Benjamin Graham thinks current S&P valuations are reasonable

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Caduceus
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by Caduceus » Sun Mar 09, 2014 2:15 pm

I think some of the challenges arise from attempting to apply Graham's value philosophy to an index. The natural context of Graham's ideas is selection of individual securities. Calculating the P/E of a company versus that of an index has significant differences. Studying the financial statements of a company (which he advocated) can establish the earnings history and what the accounting quirks are. It's much harder to do that for an index that is by its very nature an aggregation of different kinds of earnings with different kinds of accounting treatment. Not that long ago, some companies didn't even feel a need to expense out stock options. Not that long ago, goodwill was treated quite differently under GAAP than it is now.

I think it's one thing to say that the equity risk premium is reasonable. Surely we don't want to invest in stocks if they don't yield more than long-term bonds. But Graham's notion of value is not at its heart something comparative/relative. To be a value investor means to buy a company when it is trading at a discount to its fundamental value. It may be more attractively priced than other equivalent bond-type securities, but that doesn't mean it is a value investment. It may be a better investment, but it is not a value investment.

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docneil88
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by docneil88 » Sun Mar 09, 2014 2:44 pm

cb474 wrote:I also don't understand why you see a move into cash as a protection against unexpected inflation. If that's your concern, you should be holding TIPS. In fact, the move into cash to me seems to be one of the biggest risk increasing parts of your scheme, since it is a guaranteed real loss and since the timing of your move back into the market is far more likely to be wrong than right. I don't see the purpose of cash in a portfolio, other than for short term emergency funds.
On the 3-month T-Bill rate vs. inflation, from http://www.bogleheads.org/forum/viewtop ... 0&t=104565 :
Simplegift wrote:No doubt, T-bills will never track unexpected inflation as well as any directly inflation-linked security. There will be always be periods when T-bill investors' expectations for inflation fall short of the eventual number. The OP has identified one such period above.

However, if one looks at the long period of market-determined interest rates from 1951 (when interest rate caps to fund World War II were lifted) to 2008 (when the Fed's quantitative easing program began), more often than not, T-bill investors were over-compensated for unexpected inflation (i.e., they demanded and received a premium to eventual inflation), rather than under-compensated:

Image
Source: About Inflation

Are T-bills a perfect hedge against inflation? No. A pretty good one? It appears so, given an open market.

cb474
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by cb474 » Sun Mar 09, 2014 6:47 pm

I was responding, as your quote from me shows, to someone who was talking about moving a certain portion of their investments into cash (rather than just equities and bonds) if PE10 > 25. I assumed cash meant cash (something like a money market account or simply a regular bank account), not 3 month T-Bills.

Or perhaps you were just trying to make a point about my assertion concerning TIPS and unexpected inflation. I don't really get the point though and it's off topic. The quote you provide from Simplegift acknowledges that nothing tracks unexpected inflation better than an inflation linked security. And that's all I was claiming. So it seems to confirm my point.

If one wants to outperform unexpected inflation, maybe T-Bills are a good idea, maybe not. Usually the better (more risk efficient) place to look for extra returns is equities. Even Simplegift's quote acknowledges that 3 month T-Bills outperform unexpected inflation not all the time, but "more often than not." That could be 51% of the time, I don't know. Even if it's 80% or 90% of the time, if what one is looking for is protection from unexpected inflation, why choose a security that fails to track it some significant portion of the time over a security that will always track unexpected inflation?

Further, Simplegift's assertion in your quote from him is that over a nearly 60 year period (1951 to 2008) 3 month T-Bills mostly out-performed inflation. The horizon over which most people are concerned about protecting themselves against unexpected inflation is not usually 60 years. If you've got 60 years to wait, you could just throw it all in equities and you'd probably be far better off. Also in the thread, from which you quote Simplegift, the OP of that thread shows that there have been extended periods (7 years in the example) where 3 month T-Bills experienced real losses (3.41% max yearly loss in the period, .43% min, average 1.75%). I would not call a security that can experience real losses for 7 years running, with 1.75% average losses, a great hedge against unexpected inflation.

In any case, as I said, this off topic and, if people are interested, in the thread in question about T-Bills vs inflation there are many objections to the one post you extract from that thread. Someone quotes no less than Kenneth French acknowledging that TIPS are a better hedge against inflation. People can read the various arguments there.

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AndrewXnn
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by AndrewXnn » Sun Mar 09, 2014 8:15 pm

TIPs are underwater until January 2021 and
less than 1% until 2029.

http://online.wsj.com/mdc/public/page/2_3020-tips.html

bikenfool
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Re: Benjamin Graham thinks current S&P valuations are reason

Post by bikenfool » Sun Mar 09, 2014 10:42 pm

AndrewXnn wrote:TIPs are underwater until January 2021 and
less than 1% until 2029.

http://online.wsj.com/mdc/public/page/2_3020-tips.html
and right now 3 mo Tbills are yielding 0.05%, which is about negative 1.5-2% real.

