CAPE Fear: Why CAPE Naysayers Are Wrong

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letsgobobby
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by letsgobobby » Sun Jan 07, 2018 11:04 pm

staythecourse wrote:
Sun Jan 07, 2018 9:29 pm
letsgobobby wrote:
Sun Jan 07, 2018 12:23 pm
Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
has anyone ever claimed CAPE predicts one year returns?

I don't follow value metrics as I don't think it is really actionable to a high degree of certainty, but to answer your question though Vanguard's paper showed the correlation of PE1 and PE10 about the same to future stock returns of about 0.37 and 0.41 respectively. So, no neither was very useful.

Good luck.
IIRC, Vanguard didn’t claim PE10 had a correlation of 0.41 to 10 year returns, but rather than PE10 alone explained 41% of eventual ten year returns. Which actually seems quite useful to me.

But I haven’t looked at the paper in some time.

staythecourse
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by staythecourse » Sun Jan 07, 2018 11:34 pm

letsgobobby wrote:
Sun Jan 07, 2018 11:04 pm
staythecourse wrote:
Sun Jan 07, 2018 9:29 pm
letsgobobby wrote:
Sun Jan 07, 2018 12:23 pm
Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
has anyone ever claimed CAPE predicts one year returns?

I don't follow value metrics as I don't think it is really actionable to a high degree of certainty, but to answer your question though Vanguard's paper showed the correlation of PE1 and PE10 about the same to future stock returns of about 0.37 and 0.41 respectively. So, no neither was very useful.

Good luck.
IIRC, Vanguard didn’t claim PE10 had a correlation of 0.41 to 10 year returns, but rather than PE10 alone explained 41% of eventual ten year returns. Which actually seems quite useful to me.

But I haven’t looked at the paper in some time.
Sorry you must have misunderstood my comment. My comment meant to state that they looked at a whole bunch of metrics to see the correlation to future stock prices. 2 of those were PE1 and PE10. PE1 had something like 0.37 correlation to future returns and PE10 had 0.41 correlation. So my point was neither PE1 nor PE10 was predictive AND there wasn't much difference between using PE1 vs. PE10 (a surprise to many folks).

Good luck.

p.s. We do differ on "useful" though as I don't think anything less then 0.8 or so would be something I would bet on when using metrics to adjust my portfolio. Their data did suggest the 25% tail (12.5% on either extreme did give that 0.8 r2 correlation. Of course, that result is suspect as well for other methodological reasons.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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willthrill81
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Sun Jan 07, 2018 11:55 pm

staythecourse wrote:
Sun Jan 07, 2018 11:34 pm
So my point was neither PE1 nor PE10 was predictive AND there wasn't much difference between using PE1 vs. PE10 (a surprise to many folks).
In all of the ten year periods from 1900-2012, there were 42 where annual returns were 10% or higher. In 93% of those periods, the starting CAPE was below 20. Only 3 of those 42 year periods began with CAPE above 20 and ended with 10% or higher annual returns. I'd say that's pretty darned predictive.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

newimmigrant
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by newimmigrant » Mon Jan 08, 2018 12:07 am

willthrill81 wrote:
Sun Jan 07, 2018 10:28 pm
newimmigrant wrote:
Sun Jan 07, 2018 10:06 pm
willthrill81 wrote:
Sun Jan 07, 2018 9:02 pm
newimmigrant wrote:
Sun Jan 07, 2018 8:27 pm
Are we in for a long period of sideways movement of indices?
If you believe that valuations are relatively accurate tools for predicting the future, very possibly. But no one knows with certainty.
My self at 38 years old, I'm afraid about a losing a decade (which should be ideally most productive). At 3% per year compounded growth, my portfolio will grow by ~20%. That will devastate an already small nest egg.
I got a question: What will happen to the bond market if the interest rate raises in the next few years?
Are we in for a double whammy here on both bond and stock markets in the future?
Actually, 3% annually compounded growth would be about 34% after 10 years. I wouldn't call that devastating to a portfolio by any means, but it would mean that you might need to increase your savings rate in order to meet your investment goals. But keep in mind that there is a whole world out there to invest in, not just the U.S. Almost all other nations have higher long-term return expectations than the U.S.

Regarding bonds, I wouldn't worry much about interest rate increases. These do have a negative effect on the starting principal, but the reinvested funds will earn a higher yield going forward, which largely balances out. The total bond market in the U.S. has a current yield of 2.4%, and history has shown that returns over the next decade will be close to this number. But remember that you don't hold bonds for growth; they are held for safety (not that you probably need much safety at 38 years of age).
Thank you for your reply. Which markets do you suggest? Or should I pick index fund like VGTSX or VTWsx?

Bastiat
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Bastiat » Mon Jan 08, 2018 12:08 am

nedsaid wrote:
Sun Jan 07, 2018 12:57 pm
Bastiat wrote:
Sun Jan 07, 2018 9:58 am
I believe that the CAPE is currently around 33.27; apart from that, what is there to "believe"? The US equity market is going to be disappointing relative to what?

How do you plan on using this information? If one were only to buy when CAPE is below the mean, the only buying window they'd have had in the past couple decades is about a month in 2009. What actionable strategy based on the CAPE has been shown to consistently beat the market?

According to the market, the information is discounted.
The CAPE or P/E 10 is an imperfect benchmark but that doesn't mean that it is useless. The academic research and market history shows that when stock market valuations get to be sky-high, that disappointing stock market performance follows. Just look at a performance chart of the US stock market and see how the market performed in the aftermath of the roaring twenties where the market peaked in 1929, the aftermath of the go-go sixties and the Nifty-Fifty with a peak in 1968, and the aftermath of the late 1990's internet and high tech mania which peaked in early 2000.

I am amazed that people just poo-poo valuation measurements and market history. That being said, a couple of things are true. First, accounting measurements of earnings have become more conservative over time so a market P/E ratio of 16 back in 1970 might be more like a market P/E ratio of 20 today. Second, P/E ratios have been creeping up over time. Several reasons for P/E creep other than accounting standards and Larry Swedroe has commented on these reasons in several articles. So the market is expensive but perhaps as not as expensive as we think.

But at some point, when you see P/E ratios creep up and up and up during a bull market you start to get concerned. First, this bull market is getting old, we have been in this bull market since March of 2009. Second, forward P/E ratios based upon optimistic Wall Street earnings projections have been creeping up over the last few years. They have gone up from about 17-18 to about 21-22.

What I have been saying are three things. First, if you haven't rebalanced your portfolio in a while, this might be a good time to do so. Second, if valuations are making you nervous, nothing wrong with taking a bit off the top. Better to "panic" when stocks are at all time highs rather than after a 30-50% drop. Third, a bull market like this is a good time to re-evaluate your need and ability to take risk as well as your asset allocation. My guess is that most investors are taking more risk than what is perceived. It is a good time to do life planning when things are going well. I just think it is a good idea for investors to look ahead. A bit of contrarian thinking is also good for investors.

So I am not ringing a bell and calling a market top. I am not inciting panic. Actually, because of a lack of euphoria, I think this bull market could go on a while longer. The economy is starting to roar and market optimism might well be justified. What I am saying is to exercise prudence and caution knowing that bad things can happen to good markets. There are folks here who have "won the game" or who are getting close and this bull market is a great time for them to take a lower risk profile with less stocks and more bonds.

If you are in your twenties or early thirties, don't give any of this any thought. You have many years to contribute to your retirement accounts and many years to invest. Earnings can easily catch up with and surpass high market expectations and valuations over 30-40 years.
While I don't disagree with your three main points, what amazes me is the lengths people who "don't believe in market timing" will go to rationalize market timing. Unless you're using the CAPE to make changes to your portfolio (i.e. market timing) then it is useless, however informative it might be.

Here's some history for you:

The first time the CAPE surpassed this level was in January 1998. It remained above the current level for over three years, until March 2001. During that period the total return of the S&P 500 was 28%, making an annualized return just over 8%.

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willthrill81
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Mon Jan 08, 2018 12:14 am

newimmigrant wrote:
Mon Jan 08, 2018 12:07 am
willthrill81 wrote:
Sun Jan 07, 2018 10:28 pm
newimmigrant wrote:
Sun Jan 07, 2018 10:06 pm
willthrill81 wrote:
Sun Jan 07, 2018 9:02 pm
newimmigrant wrote:
Sun Jan 07, 2018 8:27 pm
Are we in for a long period of sideways movement of indices?
If you believe that valuations are relatively accurate tools for predicting the future, very possibly. But no one knows with certainty.
My self at 38 years old, I'm afraid about a losing a decade (which should be ideally most productive). At 3% per year compounded growth, my portfolio will grow by ~20%. That will devastate an already small nest egg.
I got a question: What will happen to the bond market if the interest rate raises in the next few years?
Are we in for a double whammy here on both bond and stock markets in the future?
Actually, 3% annually compounded growth would be about 34% after 10 years. I wouldn't call that devastating to a portfolio by any means, but it would mean that you might need to increase your savings rate in order to meet your investment goals. But keep in mind that there is a whole world out there to invest in, not just the U.S. Almost all other nations have higher long-term return expectations than the U.S.

Regarding bonds, I wouldn't worry much about interest rate increases. These do have a negative effect on the starting principal, but the reinvested funds will earn a higher yield going forward, which largely balances out. The total bond market in the U.S. has a current yield of 2.4%, and history has shown that returns over the next decade will be close to this number. But remember that you don't hold bonds for growth; they are held for safety (not that you probably need much safety at 38 years of age).
Thank you for your reply. Which markets do you suggest? Or should I pick index fund like VGTSX or VTWsx?
Index funds for global ex-U.S. are fine, but a tilt toward emerging markets (VEIEX) looks very attractive right now as they have the lowest valuations in the world and, consequently, the highest return expectations for the next decade. Be aware that emerging markets are very volatile. YMMV.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

MnD
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by MnD » Mon Jan 08, 2018 12:26 am

I'm liking these "be fearful" posts. 8-)

flyingaway
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by flyingaway » Mon Jan 08, 2018 12:38 am

Bastiat wrote:
Mon Jan 08, 2018 12:08 am
nedsaid wrote:
Sun Jan 07, 2018 12:57 pm
Bastiat wrote:
Sun Jan 07, 2018 9:58 am
I believe that the CAPE is currently around 33.27; apart from that, what is there to "believe"? The US equity market is going to be disappointing relative to what?

How do you plan on using this information? If one were only to buy when CAPE is below the mean, the only buying window they'd have had in the past couple decades is about a month in 2009. What actionable strategy based on the CAPE has been shown to consistently beat the market?

According to the market, the information is discounted.
The CAPE or P/E 10 is an imperfect benchmark but that doesn't mean that it is useless. The academic research and market history shows that when stock market valuations get to be sky-high, that disappointing stock market performance follows. Just look at a performance chart of the US stock market and see how the market performed in the aftermath of the roaring twenties where the market peaked in 1929, the aftermath of the go-go sixties and the Nifty-Fifty with a peak in 1968, and the aftermath of the late 1990's internet and high tech mania which peaked in early 2000.

I am amazed that people just poo-poo valuation measurements and market history. That being said, a couple of things are true. First, accounting measurements of earnings have become more conservative over time so a market P/E ratio of 16 back in 1970 might be more like a market P/E ratio of 20 today. Second, P/E ratios have been creeping up over time. Several reasons for P/E creep other than accounting standards and Larry Swedroe has commented on these reasons in several articles. So the market is expensive but perhaps as not as expensive as we think.

But at some point, when you see P/E ratios creep up and up and up during a bull market you start to get concerned. First, this bull market is getting old, we have been in this bull market since March of 2009. Second, forward P/E ratios based upon optimistic Wall Street earnings projections have been creeping up over the last few years. They have gone up from about 17-18 to about 21-22.

What I have been saying are three things. First, if you haven't rebalanced your portfolio in a while, this might be a good time to do so. Second, if valuations are making you nervous, nothing wrong with taking a bit off the top. Better to "panic" when stocks are at all time highs rather than after a 30-50% drop. Third, a bull market like this is a good time to re-evaluate your need and ability to take risk as well as your asset allocation. My guess is that most investors are taking more risk than what is perceived. It is a good time to do life planning when things are going well. I just think it is a good idea for investors to look ahead. A bit of contrarian thinking is also good for investors.

So I am not ringing a bell and calling a market top. I am not inciting panic. Actually, because of a lack of euphoria, I think this bull market could go on a while longer. The economy is starting to roar and market optimism might well be justified. What I am saying is to exercise prudence and caution knowing that bad things can happen to good markets. There are folks here who have "won the game" or who are getting close and this bull market is a great time for them to take a lower risk profile with less stocks and more bonds.

If you are in your twenties or early thirties, don't give any of this any thought. You have many years to contribute to your retirement accounts and many years to invest. Earnings can easily catch up with and surpass high market expectations and valuations over 30-40 years.
While I don't disagree with your three main points, what amazes me is the lengths people who "don't believe in market timing" will go to rationalize market timing. Unless you're using the CAPE to make changes to your portfolio (i.e. market timing) then it is useless, however informative it might be.

Here's some history for you:

The first time the CAPE surpassed this level was in January 1998. It remained above the current level for over three years, until March 2001. During that period the total return of the S&P 500 was 28%, making an annualized return just over 8%.
Was that an insane period? Had people learned their lessons from that period?

Thesaints
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Thesaints » Mon Jan 08, 2018 1:11 am

willthrill81 wrote:
Sun Jan 07, 2018 11:55 pm
In all of the ten year periods from 1900-2012, there were 42 where annual returns were 10% or higher. In 93% of those periods, the starting CAPE was below 20. Only 3 of those 42 year periods began with CAPE above 20 and ended with 10% or higher annual returns. I'd say that's pretty darned predictive.
Actually, it is not, unless we specify in how many periods overall starting CAPE was above 20 and what is the distribution of results when it was and when it was not.

bgf
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by bgf » Mon Jan 08, 2018 8:48 am

it is beyond me how a board dedicated to an investing strategy that eschews valuing individual companies due to the theoretical and empirical difficulties inherent to that approach would then be so enamored with an over-simplified and fundamentally flawed 'valuation metric,' such as CAPE.

just ignore it.

i wish i could block all threads that contain "Shiller" "CAPE" "PE10" etc... they just get me worked up.
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Bastiat
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Bastiat » Mon Jan 08, 2018 10:22 am

flyingaway wrote:
Mon Jan 08, 2018 12:38 am
Bastiat wrote:
Mon Jan 08, 2018 12:08 am
nedsaid wrote:
Sun Jan 07, 2018 12:57 pm
Bastiat wrote:
Sun Jan 07, 2018 9:58 am
I believe that the CAPE is currently around 33.27; apart from that, what is there to "believe"? The US equity market is going to be disappointing relative to what?

How do you plan on using this information? If one were only to buy when CAPE is below the mean, the only buying window they'd have had in the past couple decades is about a month in 2009. What actionable strategy based on the CAPE has been shown to consistently beat the market?

According to the market, the information is discounted.
Wall of Text
While I don't disagree with your three main points, what amazes me is the lengths people who "don't believe in market timing" will go to rationalize market timing. Unless you're using the CAPE to make changes to your portfolio (i.e. market timing) then it is useless, however informative it might be.

Here's some history for you:

The first time the CAPE surpassed this level was in January 1998. It remained above the current level for over three years, until March 2001. During that period the total return of the S&P 500 was 28%, making an annualized return just over 8%.
Was that an insane period? Had people learned their lessons from that period?
Given that the historical annualized total return of the S&P 500 is around 9% it doesn't seem very "insane" to me. Keep in mind we're talking about the S&P500, not the NASDAQ.

I'm also not sure what lessons people were supposed to learn from that period, excepting that CAPE should not have been used to time the market, unless missing a gain of 28% is somehow part of one's IPS.

Bastiat
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Bastiat » Mon Jan 08, 2018 10:34 am

willthrill81 wrote:
Sun Jan 07, 2018 11:55 pm
staythecourse wrote:
Sun Jan 07, 2018 11:34 pm
So my point was neither PE1 nor PE10 was predictive AND there wasn't much difference between using PE1 vs. PE10 (a surprise to many folks).
In all of the ten year periods from 1900-2012, there were 42 where annual returns were 10% or higher. In 93% of those periods, the starting CAPE was below 20. Only 3 of those 42 year periods began with CAPE above 20 and ended with 10% or higher annual returns. I'd say that's pretty darned predictive.
That's not predictive at all if only 7% of 10 years periods in general start with CAPE above 20. I don't know whether they do or not, just pointing out the potential faulty generalization.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by deltaneutral83 » Mon Jan 08, 2018 10:44 am

letsgobobby wrote:
Sun Jan 07, 2018 2:56 pm

I'll take the blue line, please
In the other two examples we see a 40% reduction in equities over 6 years and 8 years respectively. Either of those would be a slow drip we haven't' seen in quite a while.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Mon Jan 08, 2018 11:20 am

Thesaints wrote:
Mon Jan 08, 2018 1:11 am
willthrill81 wrote:
Sun Jan 07, 2018 11:55 pm
In all of the ten year periods from 1900-2012, there were 42 where annual returns were 10% or higher. In 93% of those periods, the starting CAPE was below 20. Only 3 of those 42 year periods began with CAPE above 20 and ended with 10% or higher annual returns. I'd say that's pretty darned predictive.
Actually, it is not, unless we specify in how many periods overall starting CAPE was above 20 and what is the distribution of results when it was and when it was not.
Here's a table with all of the periods that I already posted in this thread. CAPE was above 20 in 26 of the 103 periods. The negative relationship between CAPE and 10 year returns is clear.

Image

This chart is "of yearly CAPE values back to 1900 and future 10 year returns" in the U.S. from 1900 to 2012.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Da5id » Mon Jan 08, 2018 11:28 am

Bastiat wrote:
Mon Jan 08, 2018 12:08 am
While I don't disagree with your three main points, what amazes me is the lengths people who "don't believe in market timing" will go to rationalize market timing. Unless you're using the CAPE to make changes to your portfolio (i.e. market timing) then it is useless, however informative it might be.
Untrue. You can use CAPE without "market timing" per se. For example, you might use current CAPE and the attending projected depressed equity returns to say that an initial 3% SWR is a good target if retiring today instead of the more commonly cited 4%...

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Mon Jan 08, 2018 12:56 pm

Da5id wrote:
Mon Jan 08, 2018 11:28 am
Bastiat wrote:
Mon Jan 08, 2018 12:08 am
While I don't disagree with your three main points, what amazes me is the lengths people who "don't believe in market timing" will go to rationalize market timing. Unless you're using the CAPE to make changes to your portfolio (i.e. market timing) then it is useless, however informative it might be.
Untrue. You can use CAPE without "market timing" per se. For example, you might use current CAPE and the attending projected depressed equity returns to say that an initial 3% SWR is a good target if retiring today instead of the more commonly cited 4%...
Right. Kitces found that the correlation between CAPE and the safe withdrawal rate to be an impressive -.74, a strong relationship.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by cherijoh » Mon Jan 08, 2018 1:17 pm

nedsaid wrote:
Sun Jan 07, 2018 12:57 pm
What I have been saying are three things. First, if you haven't rebalanced your portfolio in a while, this might be a good time to do so. Second, if valuations are making you nervous, nothing wrong with taking a bit off the top. Better to "panic" when stocks are at all time highs rather than after a 30-50% drop. Third, a bull market like this is a good time to re-evaluate your need and ability to take risk as well as your asset allocation. My guess is that most investors are taking more risk than what is perceived. It is a good time to do life planning when things are going well. I just think it is a good idea for investors to look ahead. A bit of contrarian thinking is also good for investors.

So I am not ringing a bell and calling a market top. I am not inciting panic. Actually, because of a lack of euphoria, I think this bull market could go on a while longer. The economy is starting to roar and market optimism might well be justified. What I am saying is to exercise prudence and caution knowing that bad things can happen to good markets. There are folks here who have "won the game" or who are getting close and this bull market is a great time for them to take a lower risk profile with less stocks and more bonds.

If you are in your twenties or early thirties, don't give any of this any thought. You have many years to contribute to your retirement accounts and many years to invest. Earnings can easily catch up with and surpass high market expectations and valuations over 30-40 years.
I think all the euphoria is in the Bitcoin market! :oops:

I will admit to trimming my stock holdings beyond what would be considered normal rebalancing. But at this point in my life (less than a year from retirement) I'm willing to give up some upside potential to temper the consequences of a large correction in the first year or two of retirement.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by randomguy » Mon Jan 08, 2018 1:57 pm

willthrill81 wrote:
Sun Jan 07, 2018 11:55 pm
staythecourse wrote:
Sun Jan 07, 2018 11:34 pm
So my point was neither PE1 nor PE10 was predictive AND there wasn't much difference between using PE1 vs. PE10 (a surprise to many folks).
In all of the ten year periods from 1900-2012, there were 42 where annual returns were 10% or higher. In 93% of those periods, the starting CAPE was below 20. Only 3 of those 42 year periods began with CAPE above 20 and ended with 10% or higher annual returns. I'd say that's pretty darned predictive.
Well in ~70% of all cases CAPE10 was below 10 if things were totally uncorrelated, you would expect 30+ cases to start with a PE10 of less <20. And yes I would expect lower CAPE10 to lead to higher returns but the question is enough to matter. If you look historically there are a only a couple periods with PE10s>20. The early 00s, the 1920s, the 1960s, and 1992+. All of the results are a function of those sections. The odds of chance playing a role (i.e.was stagflation inevitable as a result of high PE10s or was it a result of political/economic policies?) is pretty high

Lets look at the numbers since the accounting rule change (i.e. remember the definition of earnings isn't constant)
2003 22.9 8.82%
2004 27.66 9.2%
2005 26.59 9.49%
2006 26.47 9.15%
2007 27.36 5.46%
2008 24.02 10.41%

6 periods with CAPE10 above 20. 5 out of 6 with returns above 8.5%. Not your magical 10% but still pretty good.

Over the past 30 years, sitting out the market when PE10>20 hasn't exactly been a winning strategy. YOu (and me too) might prefer to invest with a PE10 of <15, but that isn't the choice we have. It is will we make more money investing at PE10 of >20 or waiting for it to drop. So far the answer has been to invest. Who knows if that will continue or not. Either the rules have changed and we should expect PE10>20 to be the new normal, or we are in a huge bubble and we are going to revert back to the single digits that dominated most of the 1900s.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Snowjob » Mon Jan 08, 2018 2:32 pm

zaboomafoozarg wrote:
Sun Jan 07, 2018 12:50 pm
Bastiat wrote:
Sun Jan 07, 2018 9:58 am
I believe that the CAPE is currently around 33.27; apart from that, what is there to "believe"? The US equity market is going to be disappointing relative to what?
Bitcoin? :D

For the record I never bought any, and I am reminded of this blunder by people on Facebook and at work just about every day.
I feel your pain. so. much.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by marcopolo » Mon Jan 08, 2018 4:11 pm

willthrill81 wrote:
Mon Jan 08, 2018 11:20 am
Thesaints wrote:
Mon Jan 08, 2018 1:11 am
willthrill81 wrote:
Sun Jan 07, 2018 11:55 pm
In all of the ten year periods from 1900-2012, there were 42 where annual returns were 10% or higher. In 93% of those periods, the starting CAPE was below 20. Only 3 of those 42 year periods began with CAPE above 20 and ended with 10% or higher annual returns. I'd say that's pretty darned predictive.
Actually, it is not, unless we specify in how many periods overall starting CAPE was above 20 and what is the distribution of results when it was and when it was not.
Here's a table with all of the periods that I already posted in this thread. CAPE was above 20 in 26 of the 103 periods. The negative relationship between CAPE and 10 year returns is clear.

Image

This chart is "of yearly CAPE values back to 1900 and future 10 year returns" in the U.S. from 1900 to 2012.
I think that table maybe only includes data thru 2011. CAPE10 has been >20 since Oct 2011. We had >15% return in 2012 (S&P 500). But, we don't see that reflected in the table.

Not sure why the table was limited to this range, since it is now 2018, and we have the data thru 2017.
In any case, we see that prior to 2011, not a single case where CAPE10 > 20 and return > 15%. In the 6 years since then (2012 - 2017), there have been 3 years (2012, 2013, and 2017) that meet that criteria, and another 2 that would fall in the 10-15% bin of your histogram. Not sure what to make of that, but it certainly muddies the water regarding making any statement about the predictive power of CAPE10 for any given years performance. Maybe it does better for longer horizons. But whether that continues to be true given the structural changes to how it is computed remains to be seen.
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by HomerJ » Mon Jan 08, 2018 4:19 pm

marcopolo wrote:
Mon Jan 08, 2018 4:11 pm
Not sure why the table was limited to this range, since it is now 2018, and we have the data thru 2017.
In any case, we see that prior to 2011, not a single case where CAPE10 > 20 and return > 15%. In the 6 years since then (2012 - 2017), there have been 3 years (2012, 2013, and 2017) that meet that criteria, and another 2 that would fall in the 10-15% bin of your histogram. Not sure what to make of that, but it certainly muddies the water regarding making any statement about the predictive power of CAPE10 for any given years performance. Maybe it does better for longer horizons. But whether that continues to be true given the structural changes to how it is computed remains to be seen.
Basically the past 25 years have not conformed very well to the model created by the previous 75 years of "data".

If you have three "hundred-year floods" over 10 years, it's certainly possible you just were very unlucky.

It's ALSO reasonable to wonder if the model has a flaw, or if variables have changed.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Buttery Lobster » Mon Jan 08, 2018 6:48 pm

marcopolo wrote:
Mon Jan 08, 2018 4:11 pm
Not sure why the table was limited to this range, since it is now 2018, and we have the data thru 2017.
In any case, we see that prior to 2011, not a single case where CAPE10 > 20 and return > 15%. In the 6 years since then (2012 - 2017), there have been 3 years (2012, 2013, and 2017) that meet that criteria, and another 2 that would fall in the 10-15% bin of your histogram. Not sure what to make of that, but it certainly muddies the water regarding making any statement about the predictive power of CAPE10 for any given years performance. Maybe it does better for longer horizons. But whether that continues to be true given the structural changes to how it is computed remains to be seen.
I wouldn't consider CAPE10 > 20 to be a great cut-off point. Star Capital published a paper on predicting returns using data U.S. and international data from 1979 through 2015 and the CAPE10 20-25 range (647 observations) indeed had median annual returns of 5.7%. Even 25-30 (with 280 observations) had median returns of 4.1%. It's when you get above 30 (585 months when this happened across multiple countries) that the median return was 0.5% (-0.3% for the U.S.). On the other end of the spectrum, CAPE10 in the 0-10 range returned 11.7%, and 10-15 returned 8.7%.

Likewise, the same report showed a strong relationship between PB and subsequent 10-15 year returns. 14.1% median annual returns when PB was under 1, 9.9% between 1 and 1.5. 0.6% over 3.

I don't think there's much value trying to parse the middle range, but the results for both ratios are pretty compelling when CAPE10 is anywhere under 15 or above 30, and when PB is under 1.5 and above 3.

Make what you will of the current S&P 500 CAPE of 33.33 and price-to-book at 3.44. Both are solidly in the "extreme" category.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Thesaints » Mon Jan 08, 2018 7:38 pm

Buttery Lobster wrote:
Mon Jan 08, 2018 6:48 pm
Both are solidly in the "extreme" category.
Just like interest rates...

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by nedsaid » Mon Jan 08, 2018 8:49 pm

Bastiat wrote:
Mon Jan 08, 2018 12:08 am

While I don't disagree with your three main points, what amazes me is the lengths people who "don't believe in market timing" will go to rationalize market timing. Unless you're using the CAPE to make changes to your portfolio (i.e. market timing) then it is useless, however informative it might be.

Here's some history for you:

The first time the CAPE surpassed this level was in January 1998. It remained above the current level for over three years, until March 2001. During that period the total return of the S&P 500 was 28%, making an annualized return just over 8%.
I have admitted to market timing in its mildest forms. I don't do the moving averages thing or subscribe to market timing newsletters or watch for a magic indicator to flash. Pretty much I get more cautious as valuations zoom and I am always on the lookout for cheap assets. Not too many things that are cheap right now. Maybe Emerging Markets.

As far as your historical example, I want to point out that the stock market didn't bottom out in March of 2001. The bear market continued well into 2002. The US Stock Market was essentially flat from early 2000 until maybe 2012. It appears 2013 was the time the market broke out. Before that, from the early 2000 peak two 50% down markets and two recoveries that brought you have to even over a 12 year period. Valuations really do matter.
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by asif408 » Mon Jan 08, 2018 9:14 pm

nedsaid wrote:
Mon Jan 08, 2018 8:49 pm
The US Stock Market was essentially flat from early 2000 until maybe 2012. It appears 2013 was the time the market broke out. Before that, from the early 2000 peak two 50% down markets and two recoveries that brought you have to even over a 12 year period. Valuations really do matter.
And just to illustrate, here is the return of the US stock market vs. other equities that are potential diversifiers (international, emerging markets, REITs, Precious Metals Equities, Energy) between 2000 and 2010: http://quotes.morningstar.com/chart/fun ... 2%3A955%7D. The dark green line is US stocks. All of the diversifiers performed better over that time period, some dramatically, particularly emerging markets, REITs, and the stocks of commodities producers. And not surprisingly, their valuations were lower (in the case of emerging markets, significantly lower) than US equities in 2000.

