests that the market is somewhat overpriced and might show below-average returns in the futire."

(For Yahoo: The CAPE (Shiller PE10) is a real(inflation adjusted) S&P 500 Index divided by a 10-year average of real S&P 500 earnings.)

The article is mostly about confidence ( Yes We're Confident, But Who Knows Why) and whether a market high is reason for confidence. He seems to be saying not really.

User avatar
Rick Ferri
Posts: 8360
Joined: Mon Feb 26, 2007 11:40 am
Location: Austin, TX. Twitter: @Rick_Ferri
Contact:

Re: Shiller PE10 nearing nosebleed territory?

Post by Rick Ferri » Sun Mar 10, 2013 1:20 pm

Rick, I am interested in what you mean by "when earnings are increasing". Over the long haul, earnings have always increased.
Yes, they go up in the long haul, which is my argument for using peak earnings rather than trailing 10 year earnings. There have been periods several years long when corporate earnings where below previous peak earnings. For example, earnings sagged from September 2000 to April 2004 and from July 2007 to July 2011.

When trailing 10 year earnings are used, the distortion in valuation becomes greater and greater during earnings cycles. Trailing 12-month S&P earnings were $53.70 in October 2000 and fell down to $24.70 by December 2001.Trailing 12-month S&P earnings were $84.92 in July 2007 and fell all the way down to $6.86 by September 2009. The E in PE10 gets widely distorted based on how low earnings go during the recession. This distorted PE10 is then used to value stocks on the upside? What possible use is rock-bottom recession earnings in determining stock values today with earnings are approaching $90.00?

I admire Shiller and am a fan of his research, but trying to value today's earnings using PE10 (CAPE) this isn't good work, IMO. It's an interesting number, is suppose, and could be used at the extremes, but than ANY valuation factor at the extremes leads to the same forecast. Since no other valuation method is leading to this same forecast at this time, I find it highly unlikely that are anywhere near nosebleed territory on stock prices.

Rick Ferri
Last edited by Rick Ferri on Sun Mar 10, 2013 1:37 pm, edited 2 times in total.
The Education of an Index Investor: starts in darkness, finds enlightenment, overcomplicates everything, embraces simplicity.

EDN
Posts: 528
Joined: Sat Dec 29, 2012 7:55 pm
Location: Oklahoma City, OK

Re: Shiller PE10 nearing nosebleed territory?

Post by EDN » Sun Mar 10, 2013 1:34 pm

Browser wrote:Shiller PE10 now at 23.8. Every time it's gotten this high in the past, things didn't turn out well for stocks going forward -- except for the nutty nineties when it just kept on trucking up to the 40s somewhere. Doubt we'll see that again. I hate to be a party pooper, but it might be time to double-check your risko-meter to see if it's set to your correct risk tolerance level.
I don't buy it. We're about 10 years into a supposed era of "lower expected returns". Google "What Risk Premium is Normal" from 2002 that applies some very scientific sounding valuation metrics to the US stock market and concludes that very low to negative real returns are likely going forward.

Know what the ERP has been for the last 10 years thru 12/31/12 (CRSP 1-10 minus 1mo t-bills)? +6.1%. Know what the ERP was from 1927-2002? 5.8%.

Know what the difference in year-end book to market ratios on large/small and growth/value stocks in 2012 vs. 2002? Almost nothing (so this has nothing to do with stretched valuations).

We're as likely to see another 10 years of about a 5-6% ERP and another 2% for reasonable tilts to small and value as anything more sophisticated calculations would predict.

By the way, FF published a paper on expected stock returns around the same time as the Arnott piece I mentioned above. Know how much higher the stock market did over the period they studied than their model predicted? About 50%. Their 3F/5F models are priceless, but I wouldn't put an ounce of credibility on their equity return predictions anymore than I would Shiller, Arnott, or any of the other forecasters.

And even if they are right about "the market" (a few hundred really large US stocks), what bearing does that have on a multi-asset class global portfolio?

Sure, have a plan for something worse, just don't expect to have to use it.

Eric

lwfitzge
Posts: 311
Joined: Sun Jun 12, 2011 8:01 am

Re: Shiller PE10 nearing nosebleed territory?

