Can the Schiller P/E ratio be used for tactical allocation?

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anonyvestor
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Can the Schiller P/E ratio be used for tactical allocation?

Post by anonyvestor » Mon Jan 15, 2018 1:53 pm

Can the Schiller P/E ratio be used for long-term tactical asset reallocation for the equity portion of one's portfolio?

For instance, are any of you increasing your emerging market exposure while the Schiller P/E is low, with expectations that in a decade or two, you might reduce your emerging market allocation once the Schiller P/E ratios for emerging markets vs domestic vs developed international markets have flip flopped?

I recognize it might be simplistic to base one's equity allocation based on the Schiller P/E ratios alone, but I am tempted to consider allowing my domestic vs developed vs emerging market equity allocations to fluctuate by 10% or so on this basis.

lack_ey
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by lack_ey » Mon Jan 15, 2018 2:23 pm

It certainly can, but I'm pretty sure you mean this in the sense of "successfully," in which case the answer is less clear. I'm pretty sure you can devise a lot of backtests that would show outperformance using some relatively reasonable rules (i.e. not overfit and cheating), unlike if you look at the history of valuation timing using US stocks to cash, which would have been pretty miserable the last 50+ years. I think I've seen it, at least, but don't know where to look. It's out there somewhere.

Certainly if you think back to 1990 for Japan, 2007 for emerging markets, and so on, you get very elevated valuations compared to the rest, followed by underperformance. Fairly rudimentary timing schemes, even if getting the weightings wrong for years around the optimal point, would be additive for those scenarios. Problem is, we're not dealing with those kinds of valuation differences today.

For what it's worth, many global tactical allocation funds have done fairly miserably in practice (though much of this based on underweighting US for a while, for those that look more at valuations), so temper your expectations.

As you know, the information is not really that high quality because predictive ability is limited, and there are multiple reasons for valuations to be different (and different accounting standards, etc.), so large tactical bets would be unwarranted. Relatively mild bets such as "10% or so on this basis" may not be too risky or inappropriate, but they'd definitely be against the Bogleheads spirit for whatever that means to you and may cause headaches and/or regret all for a potentially modest reward.

retireearly
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by retireearly » Mon Jan 15, 2018 2:32 pm

anonyvestor wrote:
Mon Jan 15, 2018 1:53 pm
Can the Schiller P/E ratio be used for long-term tactical asset reallocation for the equity portion of one's portfolio?

For instance, are any of you increasing your emerging market exposure while the Schiller P/E is low, with expectations that in a decade or two, you might reduce your emerging market allocation once the Schiller P/E ratios for emerging markets vs domestic vs developed international markets have flip flopped?

I recognize it might be simplistic to base one's equity allocation based on the Schiller P/E ratios alone, but I am tempted to consider allowing my domestic vs developed vs emerging market equity allocations to fluctuate by 10% or so on this basis.
It depends who you ask and their bias. One thing about advice is both sides of an argument can be correct or incorrect and the person making the argument brings their bias into the equation when providing advice.

My bias/opinion is that yes, Shiller 10 should be looked at, it should be one piece of the puzzle of your decision-making. There are other value-metrics like P/B, too. While past in not prologue in that just because something happened previously, doesn't mean it will happen again, I personally feel that one is crazy not to look at the value of something since because we do have evidence of when something is cheap, LONG-TERM, returns will be higher (and vice-versa). Also, there is a lot of real compelling data that shows that people often pay up for Growth based on nothing more than hope which causes other stocks to be bypassed. This naturally creates a value premium. So, because of that, I tilt value, esp. SC value.

Starting in Jan of 2017 when I was looking to rebalance,I saw the EM and Int developed were at a discount (historically) to the US, so I moved out of the US (where I was slightly overweight from higher 10 year returns) and poured into EM and Int Dev and Int SM, to where I'm now overweight Int (60/40 INT, overweight EM).

Did I abandon US - no way, that is crazy, since the US still might beat ex-US for a while. However, I am making educated guess that INT will outperform the next 10 years and feel my overweight call is worth the risk. If I'm wrong, I've missed out on a few points, if I'm right, I reap the benefits in 10 years and then rebalance back to 50/50, or if US valuations have come back, maybe even slight tilt back to US.

Just some of my biased-thoughts!
Age:45, about to be single for first time since 1995. Kids 8/13. Current AA 70/30, Desired stock AA 50/50, overweight EM, Int SC and US SCV.

alex_686
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by alex_686 » Mon Jan 15, 2018 2:35 pm

No to Maybe.

First, every study that I have seen comes to the conclusion that Schiller does not provided any statistical meaningful information if the market is over / under valued. What it can do is predict what the long term rate of return will be.

Second, the problem with the P/E ratio is that it combines expected required return, growth, and risk. One country might have a high P/E ratio because it is considered safe and stable, another one could have a high P/E ratio because of high expected growth despite higher risk.

Lastly, I personally doubt one can use this internationally. The point about Schiller is that earnings can be manipulated via accounting standards in the short run but not the long run. 10 years evens this all out. Sort of. We know that the Schiller P/E ratio is a few points higher than it was in the 90s because accounting standards changed. But that is o.k. - we are looking at long term trends and can isolate those effects. Can you do that with international? Each country having a different standard, each updating at a different rate. I would think this would generate sufficient noise to drown out any top level information. Maybe country by country. I don't know. I would like to hear from anybody who has an idea.

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nisiprius
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by nisiprius » Mon Jan 15, 2018 2:57 pm

I don't think the Shiller (no C in his name) CAPE can be used for anything except predicting the stock market crash of 2000-2002, once.

And now that everyone knows about it, it won't work again.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

harvestbook
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by harvestbook » Mon Jan 15, 2018 3:03 pm

I don't think I could outsmart all the people who do this for a living and study global markets 16 hours a day for thirty years and still seem to be not that good at it. I'll just hold my 10 percent EM allocation and expect it to fluctuate, sometimes in step with the US and sometimes not. The Shiller CAPE seems to suggest everything has been overvalued practically since the guy invented it.
I'm not smart enough to know, and I can't afford to guess.

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Portfolio7
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by Portfolio7 » Mon Jan 15, 2018 3:20 pm

retireearly wrote:
Mon Jan 15, 2018 2:32 pm
anonyvestor wrote:
Mon Jan 15, 2018 1:53 pm
Can the Schiller P/E ratio be used for long-term tactical asset reallocation for the equity portion of one's portfolio?

For instance, are any of you increasing your emerging market exposure while the Schiller P/E is low, with expectations that in a decade or two, you might reduce your emerging market allocation once the Schiller P/E ratios for emerging markets vs domestic vs developed international markets have flip flopped?

I recognize it might be simplistic to base one's equity allocation based on the Schiller P/E ratios alone, but I am tempted to consider allowing my domestic vs developed vs emerging market equity allocations to fluctuate by 10% or so on this basis.
It depends who you ask and their bias. One thing about advice is both sides of an argument can be correct or incorrect and the person making the argument brings their bias into the equation when providing advice.

My bias/opinion is that yes, Shiller 10 should be looked at, it should be one piece of the puzzle of your decision-making. There are other value-metrics like P/B, too. While past in not prologue in that just because something happened previously, doesn't mean it will happen again, I personally feel that one is crazy not to look at the value of something since because we do have evidence of when something is cheap, LONG-TERM, returns will be higher (and vice-versa). Also, there is a lot of real compelling data that shows that people often pay up for Growth based on nothing more than hope which causes other stocks to be bypassed. This naturally creates a value premium. So, because of that, I tilt value, esp. SC value.