Being diversified over the "lost decade" in US stocks into other areas of the market with lower valuations did help over the decade. During the 2000-2002 bear market, REITs, PME, and Energy had positive returns while US, International, and Emerging were all down 40%+. An although International and Emerging markets fell with US stocks during this time, they recovered more quickly and outperformed in the 8 following years. In 2007-2009 none of those diversifiers helped. But all valuations were high in 2007.

So it appears valuations do matter, less so for younger investors but more so if you are nearing retirement or do not have a long term investment period. And the biggest benefit to CAPE is not moving from stocks to bonds, but moving among stocks. Diversification appears to be most beneficial when valuations are significantly different among asset classes (2000-2002) and not so helpful when everything is expensive (2007). Of course, over the last 5-7 years these diversifiers have performed worse, and their valuations are lower: http://quotes.morningstar.com/chart/fun ... 2%3A955%7D.

So if history repeats itself at some point the diversifiers with lower valuations should provide some benefit. In 2000, an investor who shifted into emerging markets, REITs, PMEs, and energy benefitted greatly. Now, in 2018, most of those asset classes (with the exception of REITs) also have lower valuations.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by flyingaway » Mon Jan 08, 2018 10:16 pm

Bastiat wrote:
Mon Jan 08, 2018 10:22 am
flyingaway wrote:
Mon Jan 08, 2018 12:38 am
Bastiat wrote:
Mon Jan 08, 2018 12:08 am
nedsaid wrote:
Sun Jan 07, 2018 12:57 pm
Bastiat wrote:
Sun Jan 07, 2018 9:58 am
I believe that the CAPE is currently around 33.27; apart from that, what is there to "believe"? The US equity market is going to be disappointing relative to what?

How do you plan on using this information? If one were only to buy when CAPE is below the mean, the only buying window they'd have had in the past couple decades is about a month in 2009. What actionable strategy based on the CAPE has been shown to consistently beat the market?

According to the market, the information is discounted.
Wall of Text
While I don't disagree with your three main points, what amazes me is the lengths people who "don't believe in market timing" will go to rationalize market timing. Unless you're using the CAPE to make changes to your portfolio (i.e. market timing) then it is useless, however informative it might be.

Here's some history for you:

The first time the CAPE surpassed this level was in January 1998. It remained above the current level for over three years, until March 2001. During that period the total return of the S&P 500 was 28%, making an annualized return just over 8%.
Was that an insane period? Had people learned their lessons from that period?
Given that the historical annualized total return of the S&P 500 is around 9% it doesn't seem very "insane" to me. Keep in mind we're talking about the S&P500, not the NASDAQ.

I'm also not sure what lessons people were supposed to learn from that period, excepting that CAPE should not have been used to time the market, unless missing a gain of 28% is somehow part of one's IPS.
People playing bitcoin also can claim they made good gains last year and can laugh at people who missed that period.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by HomerJ » Mon Jan 08, 2018 10:22 pm

nedsaid wrote:
Mon Jan 08, 2018 8:49 pm
Bastiat wrote:
Mon Jan 08, 2018 12:08 am

While I don't disagree with your three main points, what amazes me is the lengths people who "don't believe in market timing" will go to rationalize market timing. Unless you're using the CAPE to make changes to your portfolio (i.e. market timing) then it is useless, however informative it might be.

Here's some history for you:

The first time the CAPE surpassed this level was in January 1998. It remained above the current level for over three years, until March 2001. During that period the total return of the S&P 500 was 28%, making an annualized return just over 8%.
I have admitted to market timing in its mildest forms. I don't do the moving averages thing or subscribe to market timing newsletters or watch for a magic indicator to flash. Pretty much I get more cautious as valuations zoom and I am always on the lookout for cheap assets. Not too many things that are cheap right now. Maybe Emerging Markets.

As far as your historical example, I want to point out that the stock market didn't bottom out in March of 2001. The bear market continued well into 2002. The US Stock Market was essentially flat from early 2000 until maybe 2012. It appears 2013 was the time the market broke out. Before that, from the early 2000 peak two 50% down markets and two recoveries that brought you have to even over a 12 year period. Valuations really do matter.
Valuations really don't matter. Money invested at the very top in March 2000 has returned about 6% a year over the past 18 years.

That's investing at the highest PE ratio in U.S. history... you still got a 6% long-term return. Read that again. Investing at the worst possible time in the past 30 years, and you've made 6% a year.

And all the OTHER years you invested (1996,1997,1998,1999,2001,2002,2003,2004,2005,2006, etc.) have returned FAR more.

Just stay the course, save each year, and watch the money grow.

Now, if you are approaching retirement, you may no longer have the "long-term" to wait. You may need to start spending that money in 3 years. So in that case, yes, it's better to have a more conservative allocation that can withstand a crash where you don't break even for 5-10 years.

But that's true regardless of valuations. High valuations may indicate a crash is more likely, but the risk is never zero. One would be pretty foolish to be 100% in stocks 3 years from retirement just because valuations were "normal".

I submit that age and years to retirement are the far more important variables for determining an AA than valuations.

Now high valuations may convince you to go slightly more conservative than normal... maybe 50/50 instead of 60/40. But that's just tweaking it a little bit. The main reason one is in the 50/50 range in the first place is that he or she has achieved his or her "number", and he or she is very close to retirement.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by InvestInPasta » Tue Jan 09, 2018 4:32 am

nedsaid wrote:
Mon Jan 08, 2018 8:49 pm
Valuations really do matter.
I agree, but it's hard to stay the course:

January 1993 CAPE had already reached high valuation (>20)
Market kept growing...

January 1997 CAPE had reached 28.33
Market kept growing...

January 1998 CAPE had already skyrocketed to 32.86 (like today value).
Market kept growing...

S&P500 Total Nominal Return (excluding dividend) from Jan 93 to Jan 2000 was: 227% (CAGR 18.47%) :shock:
S&P500 Total Nominal Return (excluding dividend) from Jan 97 to Jan 2000 was: 86% :shock: :shock:
S&P500 Total Nominal Return (excluding dividend) from Jan 98 to Jan 2000 was: 48% :shock: :shock: :shock:
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by nedsaid » Tue Jan 09, 2018 10:49 pm

HomerJ wrote:
Mon Jan 08, 2018 10:22 pm

Valuations really don't matter. Money invested at the very top in March 2000 has returned about 6% a year over the past 18 years.
You are a brave man. All that 6% return has come since about 2012. The US Stock Market was flat from March 2000 until sometime in 2012. You had to wait twelve years to get any return at all. Ignore valuations at your peril.