Post by lwfitzge » Sun Mar 10, 2013 1:39 pm

EDN wrote:
Browser wrote:Shiller PE10 now at 23.8. Every time it's gotten this high in the past, things didn't turn out well for stocks going forward -- except for the nutty nineties when it just kept on trucking up to the 40s somewhere. Doubt we'll see that again. I hate to be a party pooper, but it might be time to double-check your risko-meter to see if it's set to your correct risk tolerance level.
I don't buy it. We're about 10 years into a supposed era of "lower expected returns". Google "What Risk Premium is Normal" from 2002 that applies some very scientific sounding valuation metrics to the US stock market and concludes that very low to negative real returns are likely going forward.

Know what the ERP has been for the last 10 years thru 12/31/12 (CRSP 1-10 minus 1mo t-bills)? +6.1%. Know what the ERP was from 1927-2002? 5.8%.

Know what the difference in year-end book to market ratios on large/small and growth/value stocks in 2012 vs. 2002? Almost nothing (so this has nothing to do with stretched valuations).

We're as likely to see another 10 years of about a 5-6% ERP and another 2% for reasonable tilts to small and value as anything more sophisticated calculations would predict.

By the way, FF published a paper on expected stock returns around the same time as the Arnott piece I mentioned above. Know how much higher the stock market did over the period they studied than their model predicted? About 50%. Their 3F/5F models are priceless, but I wouldn't put an ounce of credibility on their equity return forecasts anymore than I would Shiller, Arnott, or any of the other forecasters.

Sure, have a plan for something worse, just don't expect to have to use it.

Eric

Agreed.... Even Bill Gross's New Normal is looking old Normal and only after a few months! http://www.businessinsider.com/pimcos-b ... ast-2013-3

User avatar
Rick Ferri
Posts: 8360
Joined: Mon Feb 26, 2007 11:40 am
Location: Austin, TX. Twitter: @Rick_Ferri
Contact:

Re: Shiller PE10 nearing nosebleed territory?

Post by Rick Ferri » Sun Mar 10, 2013 1:46 pm

Let me give you another example of why Shiller PE10 is flawed.

You've been working as a software engineer for 8 years. Starting pay was $60,000, and over 8 years your salary grew to $100,000. Then, you get laid-off and cannot find work for 2 years. During this time you did part-time freelancing and earned only $40,000. Question: What is your human capital worth at this point? Do you say that it's only $40,000 a year, or do you seek employment back at $100,000? You wouldn't include the two recession years in your human capital value estimate to a potential employer. You would consider only your human capital value as an experienced engineer going forward at $100,000.

If I was going to buy a company, I'm interested in future earnings, not earnings from 10 years ago. The very fact that a company lived through the recession is triumph. It's even better if they earned something (as the S&P 500 did). I'd be laughed out of town if I said to a selling company, "Well, you're earnings were down in 2008, so I'm only going to give you 60% of what you're company is really worth based on today's business."

Shiller PE10 is an interesting number to look at, but not much use in current valuation.

Rick Ferri
Last edited by Rick Ferri on Sun Mar 10, 2013 1:47 pm, edited 2 times in total.
The Education of an Index Investor: starts in darkness, finds enlightenment, overcomplicates everything, embraces simplicity.

EDN
Posts: 528
Joined: Sat Dec 29, 2012 7:55 pm
Location: Oklahoma City, OK

Re: Shiller PE10 nearing nosebleed territory?

Post by EDN » Sun Mar 10, 2013 1:46 pm

lwfitzge wrote: Agreed.... Even Bill Gross's New Normal is looking old Normal and only after a few months! http://www.businessinsider.com/pimcos-b ... ast-2013-3
That is hilarious! Exactly right.

That "New Normal" think (circa 4/2009 to 2/2013) really turned out to be bad for stocks, huh?

Eric

User avatar
jeffyscott
Posts: 6866
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: Shiller PE10 nearing nosebleed territory?