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Rx 4 investing
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Re: Benjamin Graham thinks current S&P valuations are reasonable

Post by Rx 4 investing » Thu May 07, 2015 4:58 pm

A few years back, there was an interesting discussion in the BH forum that included input from Wade Pfau --- on considerations for long-term timing based on PE10 bands. I recall from a Dr Pfau paper that he traced back the origins of the concept to a model proposed by Graham and Dodd in an earlier edition of Security Analysis.

http://www.bogleheads.org/forum/viewtopic.php?p=932125

A poster asked earlier in this thread if anyone had back-tested the concept. An equal number of years back, when the market recovery was still in the early stages, an enterprising investor did test the concept, and the website claims the paper did receive some minor recognition.

Executive summary: The young researcher found that the 50% /50% portfolio implemented when the P/ E 10 was in the "high" range had a better long-term return than portfolios that used valuation bands. However , the 50/50 portfolio had a larger standard deviation. The two other tested models that used valuation rule sets for raising and lowering stock allocations based on P/E 10 produced slightly lower returns than 50%/50% , but with less risk.

http://www.mypersonalfinancejourney.com ... ssive.html

Hope this provides some additional insights to an interesting discussion. Good luck to everyone in the markets. :happy
“Everyone is a disciplined, long-term investor until the market goes down.” – Steve Forbes

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backpacker
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Re: Benjamin Graham thinks current S&P valuations are reasonable

Post by backpacker » Thu May 07, 2015 5:18 pm

Interesting. We can update the OPs calculation for 5/15. The yield of the AA 10-year corporate is currently 3%. That means that Graham recommends buying stocks only if PE3 is less than 27. PE3 is in fact only 21.35. So Graham would still be buying stocks.

Browser
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Re: Benjamin Graham thinks current S&P valuations are reasonable

Post by Browser » Thu May 07, 2015 6:43 pm

backpacker wrote:Interesting. We can update the OPs calculation for 5/15. The yield of the AA 10-year corporate is currently 3%. That means that Graham recommends buying stocks only if PE3 is less than 27. PE3 is in fact only 21.35. So Graham would still be buying stocks.
If he could find any that meet his valuation criteria....
We don't know where we are, or where we're going -- but we're making good time.

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Taylor Larimore
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Tracking P/E ratios ?

Post by Taylor Larimore » Thu May 07, 2015 7:00 pm

When we adjust P/E ratios for the yield on high-grade bonds, the S&P looks reasonably priced. Any argument that we should rely on non-adjusted P/E ratios (like PE10) needs to explain why interest rates on bonds are not a relevant factor to whether or not stocks are overvalued.
Bogleheads:

We have many discussions about P/E (Price to Earnings) ratios. Unless one is a market -timer (which seldom works), I see no reason to track the many kinds of P/E ratios.

When I started investing in 1950 the S&P 500 Index was under 20. Today the S&P 500 Index closed at 2088 (not including dividends).

Stay the course.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

LateStarter1975
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Re: Tracking P/E ratios ?

Post by LateStarter1975 » Thu May 07, 2015 7:06 pm

Taylor Larimore wrote:
When we adjust P/E ratios for the yield on high-grade bonds, the S&P looks reasonably priced. Any argument that we should rely on non-adjusted P/E ratios (like PE10) needs to explain why interest rates on bonds are not a relevant factor to whether or not stocks are overvalued.
Bogleheads:

We have many discussions about P/E (Price to Earnings) ratios. Unless one is a market -timer (which seldom works), I see no reason to track the many kinds of P/E ratios.

When I started investing in 1950 the S&P 500 Index was under 20. Today the S&P 500 Index closed at 2088 (not including dividends).

Stay the course.

Best wishes.
Taylor
I always enjoy your sage wisdom and the propensity for keeping it always simple. Truly value your comments
Debt is dangerous...simple is beautiful

LateStarter1975
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Re: Tracking P/E ratios ?

Post by LateStarter1975 » Thu May 07, 2015 7:06 pm

Taylor Larimore wrote:
When we adjust P/E ratios for the yield on high-grade bonds, the S&P looks reasonably priced. Any argument that we should rely on non-adjusted P/E ratios (like PE10) needs to explain why interest rates on bonds are not a relevant factor to whether or not stocks are overvalued.
Bogleheads:

We have many discussions about P/E (Price to Earnings) ratios. Unless one is a market -timer (which seldom works), I see no reason to track the many kinds of P/E ratios.

When I started investing in 1950 the S&P 500 Index was under 20. Today the S&P 500 Index closed at 2088 (not including dividends).

Stay the course.

Best wishes.
Taylor
I always enjoy your sage wisdom and the propensity for keeping it always simple. Truly value your comments
Debt is dangerous...simple is beautiful

Browser
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Re: Benjamin Graham thinks current S&P valuations are reasonable

Post by Browser » Thu May 07, 2015 9:17 pm

Taylor - I agree completely. Where were you in 1950 when I really could have used your advice??? :(
We don't know where we are, or where we're going -- but we're making good time.

