CAPE Fear: Why CAPE Naysayers Are Wrong

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Always passive
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CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Always passive » Sun Jan 07, 2018 12:27 am

Anothe article from RA making a case for the use of CAPE to judge long term performance. If you believe the Shiller PE10, the US equity market is going to be disappointing.
Please read....
https://www.researchaffiliates.com/en_u ... wrong.html
Any comments? For those committed to a heavy US presence in equities, can this information be discounted ?

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SimpleGift
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by SimpleGift » Sun Jan 07, 2018 1:46 am

Always passive wrote:
Sun Jan 07, 2018 12:27 am
Any comments? For those committed to a heavy US presence in equities, can this information be discounted ?
A good article, which nicely summarizes many of the issues surrounding the CAPE metric today — though the article does seem to ramble all over the waterfront on a multitude of CAPE-related topics. If there's any one conclusion, this is what I took from the piece:
Research Affiliates wrote:What is often lost in the conversation of the “right” level of CAPE is an appreciation for expectations of return in the absence of any mean reversion. Real EPS trend growth since 1871 has been 1.5%. From all-time peak earnings, as a share of GDP, dare we expect more growth than this? With a dividend yield of 2.0%, this gives us a real return (yield plus growth) of 3.5%, if valuation levels 10 years hence are exactly where they are today. (Italics in original)
Personally, I'm in the camp that U.S. stock valuations can remain in their current high range for years to come (i.e., mean reversion is not preordained), as long as interest rates stay in their current low range — and I'd be satisfied with an average real growth rate of 3.5% per year for my U.S. stock allocation. In fact, this seems a reasonable return expectation for long-term planning purposes.
Cordially, Todd

jcavana1
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by jcavana1 » Sun Jan 07, 2018 8:48 am

Just musing....3.5% real return seems about right if valuations and interest rates stay where they are.

But shouldn't we expect something less given risk of significant interest rate increase over the next 5 years.

In a taxable account 3.5% real is 3% after taxes. It is very possible in the next 12-24 months the 10 years treasury will yield >3% (after taxes). What would happen to equities in that environment? I would expect them to be hammered.

In a disaster, but not tremendously unlikely scenario, inflation accelerates, fed has to raise interest rates rapidly and the 10 yr is 5%-6% in 3-5years. In that scenario I think equities would have been very negative for the next 5 years and possibly not reach 3% real for 10 years if rates stay high.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Bastiat » 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.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by UpperNwGuy » Sun Jan 07, 2018 10:42 am

I don't plan to make any changes to my investment plan because of this article.

Nate79
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Nate79 » Sun Jan 07, 2018 12:12 pm

How well did CAPE predict 2017 return?

letsgobobby
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by letsgobobby » 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?

Buttery Lobster
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Buttery Lobster » Sun Jan 07, 2018 12:28 pm

Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
No proponents of CAPE have ever suggested it's predictive of 1-year returns. A longer time horizon is another story...
https://www.starcapital.de/fileadmin/us ... imling.pdf

We are currently over 33 in the U.S. (http://www.multpl.com/shiller-pe/), suggesting real returns close to zero for the next 10-15 years unless "this time is different."

minimalistmarc
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by minimalistmarc » Sun Jan 07, 2018 12:34 pm

Buttery Lobster wrote:
Sun Jan 07, 2018 12:28 pm
Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
No proponents of CAPE have ever suggested it's predictive of 1-year returns. A longer time horizon is another story...
https://www.starcapital.de/fileadmin/us ... imling.pdf

We are currently over 33 in the U.S. (http://www.multpl.com/shiller-pe/), suggesting real returns close to zero for the next 10-15 years unless "this time is different."
Might be different, might be the same, I don’t know so I’m just going to stay on the ride and keep buying.

Buying high, buying low, always buying, but never selling :)

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zaboomafoozarg
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by zaboomafoozarg » 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.

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zaboomafoozarg
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by zaboomafoozarg » Sun Jan 07, 2018 12:54 pm

Due to CAPE being so high I have moved a little bit of stocks to bonds/alternatives, and also moved a little bit of US stocks to international stocks.

