Equity valuation and not caring

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TechByron
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Equity valuation and not caring

Post by TechByron » Fri Apr 12, 2019 10:25 am

If U.S. equities are priced well above their historical P/E average, what's the received boglehead view on why this "overvaluation" doesn't matter beyond the basic idea of not being able to predict the future? Digging deeper, is it the idea that the historical data isn't an accurate gauge of what's to come and that we could be in a "new normal" sustained high P/Es due to things like unprecedented Fed involvement? If this is the case, when are we actually allowed to use historical data as a guide? Or, alternatively, is it that we expect earnings to ultimately catch up to prices?

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9-5 Suited
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Re: Equity valuation and not caring

Post by 9-5 Suited » Fri Apr 12, 2019 10:32 am

Not sure there's consensus on this topic by any means. I suspect most people intuitively understand that when ownership stakes in businesses become more expensive, that implies more downside than when those same ownership stakes are less expensive. But if your time horizon is measured in decades, you might not care that there's a little short-term downside risk in your investment.

For me, I can't say I ignore it entirely. I have increased my mortgage pay down contributions as a small way to acknowledge the risks of higher-than-usual equity valuations. I do not, however, change my equity asset class allocations regularly based on temporary valuations. Seems very ripe for behavioral errors to me, and there's so much uncertainty about how predictive those valuations truly are.

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Dialectical Investor
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Re: Equity valuation and not caring

Post by Dialectical Investor » Fri Apr 12, 2019 10:42 am

Money has to be allocated in some way. Equity valuations may be high, but yields on bonds are not that great. So, even if you care about valuations (most here seem not to care), there may not be much to do about it given alternative options.

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zonto
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Re: Equity valuation and not caring

Post by zonto » Fri Apr 12, 2019 12:22 pm

Vanguard put out a white paper in November 2017 addressing this: https://personal.vanguard.com/pdf/ISGGMMRR.pdf. One point they made was that historical P/E comparisons may be misleading because they do not account for other relevant factors like inflation and interest rates. Vanguard uses what it calls a "fair-value CAPE" that seeks to adjust for those factors.

In Vanguard's 2019 outlook, they pick up with the fair-value CAPE analysis starting on page 31: https://pressroom.vanguard.com/nonindex ... 120618.pdf. Their conclusion was that the U.S. market was still overvalued, but not in a bubble (likely helped in part by the flash bear in December 2018), and that international developed markets are fairly valued.

I don't allocate my portfolio based on these observations or related predictions, but this is one reason that I've held and will continue to hold a portfolio that is globally diversified across asset classes.
Last edited by zonto on Fri Apr 12, 2019 12:26 pm, edited 1 time in total.
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Re: Equity valuation and not caring

Post by Thesaints » Fri Apr 12, 2019 12:25 pm

TechByron wrote:
Fri Apr 12, 2019 10:25 am
If U.S. equities are priced well above their historical P/E average, what's the received boglehead view on why this "overvaluation"
If US treasuries are yielding well below their historical average, what’s the received boglehead view on this ?
Maybe the two things are connected ?

delamer
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Re: Equity valuation and not caring

Post by delamer » Fri Apr 12, 2019 12:49 pm

A key Boglehead precept is “stay the course.”

So I pay zero attention to P/Es and other technical measures. They are noise and don’t affect my behavior.

What matters is that over the long run, stocks prices will rise. I don’t care what happens tomorrow or next month or next year.

(I also don’t keep money that I’ll need to spend in the next few years in stocks.)
Last edited by delamer on Fri Apr 12, 2019 12:56 pm, edited 1 time in total.

HEDGEFUNDIE
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Re: Equity valuation and not caring

Post by HEDGEFUNDIE » Fri Apr 12, 2019 12:55 pm

If you had invested a lump sum in stocks at the very top of the dotcom boom in 2000 (i.e. ridiculously high valuations), you would have experienced 5.7% CAGR through the past 19 years.

That should give you some comfort.

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Re: Equity valuation and not caring

Post by Dialectical Investor » Fri Apr 12, 2019 1:17 pm

HEDGEFUNDIE wrote:
Fri Apr 12, 2019 12:55 pm
If you had invested a lump sum in stocks at the very top of the dotcom boom in 2000 (i.e. ridiculously high valuations), you would have experienced 5.7% CAGR through the past 19 years.

That should give you some comfort.
You could have gotten a similar return with a heck of a lot less risk by investing in a Treasury bond. Not comparable to CAGR of course, but the 20-year rate at the time was about 6.5%. What a crazy time.

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Re: Equity valuation and not caring

Post by Vanguard Fan 1367 » Fri Apr 12, 2019 1:23 pm

Dialectical Investor wrote:
Fri Apr 12, 2019 1:17 pm
HEDGEFUNDIE wrote:
Fri Apr 12, 2019 12:55 pm
If you had invested a lump sum in stocks at the very top of the dotcom boom in 2000 (i.e. ridiculously high valuations), you would have experienced 5.7% CAGR through the past 19 years.

That should give you some comfort.
You could have gotten a similar return with a heck of a lot less risk by investing in a Treasury bond. Not comparable to CAGR of course, but the 20-year rate at the time was about 6.5%. What a crazy time.
The great Bogle noticed this at the time and commented that the 7 percent available in bonds looked pretty good to him.

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Re: Equity valuation and not caring

Post by Tycoon » Fri Apr 12, 2019 1:25 pm

I've never paid attention to equity valuation.
“To know what you know and what you do not know, that is true knowledge.” Confucius

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Re: Equity valuation and not caring

Post by Dialectical Investor » Fri Apr 12, 2019 1:29 pm

Vanguard Fan 1367 wrote:
Fri Apr 12, 2019 1:23 pm
Dialectical Investor wrote:
Fri Apr 12, 2019 1:17 pm
HEDGEFUNDIE wrote:
Fri Apr 12, 2019 12:55 pm
If you had invested a lump sum in stocks at the very top of the dotcom boom in 2000 (i.e. ridiculously high valuations), you would have experienced 5.7% CAGR through the past 19 years.