Further on, you proceeded to make my point.
HomerJ said:
And all the OTHER years you invested (1996,1997,1998,1999,2001,2002,2003,2004,2005,2006, etc.) have returned FAR more.
Though I think the US Stock Market is getting expensive here, this isn't a bubble. Other than rebalancing or maybe taking a bit off the top, I am not telling people to re-allocate their portfolios. It is, however, a good time to re-evaluate the risks of your portfolio and asset allocation. My guess is that people are taking more risk than they realize. Risks increase as valuations rise. Even Homer seems to acknowledge that valuations affect future expected returns.
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by nedsaid » Tue Jan 09, 2018 10:53 pm

InvestInPasta wrote:
Tue Jan 09, 2018 4:32 am
nedsaid wrote:
Mon Jan 08, 2018 8:49 pm
Valuations really do matter.
I agree, but it's hard to stay the course:

January 1993 CAPE had already reached high valuation (>20)
Market kept growing...

January 1997 CAPE had reached 28.33
Market kept growing...

January 1998 CAPE had already skyrocketed to 32.86 (like today value).
Market kept growing...

S&P500 Total Nominal Return (excluding dividend) from Jan 93 to Jan 2000 was: 227% (CAGR 18.47%) :shock:
S&P500 Total Nominal Return (excluding dividend) from Jan 97 to Jan 2000 was: 86% :shock: :shock:
S&P500 Total Nominal Return (excluding dividend) from Jan 98 to Jan 2000 was: 48% :shock: :shock: :shock:
What happened after March 2000? Hint: Market was down over 50% in a bear market that lasted over two years.

You are right that nobody rings a bell when markets top out. What is the magic CAPE number? Nobody knows. What we do know is that as the number gets higher and higher that future expected returns get lower and lower. Greater and greater risk for less and less future return. The least you can do is not let your stock allocation drift upwards and that is what I have been doing.
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by BuyAndHoldOn » Sat Jan 13, 2018 3:10 pm

Threads like this - with the quality insights and sources - are why I frequent this forum.

This thread reminded me of another thread I saw a few years ago.
viewtopic.php?f=10&t=160895
letsgobobby wrote:
Thu Mar 12, 2015 1:50 pm
Oh, I'm definitely timing.

And I'm definitely tinkering.
I thought of that thread because it made me wonder: How much should I be tinkering with my portfolio based on valuation? If someone did go to majority international [in equities] in early-2015, they would have had a rough ride through early 2016, and under-performed the S&P 500. But they'd be "sitting pretty" starting out in 2018.

My takeaway from high US CAPE [etc.] is to do more international investing, including [up to a certain point] overweighting EM. And to be prepared for more volatility, should the "Goldilocks" period we experienced in 2017 come to an end.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Sat Jan 13, 2018 3:19 pm

BuyAndHoldOn wrote:
Sat Jan 13, 2018 3:10 pm
Threads like this - with the quality insights and sources - are why I frequent this forum.

This thread reminded me of another thread I saw a few years ago.
viewtopic.php?f=10&t=160895
letsgobobby wrote:
Thu Mar 12, 2015 1:50 pm
Oh, I'm definitely timing.

And I'm definitely tinkering.
I thought of that thread because it made me wonder: How much should I be tinkering with my portfolio based on valuation? If someone did go to majority international [in equities] in mid-2015, they would have had a rough ride through early 2016, but they'd be "sitting pretty" right now.

My takeaway from high US CAPE [etc.] is to do more international investing, including [up to a certain point] overweighting EM. And to be prepared for more volatility, should the "Goldilocks" period we experienced in 2017 come to an end.
Even though I am a trend follower (relative strength by 7 month MA), I've not seen anyone devise a compelling backtested argument for using valuations for market timing purposes. There is just too much variation in the historic returns. If you look above the colored table I posted, you'll see that when CAPE was historically 'high' (i.e. above 20), subsequent ten year returns ranged from -1.38% to 12.07%. Obviously, there's a huge amount of variation there.

Honestly, I think that investors should use valuation metrics like CAPE as one input among many to help them create their return expectations. As a market timing metric, I think they should be avoided.
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by BuyAndHoldOn » Wed Jan 17, 2018 8:54 pm

Could CAPE improve (go down) once we are 10 +years removed from the Financial Crisis? Maybe by some time in 2019?

Just thinking optimistically: Maybe earnings continue to go up in the US, and the Skew caused by late 2008/early 2009 leaves the statistics, and CAPE reaches more normal levels. (At least below 30).

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by roflwaffle » Wed Jan 17, 2018 10:51 pm

nedsaid wrote:
Sun Jan 07, 2018 12:57 pm
Bastiat wrote:
Sun Jan 07, 2018 9:58 am
I believe that the CAPE is currently around 33.27; apart from that, what is there to "believe"? The US equity market is going to be disappointing relative to what?

How do you plan on using this information? If one were only to buy when CAPE is below the mean, the only buying window they'd have had in the past couple decades is about a month in 2009. What actionable strategy based on the CAPE has been shown to consistently beat the market?

According to the market, the information is discounted.
The CAPE or P/E 10 is an imperfect benchmark but that doesn't mean that it is useless. The academic research and market history shows that when stock market valuations get to be sky-high, that disappointing stock market performance follows. Just look at a performance chart of the US stock market and see how the market performed in the aftermath of the roaring twenties where the market peaked in 1929, the aftermath of the go-go sixties and the Nifty-Fifty with a peak in 1968, and the aftermath of the late 1990's internet and high tech mania which peaked in early 2000.
It's not useless, but it might not be actionable either if we need one or two quarters to hash out earnings.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Shikoku » Wed Jan 17, 2018 11:19 pm

Following is somewhat relevant to this thread: "Shiller ... still got money in the U.S. markets, though he has been tilting toward Europe and emerging markets, in part, because they look cheaper."
https://www.marketwatch.com/story/dont- ... 2017-10-04
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by stlutz » Wed Jan 17, 2018 11:36 pm

Could CAPE improve (go down) once we are 10 +years removed from the Financial Crisis? Maybe by some time in 2019?
The CAPE is 33 now. Getting rid of the financial-crisis related earnings decline would drop it down to 29 or 30. Not a dramatic difference (which is the point of CAPE--reduce the impact of shorter-term fluctuations).

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by stlutz » Wed Jan 17, 2018 11:51 pm

I would suggest there are two different things to consider here.

a) CAPE as a market-timing tool. This simply doesn't work that well. The "normal" state of markets is that the CAPE is "elevated". Moving the 2008-9 years out of the equation, the tax cut, and possibly a 10% correction could all work together to restore it back to a more normal level of elevation in 2018. That type of a scenario doesn't create a burning desire in me to unload all of my stocks.

b) CAPE as a planning tool. This works relatively well. For example, if you are in retirement using a cautious withdrawal strategy makes sense given today's valuations. That wouldn't have been that necessary in 2012. This isn't so much of a market timing concern as it is a matter of more basic math. Higher multiples mean that you get less benefit as a shareholder from current earnings--you are completely dependent on growth for prices to go up. When multiples are low, then current earnings generate more return for you.

That said, this does not equate to saying the lower multiples always equal higher returns. There isn't an obvious choice between high multiples and high growth vs. low multiples and low growth. Investing nirvana is of course low multiples and high growth. We got that at the market bottom in 2009 (though we didn't know about it on the growth side yet at the time).

In more normal circumstances, one should be aware that the market prices its expectations for growth in. Low multiples indicate that the market is not expecting a ton of growth (and vice versa). The market is often wrong, but it's always good to understand what the market is saying and why before pronouncing it to be an idiot.