But I'm not doing anything bigger than a 5-10% shift. Maybe that's stupid of me but I'm trying to stay the course.

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nedsaid
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by nedsaid » 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.
A fool and his money are good for business.

Buttery Lobster
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Buttery Lobster » Sun Jan 07, 2018 12:58 pm

minimalistmarc wrote:
Sun Jan 07, 2018 12:34 pm
Might be different, might be the same, I don’t know so I’m just going to stay on the ride and keep buying.

Buying high, buying low, always buying, but never selling :)
Agreed! But the U.S. isn't the only game in town and other developed markets and emerging markets (as a whole) have a CAPE in the mid to high teens currently.

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nedsaid
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by nedsaid » Sun Jan 07, 2018 1:06 pm

Buttery Lobster wrote:
Sun Jan 07, 2018 12:58 pm
minimalistmarc wrote:
Sun Jan 07, 2018 12:34 pm
Might be different, might be the same, I don’t know so I’m just going to stay on the ride and keep buying.

Buying high, buying low, always buying, but never selling :)
Agreed! But the U.S. isn't the only game in town and other developed markets and emerging markets (as a whole) have a CAPE in the mid to high teens currently.
Good point. I should have also posted that investors should be looking overseas for better valuations. I would never advise, however, that investors abandon US Stocks.
A fool and his money are good for business.

minimalistmarc
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by minimalistmarc » Sun Jan 07, 2018 1:09 pm

Buttery Lobster wrote:
Sun Jan 07, 2018 12:58 pm
minimalistmarc wrote:
Sun Jan 07, 2018 12:34 pm
Might be different, might be the same, I don’t know so I’m just going to stay on the ride and keep buying.

Buying high, buying low, always buying, but never selling :)
Agreed! But the U.S. isn't the only game in town and other developed markets and emerging markets (as a whole) have a CAPE in the mid to high teens currently.
Yes, I buy the all world which has market weighting of emerging markets.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by InvestInPasta » Sun Jan 07, 2018 2:49 pm

Even if CAPE is correct and future expected returns will be low, the future DJI path can vary greatly by still producing the same expected returns. :|

Image

Source:
Batnick's blog

If the DJI will follow the black path, I'm wondering how many of us can wait for a lower CAPE while watching the Joneses getting wildly rich for the next 10 years. :mrgreen:
When studying English I am lazier than my portfolio. Feel free to correct my English and Investng mistakes.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Always passive » Sun Jan 07, 2018 2:54 pm

Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
The Cape is not a market timer, but a long term predictor. Please read the article.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by letsgobobby » Sun Jan 07, 2018 2:56 pm

InvestInPasta wrote:
Sun Jan 07, 2018 2:49 pm
Even if CAPE is correct and future expected returns will be low, the future DJI path can vary greatly by still producing the same expected returns. :|

Image

Source:
Batnick's blog

If the DJI will follow the black path, I'm wondering how many of us can wait for a lower CAPE while watching the Joneses getting wildly rich for the next 10 years. :mrgreen:
I'll take the blue line, please

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by bgf » Sun Jan 07, 2018 3:21 pm

Always passive wrote:
Sun Jan 07, 2018 2:54 pm
Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
The Cape is not a market timer, but a long term predictor. Please read the article.
and as a long term predictor it is poor. it is a losing game to use the Shiller CAPE to make long term investment decisions.
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Sun Jan 07, 2018 3:28 pm

letsgobobby wrote:
Sun Jan 07, 2018 2:56 pm
InvestInPasta wrote:
Sun Jan 07, 2018 2:49 pm
Even if CAPE is correct and future expected returns will be low, the future DJI path can vary greatly by still producing the same expected returns. :|