That should give you some comfort.
You could have gotten a similar return with a heck of a lot less risk by investing in a Treasury bond. Not comparable to CAGR of course, but the 20-year rate at the time was about 6.5%. What a crazy time.
The great Bogle noticed this at the time and commented that the 7 percent available in bonds looked pretty good to him.
Yes. I think he acted on it, too. I'm not sure if I remember that from seeing it at the time or only hearing about it later.

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TechByron
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Re: Equity valuation and not caring

Post by TechByron » Fri Apr 12, 2019 1:30 pm

I guess I am wondering what principle allows us to be comfortable with relying on the long term equity market return adage "staying the course" yet also requires us to not trust any more specific or shorter trend, or even more so anything to do with historical valuations of the market. Is it really meaningless to say the market is "overvalued"?

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Re: Equity valuation and not caring

Post by Thesaints » Fri Apr 12, 2019 1:34 pm

The market is correctly valued, given that bond yields are so low. This correctly valued stock market is likely to provide lower returns in the foreseeable future, compared to its historical averages.
“Staying the course” is not blind to those facts.

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Re: Equity valuation and not caring

Post by Dialectical Investor » Fri Apr 12, 2019 1:37 pm

TechByron wrote:
Fri Apr 12, 2019 1:30 pm
I guess I am wondering what principle allows us to be comfortable with relying on the long term equity market return adage "staying the course" yet also requires us to not trust any more specific or shorter trend, or even more so anything to do with historical valuations of the market. Is it really meaningless to say the market is "overvalued"?
There is a difference between saying the market is highly valued and saying the market is overvalued. Highly valued is an observation on the market itself, compared with historic valuations. That the market is highly valued is an observable fact. (You may have to tweak the historic valuation to get a more comparable number based on accounting changes. That does make it a little fuzzy.) Highly valued suggests you're paying a lot for what you get. Overvalued suggests mispricing, that you are paying too much. But unlike going to the store where you can decide not to buy anything, in this case you have to buy something. Well, what should you buy instead? About 20 years ago, you could buy bonds offering a decent return. Today, you can't do that. So overvalued compared to what?

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Re: Equity valuation and not caring

Post by KyleAAA » Fri Apr 12, 2019 1:46 pm

TechByron wrote:
Fri Apr 12, 2019 10:25 am
If U.S. equities are priced well above their historical P/E average, what's the received boglehead view on why this "overvaluation" doesn't matter beyond the basic idea of not being able to predict the future? Digging deeper, is it the idea that the historical data isn't an accurate gauge of what's to come and that we could be in a "new normal" sustained high P/Es due to things like unprecedented Fed involvement? If this is the case, when are we actually allowed to use historical data as a guide? Or, alternatively, is it that we expect earnings to ultimately catch up to prices?
There isn't broad agreement that P/E is even an intelligent way to value equities. It's not so much a question of historical data so much as it's a "is that even a reasonable metric?" question.

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Re: Equity valuation and not caring

Post by DonIce » Fri Apr 12, 2019 1:50 pm

Dialectical Investor wrote:
Fri Apr 12, 2019 1:37 pm
Overvalued suggests mispricing, that you are paying too much. But unlike going to the store where you can decide not to buy anything, in this case you have to buy something. Well, what should you buy instead? About 20 years ago, you could buy bonds offering a decent return. Today, you can't do that. So overvalued compared to what?
Your options are:

1. US equities (as you said, highly valued)
2. Bond market (low yields)
3. International equities (a lot more reasonably valued right now than US equities)
4. Real estate (plenty of markets in the US where it is not highly valued right now relative to historic norms)
5. Alternative investments (theoretically they should offer decent returns over time but recent performance has been underwhelming)
6. Timing/trading strategies (not a good track record but many still believe in them)
7. Individual corporate bonds (you can get bonds of individual reputable companies like AT&T at yields over 5% right now)
8. Individual stocks/sectors (you can pick individual US companies or sectors that have historically average or even low P/E)

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Re: Equity valuation and not caring

Post by KlangFool » Fri Apr 12, 2019 1:53 pm

TechByron wrote:
Fri Apr 12, 2019 10:25 am
If U.S. equities are priced well above their historical P/E average, what's the received boglehead view on why this "overvaluation" doesn't matter beyond the basic idea of not being able to predict the future? Digging deeper, is it the idea that the historical data isn't an accurate gauge of what's to come and that we could be in a "new normal" sustained high P/Es due to things like unprecedented Fed involvement? If this is the case, when are we actually allowed to use historical data as a guide? Or, alternatively, is it that we expect earnings to ultimately catch up to prices?
TechByron,

Unless you are 100% US stock, why do this matters to you? Your AA will make sure that you buy something else other than the US stock if it is overvalued. If you are 100% US stock, perhaps this is not such a good idea. You are stuck with US stock.

I am 60/40.