Post by jeffyscott » Sun Mar 10, 2013 2:11 pm

Rick Ferri wrote:When trailing 10 year earnings are used, the distortion in valuation becomes greater and greater during earnings cycles. Trailing 12-month S&P earnings were $53.70 in October 2000 and fell down to $24.70 by December 2001.Trailing 12-month S&P earnings were $84.92 in July 2007 and fell all the way down to $6.86 by September 2009. The E in PE10 gets widely distorted based on how low earnings go during the recession. This distorted PE10 is then used to value stocks on the upside? What possible use is rock-bottom recession earnings in determining stock values today with earnings are approaching $90.00?
Earnings have always been cyclical, that is the reason for using a cyclically adjusted PE. If you are comparing CAPE with historical CAPE that is all going to average out. You can say but, but, earnings collapsed more than they typically do this time, but if you adjust those very low figures upward, it does not make much of a difference you still end up with a number that "suggests that the market is somewhat overpriced and might show below-average returns in the future".
Since no other valuation method is leading to this same forecast at this time, I find it highly unlikely that are anywhere near nosebleed territory on stock prices.
I wouldn't call it nosebleed territory, but in addition to CAPE, GMO's methodology is indicating valuations are high. GMO has their 7 year forecast at -0.5% real for US large caps, I believe this implies a fair value of about 1000 for the S&P 500. Their method includes an assumption that profit margins will return to their historical average. Of course, they could be wrong and the new normal could be that labor continues to get less while capital continues to get more, as shown in the charts grayfox has posted above.
press on, regardless - John C. Bogle

User avatar
grayfox
Posts: 4860
Joined: Sat Sep 15, 2007 4:30 am

Re: Shiller PE10 nearing nosebleed territory?

Post by grayfox » Sun Mar 10, 2013 2:40 pm

Here is a chart of S&P 500 real earnings per share, inflation-adjusted to Jan-2013 dollars.

Image
from http://www.multpl.com/s-p-500-earnings/

Real Earnings fluctuate around a trend line, sometimes above trend, sometimes below trend. To reveal the trend, it is common to take a moving average of some length N months. E1 would use N=12. E10 would use N=120.

Exactly what should N be? There is a tradeoff. Bigger N shows the trend better, but the older data is less relevant. Shiller picked 120. I think Ben Graham said use 5 or 7 years, which would be N=60 or 84. I would say N should be big enough to at least capture a complete business cycle.

Maybe it should be your holding period. If I were going to hold for 10 years, my question is how much earnings to expect over the next 10 years? Look at the average and growth trend over the previous 10 years and extrapolate to the next 10 years.

I would not extrapolate from the peak using the growth trend to answer my question. It would imply that there is not earnings drawdown over the next 10 years. From past behavior, I am 95% certain that at least a couple of years will be down about -50% from the peak.
Last edited by grayfox on Sun Mar 10, 2013 2:47 pm, edited 1 time in total.

User avatar
tc101
Posts: 2981
Joined: Tue Feb 20, 2007 3:18 pm
Location: Atlanta - Retired in 2004 at age 54

Re: Shiller PE10 nearing nosebleed territory?

Post by tc101 » Sun Mar 10, 2013 2:47 pm

My problem is that I am about to have a windfall from the sale of a house. I don't want to invest a lot in stocks at these levels. I don't want to buy bonds at these levels. I don't want to money to sit in a bank account and get eaten up by inflation. What to do?
. | The most important thing you should know about me is that I am not an expert.

User avatar
grayfox
Posts: 4860
Joined: Sat Sep 15, 2007 4:30 am

Re: Shiller PE10 nearing nosebleed territory?

Post by grayfox » Sun Mar 10, 2013 2:51 pm

tc101 wrote:My problem is that I am about to have a windfall from the sale of a house. I don't want to invest a lot in stocks at these levels. I don't want to buy bonds at these levels. I don't want to money to sit in a bank account and get eaten up by inflation. What to do?
What is the timeframe for the investment?
If it is 40 years or longer, then a recent thread would indicate 80% to 100% stocks.
If it is 5 years or less, then 0% stocks and 100% CD or Treasury note.
Between 5 and 40 years, something in between.
Last edited by grayfox on Sun Mar 10, 2013 2:56 pm, edited 1 time in total.

User avatar
tc101
Posts: 2981
Joined: Tue Feb 20, 2007 3:18 pm
Location: Atlanta - Retired in 2004 at age 54

Re: Shiller PE10 nearing nosebleed territory?

Post by tc101 » Sun Mar 10, 2013 2:56 pm

What is the timeframe for the investment?
If it is 40 years or longer, then a recent thread would indicate 80% to 100% stocks.
If it is 5 years or less, then 0% stocks and 100% CD or Treasury note.
Between 5 and 30 years, something in between.
I'm 63 and retired. I have no heirs. I plan to die when I am 85.
. | The most important thing you should know about me is that I am not an expert.