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Taylor Larimore
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Where were you?

Post by Taylor Larimore » Thu May 07, 2015 9:44 pm

Browser wrote:Taylor - I agree completely. Where were you in 1950 when I really could have used your advice??? :(
Browser:

I was selling life-insurance and annuities for Mutual Benefit of New Jersey. :oops:

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

comeinvest
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Re: Benjamin Graham thinks current S&P valuations are reasonable

Post by comeinvest » Thu May 14, 2015 5:42 pm

I have a question to all the posters in this long thread. Why are we scratching our heads whether or not extremely high S&P 500 equity valuations are justified by extremely high bond valuations, and whether or not high bond valuations will persist. Why not just buy the MSCI world index with a dose of MSCI EM, at reasonable valuations compared to historical averages, using most valuation measures?

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JoMoney
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Re: Benjamin Graham thinks current S&P valuations are reasonable

Post by JoMoney » Thu May 14, 2015 6:37 pm

comeinvest wrote:I have a question to all the posters in this long thread. Why are we scratching our heads whether or not extremely high S&P 500 equity valuations are justified by extremely high bond valuations, and whether or not high bond valuations will persist. Why not just buy the MSCI world index with a dose of MSCI EM, at reasonable valuations compared to historical averages, using most valuation measures?
I believe the MSCI EM P/E average for the past 19 years is something close to 16, Vanguard's Emerging Market Index fund is currently showing a trailing P/E of 16.4

The S&P500's P/E average over the past 19 years is a little over 25, Vanguard's 500 Index fund is currently showing a trailing P/E of 19.8

If we're comparing valuations to those same historical averages the S&P500 would seem even cheaper. Regardless, the market is pricing the future expectations (not the past). What the P/E is telling us is that the market expects earnings growth in the 500 index to be relatively higher going forward (and the price on EM is discounted accordingly to match equivalent). If you think the market is wrong you can clearly "arbitrage" the difference by selling the higher priced one and buying the lower priced one.
Or we can just accept that our best guess isn't any better than the markets (quite possibly worse if we don't have any special information).
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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JoMoney
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Re: Benjamin Graham thinks current S&P valuations are reasonable

Post by JoMoney » Thu May 14, 2015 6:54 pm

FWIW, If someone "averaged" in a $1,000 each year to either the S&P500(1) or Emerging Markets(2) from 1995 to the end of 2014 the balances would look something like this:
PV Link
Image

(** side note, this sort of dis-parity followed by mean-reversion is almost the perfect situation for someone who chose to own both and rebalance between them. The re-balancing "bonus" however is fleeting, and disappears if one of the assets departs again leaving the investor selling the higher returning asset and putting more into the lower returning one. Unless your portfolio happens to coincide with this reversion point and you quit playing the game, otherwise the temporary "bonus" is meaningless)
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

comeinvest
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Re: Benjamin Graham thinks current S&P valuations are reasonable

Post by comeinvest » Thu May 14, 2015 8:24 pm

JoMoney wrote:
comeinvest wrote:I have a question to all the posters in this long thread. Why are we scratching our heads whether or not extremely high S&P 500 equity valuations are justified by extremely high bond valuations, and whether or not high bond valuations will persist. Why not just buy the MSCI world index with a dose of MSCI EM, at reasonable valuations compared to historical averages, using most valuation measures?
I believe the MSCI EM P/E average for the past 19 years is something close to 16, Vanguard's Emerging Market Index fund is currently showing a trailing P/E of 16.4

The S&P500's P/E average over the past 19 years is a little over 25, Vanguard's 500 Index fund is currently showing a trailing P/E of 19.8

If we're comparing valuations to those same historical averages the S&P500 would seem even cheaper. Regardless, the market is pricing the future expectations (not the past). What the P/E is telling us is that the market expects earnings growth in the 500 index to be relatively higher going forward (and the price on EM is discounted accordingly to match equivalent). If you think the market is wrong you can clearly "arbitrage" the difference by selling the higher priced one and buying the lower priced one.
Or we can just accept that our best guess isn't any better than the markets (quite possibly worse if we don't have any special information).
Just glanced over the thread again. Looks like PE10 is what is currently supposed to be potentially unreasonable for the U.S. I don't have the numbers readily available but I think the U.S. is one of the most expensive markets on a PE10 basis especially compared to EM.

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JoMoney
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Re: Benjamin Graham thinks current S&P valuations are reasonable

Post by JoMoney » Thu May 14, 2015 8:35 pm

Yes, lots of "CAPE Crusaders" preaching their view of low expected returns, and frantic investors listening and thinking that means they should do something about it, or that if they shuffle their assets around with someone else's it will somehow generate something extra.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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