KlangFool

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Re: Equity valuation and not caring

Post by Dialectical Investor » Fri Apr 12, 2019 2:01 pm

DonIce wrote:
Fri Apr 12, 2019 1:50 pm
Dialectical Investor wrote:
Fri Apr 12, 2019 1:37 pm
Overvalued suggests mispricing, that you are paying too much. But unlike going to the store where you can decide not to buy anything, in this case you have to buy something. Well, what should you buy instead? About 20 years ago, you could buy bonds offering a decent return. Today, you can't do that. So overvalued compared to what?
Your options are:

1. US equities (as you said, highly valued)
2. Bond market (low yields)
3. International equities (a lot more reasonably valued right now than US equities)
4. Real estate (plenty of markets in the US where it is not highly valued right now relative to historic norms)
5. Alternative investments (theoretically they should offer decent returns over time but recent performance has been underwhelming)
6. Timing/trading strategies (not a good track record but many still believe in them)
7. Individual corporate bonds (you can get bonds of individual reputable companies like AT&T at yields over 5% right now)
8. Individual stocks/sectors (you can pick individual US companies or sectors that have historically average or even low P/E)
I don't see anything compelling there for the average retail investor--real estate, individual stocks, and individual bonds wouldn't be appropriate, in my opinion. The difference in valuation between international and US isn't so great that I would say I know one is undervalued and the other is overvalued and that I'm confident enough about it to take action.

delamer
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Re: Equity valuation and not caring

Post by delamer » Fri Apr 12, 2019 3:06 pm

TechByron wrote:
Fri Apr 12, 2019 1:30 pm
I guess I am wondering what principle allows us to be comfortable with relying on the long term equity market return adage "staying the course" yet also requires us to not trust any more specific or shorter trend, or even more so anything to do with historical valuations of the market. Is it really meaningless to say the market is "overvalued"?
We all know stock returns are volatile in the short run, and we all know that they return more than other investments over the long run.

Are you investing for short run or the long run?

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Re: Equity valuation and not caring

Post by TheDDC » Fri Apr 12, 2019 3:17 pm

I view P/E soothsayers as I view other "technical analysts". I don't trust them, or care what they have to say as "nobody knows nuttin'." I DCA over 40% of my annual income.

-TheDDC

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TechByron
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Re: Equity valuation and not caring

Post by TechByron » Fri Apr 12, 2019 3:34 pm

I am long term here (20-30 years). I guess another way of asking the question is if there is any piece of equity evidence you would ever use that would make you change your asset allocation at a given point in time and if not, why not? Is there some mechanism we can point to that can further help us sleep at night at how business and the resulting stock market will likely continue to increase in value over the long term or do we really just have to rely on the long term historical average and that's simply it?

delamer
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Re: Equity valuation and not caring

Post by delamer » Fri Apr 12, 2019 3:59 pm

TechByron wrote:
Fri Apr 12, 2019 3:34 pm
I am long term here (20-30 years). I guess another way of asking the question is if there is any piece of equity evidence you would ever use that would make you change your asset allocation at a given point in time and if not, why not? Is there some mechanism we can point to that can further help us sleep at night at how business and the resulting stock market will likely continue to increase in value over the long term or do we really just have to rely on the long term historical average and that's simply it?
1) I think you need to provide an example of such evidence, not ask others to theorize.

2) I don’t know what such as mechanism would be. Either you believe in the way equity markets work over the long run, or you don’t.

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Re: Equity valuation and not caring

Post by Dialectical Investor » Fri Apr 12, 2019 4:06 pm

TechByron wrote:
Fri Apr 12, 2019 3:34 pm
I am long term here (20-30 years). I guess another way of asking the question is if there is any piece of equity evidence you would ever use that would make you change your asset allocation at a given point in time and if not, why not?
Yes. If the risk profile of Asset B became more desirable to me than the risk profile of Asset A, combined my with personal needs and preferences, I would change my asset allocation. This is a lot harder to assess when A and B are both equity assets than when one of them is an equity asset and the other is a government bond with a government guarantee, denominated in my local currency.
TechByron wrote:
Fri Apr 12, 2019 3:34 pm

Is there some mechanism we can point to that can further help us sleep at night at how business and the resulting stock market will likely continue to increase in value over the long term or do we really just have to rely on the long term historical average and that's simply it?
It is possible future returns will be far lower than historic returns. Population could decrease. Productivity could drop. There could be war and pestilence. Something could happen that slows trade and commerce, and people go back to farming their own land, building their own shelters, and making their own clothes. Something less drastic also is possible. No guarantees.

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Re: Equity valuation and not caring

Post by Ferdinand2014 » Fri Apr 12, 2019 4:18 pm

TechByron wrote:
Fri Apr 12, 2019 10:25 am
If U.S. equities are priced well above their historical P/E average, what's the received boglehead view on why this "overvaluation" doesn't matter beyond the basic idea of not being able to predict the future? Digging deeper, is it the idea that the historical data isn't an accurate gauge of what's to come and that we could be in a "new normal" sustained high P/Es due to things like unprecedented Fed involvement? If this is the case, when are we actually allowed to use historical data as a guide? Or, alternatively, is it that we expect earnings to ultimately catch up to prices?
'We have noted that the historical real return on equity has been between 6 and 7 percent per year over long periods and that this has coincided with an average P/E ratio of approximately 15. But there have been changes in the economy and financial markets that may raise the P/E ratio in the future. These changes include a decrease in the cost of investing in equity indexes, a lower discount rate, and an increase in knowledge about the advantages of equity versus fixed-income investments.'

Siegel, Jeremy J.. Stocks for the Long Run 5/E: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies (pp. 169-170). McGraw-Hill Education. Kindle Edition.


These are some reasons that Jeremy Siegel has proposed for a chronically higher long term PE ratio. Either way, in the end, we really do not have much choice. 'Invest we must' You can mitigate the risk with bonds, real estate or other diversifier's. You can also dollar cost average into equities (as most investors naturally do) to avoid all of your money invested at high PE ratios. You can also invest internationally where PE ratios are currently lower. In the end nobody can really say what the future will be. However, to not invest will be a guarantee of not keeping pace with inflation.

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Re: Equity valuation and not caring

Post by TomCat96 » Fri Apr 12, 2019 4:37 pm

TechByron wrote:
Fri Apr 12, 2019 10:25 am
If U.S. equities are priced well above their historical P/E average, what's the received boglehead view on why this "overvaluation" doesn't matter beyond the basic idea of not being able to predict the future? Digging deeper, is it the idea that the historical data isn't an accurate gauge of what's to come and that we could be in a "new normal" sustained high P/Es due to things like unprecedented Fed involvement? If this is the case, when are we actually allowed to use historical data as a guide? Or, alternatively, is it that we expect earnings to ultimately catch up to prices?