In short, my view is that market multiples are useful indicators of future returns, but they are far from being the holy grail.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by HomerJ » Thu Jan 18, 2018 11:43 am

stlutz wrote:
Wed Jan 17, 2018 11:51 pm
b) CAPE as a planning tool. This works relatively well. For example, if you are in retirement using a cautious withdrawal strategy makes sense given today's valuations. That wouldn't have been that necessary in 2012.
This thread started with an article from Research Affiliates. Research Affiliates had an article in 2012 forecasting 6% nominal as the expected return for stocks, well below the 9% historical return. And 2% for bonds or a 4.4% returns for a 60/40 portfolio. They warned back then that investors better be conservative. It was indeed considered necessary in 2012.

https://www.researchaffiliates.com/docu ... Return.pdf

For 25 years, CAPE has been "high". For 25 years, CAPE proponents have indeed warned people to use a cautious withdrawal strategy, since expected returns are low.

We WILL see a crash, and returns will go much lower. Maybe even starting tomorrow. But "experts" have proven again and again that forecasting actual numbers is a fools game.

It's certainly not as easy as just looking at a single ratio.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by stlutz » Thu Jan 18, 2018 10:44 pm

This thread started with an article from Research Affiliates. Research Affiliates had an article in 2012 forecasting 6% nominal as the expected return for stocks, well below the 9% historical return. And 2% for bonds or a 4.4% returns for a 60/40 portfolio. They warned back then that investors better be conservative. It was indeed considered necessary in 2012.

https://www.researchaffiliates.com/docu ... Return.pdf

For 25 years, CAPE has been "high". For 25 years, CAPE proponents have indeed warned people to use a cautious withdrawal strategy, since expected returns are low.

We WILL see a crash, and returns will go much lower. Maybe even starting tomorrow. But "experts" have proven again and again that forecasting actual numbers is a fools game.

It's certainly not as easy as just looking at a single ratio.
Perhaps my recommendation would be to listen to stlutz and not Rob Arnott. :twisted:

Relative to other Price-to-X ratios, I'm actually not a big CAPE fan because earnings from 10 years ago aren't that relevant (otherwise people should say that standard P/(latest 12 months E) and P/(E from 10 years ago) are equally good ways to evaluate a stock).

Quite aside from that, whether you look at CAPE, PE, price-to-book, and price-to-sales, current valuations are quite elevated. That's not versus questionable data from the 1870s but versus known-to-be-good data from the past 30 years.

I'm no good at predicting crashes, so I'm not going to do so. However, I am willing to say that retiring today planning to use a 6% withdrawal rate isn't such a good plan. (And for the record, I'm not suggesting that you are advocating such an approach).

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by siamond » Fri Jan 19, 2018 7:36 am

willthrill81 wrote:
Sun Jan 07, 2018 7:58 pm
You are basically arguing for a deductive approach rather than an inductive one. I agree that the deductive approach as you've laid it out is more convincing, but the inductive approach is perfectly plausible as well IF the pattern can be replicated with other data. With CAPE, this has indeed been done as it has shown itself to be a good, though not perfect, predictor of future returns in markets around the globe.
Could you please share what research you found justifying the last statement? I mean, besides StarCapital? Just curious.

EDIT: oops, sorry, didn't see that the RA article in the OP did address this precise question! My bad.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Bacchus01 » Fri Jan 19, 2018 8:12 am

What is the CAPE when 2008 or 2009 is removed?

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Bacchus01 » Fri Jan 19, 2018 8:15 am

stlutz wrote:
Thu Jan 18, 2018 10:44 pm
This thread started with an article from Research Affiliates. Research Affiliates had an article in 2012 forecasting 6% nominal as the expected return for stocks, well below the 9% historical return. And 2% for bonds or a 4.4% returns for a 60/40 portfolio. They warned back then that investors better be conservative. It was indeed considered necessary in 2012.

https://www.researchaffiliates.com/docu ... Return.pdf

For 25 years, CAPE has been "high". For 25 years, CAPE proponents have indeed warned people to use a cautious withdrawal strategy, since expected returns are low.

We WILL see a crash, and returns will go much lower. Maybe even starting tomorrow. But "experts" have proven again and again that forecasting actual numbers is a fools game.

It's certainly not as easy as just looking at a single ratio.
Perhaps my recommendation would be to listen to stlutz and not Rob Arnott. :twisted:

Relative to other Price-to-X ratios, I'm actually not a big CAPE fan because earnings from 10 years ago aren't that relevant (otherwise people should say that standard P/(latest 12 months E) and P/(E from 10 years ago) are equally good ways to evaluate a stock).

Quite aside from that, whether you look at CAPE, PE, price-to-book, and price-to-sales, current valuations are quite elevated. That's not versus questionable data from the 1870s but versus known-to-be-good data from the past 30 years.

I'm no good at predicting crashes, so I'm not going to do so. However, I am willing to say that retiring today planning to use a 6% withdrawal rate isn't such a good plan. (And for the record, I'm not suggesting that you are advocating such an approach).
But didn’t the tax change just create a large shift in P/E for US companies? How do P/Es look through that lens

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willthrill81
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Fri Jan 19, 2018 11:15 am

siamond wrote:
Fri Jan 19, 2018 7:36 am
willthrill81 wrote:
Sun Jan 07, 2018 7:58 pm
You are basically arguing for a deductive approach rather than an inductive one. I agree that the deductive approach as you've laid it out is more convincing, but the inductive approach is perfectly plausible as well IF the pattern can be replicated with other data. With CAPE, this has indeed been done as it has shown itself to be a good, though not perfect, predictor of future returns in markets around the globe.
Could you please share what research you found justifying the last statement? I mean, besides StarCapital? Just curious.

EDIT: oops, sorry, didn't see that the RA article in the OP did address this precise question! My bad.
I believe that Rob Arnott and Meb Faber have both done work in this area in support of my statement.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

staythecourse
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by staythecourse » Fri Jan 19, 2018 11:25 am

bgf wrote:
Mon Jan 08, 2018 8:48 am
it is beyond me how a board dedicated to an investing strategy that eschews valuing individual companies due to the theoretical and empirical difficulties inherent to that approach would then be so enamored with an over-simplified and fundamentally flawed 'valuation metric,' such as CAPE.

just ignore it.

i wish i could block all threads that contain "Shiller" "CAPE" "PE10" etc... they just get me worked up.
Man, another brother from the same mother. :D

I don't understand folks love affair with super simple formulas that have not shown to be predictive yet still are used as if they are the holy grail. It is like the "cap rate" with real estate investing. A super simple formula to use that ANYONE can do it 2 seconds yet is supposed to be the end all be all of investing in real estate yet no one can show me one study showing it has any predictive value.

Makes me even madder talking about it. :annoyed

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by staythecourse » Fri Jan 19, 2018 11:33 am

willthrill81 wrote:
Sun Jan 07, 2018 11:55 pm
staythecourse wrote:
Sun Jan 07, 2018 11:34 pm
So my point was neither PE1 nor PE10 was predictive AND there wasn't much difference between using PE1 vs. PE10 (a surprise to many folks).
In all of the ten year periods from 1900-2012, there were 42 where annual returns were 10% or higher. In 93% of those periods, the starting CAPE was below 20. Only 3 of those 42 year periods began with CAPE above 20 and ended with 10% or higher annual returns. I'd say that's pretty darned predictive.
Just curious if you think folks in 1900 had the data of CAPE? Also, those going forward from 1900 to current KNEW to use the number 20 as some magical number at that time (standing in the footsteps of investors at that time)? What you have done is a super simplistic data mining experiment. You basically will just find a number to give you the returns you want, i.e. torturing the data.