Image

Source:
Batnick's blog

If the DJI will follow the black path, I'm wondering how many of us can wait for a lower CAPE while watching the Joneses getting wildly rich for the next 10 years. :mrgreen:
I'll take the blue line, please
Which you would prefer would depend not only on your risk tolerance but also on your stage in accumulation or decumulation. In the early stages of accumulation, when you have few assets to compound, you would prefer the red line. In the latter stages of accumulation, you would prefer the blue line since it has the least volatility leading up to retirement. In the decumulation phase, you would prefer the black line since the first decade or so of a 30 year retirement is critical for overall 'success' (i.e. not running out of money).
“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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willthrill81
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Sun Jan 07, 2018 3:31 pm

bgf wrote:
Sun Jan 07, 2018 3:21 pm
Always passive wrote:
Sun Jan 07, 2018 2:54 pm
Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
The Cape is not a market timer, but a long term predictor. Please read the article.
and as a long term predictor it is poor. it is a losing game to use the Shiller CAPE to make long term investment decisions.
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 shows that anything can happen, but there has been a strong tendency for long-term returns to be inversely correlated with the current CAPE. It's far from perfect, but it's far better than nothing.

Still, even if the future were to replicate the past, returns for the next 10 years could be anywhere between -1.38% and 12.07%. Most of the prior 10 year returns with a high CAPE have been between 2% and 7% though.
Last edited by willthrill81 on Sun Jan 07, 2018 3:35 pm, edited 1 time in total.
“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 Always passive » Sun Jan 07, 2018 3:33 pm

bgf wrote:
Sun Jan 07, 2018 3:21 pm
Always passive wrote:
Sun Jan 07, 2018 2:54 pm
Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
The Cape is not a market timer, but a long term predictor. Please read the article.
and as a long term predictor it is poor. it is a losing game to use the Shiller CAPE to make long term investment decisions.
Where is the data you use to make your claim?
I doubt you have read the article. Let me simplify it for you, go to the article, look at Figure 2 and read the text associated with it. Not too much to ask, right?

bgf
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by bgf » Sun Jan 07, 2018 3:34 pm

willthrill81 wrote:
Sun Jan 07, 2018 3:31 pm
bgf wrote:
Sun Jan 07, 2018 3:21 pm
Always passive wrote:
Sun Jan 07, 2018 2:54 pm
Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
The Cape is not a market timer, but a long term predictor. Please read the article.
and as a long term predictor it is poor. it is a losing game to use the Shiller CAPE to make long term investment decisions.
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 shows that anything can happen, but there has been a strong tendency for long-term returns to be inversely correlated with the current CAPE. It's far from perfect, but it's far better than nothing.
i'd rather take my 'nothing' and just bet on equities across the board.
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

bgf
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by bgf » Sun Jan 07, 2018 3:38 pm

Always passive wrote:
Sun Jan 07, 2018 3:33 pm
bgf wrote:
Sun Jan 07, 2018 3:21 pm
Always passive wrote:
Sun Jan 07, 2018 2:54 pm
Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
The Cape is not a market timer, but a long term predictor. Please read the article.
and as a long term predictor it is poor. it is a losing game to use the Shiller CAPE to make long term investment decisions.
Where is the data you use to make your claim?
I doubt you have read the article. Let me simplify it for you, go to the article, look at Figure 2 and read the text associated with it. Not too much to ask, right?
thanks for the simplification...

https://personal.vanguard.com/pdf/s338.pdf

"However, we feel it is important to stress that even
conditioning on initial P/E ratios leaves approximately
60% of the historical variation in long-term real
returns unexplained. Graphically, this negative-but imperfect
relationship between P/E ratios and future
long-run stock returns is illustrated in Figure 5. The
average negative relationship over long horizons is
evident from the fitted lines, but so is the dispersion
in actual returns around those lines.

