Seasonal wrote: ↑Wed Dec 16, 2020 12:02 pm
willthrill81 wrote: ↑Wed Dec 16, 2020 11:44 am<quote snipped>
I'm not trying to be rude or snippy at all, but if
you believe that CAPE is capable of explaining 40% of market returns, then I think that the burden of proof is on
you to show that it's
not useful.
<second post>
The burden of proof lies with the one making the claim. Yes, vineviz made a claim, but you have made a claim yourself. How can a statistically significant variable explain 40% of the variance and not be useful in some way?
I have no idea if CAPE can consistently explain 40% of returns. I referred to a paper in which Vanguard found that it did over a defined period and didn't find anything better. Something can easily be the best, especially over a specific historic period, and not continue to even hit that level. My crystal ball is cloudy. It might or might not work going forward.
In other words, I'm not claiming anything beyond that Vanguard made a statement.
I did not say whether or not CAPE is useful. vineviz made a clear statement that it's useful. See above. If vineviz does not belief it is in fact useful, I'd appreciate a clarification.
As you note, the burden of proof is on the one who makes a claim.
I've lost faith that anyone who things CAPE is useless can be persuaded by evidence at this point, but here is some anyway.
Imagine an investor who must decide at the beginning of each year how much to invest for their retirement in 30 years. Call this the savings rate. For the sake of simplicity, let's assume they are 100% invested in equities and that each year they make the decision mechanically using as inputs three numbers: the current balance in the account, the number of years remaining until retirement, and an estimate of future real returns. I use real returns so I can simulate over multiple time periods without bias. The target retirement wealth is $100,000.
There are two options for estimating future real returns. Option 1 is to use a CAPE regression which incorporates only the data available as of 12/31 of the prior year (i.e. no look-ahead bias). Option 2 is to just use the long-run average return as of 12/31 of the prior year. I compared the outcomes for all 81 rolling 30-year periods starting in 1910. Option 1 (using CAPE) produced a higher retirement wealth on average (about 6% higher) with smoother contributions (about 8% less volatility) than not using CAPE.
By way of illustration, here are the annual contributions for the 1989 start years for the investor using CAPE (blue line) and not using CAPE (orange line). Ignoring valuations in formulating the financial plan, as the orange line investor did, produced the kind of sudden and severe adjustments in savings rate that investors generally prefer to avoid.
Now imagine the reverse scenario. A retired investor starts with $100,000 and must decide at the beginning of each year how much of their portfolio to withdraw. Using the same options, with a goal of drawing down the portfolio to zero at the end of 30 years, the investor using CAPE to inform their withdrawal rates had less volatile swings in retirement consumption (about 11% less) than the investor who did not use CAPE to inform their withdrawal rate.
By way of illustration, here are the annual withdrawals for the 1965 start years for the investor using CAPE (blue line) and not using CAPE (orange line). Ignoring valuations in formulating the financial plan, as the orange line investor did, produced the kind of sudden and severe curtailments in consumption that investors generally prefer to avoid.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch