If Valuation doesn't matter, what does?

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CraigTester
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If Valuation doesn't matter, what does?

Post by CraigTester »

If "nobody knows nuttin", then why don't stock prices just drift aimlessly to the moon... or to zero....?

We've all seen a gazillion topics on this site which ultimately root back to the question of whether or not valuation "theory" matters.

I don't think there is currently much debate about whether or not US equity markets have reached the upper percentiles of their historical valuations, but there seems to be endless debate about whether it matters.

So my question is, if valuation doesn't matter, then what does?
Copernicus
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Re: If Valuation doesn't matter, what does?

Post by Copernicus »

Valuation matters, but it is a poor tool to time investing decisions.
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Re: If Valuation doesn't matter, what does?

Post by Ramjet »

CraigTester wrote: Wed Jan 05, 2022 10:29 am If "nobody knows nuttin", then why don't stock prices just drift aimlessly to the moon... or to zero....?

We've all seen a gazillion topics on this site which ultimately root back to the question of whether or not valuation "theory" matters.

I don't think there is currently much debate about whether or not US equity markets have reached the upper percentiles of their historical valuations, but there seems to be endless debate about whether it matters.

So my question is, if valuation doesn't matter, then what does?
A better question might be even if they matter, what can anyone do about high valuations? Trying to time the market for a crash or downturn that may happen tomorrow or in 10 years seems like a losing battle. I personally, did do something in part, due to high valuations. I am invested at global market cap when I wasn't previously. This was not a decision I made to make a quick buck, planning on staying at this AA no matter what
VT & HFEA
scout1
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Re: If Valuation doesn't matter, what does?

Post by scout1 »

CraigTester wrote: Wed Jan 05, 2022 10:29 am So my question is, if valuation doesn't matter, then what does?
Nothing, which is the whole point of the boglehead philosophy.
MarkRoulo
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Re: If Valuation doesn't matter, what does?

Post by MarkRoulo »

CraigTester wrote: Wed Jan 05, 2022 10:29 am If "nobody knows nuttin", then why don't stock prices just drift aimlessly to the moon... or to zero....?

We've all seen a gazillion topics on this site which ultimately root back to the question of whether or not valuation "theory" matters.

I don't think there is currently much debate about whether or not US equity markets have reached the upper percentiles of their historical valuations, but there seems to be endless debate about whether it matters.

So my question is, if valuation doesn't matter, then what does?
Valuations DO matter.

The problem for any particular investor is that to successfully take advantage of incorrect values you need to have a better ability to value at least some stocks AND the ability to not lose if the valuations get even more wrong.

Think about this as being at a racetrack and being allowed to bet on individual horses for a given race. The odds clearly matter. But if you don't have a better idea about the "correct" odds than the rest of the crowd then you won't do better by picking an individual horse than you will by betting on all of them.

Worse, imagine that you don't know WHEN the race is to be run, so if you bet against a horse you might have to keep adding to your position to maintain your bet! [this is the basic risk with selling short]

So ... yes, valuations do matter.

But the odds that any individual investor can value more accurately than the market is empirically low so there isn't much one can do with an opinion on valuations. As crazy as prices can seem. Amazon was founded in 1994, didn't have an actual yearly profit until 2003 and today is worth $1.5T with net profits of about $26B. It has looked overprices for decades, but the folks betting against it have (net) lost money.
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CraigTester
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Re: If Valuation doesn't matter, what does?

Post by CraigTester »

Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

What is causing so many people to reach this new consensus at the same time?

Who is "deciding" this for the rest of us...? And what are they basing this decision on?

Why doesn't everyone just refuse to pay 3X more today than they were in 2009?

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
JSPECO9
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Re: If Valuation doesn't matter, what does?

Post by JSPECO9 »

Valuations absolutely do matter. No matter what type of investor you are. As a passive investor, it's not actionable though. But high valuations mean you should temper your expectations for future returns.
tvubpwcisla
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Re: If Valuation doesn't matter, what does?

Post by tvubpwcisla »

Staying invested might be a more important factor than valuations.
JSPECO9
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Re: If Valuation doesn't matter, what does?

Post by JSPECO9 »

CraigTester wrote: Wed Jan 05, 2022 11:07 am
Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

What is causing so many people to reach this new consensus at the same time?

Who is "deciding" this for the rest of us...? And what are they basing this decision on?

Why doesn't everyone just refuse to pay 3X more today than they were in 2009?

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
Vanguard has VOO market weight P/E at 24.4, morningstar shows it at 20.99. Where are you seeing 40?

To kind of answer why valuations might be drastically different at different time periods: the main 2 reasons are investor sentiment and risk-free rate. Those 2 things vary from time to time.
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HomerJ
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Re: If Valuation doesn't matter, what does?

Post by HomerJ »

CraigTester wrote: Wed Jan 05, 2022 11:07 am
Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

What is causing so many people to reach this new consensus at the same time?

Who is "deciding" this for the rest of us...? And what are they basing this decision on?

Why doesn't everyone just refuse to pay 3X more today than they were in 2009?

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
No one is pricing stocks today based on earnings from 8, 9, 10 years ago.

CAPE with 10-year earning average is just a data-mining artifact created in an attempt to predict the future and time the market.

When people price stocks today, they look at price and forward projected earnings. You price a stock on how much you think the earnings will be going forward THIS year or next.

No one cares what Apple made 9 years ago when pricing the stock today.

S&P 500 Forward PE is like 21. Actually down from like 23 a year ago.

CAPE has nothing to do with stock pricing today.
"The best tools available to us are shovels, not scalpels. Don't get carried away." - vanBogle59
Kookaburra
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Re: If Valuation doesn't matter, what does?

Post by Kookaburra »

JSPECO9 wrote: Wed Jan 05, 2022 11:19 am
CraigTester wrote: Wed Jan 05, 2022 11:07 am
Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

What is causing so many people to reach this new consensus at the same time?

Who is "deciding" this for the rest of us...? And what are they basing this decision on?

Why doesn't everyone just refuse to pay 3X more today than they were in 2009?

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
Vanguard has VOO market weight P/E at 24.4, morningstar shows it at 20.99. Where are you seeing 40?

To kind of answer why valuations might be drastically different at different time periods: the main 2 reasons are investor sentiment and risk-free rate. Those 2 things vary from time to time.

https://www.multpl.com/shiller-pe
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Re: If Valuation doesn't matter, what does?

Post by Kookaburra »

HomerJ wrote: Wed Jan 05, 2022 11:21 am
CraigTester wrote: Wed Jan 05, 2022 11:07 am
Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

What is causing so many people to reach this new consensus at the same time?

Who is "deciding" this for the rest of us...? And what are they basing this decision on?

Why doesn't everyone just refuse to pay 3X more today than they were in 2009?

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
No one is pricing stocks today based on earnings from 8, 9, 10 years ago.

CAPE with 10-year earning average is just a data-mining artifact created in an attempt to predict the future and time the market.

When people price stocks today, they look at price and forward projected earnings. You price a stock on how much you think the earnings will be going forward THIS year or next.

No one cares what Apple made 9 years ago when pricing the stock today.

S&P 500 Forward PE is like 21. Actually down from like 23 a year ago.

CAPE has nothing to do with stock pricing today.
Some may not agree… viewtopic.php?f=10&t=331341
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HomerJ
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Re: If Valuation doesn't matter, what does?

Post by HomerJ »

Kookaburra wrote: Wed Jan 05, 2022 11:37 am
JSPECO9 wrote: Wed Jan 05, 2022 11:19 am
CraigTester wrote: Wed Jan 05, 2022 11:07 am
Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

What is causing so many people to reach this new consensus at the same time?

Who is "deciding" this for the rest of us...? And what are they basing this decision on?

Why doesn't everyone just refuse to pay 3X more today than they were in 2009?

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
Vanguard has VOO market weight P/E at 24.4, morningstar shows it at 20.99. Where are you seeing 40?

To kind of answer why valuations might be drastically different at different time periods: the main 2 reasons are investor sentiment and risk-free rate. Those 2 things vary from time to time.

https://www.multpl.com/shiller-pe
That's CAPE, Shiller PE, 10-year earnings averaged.

Forward PE is an estimate of what the next year's earnings will be. Which is the only thing investors care about when setting prices today.

Market is forward-looking.

If you believe Apple is going to triple its profits next year or two, people will be willing to pay more for it today. No one pricing Apple today cares what Apple's profits were 9 years ago.
Last edited by HomerJ on Wed Jan 05, 2022 11:46 am, edited 1 time in total.
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HomerJ
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Re: If Valuation doesn't matter, what does?

Post by HomerJ »

Kookaburra wrote: Wed Jan 05, 2022 11:40 am
HomerJ wrote: Wed Jan 05, 2022 11:21 am
CraigTester wrote: Wed Jan 05, 2022 11:07 am
Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

What is causing so many people to reach this new consensus at the same time?

Who is "deciding" this for the rest of us...? And what are they basing this decision on?

Why doesn't everyone just refuse to pay 3X more today than they were in 2009?

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
No one is pricing stocks today based on earnings from 8, 9, 10 years ago.

CAPE with 10-year earning average is just a data-mining artifact created in an attempt to predict the future and time the market.

When people price stocks today, they look at price and forward projected earnings. You price a stock on how much you think the earnings will be going forward THIS year or next.

No one cares what Apple made 9 years ago when pricing the stock today.

S&P 500 Forward PE is like 21. Actually down from like 23 a year ago.

CAPE has nothing to do with stock pricing today.
Some may not agree… viewtopic.php?f=10&t=331341
That's not really the question the OP is asking. He's not asking if CAPE is predictive.

He is asking how the price is set today, why people are willing to pay 40x for each $1 of earnings.

My answer is that that people are not paying 40x for each $1 of earnings. They are paying 20x for each $1 of earning, which is fairly reasonable, historically.

When you buy the SP500 today, you are paying a multiple of expected earnings going forward.
Last edited by HomerJ on Wed Jan 05, 2022 11:55 am, edited 1 time in total.
"The best tools available to us are shovels, not scalpels. Don't get carried away." - vanBogle59
MarkRoulo
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Re: If Valuation doesn't matter, what does?

Post by MarkRoulo »

CraigTester wrote: Wed Jan 05, 2022 11:07 am
Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

What is causing so many people to reach this new consensus at the same time?

Who is "deciding" this for the rest of us...? And what are they basing this decision on?

Why doesn't everyone just refuse to pay 3X more today than they were in 2009?

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
Two things come to mind about valuation expansion:
  • 10-year treasury bond yields in 2009 seem to be around 2.5% - 3.5%, in 2021 1.0% to 1.7%
  • The economy looked a lot more wrecked in 2009
Both would tend to make stocks less valuable for a given amount of earnings.

What is causing so many people to reach this new consensus? Bond yields for one. They are now negative in real terms. A lot of folks don't like that and are looking for alternatives.

"Who"? Dollar weighted by investments. If lots of money piles out of stocks (and, presumably into bonds) then we'll be discussing who is deciding that bonds yielding -1% read for ten years is a good choice.

"Why doesn't everyone just refuse to pay 3X more today than they were in 2009?"

Because the savings need to go somewhere. Cash is yielding around 0% nominal (and negative real). Bonds are yielding a bit more nominal, but still negative real. Folks don't like to invest in guaranteed losses. This is why lots of people aren't piling out of stocks -- there isn't a good place to go. I'm quite confident that 5% bond yields would be paired with lower stock prices.
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Re: If Valuation doesn't matter, what does?

Post by Marseille07 »

CraigTester wrote: Wed Jan 05, 2022 10:29 am So my question is, if valuation doesn't matter, then what does?
Money flowing into the market. That's all there is to it.
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tadamsmar
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Re: If Valuation doesn't matter, what does?

Post by tadamsmar »

CraigTester wrote: Wed Jan 05, 2022 10:29 am So my question is, if valuation doesn't matter, then what does?
Do current valuations matter?

Current valuations statistically imply 0% equity returns on average over 10 years.

Does 0% 10-year returns matter?

I dare say the if the typical Boglehead projected 0% returns for 10 years they would find that they do not need to adjust their plan to meet their goals. The typical Boglehead is relying on an appropriate mix of bonds, fixed income, and personal human capital to sufficiently mitigate the risk.

That is what matters.

Heck, when I was younger, I projected my plan at various plausible stock return rates including 0%
Last edited by tadamsmar on Wed Jan 05, 2022 11:52 am, edited 1 time in total.
JSPECO9
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Re: If Valuation doesn't matter, what does?

Post by JSPECO9 »

Kookaburra wrote: Wed Jan 05, 2022 11:37 am
JSPECO9 wrote: Wed Jan 05, 2022 11:19 am
CraigTester wrote: Wed Jan 05, 2022 11:07 am
Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

What is causing so many people to reach this new consensus at the same time?

Who is "deciding" this for the rest of us...? And what are they basing this decision on?

Why doesn't everyone just refuse to pay 3X more today than they were in 2009?

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
Vanguard has VOO market weight P/E at 24.4, morningstar shows it at 20.99. Where are you seeing 40?

To kind of answer why valuations might be drastically different at different time periods: the main 2 reasons are investor sentiment and risk-free rate. Those 2 things vary from time to time.

https://www.multpl.com/shiller-pe
That's Shiller P/E.
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Lee_WSP
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Re: If Valuation doesn't matter, what does?

Post by Lee_WSP »

CraigTester wrote: Wed Jan 05, 2022 11:07 am
Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
What's the alternative?

It also depends on whether you accept EMH and if youbdo, what flavor. Weak, semi strong or strong.
JackoC
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Re: If Valuation doesn't matter, what does?

Post by JackoC »

CraigTester wrote: Wed Jan 05, 2022 10:29 am If "nobody knows nuttin", then why don't stock prices just drift aimlessly to the moon... or to zero....?

We've all seen a gazillion topics on this site which ultimately root back to the question of whether or not valuation "theory" matters.

I don't think there is currently much debate about whether or not US equity markets have reached the upper percentiles of their historical valuations, but there seems to be endless debate about whether it matters.

So my question is, if valuation doesn't matter, then what does?
There's no reasonable debate that it matters. That there's 'debate' about it is the result of various misunderstandings, like:

Not distinguishing ex ante expected and ex post realized return. Stocks are a risk asset. Therefore, by definition the future realized return is unknown. But the expected return, the 'center of gravity' of the distribution of future realized returns, can be estimated and it obviously depends on valuation. Just like the expected return of bonds obviously depends on what they yield when you buy them. It would be absurd to say your expected return on a default-riskless bond you hold to maturity is independent of the yield at which you buy it, but rather 'let's look at history to see what my expected return is'. It's not fundamentally different for stocks once you get your head around the difference between ex ante expected return v. ex post realized return.

The other mix up is the idea a lower or higher expected return would have any direct implication on asset allocation, therefore speaking of valuations automatically implies proposing tactical allocation shifts. But it doesn't. You'd only shift allocation between bonds and stocks if you were saying the *relative* valuation of stocks to bonds was more expensive than some norm you could expect it to return to*. Any stock market metric you look at now is expensive, you really have to cherry pick to find one which isn't**, but the arguably best proxy for the 'riskless asset', the 5 yr, yields -1.6% real. IOW they are both very expensive, not clear why anyone would interpret quoting one of those valuations as implying people should pile into the other one. It's clear that expected return is low on both compared to history, but not at all obvious which has become more attractive relatively than it used to be. The neutral 'efficient market' default assumption would be they're both equally unattractive vs. history. But there's no 'efficient' reason to think you 'deserve' the past geometric average of stock returns as your expected return from now and that's the inevitable practical conclusion drawn from 'valuations don't matter for return'. Because you can't actually assume nothing. 'Nobody knows nuthin' virtually 100% of the time translates practically to 'nobody knows nuthin, but let's look at what did happen since we know that', which generally progresses to investment planning based de facto on assuming the expected return is the past realized average return.

*or if your personal risk/utility function demands more or less risk when returns, risky and riskless, are generally higher or lower. That could be true but it's individual so can't be generalized.
**even spot P/E is pretty high, but obviously there has to be *some* correction for the earnings cycle or else you'd repeatedly conclude stocks were expensive in recessions and cheap in economic upswings. The basic idea of averaging as per CAPE is hard to argue with in concept. I really believe a lot of the push back on CAPE is 1) people just don't like the idea that expected returns are low now and 2) related off track discussions of whether ex post realized returns exactly tracked ex ante expected returns per CAPE ignoring both a) if those two things were correlated very closely it would prove stocks aren't a risk asset, but we know they are, b) neglects the fact that generally increasing valuation was itself a very significant component in ex post realized return tending to overshoot ex ante expected return more often than the opposite. That can be expected to continue if you claim the *expected value* of future valuation is higher than now's. But that seems like a pretty heroic assumption. Estimating the expected return as the earnings yield now (1/PE, 1/CAPE) OTOH does *not* assume the expected future valuation is lower, it implicitly assumes the expected future valuation is just as high as now's.
Last edited by JackoC on Wed Jan 05, 2022 11:58 am, edited 1 time in total.
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CraigTester
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Re: If Valuation doesn't matter, what does?

Post by CraigTester »

JSPECO9 wrote: Wed Jan 05, 2022 11:19 am
CraigTester wrote: Wed Jan 05, 2022 11:07 am
Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

What is causing so many people to reach this new consensus at the same time?

Who is "deciding" this for the rest of us...? And what are they basing this decision on?

Why doesn't everyone just refuse to pay 3X more today than they were in 2009?

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
Vanguard has VOO market weight P/E at 24.4, morningstar shows it at 20.99. Where are you seeing 40?

To kind of answer why valuations might be drastically different at different time periods: the main 2 reasons are investor sentiment and risk-free rate. Those 2 things vary from time to time.
I should have clarified that I was referencing CAPE-10 on the SP500 at 40 today, versus 15 in 2009

But whether you look at the Buffet indicator, P/S ratios, CAPE50, CAPE40 or even CAPE1...it appears that valuations are historically VERY high at this time.

If I was to learn that there is consensus that markets are not currently historically very expensive, that would answer my question.... And I could take comfort that the market is behaving "logically", even though I just happen to disagree with the current assessment of its price relative to its intrinsic value.

As for risk-free rate, I believe interest rates are historically very low around the globe with only the US responding so optimistically...

As for "investor sentiment" this might be what I'm really digging for..... what is it about investor sentiment today, rather than any other time in our US history, that is causing such historically high valuations....?
NiceUnparticularMan
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Re: If Valuation doesn't matter, what does?

Post by NiceUnparticularMan »

First, I want to echo HomerJ's well-articulated stance that logically what matters is forward-looking predictions of earnings.

Second, I want to note there are two well-known reasons why even given the same expected set of future earnings, the price could vary over time.

The first is that there is risk to those predictions. So if the risk involved in those predicted earnings was higher at one point, lower at a second point, prices could rationally be lower, and expected returns higher, at the first point, and prices could rationally be higher, and expected returns lower, at the second point.

The second is that specific stock markets do not operated in a vacuum. Investors with capital to invest can invest in different stock markets, different financial markets, or different ways entirely. Indeed, even the total supply of capital is a variable, including because of savings versus consumption decisions, the distribution of income, and so on. So, if those alternatives were more competitive at one point, less competitive at another, prices could rationally be lower, and expected returns higher, at the first point, and prices could rationally be higher, and expected returns lower, at the second point. Same deal if total financial capital supply was lower at one point, higher at another.

Obviously one thing I have tried to emphasize is that these sorts of "rational" explanations for why the same set of expected earnings could be priced differently in different contexts are necessarily double-edged. It may well be true there is such a rational explanation for higher prices. But almost invariably, if it is truly a difference in valuations over predicted earnings (and not a difference in earnings predictions), then the same rational explanation will support expecting lower returns.
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CraigTester
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Re: If Valuation doesn't matter, what does?

Post by CraigTester »

JSPECO9 wrote: Wed Jan 05, 2022 11:10 am Valuations absolutely do matter. No matter what type of investor you are. As a passive investor, it's not actionable though. But high valuations mean you should temper your expectations for future returns.
Assuming that 100% of investors are not "passive", if expectations for future returns are lower, doesn't that imply that the value of the thing I'm investing in is lower.... and therefore I should not be willing to pay as much for it?

Logically wouldn't it then follow that prices should fall to balance the lower future expected returns....?

But that last step isn't happening.... Why?
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Re: If Valuation doesn't matter, what does?

Post by Lee_WSP »

CraigTester wrote: Wed Jan 05, 2022 12:22 pm
JSPECO9 wrote: Wed Jan 05, 2022 11:10 am Valuations absolutely do matter. No matter what type of investor you are. As a passive investor, it's not actionable though. But high valuations mean you should temper your expectations for future returns.
Assuming that 100% of investors are not "passive", if expectations for future returns are lower, doesn't that imply that the value of the thing I'm investing in is lower.... and therefore I should not be willing to pay as much for it?

Logically wouldn't it then follow that prices should fall to balance the lower future expected returns....?

But that last step isn't happening.... Why?
The majority opinion is clearly bigger growth going forward.
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CraigTester
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Re: If Valuation doesn't matter, what does?

Post by CraigTester »

scout1 wrote: Wed Jan 05, 2022 10:48 am
CraigTester wrote: Wed Jan 05, 2022 10:29 am So my question is, if valuation doesn't matter, then what does?
Nothing, which is the whole point of the boglehead philosophy.
Then why don't stock prices drift to the moon... or to zero?
JSPECO9
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Re: If Valuation doesn't matter, what does?

Post by JSPECO9 »

CraigTester wrote: Wed Jan 05, 2022 12:22 pm
JSPECO9 wrote: Wed Jan 05, 2022 11:10 am Valuations absolutely do matter. No matter what type of investor you are. As a passive investor, it's not actionable though. But high valuations mean you should temper your expectations for future returns.
Assuming that 100% of investors are not "passive", if expectations for future returns are lower, doesn't that imply that the value of the thing I'm investing in is lower.... and therefore I should not be willing to pay as much for it?

Logically wouldn't it then follow that prices should fall to balance the lower future expected returns....?

But that last step isn't happening.... Why?
Nope. Because what matters is: what's the alternative?

Pretend that you have a lump-sum of money that you inherited (let's say $1m) and want to invest for the long-term. Let's pretend that your definition of "long-term" is 30 years. So you need to find the best possible investment to make for 30 years. What are your options? Lets rank them from safest to riskiest and look at their expected rate of returns and how safe they are (you can shuffle these around if you disagree on the risk scale).

-High-yield savings account (0.50% annually) - very safe
-2-year treasury bond (0.8% annually) - also very safe for the 2 year period
-5-year treasury (1.4% annually) - very safe for the 5 year period
-10-year treasury (1.68% annually) - safe for the 10 year period
-30 year treasury (2.09% annually) - safe for the 30 year period
-Diversified basket of U.S. stocks (4.29% earnings yield, using the current 23.3 weighted p/e on the Vanguard website) - taking on risk

You are investing for the long-run (30 years), which of these investments will you choose?

Bear in mind 2 things:
-The earnings of the basket of stocks are expected to grow annually, so the longer you hold the investment, the less riskier it becomes
-When you buy a 30 year treasury, you are locking in your earnings for 30 years, no growth. If I offered you a basket of AAA-, AA+, & AA rated, blue-chip stocks, for a weighted P/E of 50 (invert the 2% annual yield), but told you that there is no chance that the earnings will grow on an annual basis, would you buy it?

Now, with all of the facts of the present investing environment I just gave you, which 30 year investment will you choose?

In my opinion (and I can be wrong, feel free to correct me), I am going with the diversified basket of stocks. I don't care what valuations were in 2005, 1990, 1980, 1970, etc. I need to make an investment today, and I need to look at my options today. So yes, valuations for equities do matter, but they matter relative to other investment alternatives. If the alternatives have even higher valuations that the stocks do (ex: 30 year treasury having a p/e of 50), then the laws of supply & demand will naturally raise the valuations for stocks as well, as more and more investors will move towards stocks.

Of course, the real alternative is to say "well, I predict that in the next few years, treasury rates will go up, and stock valuations will crash, so I will sit on the sidelines, wait and get a much better bargain." But I will respond "good luck."
Last edited by JSPECO9 on Wed Jan 05, 2022 12:57 pm, edited 1 time in total.
asif408
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Re: If Valuation doesn't matter, what does?