I'm 100% US equities at the moment and I don't care. Historical P/E is one of those numbers that I would call financial sophistry.
There's a basis in reality, but there's so much gray area, it's predictive capabilities are limited.

I mean, why not go 100% international, and 0% US if you think the US is overvalued? You might say the US is overdue for a drop, and the International Markets are overdue for a tremendous gain right? It's not just unprecedented fed involvement is it?

The recent growth of the S&P 500 has largely been constrained to tech. The P/E ratios of tech are completely at odds with what was once considered reasonable P/Es. Do you remember the tech bubble of the 90s? Every day there was some article lambasting the outrageous PE ratios of the tech companies of the era. It's true the bubble burst, but the PE ratios of tech has never turned into something like railroads, electrical utilities, or long standing physical industries.

What's the deal? Should the PEs of the tech companies eventually converge to old historical P/E valuations? Or can we say that Amazon (for example) is in fact something different from other industries with historically far lower PEs?

The market has made its decision, and continues to validate its decision on a daily basis. The market has said tech companies do deserve a higher P/E valuation. And of course there's plenty of rational objection to be had there...plenty. But it's what the market has declared, and has declared for the past few decades.

But digging down deeper, at the core of the industries themselves, no I don't think that every industry deserves the same P/E ratio. Biotech is not energy. Energy is not Software. If you can accept that as a proposition, then let me go further and ask,

Should the ratio of industries in equity valuations remain the same for all time? It's another way of asking the same question if you accept my premise.

If the answer is no...eg.("it doesn't seem true that Energy should be 5% of the equity market capitalization in perpetuity, or that Tech should remain forever wedded to a 10% number")--if your answer is no, then it makes no sense for the PE ratio to be attached to a single historical valuation.

The various sector weights, and their differing PE ratios, will probably vary as the economy needs it, and so too the cumulative average of the resulting historical PE ratio.

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Re: Equity valuation and not caring

Post by Dialectical Investor » Fri Apr 12, 2019 4:46 pm

TomCat96 wrote:
Fri Apr 12, 2019 4:37 pm

But digging down deeper, at the core of the industries themselves, no I don't think that every industry deserves the same P/E ratio. Biotech is not energy. Energy is not Software. If you can accept that as a proposition, then let me go further and ask,

Should the ratio of industries in equity valuations remain the same for all time? It's another way of asking the same question if you accept my premise.

If the answer is no...eg.("it doesn't seem true that Energy should be 5% of the equity market capitalization in perpetuity, or that Tech should remain forever wedded to a 10% number")--if your answer is no, then it makes no sense for the PE ratio to be attached to a single historical valuation.

The various sector weights, and their differing PE ratios, will probably vary as the economy needs it, and so too the cumulative average of the resulting historical PE ratio.
You can have historical PE ratios remain constant while still having changes in market cap by sector. Both earnings and the number of public companies in each can change at different rates, depending on the sector.

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Re: Equity valuation and not caring

Post by TomCat96 » Fri Apr 12, 2019 4:49 pm

Dialectical Investor wrote:
Fri Apr 12, 2019 4:46 pm
TomCat96 wrote:
Fri Apr 12, 2019 4:37 pm

But digging down deeper, at the core of the industries themselves, no I don't think that every industry deserves the same P/E ratio. Biotech is not energy. Energy is not Software. If you can accept that as a proposition, then let me go further and ask,

Should the ratio of industries in equity valuations remain the same for all time? It's another way of asking the same question if you accept my premise.

If the answer is no...eg.("it doesn't seem true that Energy should be 5% of the equity market capitalization in perpetuity, or that Tech should remain forever wedded to a 10% number")--if your answer is no, then it makes no sense for the PE ratio to be attached to a single historical valuation.

The various sector weights, and their differing PE ratios, will probably vary as the economy needs it, and so too the cumulative average of the resulting historical PE ratio.
You can have historical PE ratios remain constant while still having changes in market cap by sector. Both earnings and the number of public companies in different sectors can change at different rates.

Yes you can. But why? Is the market going to go out of its way to enforce that? Or is the market simply going to make its valuations firm by firm, sector by sector, and let the chips fall where they will?

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Re: Equity valuation and not caring

Post by vitaflo » Fri Apr 12, 2019 4:53 pm

TechByron wrote:
Fri Apr 12, 2019 3:34 pm
I guess another way of asking the question is if there is any piece of equity evidence you would ever use that would make you change your asset allocation at a given point in time and if not, why not?
If your AA is tied to the value of your portfolio, this kind of all takes care of itself. As my portfolio value rises, my AA becomes more conservative. If P/E suddenly shoots through the roof, so will my portfolio value, which means more of it gets moved to bonds and less in equity. So for me anyway, this is a solved "problem".

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Re: Equity valuation and not caring

Post by Dialectical Investor » Fri Apr 12, 2019 5:11 pm

TomCat96 wrote:
Fri Apr 12, 2019 4:49 pm
Dialectical Investor wrote:
Fri Apr 12, 2019 4:46 pm
TomCat96 wrote:
Fri Apr 12, 2019 4:37 pm

But digging down deeper, at the core of the industries themselves, no I don't think that every industry deserves the same P/E ratio. Biotech is not energy. Energy is not Software. If you can accept that as a proposition, then let me go further and ask,

Should the ratio of industries in equity valuations remain the same for all time? It's another way of asking the same question if you accept my premise.

If the answer is no...eg.("it doesn't seem true that Energy should be 5% of the equity market capitalization in perpetuity, or that Tech should remain forever wedded to a 10% number")--if your answer is no, then it makes no sense for the PE ratio to be attached to a single historical valuation.