Economically for investors, such fat-tailed deviations
from any fitted “point forecast” have been and can
be meaningful. The average is in fact a poor description
of the norm: In Figure 5, about two-thirds of 10-year
periods had realized returns that deviated from a
5% band around the best-fit line. In other words,
for a majority of history, the forecast was wrong
by a meaningful margin."
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

Engineer250
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Engineer250 » Sun Jan 07, 2018 3:41 pm

nedsaid wrote:
Sun Jan 07, 2018 12:57 pm
First, if you haven't rebalanced your portfolio in a while, this might be a good time to do so.
Excellent advice. I was surprised on the "it's time to quit playing" thread how many folks who were within 10-15 years of retirement who had allowed their stock percentage to grow above their former AA and didn't seem at all troubled by it, I guess because they had more assets than they anticipated at this age. I re-ran the numbers in my spreadsheet and see it's time for me to buy a little G Fund on Monday to get my non-equity back up 2%.
Where the tides of fortune take us, no man can know.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by randomguy » Sun Jan 07, 2018 3:45 pm

InvestInPasta wrote:
Sun Jan 07, 2018 2:49 pm

If the DJI will follow the black path, I'm wondering how many of us can wait for a lower CAPE while watching the Joneses getting wildly rich for the next 10 years. :mrgreen:
Black path would be awesome. UP at 60x or so of retirement assets and 10 years, I would be taking plenty of money off the table:) Red would suck horribly as it would potentially push off retirement by 5 years. Blue would depend a lot on what PEs were doing. Staying up at the elevated level while getting no returns? Might make me feel bad. Dropping down to 12 or so? I could live with that.

The blue line would be interesting in that it would likely be a period that favors active trading (i.e. selling when up 10% and then buying when stocks fall 8%) as we see saw up for those minimal gains. I would expect to be exposed to even more trading systems than normal:)

What you really need to see is what your balances do with these various assumptions. Depending on portfolio size and additions/subtractions, you are going to end up in radically different spots.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by whodidntante » Sun Jan 07, 2018 3:51 pm

Expected return models are usually a projection several years out (e.g. 10 years). Momentum is shorter term.

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nedsaid
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by nedsaid » Sun Jan 07, 2018 3:53 pm

Engineer250 wrote:
Sun Jan 07, 2018 3:41 pm
nedsaid wrote:
Sun Jan 07, 2018 12:57 pm
First, if you haven't rebalanced your portfolio in a while, this might be a good time to do so.
Excellent advice. I was surprised on the "it's time to quit playing" thread how many folks who were within 10-15 years of retirement who had allowed their stock percentage to grow above their former AA and didn't seem at all troubled by it, I guess because they had more assets than they anticipated at this age. I re-ran the numbers in my spreadsheet and see it's time for me to buy a little G Fund on Monday to get my non-equity back up 2%.
Well, I am the poster boy for portfolio drift. I started out as an ultraconservative investor who had his IRA in FDIC Insured Certificates of Deposit. As I learned more and as the 1980's and 1990's bull market raced on, I became increasingly aggressive. By early 2000 at age 40, I had 94% of my retirement in stocks. Half of my stocks were in individual stocks and the other half in mutual funds. Fortunately, I was learning about portfolio theory and I went to 80% stocks before everything crashed later in the year. It is amazing how brave and aggressive you get in a bull market. You just forget over time how risky stocks can be. Now at age 58, I have 66% in stocks and only 13% of my portfolio is in individual stocks. I learned painful lessons about the volatility of the stock market in general and the risks of individual stocks in particular.

So I have invested through the 2000-2002 bear market and also through the 2008-2009 bear market. Both times, the stock market fell by over 50%. I might be a bit slow but eventually even I start to absorb the lessons.
A fool and his money are good for business.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by orphic » Sun Jan 07, 2018 3:55 pm

Vanguard has their own "fair-value" CAPE that seeks to correct for secularly low interest rates and low inflation...

https://personal.vanguard.com/pdf/ISGGMMRR.pdf

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patrick013
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by patrick013 » Sun Jan 07, 2018 4:22 pm

This isn't exactly CAPE but assuming that from inflationary growth in
profits and increased earnings from the new tax laws the 500 earnings
may touch 125 this year or shortly thereafter using the most reasonable
estimates.

As interest rates rise but PE's stay high as they usually do for some time
before reacting to higher interest rates with lowering PE's seeing the
500 trading at 3000 is all but assured with a market PE of only 24.