Post by asif408 »

CraigTester wrote: Wed Jan 05, 2022 11:56 am I should have clarified that I was referencing CAPE-10 on the SP500 at 40 today, versus 15 in 2009

But whether you look at the Buffet indicator, P/S ratios, CAPE50, CAPE40 or even CAPE1...it appears that valuations are historically VERY high at this time.

If I was to learn that there is consensus that markets are not currently historically very expensive, that would answer my question.... And I could take comfort that the market is behaving "logically", even though I just happen to disagree with the current assessment of its price relative to its intrinsic value.

As for risk-free rate, I believe interest rates are historically very low around the globe with only the US responding so optimistically...

As for "investor sentiment" this might be what I'm really digging for..... what is it about investor sentiment today, rather than any other time in our US history, that is causing such historically high valuations....?
You've hit the nail on the head. High valuations are pretty much always accompanied by very positive sentiment. And very negative sentiment is nearly always accompanied by low valuations. The relationship between valuations and sentiment is pretty much one to one. If anyone knows an exception to this I'd love to see it.

So don't expect much if any negativity about US stocks at a CAPE of 40 by individuals . Now ask people what they think of Japan, the UK, China, Turkey, Russia, and Chile and you'll get much more negativity, and not surprisingly their CAPE ratios are lower. And then ask them about foreign value stocks and the negativity will overwhelm you. In general I like to invest where sentiment is the most negative and move away from where sentiment is the most positive, in a low cost, diversified way of course.

One poster above even said as a passive investor, valuations matter but are not actionable. Ironically, in their signature they indicate they have an allocation of 40% to foreign stocks and 20% in US SCV, with only 40% in US large stocks. Sounds like they took some action and don't have all their eggs in the CAPE 40 basket.
Nathan Drake
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Re: If Valuation doesn't matter, what does?

Post by Nathan Drake »

asif408 wrote: Wed Jan 05, 2022 12:56 pm
CraigTester wrote: Wed Jan 05, 2022 11:56 am I should have clarified that I was referencing CAPE-10 on the SP500 at 40 today, versus 15 in 2009

But whether you look at the Buffet indicator, P/S ratios, CAPE50, CAPE40 or even CAPE1...it appears that valuations are historically VERY high at this time.

If I was to learn that there is consensus that markets are not currently historically very expensive, that would answer my question.... And I could take comfort that the market is behaving "logically", even though I just happen to disagree with the current assessment of its price relative to its intrinsic value.

As for risk-free rate, I believe interest rates are historically very low around the globe with only the US responding so optimistically...

As for "investor sentiment" this might be what I'm really digging for..... what is it about investor sentiment today, rather than any other time in our US history, that is causing such historically high valuations....?
You've hit the nail on the head. High valuations are pretty much always accompanied by very positive sentiment. And very negative sentiment is nearly always accompanied by low valuations. The relationship between valuations and sentiment is pretty much one to one. If anyone knows an exception to this I'd love to see it.

So don't expect much if any negativity about US stocks at a CAPE of 40 by individuals . Now ask people what they think of Japan, the UK, China, Turkey, Russia, and Chile and you'll get much more negativity, and not surprisingly their CAPE ratios are lower. And then ask them about foreign value stocks and the negativity will overwhelm you. In general I like to invest where sentiment is the most negative and move away from where sentiment is the most positive, in a low cost, diversified way of course.

One poster above even said as a passive investor, valuations matter but are not actionable. Ironically, in their signature they indicate they have an allocation of 40% to foreign stocks and 20% in US SCV, with only 40% in US large stocks. Sounds like they took some action and don't have all their eggs in the CAPE 40 basket.
Or me :)

Only 20% exposed to CAPE10 of 40, and a very intentional tilt against what I believe to be lower returning assets
20% VOO | 30% VXUS | 20% AVUV | 15% AVDV | 15% AVES
JSPECO9
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Re: If Valuation doesn't matter, what does?

Post by JSPECO9 »

asif408 wrote: Wed Jan 05, 2022 12:56 pm
CraigTester wrote: Wed Jan 05, 2022 11:56 am I should have clarified that I was referencing CAPE-10 on the SP500 at 40 today, versus 15 in 2009

But whether you look at the Buffet indicator, P/S ratios, CAPE50, CAPE40 or even CAPE1...it appears that valuations are historically VERY high at this time.

If I was to learn that there is consensus that markets are not currently historically very expensive, that would answer my question.... And I could take comfort that the market is behaving "logically", even though I just happen to disagree with the current assessment of its price relative to its intrinsic value.

As for risk-free rate, I believe interest rates are historically very low around the globe with only the US responding so optimistically...

As for "investor sentiment" this might be what I'm really digging for..... what is it about investor sentiment today, rather than any other time in our US history, that is causing such historically high valuations....?
You've hit the nail on the head. High valuations are pretty much always accompanied by very positive sentiment. And very negative sentiment is nearly always accompanied by low valuations. The relationship between valuations and sentiment is pretty much one to one. If anyone knows an exception to this I'd love to see it.

So don't expect much if any negativity about US stocks at a CAPE of 40 by individuals . Now ask people what they think of Japan, the UK, China, Turkey, Russia, and Chile and you'll get much more negativity, and not surprisingly their CAPE ratios are lower. And then ask them about foreign value stocks and the negativity will overwhelm you. In general I like to invest where sentiment is the most negative and move away from where sentiment is the most positive, in a low cost, diversified way of course.

One poster above even said as a passive investor, valuations matter but are not actionable. Ironically, in their signature they indicate they have an allocation of 40% to foreign stocks and 20% in US SCV, with only 40% in US large stocks. Sounds like they took some action and don't have all their eggs in the CAPE 40 basket.
Correct that throughout my short investment career I went from 100% S&P 500 to global stocks and SCV stocks, because of more diversification. I can't control how highly valued stocks get, but I can control how diversified I am.

So I guess you're right on the actionable part, if OP is really worried about the stock valuations of a few stocks, maybe he/she isn't diversified enough.
Nathan Drake
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Re: If Valuation doesn't matter, what does?

Post by Nathan Drake »

JSPECO9 wrote: Wed Jan 05, 2022 1:04 pm
asif408 wrote: Wed Jan 05, 2022 12:56 pm
CraigTester wrote: Wed Jan 05, 2022 11:56 am I should have clarified that I was referencing CAPE-10 on the SP500 at 40 today, versus 15 in 2009

But whether you look at the Buffet indicator, P/S ratios, CAPE50, CAPE40 or even CAPE1...it appears that valuations are historically VERY high at this time.

If I was to learn that there is consensus that markets are not currently historically very expensive, that would answer my question.... And I could take comfort that the market is behaving "logically", even though I just happen to disagree with the current assessment of its price relative to its intrinsic value.

As for risk-free rate, I believe interest rates are historically very low around the globe with only the US responding so optimistically...

As for "investor sentiment" this might be what I'm really digging for..... what is it about investor sentiment today, rather than any other time in our US history, that is causing such historically high valuations....?
You've hit the nail on the head. High valuations are pretty much always accompanied by very positive sentiment. And very negative sentiment is nearly always accompanied by low valuations. The relationship between valuations and sentiment is pretty much one to one. If anyone knows an exception to this I'd love to see it.

So don't expect much if any negativity about US stocks at a CAPE of 40 by individuals . Now ask people what they think of Japan, the UK, China, Turkey, Russia, and Chile and you'll get much more negativity, and not surprisingly their CAPE ratios are lower. And then ask them about foreign value stocks and the negativity will overwhelm you. In general I like to invest where sentiment is the most negative and move away from where sentiment is the most positive, in a low cost, diversified way of course.

One poster above even said as a passive investor, valuations matter but are not actionable. Ironically, in their signature they indicate they have an allocation of 40% to foreign stocks and 20% in US SCV, with only 40% in US large stocks. Sounds like they took some action and don't have all their eggs in the CAPE 40 basket.
Correct that throughout my short investment career I went from 100% S&P 500 to global stocks and SCV stocks, because of more diversification. I can't control how highly valued stocks get, but I can control how diversified I am.

So I guess you're right on the actionable part, if OP is really worried about the stock valuations of a few stocks, maybe he/she isn't diversified enough.
You can have a core factor based portfolio that gradually tilts if any asset class looks to be significantly drifting away from historical valuations relative to other assets

This is what I do. CAPE is actionable but requires a very long term mindset with the ability to stay the course even while things continue to get more richly valued
20% VOO | 30% VXUS | 20% AVUV | 15% AVDV | 15% AVES
Topic Author
CraigTester
Posts: 366
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Re: If Valuation doesn't matter, what does?