The various sector weights, and their differing PE ratios, will probably vary as the economy needs it, and so too the cumulative average of the resulting historical PE ratio.
You can have historical PE ratios remain constant while still having changes in market cap by sector. Both earnings and the number of public companies in different sectors can change at different rates.

Yes you can. But why? Is the market going to go out of its way to enforce that? Or is the market simply going to make its valuations firm by firm, sector by sector, and let the chips fall where they will?
I don't think the market enforces it--was just noting it's possible. I agree valuations do and should differ between sectors and firms.

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Re: Equity valuation and not caring

Post by Trader Joe » Fri Apr 12, 2019 5:30 pm

Equity valuation and not caring

Yes, I do not know and I am not interested in P/E. It simply never enters my mind.

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Re: Equity valuation and not caring

Post by mark_in_denver » Fri Apr 12, 2019 5:46 pm

Dialectical Investor wrote:
Fri Apr 12, 2019 10:42 am
Money has to be allocated in some way. Equity valuations may be high, but yields on bonds are not that great. So, even if you care about valuations (most here seem not to care), there may not be much to do about it given alternative options.
I never understood this. So if yields in bonds are 3%, an equity holding could easily drop by five times that yield.

I remember when Cramer was touting At&t due to the dividends of 5% instead of a bond. Ok but if the stock drops 10% which it could easily do, it'll take two years just to break even.

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Re: Equity valuation and not caring

Post by Dialectical Investor » Fri Apr 12, 2019 5:58 pm

mark_in_denver wrote:
Fri Apr 12, 2019 5:46 pm
Dialectical Investor wrote:
Fri Apr 12, 2019 10:42 am
Money has to be allocated in some way. Equity valuations may be high, but yields on bonds are not that great. So, even if you care about valuations (most here seem not to care), there may not be much to do about it given alternative options.
I never understood this. So if yields in bonds are 3%, an equity holding could easily drop by five times that yield.

I remember when Cramer was touting At&t due to the dividends of 5% instead of a bond. Ok but if the stock drops 10% which it could easily do, it'll take two years just to break even.
Stock dividends are never a substitute for bonds. I agree there. But in your scenario, I would expect a diversified portfolio of stocks to return more than 3% over the long term. (What would happen to AT&T stock specifically, I don't know, and I wouldn't try to guess. I wouldn't be interested in the next two years either.) If my options were stocks at current valuations versus a collection of investment grade bonds at 3%, I'm going to hang around the middle of my asset allocation range and take no special action.

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Re: Equity valuation and not caring

Post by ososnilknarf » Fri Apr 12, 2019 6:31 pm

Since I just recently read the updated edition (Oct 2017) of Bogle's "Little Book of Common Sense Investing", I'll add Jack Bogle's take to the conversation here.
I'm going from memory here, but he uses PE ratio to help develop reasonable expectations for equity returns going forward. In this way he says we should expect stock returns over the next decade to be lower than usual because of the higher PE ratio reverting to the mean. He uses this along with forecasts of business earnings and dividends to come up with a expected annual nominal returns of somewhere in the 3%-4% range (which I found depressing).
He acknowledges that actual returns could be higher and the could be lower, but that coming up with such expectations are helpful for planning purposes. It certainly got me to plug in some different numbers for my lower end expectations. It doesn't affect my desired asset allocation, but it has affected my range of expectations for making a realistic plan.

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Re: Equity valuation and not caring

Post by staythecourse » Fri Apr 12, 2019 6:39 pm

delamer wrote:
Fri Apr 12, 2019 12:49 pm
A key Boglehead precept is “stay the course.”

So I pay zero attention to P/Es and other technical measures. They are noise and don’t affect my behavior.

What matters is that over the long run, stocks prices will rise. I don’t care what happens tomorrow or next month or next year.

(I also don’t keep money that I’ll need to spend in the next few years in stocks.)
Agreed. Investing is SUPER simple IF you accept one major tenet: NO ONE knows when the market will go up, down, or sideways. There is no BUT. It should be treated as dogma. If you accept that then it leads to focusing on what you can control... Saving, LBYM, asset allocation, avoiding all active management, controlling fees/ taxes/ expense ratio, and staying the course.

As you can see NONE of them has anything to do with returns. For whatever reason investors spend 90% of their effort worrying about returns when it is one of the few things that can not be controlled. Focus on the 90% of investing that can be controlled and investing becomes very easy.

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

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Re: Equity valuation and not caring

Post by Seasonal » Fri Apr 12, 2019 6:58 pm

TechByron wrote:
Fri Apr 12, 2019 1:30 pm
I guess I am wondering what principle allows us to be comfortable with relying on the long term equity market return adage "staying the course" yet also requires us to not trust any more specific or shorter trend, or even more so anything to do with historical valuations of the market. Is it really meaningless to say the market is "overvalued"?
"Stay the course" is not a function of "the long term equity market return"; it is a function of the fact that you are not better at predicting the future than the market is and that strategies other than stay the course are often worse strategies.
Is it really meaningless to say the market is "overvalued"?
Unless you are better than the market at predicting the future, it most probably is meaningless.

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Re: Equity valuation and not caring

Post by staythecourse » Fri Apr 12, 2019 7:17 pm

ososnilknarf wrote:
Fri Apr 12, 2019 6:31 pm
Since I just recently read the updated edition (Oct 2017) of Bogle's "Little Book of Common Sense Investing", I'll add Jack Bogle's take to the conversation here.
I'm going from memory here, but he uses PE ratio to help develop reasonable expectations for equity returns going forward. In this way he says we should expect stock returns over the next decade to be lower than usual because of the higher PE ratio reverting to the mean. He uses this along with forecasts of business earnings and dividends to come up with a expected annual nominal returns of somewhere in the 3%-4% range (which I found depressing).
He acknowledges that actual returns could be higher and the could be lower, but that coming up with such expectations are helpful for planning purposes. It certainly got me to plug in some different numbers for my lower end expectations. It doesn't affect my desired asset allocation, but it has affected my range of expectations for making a realistic plan.
I believe he uses PE ratio to determine the speculative return. He uses the usual dividend rate+ growth to come up with x. Speculative return adds or lowers from that number. Please correct me if I am wrong, but that is usually how he does his predictions.