As the saying goes when I see it I'll believe it. Thereafter, no comment.
age in bonds, buy-and-hold, 10 year business cycle

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Nate79 » Sun Jan 07, 2018 5:17 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?
Read the article. People have been crying about CAPE10 for a while now. If you made it actionable and changed your asset allocation you lost out on a nice year. Myself, I'm enjoying the 2017 20% gain.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by Nate79 » Sun Jan 07, 2018 5:18 pm

Always passive wrote:
Sun Jan 07, 2018 2:54 pm
Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
The Cape is not a market timer, but a long term predictor. Please read the article.
So it's not actionable? Yes, I agree. But you wouldn't guess that from the years of crying that the sky is falling due to high CAPE10.

letsgobobby
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by letsgobobby » Sun Jan 07, 2018 5:27 pm

Nate79 wrote:
Sun Jan 07, 2018 5:17 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?
Read the article. People have been crying about CAPE10 for a while now. If you made it actionable and changed your asset allocation you lost out on a nice year. Myself, I'm enjoying the 2017 20% gain.
Cape is a ten year story (or maybe a 7 or 11 year story), not a 1 year story. An adherent might be perfectly happy 'missing out' on a 20% gain if he felt confident he'd also be missing out on 10 years of negative returns, net, while he earned 2.5% in bonds.

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tadamsmar
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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by tadamsmar » Sun Jan 07, 2018 5:32 pm

willthrill81 wrote:
Sun Jan 07, 2018 3:31 pm
Still, even if the future were to replicate the past, returns for the next 10 years could be anywhere between -1.38% and 12.07%. Most of the prior 10 year returns with a high CAPE have been between 2% and 7% though.
I seem to recall that high CAPE is also an indicator that long term bond returns will be lower.

Maybe you just have to plan for low returns, period.

You need a plan that works even if the CAPE naysayers are wrong. You can set in bonds forever, or you can just plan on getting the bond rate anyway and perhaps put a smile on you heir's faces.
Last edited by tadamsmar on Sun Jan 07, 2018 7:14 pm, edited 1 time in total.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Sun Jan 07, 2018 6:40 pm

Nate79 wrote:
Sun Jan 07, 2018 5:18 pm
Always passive wrote:
Sun Jan 07, 2018 2:54 pm
Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
The Cape is not a market timer, but a long term predictor. Please read the article.
So it's not actionable? Yes, I agree. But you wouldn't guess that from the years of crying that the sky is falling due to high CAPE10.
Just because CAPE is not a very effective market timing tool does not mean it is not an actionable tool. Many use CAPE to help them determine which countries they will tilt toward, and this has been quite effective as it diversifies the length of time it can take for valuations to at least somewhat revert to the mean. Alternatively, a high CAPE tends to lead to lower returns going forward, so Larry Swedroe has suggested that a high CAPE may actually lead an investor to increase their equity exposure to compensate for the lower returns going forward; I'm not onboard with that at all personally, mostly because a high CAPE often precedes market turmoil.

Most of the CAPE naysayers are focusing on the U.S. only, but even in that regard, it's been 'right' more often than not, though no predictive measure is or ever will be perfect.
“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 Thesaints » Sun Jan 07, 2018 6:52 pm

CAPE operates on the assumption that earnings follow a somewhat smooth curve, so that sharp jumps are rare and earnings from ten years ago are relevant for today's price.
This was certainly true in the old days, let's say until the 50's/60's, perhaps the 70's, but not necessarily today.
10 years ago Apple was a personal computer company and Facebook an internet bulletin board for ivy leaguers. Today they the #1 and #4 largest companies in the World.

From a strictly mathematical point of view, the "E" in the P/E ratio calculated CAPE-style has a multi-year long latency, i.e. before it can change appreciably several years have to elapse. It is abundantly clear that such a figure cannot be used to time the market.