Post by CraigTester »

HomerJ wrote: Wed Jan 05, 2022 11:21 am
CraigTester wrote: Wed Jan 05, 2022 11:07 am
Copernicus wrote: Wed Jan 05, 2022 10:32 am Valuation matters, but it is a poor tool to time investing decisions.
I'm trying really hard to not start another market timing debate...,

But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.

What is causing so many people to reach this new consensus at the same time?

Who is "deciding" this for the rest of us...? And what are they basing this decision on?

Why doesn't everyone just refuse to pay 3X more today than they were in 2009?

Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
No one is pricing stocks today based on earnings from 8, 9, 10 years ago.

CAPE with 10-year earning average is just a data-mining artifact created in an attempt to predict the future and time the market.

When people price stocks today, they look at price and forward projected earnings. You price a stock on how much you think the earnings will be going forward THIS year or next.

No one cares what Apple made 9 years ago when pricing the stock today.

S&P 500 Forward PE is like 21. Actually down from like 23 a year ago.

CAPE has nothing to do with stock pricing today.
So is that your answer to my original question? It's not valuation, but rather, its forward P/E ratios that matter most...

I appreciate your response, but I wonder how broadly that belief is held?

Individual companies may figure out how to reinvent themselves in any given year, but in aggregate, the 50,000 employees making widgets at your average SP500 company, don't produce step-function growth in earnings from year to year.....

This is why the best predictor of what an average company will produce next year, is a little bit more than what they did last year....

Ad libbing a Buffett quote, Forward P/E ratios tell you a lot more about the forecaster than anything else....
JSPECO9
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Re: If Valuation doesn't matter, what does?

Post by JSPECO9 »

Nathan Drake wrote: Wed Jan 05, 2022 1:07 pm
JSPECO9 wrote: Wed Jan 05, 2022 1:04 pm
asif408 wrote: Wed Jan 05, 2022 12:56 pm
CraigTester wrote: Wed Jan 05, 2022 11:56 am I should have clarified that I was referencing CAPE-10 on the SP500 at 40 today, versus 15 in 2009

But whether you look at the Buffet indicator, P/S ratios, CAPE50, CAPE40 or even CAPE1...it appears that valuations are historically VERY high at this time.

If I was to learn that there is consensus that markets are not currently historically very expensive, that would answer my question.... And I could take comfort that the market is behaving "logically", even though I just happen to disagree with the current assessment of its price relative to its intrinsic value.

As for risk-free rate, I believe interest rates are historically very low around the globe with only the US responding so optimistically...

As for "investor sentiment" this might be what I'm really digging for..... what is it about investor sentiment today, rather than any other time in our US history, that is causing such historically high valuations....?
You've hit the nail on the head. High valuations are pretty much always accompanied by very positive sentiment. And very negative sentiment is nearly always accompanied by low valuations. The relationship between valuations and sentiment is pretty much one to one. If anyone knows an exception to this I'd love to see it.

So don't expect much if any negativity about US stocks at a CAPE of 40 by individuals . Now ask people what they think of Japan, the UK, China, Turkey, Russia, and Chile and you'll get much more negativity, and not surprisingly their CAPE ratios are lower. And then ask them about foreign value stocks and the negativity will overwhelm you. In general I like to invest where sentiment is the most negative and move away from where sentiment is the most positive, in a low cost, diversified way of course.

One poster above even said as a passive investor, valuations matter but are not actionable. Ironically, in their signature they indicate they have an allocation of 40% to foreign stocks and 20% in US SCV, with only 40% in US large stocks. Sounds like they took some action and don't have all their eggs in the CAPE 40 basket.
Correct that throughout my short investment career I went from 100% S&P 500 to global stocks and SCV stocks, because of more diversification. I can't control how highly valued stocks get, but I can control how diversified I am.

So I guess you're right on the actionable part, if OP is really worried about the stock valuations of a few stocks, maybe he/she isn't diversified enough.
You can have a core factor based portfolio that gradually tilts if any asset class looks to be significantly drifting away from historical valuations relative to other assets

This is what I do.
As long as one can live with the tracking error regret and fight FOMO, I think it's a great strategy IMO. For me, I am more afraid of bubbles and long periods of no returns than I am of underperforming the S&P 500, hence my portfolio.
Topic Author
CraigTester
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Re: If Valuation doesn't matter, what does?

Post by CraigTester »

Marseille07 wrote: Wed Jan 05, 2022 11:49 am
CraigTester wrote: Wed Jan 05, 2022 10:29 am So my question is, if valuation doesn't matter, then what does?
Money flowing into the market. That's all there is to it.
If you are correct, is that sustainable?
Nathan Drake
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Re: If Valuation doesn't matter, what does?

Post by Nathan Drake »

JSPECO9 wrote: Wed Jan 05, 2022 1:10 pm
Nathan Drake wrote: Wed Jan 05, 2022 1:07 pm
JSPECO9 wrote: Wed Jan 05, 2022 1:04 pm
asif408 wrote: Wed Jan 05, 2022 12:56 pm
CraigTester wrote: Wed Jan 05, 2022 11:56 am I should have clarified that I was referencing CAPE-10 on the SP500 at 40 today, versus 15 in 2009

But whether you look at the Buffet indicator, P/S ratios, CAPE50, CAPE40 or even CAPE1...it appears that valuations are historically VERY high at this time.

If I was to learn that there is consensus that markets are not currently historically very expensive, that would answer my question.... And I could take comfort that the market is behaving "logically", even though I just happen to disagree with the current assessment of its price relative to its intrinsic value.

As for risk-free rate, I believe interest rates are historically very low around the globe with only the US responding so optimistically...

As for "investor sentiment" this might be what I'm really digging for..... what is it about investor sentiment today, rather than any other time in our US history, that is causing such historically high valuations....?
You've hit the nail on the head. High valuations are pretty much always accompanied by very positive sentiment. And very negative sentiment is nearly always accompanied by low valuations. The relationship between valuations and sentiment is pretty much one to one. If anyone knows an exception to this I'd love to see it.

So don't expect much if any negativity about US stocks at a CAPE of 40 by individuals . Now ask people what they think of Japan, the UK, China, Turkey, Russia, and Chile and you'll get much more negativity, and not surprisingly their CAPE ratios are lower. And then ask them about foreign value stocks and the negativity will overwhelm you. In general I like to invest where sentiment is the most negative and move away from where sentiment is the most positive, in a low cost, diversified way of course.

One poster above even said as a passive investor, valuations matter but are not actionable. Ironically, in their signature they indicate they have an allocation of 40% to foreign stocks and 20% in US SCV, with only 40% in US large stocks. Sounds like they took some action and don't have all their eggs in the CAPE 40 basket.
Correct that throughout my short investment career I went from 100% S&P 500 to global stocks and SCV stocks, because of more diversification. I can't control how highly valued stocks get, but I can control how diversified I am.

So I guess you're right on the actionable part, if OP is really worried about the stock valuations of a few stocks, maybe he/she isn't diversified enough.
You can have a core factor based portfolio that gradually tilts if any asset class looks to be significantly drifting away from historical valuations relative to other assets

This is what I do.
As long as one can live with the tracking error regret and fight FOMO, I think it's a great strategy IMO. For me, I am more afraid of bubbles and long periods of no returns than I am of underperforming the S&P 500, hence my portfolio.
Same for me.

I am fine with 8-10% annualized returns over most 5-10 year periods, even if one portion of my portfolio is doing 16%

What I would find unacceptable are 10-15 years of zero or negative returns which individual asset classes have shown to encounter periodically (US & Japan, plus many others)
20% VOO | 30% VXUS | 20% AVUV | 15% AVDV | 15% AVES
asif408
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Re: If Valuation doesn't matter, what does?

Post by asif408 »

JSPECO9 wrote: Wed Jan 05, 2022 1:04 pm
asif408 wrote: Wed Jan 05, 2022 12:56 pm
CraigTester wrote: Wed Jan 05, 2022 11:56 am I should have clarified that I was referencing CAPE-10 on the SP500 at 40 today, versus 15 in 2009

But whether you look at the Buffet indicator, P/S ratios, CAPE50, CAPE40 or even CAPE1...it appears that valuations are historically VERY high at this time.