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

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Re: Equity valuation and not caring

Post by Dialectical Investor » Fri Apr 12, 2019 10:31 pm

staythecourse wrote:
Fri Apr 12, 2019 6:39 pm
delamer wrote:
Fri Apr 12, 2019 12:49 pm
A key Boglehead precept is “stay the course.”

So I pay zero attention to P/Es and other technical measures. They are noise and don’t affect my behavior.

What matters is that over the long run, stocks prices will rise. I don’t care what happens tomorrow or next month or next year.

(I also don’t keep money that I’ll need to spend in the next few years in stocks.)
Agreed. Investing is SUPER simple IF you accept one major tenet: NO ONE knows when the market will go up, down, or sideways. There is no BUT. It should be treated as dogma. If you accept that then it leads to focusing on what you can control... Saving, LBYM, asset allocation, avoiding all active management, controlling fees/ taxes/ expense ratio, and staying the course.

As you can see NONE of them has anything to do with returns. For whatever reason investors spend 90% of their effort worrying about returns when it is one of the few things that can not be controlled. Focus on the 90% of investing that can be controlled and investing becomes very easy.

Good luck.
I understand where you are coming from, but people worry about return because it is extremely important to the outcome. The only scenario in which you can manage to get along without caring about return is if you don't need to invest to begin with and are able to hold cash/T-bills. Return expectations also inform asset allocation. For instance, if you expected to lose money on stocks, you would not invest in them. If you expect to earn only as much in stocks as you do in bonds, you also would not invest in stocks. We can judge with some confidence the returns on bonds over certain timeframes because the risks are well defined. I know, for instance, that if I buy a 10-year T-note today, I'm not going to earn 5% for the next 10 years. On the other hand, if I could get 3% real in TIPS, and that's all I think I need, I'm not going to risk investing too much in stocks.

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Re: Equity valuation and not caring

Post by alpine_boglehead » Fri Apr 12, 2019 11:54 pm

Dialectical Investor wrote:
Fri Apr 12, 2019 10:31 pm
staythecourse wrote:
Fri Apr 12, 2019 6:39 pm
delamer wrote:
Fri Apr 12, 2019 12:49 pm
A key Boglehead precept is “stay the course.”

So I pay zero attention to P/Es and other technical measures. They are noise and don’t affect my behavior.

What matters is that over the long run, stocks prices will rise. I don’t care what happens tomorrow or next month or next year.

(I also don’t keep money that I’ll need to spend in the next few years in stocks.)
Agreed. Investing is SUPER simple IF you accept one major tenet: NO ONE knows when the market will go up, down, or sideways. There is no BUT. It should be treated as dogma. If you accept that then it leads to focusing on what you can control... Saving, LBYM, asset allocation, avoiding all active management, controlling fees/ taxes/ expense ratio, and staying the course.

As you can see NONE of them has anything to do with returns. For whatever reason investors spend 90% of their effort worrying about returns when it is one of the few things that can not be controlled. Focus on the 90% of investing that can be controlled and investing becomes very easy.

Good luck.
I understand where you are coming from, but people worry about return because it is extremely important to the outcome. The only scenario in which you can manage to get along without caring about return is if you don't need to invest to begin with and are able to hold cash/T-bills. Return expectations also inform asset allocation. For instance, if you expected to lose money on stocks, you would not invest in them. If you expect to earn only as much in stocks as you do in bonds, you also would not invest in stocks. We can judge with some confidence the returns on bonds over certain timeframes because the risks are well defined. I know, for instance, that if I buy a 10-year T-note today, I'm not going to earn 5% for the next 10 years. On the other hand, if I could get 3% real in TIPS, and that's all I think I need, I'm not going to risk investing too much in stocks.
Holding cash/T-bills also holds it's own risk: inflation.
E.g. my equivalent to T-bills (short-term German bunds) have a -0.6% nominal yield, so it's something like -2.5% real. A guaranteed loss of 2.5% per annum doesn't seem riskless. The risks on bonds may seem well-defined, but how do you quantify inflation risk (or for that matter, just the risk of bond returns being permanently below inflation) in a world where the biggest debtors are also those who are in control of interest rates?

Pretty much the only "sleep well" investment would be TIPS in a tax-advantaged account.

I very much agree with staythecourse's point. Worrying excessively about future returns is like worrying about getting a random illness you can't control (e.g. cancer, Alzheimer's). A severe, basically random disease or a random accident is also extremely important to the outcome. But you can't do much about it. You can just do what's under your control, e.g. eating healthy and exercising.

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TechByron
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Re: Equity valuation and not caring

Post by TechByron » Sat Apr 13, 2019 7:47 am

Thanks all, the replies were all very helpful. Humble Dollar talks about valuation this morning too and touches on a number of things said: https://humbledollar.com/2019/04/on-the-other-hand-2/

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Re: Equity valuation and not caring

Post by Dialectical Investor » Sat Apr 13, 2019 8:32 am

alpine_boglehead wrote:
Fri Apr 12, 2019 11:54 pm
Dialectical Investor wrote:
Fri Apr 12, 2019 10:31 pm

I understand where you are coming from, but people worry about return because it is extremely important to the outcome. The only scenario in which you can manage to get along without caring about return is if you don't need to invest to begin with and are able to hold cash/T-bills. Return expectations also inform asset allocation. For instance, if you expected to lose money on stocks, you would not invest in them. If you expect to earn only as much in stocks as you do in bonds, you also would not invest in stocks. We can judge with some confidence the returns on bonds over certain timeframes because the risks are well defined. I know, for instance, that if I buy a 10-year T-note today, I'm not going to earn 5% for the next 10 years. On the other hand, if I could get 3% real in TIPS, and that's all I think I need, I'm not going to risk investing too much in stocks.
Holding cash/T-bills also holds it's own risk: inflation.
E.g. my equivalent to T-bills (short-term German bunds) have a -0.6% nominal yield, so it's something like -2.5% real. A guaranteed loss of 2.5% per annum doesn't seem riskless. The risks on bonds may seem well-defined, but how do you quantify inflation risk (or for that matter, just the risk of bond returns being permanently below inflation) in a world where the biggest debtors are also those who are in control of interest rates?