User avatar
Cut-Throat
Posts: 2011
Joined: Sun Oct 17, 2010 9:46 am

Re: Shiller PE10 nearing nosebleed territory?

Post by Cut-Throat » Sun Mar 10, 2013 3:01 pm

tc101 wrote:
What is the timeframe for the investment?
If it is 40 years or longer, then a recent thread would indicate 80% to 100% stocks.
If it is 5 years or less, then 0% stocks and 100% CD or Treasury note.
Between 5 and 30 years, something in between.
I'm 63 and retired. I have no heirs. I plan to die when I am 85.
You could buy an SPIA and get a cash flow from the dough.

Not sure what your other assets look like.....

User avatar
grayfox
Posts: 4860
Joined: Sat Sep 15, 2007 4:30 am

Re: Shiller PE10 nearing nosebleed territory?

Post by grayfox » Sun Mar 10, 2013 3:04 pm

tc101 wrote:
What is the timeframe for the investment?
If it is 40 years or longer, then a recent thread would indicate 80% to 100% stocks.
If it is 5 years or less, then 0% stocks and 100% CD or Treasury note.
Between 5 and 30 years, something in between.
I'm 63 and retired. I have no heirs. I plan to die when I am 85.
If you start withdrawing at 65, then your time frame is 2 to 22 years.

Here's one idea. Put anything you intend to w/d over the next 5 years into CD ladder. If you are lucky, you will get 1%.
Money for w/d in 10 to 22 years, put into stocks.
Money needed between 5 and 10. Some mixture of stocks and bonds.

And the SPIA idea sounds pretty smart. Look at the paper by Wade Pfau.

User avatar
tc101
Posts: 2981
Joined: Tue Feb 20, 2007 3:18 pm
Location: Atlanta - Retired in 2004 at age 54

Re: Shiller PE10 nearing nosebleed territory?

Post by tc101 » Sun Mar 10, 2013 3:06 pm

Code: Select all

Not sure what your other assets look like.....
60% Liquid assets divided 45% equities/ 55% fixed income
15% Cash after the closing on the old house
15% Value of the new house I live in now. No mortgage
10% Real estate investments with my brother
. | The most important thing you should know about me is that I am not an expert.

User avatar
tc101
Posts: 2981
Joined: Tue Feb 20, 2007 3:18 pm
Location: Atlanta - Retired in 2004 at age 54

Re: Shiller PE10 nearing nosebleed territory?

Post by tc101 » Sun Mar 10, 2013 3:08 pm

And the SPIA idea sounds pretty smart. Look at the paper by Wade Pfau.
I thought I should wait to do a SPIA. A discussion here a few years ago made me think I should wait until about age 70, and do it after I take SS, which I also plan to do at 70.
. | The most important thing you should know about me is that I am not an expert.

blinx77
Posts: 226
Joined: Sat Jan 07, 2012 11:23 am

Re: Shiller PE10 nearing nosebleed territory?

Post by blinx77 » Sun Mar 10, 2013 3:14 pm

tc101 wrote:I plan to die when I am 85.
The best laid plans of mice and men often go astray.

User avatar
grayfox
Posts: 4860
Joined: Sat Sep 15, 2007 4:30 am

Re: Shiller PE10 nearing nosebleed territory?

Post by grayfox » Sun Mar 10, 2013 3:20 pm

tc101 wrote:
And the SPIA idea sounds pretty smart. Look at the paper by Wade Pfau.
I thought I should wait to do a SPIA. A discussion here a few years ago made me think I should wait until about age 70, and do it after I take SS, which I also plan to do at 70.
That's the impression I get also, that buying at age 70 is the optimum.

Let's say your goal is to buy a SPIA in 7 years, which is 2020. I would want to have the SPIA-purchase money in risk-free investment like CD by 2015, at the latest. In fact, the best option may be to put it in a 7-year CD at PenFed right now, and when it matures in 2020, buy the SPIA. PenFed 7-year CD is 1.75% APR, guaranteed.

BTW, if you buy the SPIA, you don't have to worry about outliving your money.

Post Reply