If I was to learn that there is consensus that markets are not currently historically very expensive, that would answer my question.... And I could take comfort that the market is behaving "logically", even though I just happen to disagree with the current assessment of its price relative to its intrinsic value.

As for risk-free rate, I believe interest rates are historically very low around the globe with only the US responding so optimistically...

As for "investor sentiment" this might be what I'm really digging for..... what is it about investor sentiment today, rather than any other time in our US history, that is causing such historically high valuations....?
You've hit the nail on the head. High valuations are pretty much always accompanied by very positive sentiment. And very negative sentiment is nearly always accompanied by low valuations. The relationship between valuations and sentiment is pretty much one to one. If anyone knows an exception to this I'd love to see it.

So don't expect much if any negativity about US stocks at a CAPE of 40 by individuals . Now ask people what they think of Japan, the UK, China, Turkey, Russia, and Chile and you'll get much more negativity, and not surprisingly their CAPE ratios are lower. And then ask them about foreign value stocks and the negativity will overwhelm you. In general I like to invest where sentiment is the most negative and move away from where sentiment is the most positive, in a low cost, diversified way of course.

One poster above even said as a passive investor, valuations matter but are not actionable. Ironically, in their signature they indicate they have an allocation of 40% to foreign stocks and 20% in US SCV, with only 40% in US large stocks. Sounds like they took some action and don't have all their eggs in the CAPE 40 basket.
Correct that throughout my short investment career I went from 100% S&P 500 to global stocks and SCV stocks, because of more diversification. I can't control how highly valued stocks get, but I can control how diversified I am.

So I guess you're right on the actionable part, if OP is really worried about the stock valuations of a few stocks, maybe he/she isn't diversified enough.
FWIW, I think your approach is reasonable and prudent, but a lot of folks here with heavy large cap US stock allocations give the impression that something like that is useless because valuations don't matter.
Nathan Drake
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Re: If Valuation doesn't matter, what does?

Post by Nathan Drake »

asif408 wrote: Wed Jan 05, 2022 1:25 pm
JSPECO9 wrote: Wed Jan 05, 2022 1:04 pm
asif408 wrote: Wed Jan 05, 2022 12:56 pm
CraigTester wrote: Wed Jan 05, 2022 11:56 am I should have clarified that I was referencing CAPE-10 on the SP500 at 40 today, versus 15 in 2009

But whether you look at the Buffet indicator, P/S ratios, CAPE50, CAPE40 or even CAPE1...it appears that valuations are historically VERY high at this time.

If I was to learn that there is consensus that markets are not currently historically very expensive, that would answer my question.... And I could take comfort that the market is behaving "logically", even though I just happen to disagree with the current assessment of its price relative to its intrinsic value.

As for risk-free rate, I believe interest rates are historically very low around the globe with only the US responding so optimistically...

As for "investor sentiment" this might be what I'm really digging for..... what is it about investor sentiment today, rather than any other time in our US history, that is causing such historically high valuations....?
You've hit the nail on the head. High valuations are pretty much always accompanied by very positive sentiment. And very negative sentiment is nearly always accompanied by low valuations. The relationship between valuations and sentiment is pretty much one to one. If anyone knows an exception to this I'd love to see it.

So don't expect much if any negativity about US stocks at a CAPE of 40 by individuals . Now ask people what they think of Japan, the UK, China, Turkey, Russia, and Chile and you'll get much more negativity, and not surprisingly their CAPE ratios are lower. And then ask them about foreign value stocks and the negativity will overwhelm you. In general I like to invest where sentiment is the most negative and move away from where sentiment is the most positive, in a low cost, diversified way of course.

One poster above even said as a passive investor, valuations matter but are not actionable. Ironically, in their signature they indicate they have an allocation of 40% to foreign stocks and 20% in US SCV, with only 40% in US large stocks. Sounds like they took some action and don't have all their eggs in the CAPE 40 basket.
Correct that throughout my short investment career I went from 100% S&P 500 to global stocks and SCV stocks, because of more diversification. I can't control how highly valued stocks get, but I can control how diversified I am.

So I guess you're right on the actionable part, if OP is really worried about the stock valuations of a few stocks, maybe he/she isn't diversified enough.
FWIW, I think your approach is reasonable and prudent, but a lot of folks here with heavy large cap US stock allocations give the impression that something like that is useless because valuations don't matter.
For them it may be, if they can stick to it and are OK with very long periods of very poor performance

I certainly don’t find that head in the sand approach appealing, but over the very long term it is likely to be fine, if suboptimal
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Re: If Valuation doesn't matter, what does?

Post by firebirdparts »

I'm a fundamentalist, and I just accept that about myself. It only makes sense that you consider how fast companies are growing and the degree to which they're making money and then you act accordingly, taking into consideration the cost of capital. Fortunately this is a pretty transparent process, legally required, and in fact there are analysts that do this all the time and publish what they think. For the most part, companies give "guidance" and so you don't even have to wait around for the earnings report.

NOW. The effect of this is that stock prices are set by many many people all looking at this information. history has shown that investing index funds in that environment is pretty good. history has shown that buy-&-hold is pretty good.

If you want to market time, then you can, but everybody is just warning you to be careful about doing it based on valuation. They are warning you to be careful because history has shown that you should be careful. If you are the kind of person that wants to make everything fit some rule-based framework, then my advice is don't be that kind of person.

I am not a market timer, but if I was, I probably would be likely to try a moving averages approach. What I would most like to have is a way to predict the cost of capital, but I don't have any plans to develop one.
Last edited by firebirdparts on Wed Jan 05, 2022 1:38 pm, edited 1 time in total.
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JackoC
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Re: If Valuation doesn't matter, what does?

Post by JackoC »

Lee_WSP wrote: Wed Jan 05, 2022 12:25 pm
CraigTester wrote: Wed Jan 05, 2022 12:22 pm
JSPECO9 wrote: Wed Jan 05, 2022 11:10 am Valuations absolutely do matter. No matter what type of investor you are. As a passive investor, it's not actionable though. But high valuations mean you should temper your expectations for future returns.
Assuming that 100% of investors are not "passive", if expectations for future returns are lower, doesn't that imply that the value of the thing I'm investing in is lower.... and therefore I should not be willing to pay as much for it?

Logically wouldn't it then follow that prices should fall to balance the lower future expected returns....?

But that last step isn't happening.... Why?
The majority opinion is clearly bigger growth going forward.
Assuming a whole market (important assumption, see below) PE is independent of earnings growth. If earnings growth is going to be higher and a basically efficient market knows it, prices go up *now* to compensate. Simplified theory:

Model a stock as a perpetual paying Div, but Div is not fixed. Assuming for simplicity Div grows at rate g, the price of a stock P=Div/(r-g) P the stock price, r the return, and g the dividend growth rate. Thus r=P/Div+g. But dividend growth comes from earnings growth comes from return on actual assets. Assume in equilibrium the real expected return on the stock is the return on capital of the company.
So restate the last equation as P= p*E/(r-(1-p)*r), where p is the payout ratio, ie Div=p*E, div growth rate is (1-p)*r
Simplify and you get r=E/P, g drops out.

The big real world limitation in this is in a single company or even national stock market, the internal rate of return doesn't have to equal the market's expected return of the whole market, nor does the risk element in r have to be the same across the board. But across the entire market it should be true enough at least to discard the idea that the market anticipating better profit prospects for companies in general from now on will result in a higher expected return in the future. No, in an efficient market expected return is determined by the confluence of the supply and demand of investment capital and the market's average risk aversion (in the case of risky v riskless return). Those things varying are what change the expected return. Expected 'g' going up across the market does not.

But while as index investors we presumably shun 'hot stocks', we might (or not) diversify among global markets. In which case it's relevant that the world stock CAPE* (that is, including the US total market) was only 26 at mid year 2021 when the S&P CAPE was 37. The equation should hold basically for the world, there's more room for debate whether it should hold for one country in a well interconnected global market.