Pretty much the only "sleep well" investment would be TIPS in a tax-advantaged account.

I very much agree with staythecourse's point. Worrying excessively about future returns is like worrying about getting a random illness you can't control (e.g. cancer, Alzheimer's). A severe, basically random disease or a random accident is also extremely important to the outcome. But you can't do much about it. You can just do what's under your control, e.g. eating healthy and exercising.
That's just it. It's not all random. As you note, cash under the mattress is likely to lose purchasing power. (My example was just to indicate you could afford this if you had enough money.) If you buy an instrument like TIPS, and the yields are negative like they were a few years ago, you are very likely to have a negative real return over the term of the TIPS--not random. In your bund example, you note you are guaranteed a negative real loss. You can't control what is offered to you, but you do have some control over your return by way of your selection from what is offered. The stock market has a wide dispersion of returns. You have control over whether you are going to take that sort of risk, or select one of the options with a narrower dispersion of returns (bonds). The level of likely return on the bonds is knowable, within certain parameters, and changes over time. It makes sense that your asset allocation might change accordingly.

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Re: Equity valuation and not caring

Post by whodidntante » Sat Apr 13, 2019 8:59 am

You might want to write your beliefs as an essay and support your thesis.

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Re: Equity valuation and not caring

Post by SovereignInvestor » Sat Apr 13, 2019 9:04 am

It seems like  many are bearish on stocks for alleged over valuation.  The fact that so many say this supports the notion that the  stock market will continue to perform well.

In a nutshell the valuations are quite justified by lower long term rates.

Since the early 1990s the average forward operating PE ratio has been around 17, and the average 10Y note yield has been in the 4% range.  Now there was a  bubble when PE spiked toward 25 in 1999...the bubble really was 1997-2001. In 1999 the 10Y note was over 6%, but PE was 25!  The equity yield spread was negative 2%!

Then there was a depressed period from 2008-12 when the PE was lingering in the 10-12 range.  In 2011, the forward PE was around 10 leading to an earnings yield of 10% while the 10Y yield was not even 3%, for a spread of positive 7%.


In 1999 the yield spread was negative 2%, and in 2011 it was positive 7%.

Now, despite the 10Y note yield of just 2.5% barely, the forward PE is around 17, leading to a yield of around 6% or a positive spread of about 3.5%.

The 3.5% spread, is not screaming cheap like 2011 (7%) and not bubblish like 1999 (minus 2%).

It is imperative to compare stocks to the risk free rate, as  Buffett says, interest rates are the Gravity pulling down on equity prices.

Forward PE is not perfect but it is more reliable than trailing.  The trailing PE was sky high entering into 2009 and 2017 signaling not to buy stocks and investors if they took the bad warning missed out on 2 great years with 2009 having a high trailing  PE because earnings were about to explode as the recession ended, and in 2017 the trailing PE was high to start as slowdown was ending and tax cuts were coming, so looking into the past was harmful.

Yes, the forward estimates are not what actually will happen, and they tend to be biased high but this would always be the case so if the same bias exists then it still makes Relative comparisons meaningful.

Operating earnings are more useful than GAAP. With GAAP, that is harmful because first it literally assumes REITS which are 3% of the S&P have no earnings since it assumes commercial RE depreciates over time which is absurd among other distortions. Also GAAP has large swings and the bias is inconsistent so comparisons are unreliable. There is a reason why the Fed doesn't use the entire PCE deflator for policy decisions, they use CORE PCE to exclude volatile food and energy which are noise that cloud out the signal of core inflation.


So right now at a foward PE barely 17, and the forward earnings being about 5% lower than the peak in September 2018, there is a case we are closer to mid cycle than the top, since normally earnings growth about 6% a year and in the last seven months they dropped 5% so it is about 8% off the otherwise historically normal trend.  So if 17 was about an average PE since 1990 during periods of higher average 10Y yield the current PE seems reasonable enough to assume no contraction.

S&p stocks get about 40% of sales overseas and assume profits too.  In long run its not unrealistic to assume gross earnings grow with nominal GDP.  IMF long run real global GDP growth rates are around 3.0% and for the US they have it at 1.8%.   So if SPX stocks get 40% overseas and 60% profits in home then the pertinent Real GDP growth is a blend of the two or around 2.25%.  The fed inflation target is about 2.0%, so pertinent nominal GDP can assume to grow in the 4.25% range.

Therefore earnings may grow around 4.25%.   Since 2005, buybacks as a percent of market cap have averaged around 3.0%, but there's always equity dilution from issuance so net share reduction may be more like just 2.0%.  4.25% nominal earnings growth Plus 2.0% annual share reduction leads to 6.25% target EPS growth.

Then add on the 2.0% dividend yield for SPX and we have a 8.25% total return target if we assume no PE expansion or contraction from 17 level which is average since 1990 even though rates are lower than average. 

8.25%, seems too high?  Well it suggests 6.25% real return if inflation is 2.0% target which is in line with the around 6.5% average real return since 1870.  It also suggests a risk premium of near 5.75% over the current 10Y yield of 2.5% which admittedly is a bit elevated above the long term average a bit below 5.0%.

What assumptions here would one disagree with to get projected returns well below 8.25%.

A) GDP growth being much less than what IMF project even though they have already downgraded long term growth forecasts many years now? Or do profits contract as a percent of GDP? How much per year in long run?

B) The assumption of no PE contraction?  Even if we assume PE contracts down to 15 over 10 years, which is low given current rates, it would only shave about 1 pt off the 8.25% estimate over 10 years.

C) Buybacks.  Harder to gauge here but dividend payout ratios are near historical lows so it's not unreasonable to expect current 3% buyback rate to persist.  Hard to find data on share issuance not used for accretive acqusitions but one would be hard pressed to find many stocks issuing over 1% of market cap each year, many do not come close to that, so 1% average used is a bit high.

I see many forecasting 10 year returns in the 3% range. What assumptions deviate from outlines above to lead to 5 points difference?

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Re: Equity valuation and not caring

Post by james22 » Sat Apr 13, 2019 9:30 am

SovereignInvestor wrote:
Sat Apr 13, 2019 9:04 am
In a nutshell the valuations are quite justified by lower long term rates.
Why Market Valuations are Not Justified by Low Interest Rates

https://www.hussmanfunds.com/wmc/wmc171009.htm
Last edited by james22 on Sun Apr 14, 2019 12:35 am, edited 1 time in total.

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Re: Equity valuation and not caring

Post by SovereignInvestor » Sat Apr 13, 2019 10:54 pm

The Hussman link didn't work.

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Re: Equity valuation and not caring

Post by heyyou » Sun Apr 14, 2019 12:27 am

focusing on what you can control... Saving, LBYM, asset allocation, avoiding all active management, controlling fees/ taxes/ expense ratio, and staying the course.
As you can see NONE of them has anything to do with returns.
Well said by staythecourse.
In retirement, our free time is joyous, less because of what we do, and more of just gratitude for not having to go to jobs. We do not have feelings of deprivation about not buying overly expensive things or activities. We like our lifestyle which just happens to be a continuation of living within our means, without having to work.

If the stock market has a sustained period of low returns, our spending of a somewhat fixed (longevity adjusted) percentage of each annual remaining portfolio value, will compensate for the lack of growth. Valuations? We don't know and don't care, but we can adapt as necessary for portfolio survival, due to low necessary expenses relative to our assets.

The news media need headlines every day, the scarier, and more attention grabbing, the better. Oh no, WE MIGHT BE ENTERING A PERIOD OF LOW RETURNS!!! You better spend time at our ad-laden website for more details, where we will speculate about what could happen if A leads to B, then C to D to E, to the brink of being F'd.

Was it Fama or French who said that market forecasters made astrologers look comparatively reliable?

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Re: Equity valuation and not caring

Post by james22 » Sun Apr 14, 2019 12:36 am

SovereignInvestor wrote:
Sat Apr 13, 2019 10:54 pm
The Hussman link didn't work.
Sorry, edited to correct.

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Re: Equity valuation and not caring

Post by SovereignInvestor » Sun Apr 14, 2019 6:37 am

There are a litany of issues with Hussman argument.

First he keeps using US GDP to make broad statements about the US stock market when over 40% of sales are overseas. Most of the growth comes from overseas as I noted. Real global GDP is forecasted to grow around 3.0%, which is not that far below long term norms so his argument of stalling growth in earnings is muted.

Second the margin adjusted features lose a lot of weight when we have the lowest tax rates ever in history. Of course margins will be near the highest in history.

Using CAPE is misleading as it doesn't adjust for buybacks so comparing recent readings to long term averages is a major issue. I've written about this in detail. Buybacks allow earnings to grow faster than inflation indefinitely which is not accounted for appear like unsustainable high earnings levels. But the high levels are sustainable when the share count reduction from.buybacks are permanent.

CAPE Is Leading Bears Astray https://seekingalpha.com/article/4207295?source=ansh

He is suggesting the SPX is 175% over valued. This implies fair value of 1400 or so. That would mean the S&P current buyback and dividend yield would be over 10%. So if the economy never grew again...0% inflation and 0% real growth, the s&p long run return would be 10% if it was at 1400 now. That is way way too high...because that would be 10% real return and if there's no growth ever it's pretty likely long term interest rates would be around 0%, so the equity return premium would also likely be near 10%. Historically long term rates are at or a little below nominal GDP growth.

The historical average equity return is 6.5% in real terms and ballpark 5% premium to long term bonds.

The 1400 level leads to egregiously excessive risk premiums.

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Re: Equity valuation and not caring

Post by dogagility » Sun Apr 14, 2019 6:56 am

heyyou wrote:
Sun Apr 14, 2019 12:27 am
The news media need headlines every day, the scarier, and more attention grabbing, the better. Oh no, WE MIGHT BE ENTERING A PERIOD OF LOW RETURNS!!! You better spend time at our ad-laden website for more details, where we will speculate about what could happen if A leads to B, then C to D to E, to the brink of being F'd.
Heyyou! That... was... awesome! :beer
Taking "risk" since 1995.

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Re: Equity valuation and not caring

Post by cjking » Sun Apr 14, 2019 7:17 am

HEDGEFUNDIE wrote:
Fri Apr 12, 2019 12:55 pm
If you had invested a lump sum in stocks at the very top of the dotcom boom in 2000 (i.e. ridiculously high valuations), you would have experienced 5.7% CAGR through the past 19 years.
I've just had a look on moneychimp, and with dividends reinvested and adjustment for inflation they say the CAGR was 2.64%, for the period 1 Jan 2000 to 31 Dec 2018.

Edited to add random observation: Vanguard UK's web site is showing their European tracker ETF VEUR on a dividend yield of 3.37%, as of the end of March.

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Re: Equity valuation and not caring

Post by MnD » Sun Apr 14, 2019 8:58 am

Still pounding the valuation gong?

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