On top of this, CAPE, nor any other valuation metric is very meaningful taken in isolation. When real interest rates are extremely low a P/E=30 is a lot cheaper than a P/E=15 when real interest rates are very high.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Sun Jan 07, 2018 7:02 pm

Thesaints wrote:
Sun Jan 07, 2018 6:52 pm
CAPE operates on the assumption that earnings follow a somewhat smooth curve, so that sharp jumps are rare and earnings from ten years ago are relevant for today's price.
This was certainly true in the old days, let's say until the 50's/60's, perhaps the 70's, but not necessarily today.
10 years ago Apple was a personal computer company and Facebook an internet bulletin board for ivy leaguers. Today they the #1 and #4 largest companies in the World.

From a strictly mathematical point of view, the "E" in the P/E ratio calculated CAPE-style has a multi-year long latency, i.e. before it can change appreciably several years have to elapse. It is abundantly clear that such a figure cannot be used to time the market.

On top of this, CAPE, nor any other valuation metric is very meaningful taken in isolation. When real interest rates are extremely low a P/E=30 is a lot cheaper than a P/E=15 when real interest rates are very high.
That might be true, but historically the measurement period for earnings has not changed the situation much.
“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 Thesaints » Sun Jan 07, 2018 7:10 pm

willthrill81 wrote:
Sun Jan 07, 2018 7:02 pm
That might be true, but historically the measurement period for earnings has not changed the situation much.
Unfortunately, there is not sufficient statistical basis for the new economy. In particular, outperforming in the 1980-2012 period does not guarantee the method is sound. Differences are small and of 6 strategies necessarily one has to be the best and one has to be the worst.
A way to look at it is that betting on the red because black came out 5 times in a row, still has a 50/50 chance of succeeding, but winning is not evidence that the strategy is correct.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Sun Jan 07, 2018 7:14 pm

Thesaints wrote:
Sun Jan 07, 2018 7:10 pm
willthrill81 wrote:
Sun Jan 07, 2018 7:02 pm
That might be true, but historically the measurement period for earnings has not changed the situation much.
Unfortunately, there is not sufficient statistical basis for the new economy. In particular, outperforming in the 1980-2012 period does not guarantee the method is sound. Differences are small and of 6 strategies necessarily one has to be the best and one has to be the worst.
A way to look at it is that betting on the red because black came out 5 times in a row, still has a 50/50 chance of succeeding, but winning is not evidence that the strategy is correct.
When people start saying "This time, it's different," there isn't much left to discuss.

Regarding betting on red because it's come up 5 times in a row, you're absolutely right. But keep in mind that unlike dice or shuffled cards, markets are not 'memory-less'; the past absolutely has an impact on the future.
“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 Thesaints » Sun Jan 07, 2018 7:50 pm

My point was not about the memory of the market, but rather that wrong theories are not necessarily always wrong in their predictions.
In my opinion, the correct way to use backtesting is first to formulate a solid theory and then check its validity with old dat, instead of rummaging through old data trying to detect patterns.

Out of strictly logical considerations, using earnings from many years ago (and giving them the very same importance as the most recent ones !) to predict future prices doesn't sound too convincing

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » Sun Jan 07, 2018 7:58 pm

Thesaints wrote:
Sun Jan 07, 2018 7:50 pm
My point was not about the memory of the market, but rather that wrong theories are not necessarily always wrong in their predictions.
In my opinion, the correct way to use backtesting is first to formulate a solid theory and then check its validity with old dat, instead of rummaging through old data trying to detect patterns.
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.
“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 HomerJ » Sun Jan 07, 2018 8:02 pm

People on this board say quite often that dividends don't matter, and stock buy-backs are exactly the same, and even better (tax-wise)

Interesting that predictions use current dividend yield.
Real EPS trend growth since 1871 has been 1.5%. From all-time peak earnings, as a share of GDP, dare we expect more growth than this? With a dividend yield of 2.0%, this gives us a real return (yield plus growth) of 3.5%
Dividends are far lower than historical, and stock buy-backs are much higher. Why shouldn't EPS growth be higher than the past? Since there are less shares because of stock buy-backs.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by HomerJ » Sun Jan 07, 2018 8:11 pm

Buttery Lobster wrote:
Sun Jan 07, 2018 12:28 pm
Nate79 wrote:
Sun Jan 07, 2018 12:12 pm
How well did CAPE predict 2017 return?
No proponents of CAPE have ever suggested it's predictive of 1-year returns. A longer time horizon is another story...
The "experts" predicted 4.5% real return in 2010

https://www.cbsnews.com/news/are-stocks-a-good-buy/

Instead over the past 7-8 years we've gotten 15% nominal, so what is that, 13% real?