Starting in Jan of 2017 when I was looking to rebalance,I saw the EM and Int developed were at a discount (historically) to the US, so I moved out of the US (where I was slightly overweight from higher 10 year returns) and poured into EM and Int Dev and Int SM, to where I'm now overweight Int (60/40 INT, overweight EM).

Did I abandon US - no way, that is crazy, since the US still might beat ex-US for a while. However, I am making educated guess that INT will outperform the next 10 years and feel my overweight call is worth the risk. If I'm wrong, I've missed out on a few points, if I'm right, I reap the benefits in 10 years and then rebalance back to 50/50, or if US valuations have come back, maybe even slight tilt back to US.

Just some of my biased-thoughts!
+1

In January of last year there were several indications of long term opportunity: EM and Int P/E were low relative to their individual historical trends, they were low relative to the US compared to their historical trends, they had been depressed for many years, profits appeared to be increasing, and many global central banks were still pursuing expansionist policies. At least, that's how I read the tea leaves, others may think I was wrong about some of those. Anyways, I modified my AA at the time to try to take advantage, intending to stay with the adjusted AA for a few years, because I'm not trying to speculate (though some may disagree), I'm trying to find genuine market opportunity that will be unlocked by a little patience. My US allocation is still almost 50% of equities vs my usual 58%; I believe in modest tilts, not reckless performance chasingy/predicting. What I'm looking for is not just an under-appreciated area, but one that's been under-appreciated for a long time relative to it's own history and relative to comparable markets. While this has worked modestly well for me in the past, it's important to also note that my long term AA under-performed this year on the value and size tilts, so despite help from EM and Int'l my portfolio just barely managed to hit my benchmark for the year (which is another topic). ymmv.

However, a low P/E (relative to...) can simply signal a host of economic risks. I think just looking at P/E in isolation has been demonstrated to be hazardous to your investing health.
An investment in knowledge pays the best interest.

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nedsaid
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by nedsaid » Mon Jan 15, 2018 3:57 pm

anonyvestor wrote:
Mon Jan 15, 2018 1:53 pm
Can the Schiller P/E ratio be used for long-term tactical asset reallocation for the equity portion of one's portfolio?

For instance, are any of you increasing your emerging market exposure while the Schiller P/E is low, with expectations that in a decade or two, you might reduce your emerging market allocation once the Schiller P/E ratios for emerging markets vs domestic vs developed international markets have flip flopped?

I recognize it might be simplistic to base one's equity allocation based on the Schiller P/E ratios alone, but I am tempted to consider allowing my domestic vs developed vs emerging market equity allocations to fluctuate by 10% or so on this basis.
Yes, Shiller P/E 10 could be used for tactical asset allocation. A couple of problems with this are that markets can stay expensive for a long time and we have seen P/E ratios creep up over decades. You have to wonder how meaningful historical comparisons are. A lot of things have changed in the markets and the economy over my lifetime. Hard to say how high of a P/E ratio is too high. Also when you look at P/E ratios, you have to look at the economic environment too. Interest rates are still pretty low, so a bit higher than normal P/E ratios can be expected. The bull market is now about 8 1/2 years old now, and that is a factor too. Also stocks in a bull market always look expensive.

I suppose the best you can do is calculate future expected returns for the various asset classes and overweight those asset classes that have the highest future expected returns. This is a rational approach but unfortunately markets don't have to behave as we expect. Expensive can stay expensive and cheap can remain cheap for a long time. Tactical allocation is a calculated risk but there are no guarantees it will actually work. Tactical allocation might be more about controlling risk than enhancing returns.
A fool and his money are good for business.

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munemaker
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by munemaker » Mon Jan 15, 2018 4:16 pm

OP might be interested in this article that is the result of new research. It is not allocation, but rather withdrawal strategy that utilizes Shiller's CAPE ratio.

https://www.caniretireyet.com/the-best- ... ng-deeper/

CAPE Median— This is the simple strategy based on Robert Shiller’s Cyclically Adjusted Price-to-Earnings ratio (CAPE). If the CAPE is greater than its long-term median, then we assume that stocks are highly valued, and the strategy withdraws entirely from stocks. If the CAPE is below its long-term median, the strategy withdraws entirely from bonds. Despite the apparent simplicity, it remains the leading strategy in many scenarios.

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HomerJ
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by HomerJ » Mon Jan 15, 2018 4:43 pm

nisiprius wrote:
Mon Jan 15, 2018 2:57 pm
I don't think the Shiller (no C in his name) CAPE can be used for anything except predicting the stock market crash of 2000-2002, once.

And now that everyone knows about it, it won't work again.
It didn't even work for that.

Shiller's CAPE "predicted" that stocks were overvalued in 1996, not 2000. Stock market more than doubled over the next 4 years, and even AFTER the crash, the stock market still was more expensive than it was in 1996.

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HomerJ
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by HomerJ » Mon Jan 15, 2018 4:45 pm

Portfolio7 wrote:
Mon Jan 15, 2018 3:20 pm
In January of last year there were several indications of long term opportunity: EM and Int P/E were low relative to their individual historical trends, they were low relative to the US compared to their historical trends, they had been depressed for many years, profits appeared to be increasing, and many global central banks were still pursuing expansionist policies. At least, that's how I read the tea leaves, others may think I was wrong about some of those. Anyways, I modified my AA at the time to try to take advantage, intending to stay with the adjusted AA for a few years, because I'm not trying to speculate (though some may disagree), I'm trying to find genuine market opportunity that will be unlocked by a little patience.
That sure seems like a lot of work.
My US allocation is still almost 50% of equities vs my usual 58%; I believe in modest tilts, not reckless performance chasingy/predicting.
For very little benefit.

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Portfolio7
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by Portfolio7 » Mon Jan 15, 2018 6:31 pm

HomerJ wrote:
Mon Jan 15, 2018 4:45 pm
Portfolio7 wrote:
Mon Jan 15, 2018 3:20 pm
In January of last year there were several indications of long term opportunity: EM and Int P/E were low relative to their individual historical trends, they were low relative to the US compared to their historical trends, they had been depressed for many years, profits appeared to be increasing, and many global central banks were still pursuing expansionist policies. At least, that's how I read the tea leaves, others may think I was wrong about some of those. Anyways, I modified my AA at the time to try to take advantage, intending to stay with the adjusted AA for a few years, because I'm not trying to speculate (though some may disagree), I'm trying to find genuine market opportunity that will be unlocked by a little patience.
That sure seems like a lot of work.
My US allocation is still almost 50% of equities vs my usual 58%; I believe in modest tilts, not reckless performance chasingy/predicting.
For very little benefit.
Maybe. I think there are a couple considerations before judgement is passed:
- My initial estimate is this tilt to EM and Int'l improved returns by over 1% last year vs my base AA.
(I did a high-level calc of 1.4% improvement but have yet to factor in timing of some of the changes and a mid-year rebalance.)
- This was year one. There are a couple years to go (at least) to see if returns hurt me at all, relative to my base AA.
- I consider this 'fun', not 'work'. If I didn't enjoy the process, I'd employ a 3-Fund Portfolio and let it ride.
- I don't mean to promote this approach for anyone else, but I do enjoy talking about it.
Edit- related to the first item above, a 1% advantage compounded over several years can yield a substantial long term impact. Saving more is the best option, but I'm throwing every extra penny into paying down debt as fast as possible while still taking advantage of employer matching.
An investment in knowledge pays the best interest.

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whodidntante
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Re: Can the Schiller P/E ratio be used for tactical allocation?

Post by whodidntante » Mon Jan 15, 2018 6:36 pm

Sure, but don't try to build your own kludged together expected return model. Use an educated professional's kludged together expected return model. https://interactive.researchaffiliates. ... terms=REAL

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