This is not to go on a tangent of US vs international, the opposite actually. Seems to me many posters in many of these discussions are basically saying 'show me what the expected return metric is and its value and then I may come up with arguments why I won't believe it if I don't like it'. This seems clearly implied by saying 'well the spot S&P PE isn't that terribly high'...has the person accepted that valuation affects expected return or not? Or only as long as the implied return is 'acceptably' high? :happy

But to reiterate higher stock market valuation does not mean the market anticipates higher stock returns. It means the market is willing to accept a lower expected return, and why? Change in the balance of supply/demand for investment capital (for assets overall) and change in the riskless expected return and whole market risk tolerance when it comes to risky assets specifically.

*in this context just an averaging to reduce noise from the business cycle, *NOT* talking about regression analysis of past increase/decrease in CAPE when it started low/high *NOT* talking about 'this country's CAPE is lower, so overweight there'. There is no good argument not to do some kind of smoothing like that. 'The market anticipates the future' is not one. WS analyst 'bottom up' earnings projections a) usually are only a year, b) have almost never reflected a significant expected decrease but the markets knows there's a business cycle. The problem with 'let's use the next several years' to model the business cycle effect is that there's no unbiased estimator of that, whereas the past business cycle effect is known, and of projections about the future, all uncertain, that there will still be business cycles is relatively less uncertain than most.
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Re: If Valuation doesn't matter, what does?

Post by patrick »

CraigTester wrote: Wed Jan 05, 2022 11:56 amIf I was to learn that there is consensus that markets are not currently historically very expensive, that would answer my question.... And I could take comfort that the market is behaving "logically", even though I just happen to disagree with the current assessment of its price relative to its intrinsic value.

As for risk-free rate, I believe interest rates are historically very low around the globe with only the US responding so optimistically...

As for "investor sentiment" this might be what I'm really digging for..... what is it about investor sentiment today, rather than any other time in our US history, that is causing such historically high valuations....?
One aspect of investor sentiment today is quite normal by historical standards: people are stating that stocks are very expensive. Such statements have been made regularly since well before 2009. Even in 2009, people used 12-month trailings earning and/or pessimistic forecasts to argue that stocks were very expensive then and would soon go down much further.

As for why those ratios are higher in the US, look at which companies dominate the US indexes. The market is implicitly forecasting that large US tech companies will further grow their dominance of the global economy. You might happen to disagree with that forecast, and you might be right, but there is at least a plausible reason behind it.
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CraigTester
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Re: If Valuation doesn't matter, what does?

Post by CraigTester »

JSPECO9 wrote: Wed Jan 05, 2022 12:54 pm
CraigTester wrote: Wed Jan 05, 2022 12:22 pm
JSPECO9 wrote: Wed Jan 05, 2022 11:10 am Valuations absolutely do matter. No matter what type of investor you are. As a passive investor, it's not actionable though. But high valuations mean you should temper your expectations for future returns.
Assuming that 100% of investors are not "passive", if expectations for future returns are lower, doesn't that imply that the value of the thing I'm investing in is lower.... and therefore I should not be willing to pay as much for it?

Logically wouldn't it then follow that prices should fall to balance the lower future expected returns....?

But that last step isn't happening.... Why?
Nope. Because what matters is: what's the alternative?

Pretend that you have a lump-sum of money that you inherited (let's say $1m) and want to invest for the long-term. Let's pretend that your definition of "long-term" is 30 years. So you need to find the best possible investment to make for 30 years. What are your options? Lets rank them from safest to riskiest and look at their expected rate of returns and how safe they are (you can shuffle these around if you disagree on the risk scale).

-High-yield savings account (0.50% annually) - very safe
-2-year treasury bond (0.8% annually) - also very safe for the 2 year period
-5-year treasury (1.4% annually) - very safe for the 5 year period
-10-year treasury (1.68% annually) - safe for the 10 year period
-30 year treasury (2.09% annually) - safe for the 30 year period
-Diversified basket of U.S. stocks (4.29% earnings yield, using the current 23.3 weighted p/e on the Vanguard website) - taking on risk

You are investing for the long-run (30 years), which of these investments will you choose?

Bear in mind 2 things:
-The earnings of the basket of stocks are expected to grow annually, so the longer you hold the investment, the less riskier it becomes
-When you buy a 30 year treasury, you are locking in your earnings for 30 years, no growth. If I offered you a basket of AAA-, AA+, & AA rated, blue-chip stocks, for a weighted P/E of 50 (invert the 2% annual yield), but told you that there is no chance that the earnings will grow on an annual basis, would you buy it?

Now, with all of the facts of the present investing environment I just gave you, which 30 year investment will you choose?

In my opinion (and I can be wrong, feel free to correct me), I am going with the diversified basket of stocks. I don't care what valuations were in 2005, 1990, 1980, 1970, etc. I need to make an investment today, and I need to look at my options today. So yes, valuations for equities do matter, but they matter relative to other investment alternatives. If the alternatives have even higher valuations that the stocks do (ex: 30 year treasury having a p/e of 50), then the laws of supply & demand will naturally raise the valuations for stocks as well, as more and more investors will move towards stocks.

Of course, the real alternative is to say "well, I predict that in the next few years, treasury rates will go up, and stock valuations will crash, so I will sit on the sidelines, wait and get a much better bargain." But I will respond "good luck."
I think you've laid out the conundrum very accurately.

And to add to the difficulty with this decision, we need to remember that Sp500 earnings have just grown 60% versus the historical median growth of 11% per year.

And for anyone actively working, you know how incredibly easy it was to juice earnings during this last year. We've enjoyed historically generous "temporary stimulus" shared like peanut butter with so many companies that may have not actually "needed" it.

All this makes a 1 year PE calculation within this environment very questionable. And despite a record level denominator, according to Shiller's website, PE1 = 30 (twice it's long term median).

So absent a good "sleep-well-at-night" answer to my original question, I would NOT put $1m into the SP500 at this moment in time.

And even though all the alternatives are terrible, I would rather lose a couple percent to inflation (say $20K per year) sitting in low duration bonds, than subjecting myself to the historically likely event of losing, say $500K...

I can sleep a lot easier with the opportunity cost of not investing when CAPE = 40 (and missing a run-up to say, CAPE = 50), than I could tolerate losing $500K of cash I already held in my hand....

All this is precisely why I started this thread.... I'm desperately trying to determine, if valuation doesn't matter, what does....?
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David Jay
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Re: If Valuation doesn't matter, what does?

Post by David Jay »

CraigTester wrote: Wed Jan 05, 2022 1:15 pm
Marseille07 wrote: Wed Jan 05, 2022 11:49 am
CraigTester wrote: Wed Jan 05, 2022 10:29 am So my question is, if valuation doesn't matter, then what does?
Money flowing into the market. That's all there is to it.
If you are correct, is that sustainable?
I'm not Marseille, but the obvious answer is "no". It is not sustainable. There will be another market pullback. Just like in 2001, 2008, 2020, etc.

But what can you do about it? "That, Detective, is the right question".
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
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Re: If Valuation doesn't matter, what does?

Post by Lee_WSP »

David Jay wrote: Wed Jan 05, 2022 2:25 pm
CraigTester wrote: Wed Jan 05, 2022 1:15 pm
Marseille07 wrote: Wed Jan 05, 2022 11:49 am
CraigTester wrote: Wed Jan 05, 2022 10:29 am So my question is, if valuation doesn't matter, then what does?
Money flowing into the market. That's all there is to it.
If you are correct, is that sustainable?
I'm not Marseille, but the obvious answer is "no". It is not sustainable. There will be another market pullback. Just like in 2001, 2008, 2020, etc.

But what can you do about it? "That, Detective, is the right question".
Agreed. What 2020 taught me is that you really do need to have, not perfect but, very good timing on the exit and re-entrance. Couple that with tax drag costs for making the round trip, and you need a very strong conviction on both the exit and re-entry to pull such a maneuver off.
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HomerJ
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Re: If Valuation doesn't matter, what does?

Post by HomerJ »

Nathan Drake wrote: Wed Jan 05, 2022 1:07 pm You can have a core factor based portfolio that gradually tilts if any asset class looks to be significantly drifting away from historical valuations relative to other assets

This is what I do. CAPE is actionable but requires a very long term mindset with the ability to stay the course even while things continue to get more richly valued
So far, every action you've taken based on CAPE has cost you money. You started moving out of the U.S. stocks in 2014 because of CAPE.