That's not just a little bit off.

In 1996, Shiller himself, predicted 0% 10-year real returns. Instead, we got around 6% real, just slightly less than the historical average.

CAPE has been terrible at predicting stock returns for the past 25 years, because for the past 25 years, PE ratios have been consistently high compared to the historical average. The model was originally built on data from 1900-1992, and amazingly enough, the moment it was quantified, it stopped working.

At what point do we stop listening to the "experts"? Or at least, when it is okay not to take their word as gospel? Economics isn't a real science. They can't do any real closed-room repeatable experiments. There are far too many variables to think that looking at just Price and Earnings is enough to predict the future.

Note I am NOT saying that the market will keep on trucking forever. It may indeed crash tomorrow. But that was true a year ago, and 5 years ago. One should always be prepared for the market to start a crash tomorrow. Because it could. Regardless of PE ratios.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by newimmigrant » Sun Jan 07, 2018 8:27 pm

Are we in for a long period of sideways movement of indices?

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » 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.
“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 » 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.
"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 newimmigrant » 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?

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by HomerJ » Sun Jan 07, 2018 10:27 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?
Are you retiring at 48? Because a "lost decade" probably won't hurt you at all. You'll still be saving, and then when stocks take off again, you'll have ten years of purchases bought at today's low price.

The 10% (nominal) historical return of the stock market? That INCLUDES crashes and "lost decades". It's not likely going to be 0% for ten years, and then back to 10% for ten years... It will more likely be 0% for ten years, then another booming bull market at 21% a year for ten years to average out to 10% a year for all 20 years.

All that money you saved for the "lost decade" will grow substantially.

$10,000 a year for 20 years that grows at a steady 10% gives you $630,000.

$10,000 a year for 10 years that grows at 0%, and then ten more years at 21% gives you $1 million.

So there's no reason to fear a "lost decade"
Last edited by HomerJ on Sun Jan 07, 2018 10:30 pm, edited 2 times in total.

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Re: CAPE Fear: Why CAPE Naysayers Are Wrong

Post by willthrill81 » 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).
“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 Buttery Lobster » Sun Jan 07, 2018 10:31 pm

HomerJ wrote:
Sun Jan 07, 2018 8:11 pm
The "experts" predicted 4.5% real return in 2010

https://www.cbsnews.com/news/are-stocks-a-good-buy/

Instead over the past 7-8 years we've gotten 15% nominal, so what is that, 13% real?

That's not just a little bit off.

In 1996, Shiller himself, predicted 0% 10-year real returns. Instead, we got around 6% real, just slightly less than the historical average.

CAPE has been terrible at predicting stock returns for the past 25 years, because for the past 25 years, PE ratios have been consistently high compared to the historical average. The model was originally built on data from 1900-1992, and amazingly enough, the moment it was quantified, it stopped working.
I'm not sure what the 2010 prediction was based on, but at that time the CAPE was a bit over 20. Perhaps a little elevated but by no means extreme and, even then, exacerbated by a massive collapse in earnings in the couple years prior. I don't see any mention of CAPE in that article?

And was Shiller's prediction really all that far off? If you timed it 10 years to the day, he would have been wrong (by a lot). Another 2-3 years years after that and we were essentially at a 0% return. Or as CAPE became even further elevated in the few years after his prediction, we experienced negative returns in the next decade.

I wouldn't suggest CAPE be used as a timing indicator to enter/exit the market. I do, however, believe there's value in relative comparisons to the rest of the world and it reinforces the value of investing globally. The only time U.S. stocks have reached a CAPE ratio this high was leading up to the dot-com collapse whereas the rest of the world looks to be 35-40% cheaper.

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