How about using the number 20.1 or 19.875? This is a classic example of correlation does not equal causation. Do you REALLY in your heart believe the markets are so preodained that once some random man made number turns exactly 20 that is means all returns going forward HAS to be less then 10%?

Good luck.

p.s. As I have stated Vanguard has already did the REAL statistical analysis (regression) and their correlation is poor as I already mentioned.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Fri Jan 19, 2018 11:49 am

staythecourse wrote:
Fri Jan 19, 2018 11:33 am
willthrill81 wrote:
Sun Jan 07, 2018 11:55 pm
staythecourse wrote:
Sun Jan 07, 2018 11:34 pm
So my point was neither PE1 nor PE10 was predictive AND there wasn't much difference between using PE1 vs. PE10 (a surprise to many folks).
In all of the ten year periods from 1900-2012, there were 42 where annual returns were 10% or higher. In 93% of those periods, the starting CAPE was below 20. Only 3 of those 42 year periods began with CAPE above 20 and ended with 10% or higher annual returns. I'd say that's pretty darned predictive.
Just curious if you think folks in 1900 had the data of CAPE? Also, those going forward from 1900 to current KNEW to use the number 20 as some magical number at that time (standing in the footsteps of investors at that time)? What you have done is a super simplistic data mining experiment. You basically will just find a number to give you the returns you want, i.e. torturing the data.

How about using the number 20.1 or 19.875? This is a classic example of correlation does not equal causation. Do you REALLY in your heart believe the markets are so preodained that once some random man made number turns exactly 20 that is means all returns going forward HAS to be less then 10%?

Good luck.

p.s. As I have stated Vanguard has already did the REAL statistical analysis (regression) and their correlation is poor as I already mentioned.
That's scathing. :wink:

I'm just reporting the results; interpret them as you will. The same could be said, more or less, of literally any analysis with backtested data.

There is no reason why people had to have the CAPE data we have today in order for it to impact their behavior. There are countless variables that we are not consciously aware of that have a definite impact on our attitudes and behaviors.

You're correct that correlation does not equal causation. But there is at least some theoretical reasoning for a relationship between CAPE and future market returns, enough to win a Nobel prize for the fellow who discovered the hypothesized relationship.

Correlation is not the only valid means of analyzing ratio data like this. Almost any type of analysis is possible with ratio data (i.e. interval data plus a meaningful zero point), from chi-square to ANOVA to regression to structural equation modeling to simple charts. As long as they are performed correctly, they are all 'real'.

I've said repeatedly that there is a lot of variation in the returns predicted by CAPE, which is indeed indicative of the correlation having been only a moderate one (roughly .40 for 10 year forward returns). For instance, when CAPE was over 20, the forward ten year returns have been anywhere from about -1.5% to +12%, which is a range too big to probably do a lot with, but it does seem to make one question whether 10% or higher returns are reasonable with a CAPE starting at around 30.

The future could look very different from the past, and I don't think that CAPE should be used for timing purposes. For planning purposes, maybe; it depends on each person's interpretation of the data.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by staythecourse » Fri Jan 19, 2018 12:38 pm

willthrill81 wrote:
Fri Jan 19, 2018 11:49 am
For instance, when CAPE was over 20, the forward ten year returns have been anywhere from about -1.5% to +12%, which is a range too big to probably do a lot with, but it does seem to make one question whether 10% or higher returns are reasonable with a CAPE starting at around 30.
Vanguard data shows that the correlation is very high when the tails of the PE10 are reached (25%) which I interpreted as 12.5% on this and 12.5% on that side of the returns. Crunching the numbers I believe that showed a PE10 <10 or >25 had high correlations (0.8).

The question I had after reading that was that is AFTER we looked at all the PE10 up to current. Did that same theory (extreme 25% of returns) hold true AT THE TIME the investor was sitting there in 1920 or 1941 or 1961 or 1981 or etc... OF course, the investors at that time did NOT have the current 25% tail. When they invest they have a different set of 25% tail up to their current year of investing. So that 25% tail may keep changing based on what happens for each year going forward. Does that make sense?

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by vitaflo » Fri Jan 19, 2018 1:23 pm

Bacchus01 wrote:
Fri Jan 19, 2018 8:12 am
What is the CAPE when 2008 or 2009 is removed?
CAPE7 is 28.44. See here:

http://www.philosophicaleconomics.com/2 ... per-limit/

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by HomerJ » Fri Jan 19, 2018 1:33 pm

willthrill81 wrote:
Fri Jan 19, 2018 11:15 am
siamond wrote:
Fri Jan 19, 2018 7:36 am
willthrill81 wrote:
Sun Jan 07, 2018 7:58 pm
You are basically arguing for a deductive approach rather than an inductive one. I agree that the deductive approach as you've laid it out is more convincing, but the inductive approach is perfectly plausible as well IF the pattern can be replicated with other data. With CAPE, this has indeed been done as it has shown itself to be a good, though not perfect, predictor of future returns in markets around the globe.
Could you please share what research you found justifying the last statement? I mean, besides StarCapital? Just curious.

EDIT: oops, sorry, didn't see that the RA article in the OP did address this precise question! My bad.
I believe that Rob Arnott and Meb Faber have both done work in this area in support of my statement.
What did Rob Arnott predict in the past?

Look at their ACTUAL predictions, not stuff they post in 2018 showing how their (new) model worked in 2004 and 2012. Look at their ACTUAL predictions IN 2004 and 2012, and see how they couldn't predict jack-squat.

Nobody knows enough.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by HomerJ » Fri Jan 19, 2018 1:39 pm

staythecourse wrote:
Fri Jan 19, 2018 12:38 pm
willthrill81 wrote:
Fri Jan 19, 2018 11:49 am
For instance, when CAPE was over 20, the forward ten year returns have been anywhere from about -1.5% to +12%, which is a range too big to probably do a lot with, but it does seem to make one question whether 10% or higher returns are reasonable with a CAPE starting at around 30.
Vanguard data shows that the correlation is very high when the tails of the PE10 are reached (25%) which I interpreted as 12.5% on this and 12.5% on that side of the returns. Crunching the numbers I believe that showed a PE10 <10 or >25 had high correlations (0.8).

The question I had after reading that was that is AFTER we looked at all the PE10 up to current. Did that same theory (extreme 25% of returns) hold true AT THE TIME the investor was sitting there in 1920 or 1941 or 1961 or 1981 or etc... OF course, the investors at that time did NOT have the current 25% tail. When they invest they have a different set of 25% tail up to their current year of investing. So that 25% tail may keep changing based on what happens for each year going forward. Does that make sense?

Good luck.
This. All the models today are using ex post facto information. CAPE has NOT been useful, because the numbers keep changing.

CAPE in 1996 at 25 was the highest it had been for nearly 70 years. The last time it was that high was right before the Great Depression.

No one in 1996 waited for a CAPE above 30 to act. Any CAPE followers were all expecting a crash in 1996, and many would have been lowering their stock allocation in 1992 (when CAPE crossed 20).

Academics use 1900-2017 data to show what the correct move would have been in 1992 or 1996, and actually have the chutzpah to say "See how well the model worked in the past?"

But people in 1992 only had 1900-1992 data, and the model derived from THAT data turned out to be completely wrong.

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