Nearly anyone who has used CAPE to change their allocation since the day CAPE was invented in 1988, has less money because of it. CAPE indicated that one should start moving out of U.S. stocks in 1992, just like it did in 2014.

Both were decisions that would have cost investors money.

It may pay off in the future, but so far, believing CAPE is actionable has not worked.
"The best tools available to us are shovels, not scalpels. Don't get carried away." - vanBogle59
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HomerJ
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Re: If Valuation doesn't matter, what does?

Post by HomerJ »

CraigTester wrote: Wed Jan 05, 2022 1:09 pm So is that your answer to my original question? It's not valuation, but rather, its forward P/E ratios that matter most...
I was answering your question about how stocks are priced.

You asked why people would pay more for $1 of earnings today than in 2009.

That seems like an easy question to me. In 2009, there was a real chance of a complete global financial collapse.

So of course, people paid less for stocks in 2009, and more today.

Individual companies may figure out how to reinvent themselves in any given year, but in aggregate, the 50,000 employees making widgets at your average SP500 company, don't produce step-function growth in earnings from year to year.....

This is why the best predictor of what an average company will produce next year, is a little bit more than what they did last year....

Ad libbing a Buffett quote, Forward P/E ratios tell you a lot more about the forecaster than anything else....
Fine, go with last year's earnings... Just simple P/E. People who are buying and selling stocks care about what companies are earning today, not the average of the past 10 years. They don't care if some bio-medical company had great earnings 8 years ago. If the company is losing money today, the stock price is slashed.

Some people think valuations (10-year CAPE) are predictive. Maybe they are, maybe they aren't. So far, they haven't proven themselves to be.

But are you asking about predictions or how stocks are valued?

NONE of the active buyers and sellers care about CAPE or long ago earnings. They are looking at recent earnings, and forecasting (guessing) about future earnings.
"The best tools available to us are shovels, not scalpels. Don't get carried away." - vanBogle59
JSPECO9
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Re: If Valuation doesn't matter, what does?

Post by JSPECO9 »

CraigTester wrote: Wed Jan 05, 2022 2:21 pm
So absent a good "sleep-well-at-night" answer to my original question, I would NOT put $1m into the SP500 at this moment in time.

And even though all the alternatives are terrible, I would rather lose a couple percent to inflation (say $20K per year) sitting in low duration bonds, than subjecting myself to the historically likely event of losing, say $500K...
When you say "losing $500k," what exactly does that mean? Because if you put 100% of your $1m into the S&P 500 today, automatically reinvest the dividends, it is highly unlikely that at the end of the 30 year period, you will have less than your original $1m. If your argument is that in the short-term the stock market is risky because valuations are at an all-time high, well that goes without saying, no? Stock market is always a short-term risk no matter where valuations are. This is why if you are close to retirement or in retirement, you're not supposed to be 100% anything. Not large domestic stocks, not international, not large, not small, not real estate, not bonds, etc. You diversify.

If you are saying that for a long-term buy & hold investor in accumulation valuations do matter, well I say you're wrong.
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Re: If Valuation doesn't matter, what does?

Post by Tamalak »

I certainly think valuations matter. I base safe withdrawal rates off of them. I don't see high valuations as a reason not to continue investing or holding.
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HomerJ
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Re: If Valuation doesn't matter, what does?

Post by HomerJ »

David Jay wrote: Wed Jan 05, 2022 2:25 pm
CraigTester wrote: Wed Jan 05, 2022 1:15 pm
Marseille07 wrote: Wed Jan 05, 2022 11:49 am
CraigTester wrote: Wed Jan 05, 2022 10:29 am So my question is, if valuation doesn't matter, then what does?
Money flowing into the market. That's all there is to it.
If you are correct, is that sustainable?
I'm not Marseille, but the obvious answer is "no". It is not sustainable. There will be another market pullback. Just like in 2001, 2008, 2020, etc.

But what can you do about it? "That, Detective, is the right question".
Agreed...

Diversification is a great idea.

Because there WILL be another U.S. market pull-back.

Maybe tomorrow

Maybe in 4 years.

No one knows.

But you don't need to make changes to your diversified Asset Allocation. Buy and Hold is important there too.
Last edited by HomerJ on Wed Jan 05, 2022 3:47 pm, edited 1 time in total.
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Nathan Drake
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Re: If Valuation doesn't matter, what does?

Post by Nathan Drake »

HomerJ wrote: Wed Jan 05, 2022 2:57 pm
Nathan Drake wrote: Wed Jan 05, 2022 1:07 pm You can have a core factor based portfolio that gradually tilts if any asset class looks to be significantly drifting away from historical valuations relative to other assets

This is what I do. CAPE is actionable but requires a very long term mindset with the ability to stay the course even while things continue to get more richly valued
So far, every action you've taken based on CAPE has cost you money. You started moving out of the U.S. stocks in 2014 because of CAPE.

Nearly anyone who has used CAPE to change their allocation since the day CAPE was invented in 1988, has less money because of it. CAPE indicated that one should start moving out of U.S. stocks in 1992, just like it did in 2014.

Both were decisions that would have cost investors money.

It may pay off in the future, but so far, believing CAPE is actionable has not worked.
Completely false

Moving to SCV has paid off big time. AVUV was up 44% last year and is off to a great start this year

I was uncomfortable reducing US exposure below 40% or so, and that’s when I started digging into the factor rabbit hole which aligned with my personal investment behavior.

This allowed me to tilt 50% to SCV, which has outperformed both US TSM and my exUS TSM funds

My slight 10% tilt towards exUS hasn’t paid off in the handful of years I’ve started moving new money over, but I’m not gauging that allocation on a few years of underperformance

There’s also a strategy of being 60% exUS because it’s a hedge against my income and future SS being tied to the US economy and debt. In other words, human and future capital are greatly exposed to the US already and I want to further diversify that risk on the portfolio side

Also, your example of timing is false…exUS CAPE in the late 80s and early 90s was significantly higher than US…so tilting to US during this time paid off.
Last edited by Nathan Drake on Wed Jan 05, 2022 3:20 pm, edited 2 times in total.
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NiceUnparticularMan
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Re: If Valuation doesn't matter, what does?

Post by NiceUnparticularMan »

CraigTester wrote: Wed Jan 05, 2022 2:21 pm And even though all the alternatives are terrible, I would rather lose a couple percent to inflation (say $20K per year) sitting in low duration bonds, than subjecting myself to the historically likely event of losing, say $500K...

I can sleep a lot easier with the opportunity cost of not investing when CAPE = 40 (and missing a run-up to say, CAPE = 50), than I could tolerate losing $500K of cash I already held in my hand....

All this is precisely why I started this thread.... I'm desperately trying to determine, if valuation doesn't matter, what does....?
To be blunt, people who are very adverse to short-term, paper-only losses should probably not be managing their own long-term investments. That (very common) feeling is sometimes called Myopic Loss Aversion (MLA), and MLA is known to lead to all sorts of behavior which is very likely to be self-defeating in the long run. Fortunately, there are many very reasonable, low-cost alternatives, like index-based target date funds available from a variety of reputable companies.

For what it is worth, though, I do think it helps to think in real terms about investing in stocks. By that I mean when you buy a common stock, you are buying an ownership share of that company, and those shares have value because the company has assets from which it is expected it will generate future net revenues, and you will be entitled to a proportionate share of those future net revenues. You seem resistant to this notion because future net revenues can be hard to predict, but that is precisely why common stocks have any value at all. If there was no such ownership, no such entitlement to future net revenues, no one would pay anything for them at all.

OK, so if you buy a share at $100, and its price drops to $50 ONLY because of a "valuation" change, you have lost nothing in terms of that share of future revenues to which you are entitled. That is basically definitional. And unless you panic sell, that really does not have any immediate implications.

Of course you might be planning on selling your shares in the far future (or maybe not! maybe you plan to pass them on to heirs! or charity! or so on). But it would then be the price at that time of sale which matters. Before then, price changes in what you bought that are driven solely by valuation changes have no practical meaning to you.

Now I understand you just don't think this way about stocks at all, that you think if you buy a share at $100 and then the price goes down to $50, you have thereby lost "$50 of cash I already held in my hand." And again I think you would be well-advised just to get out of this type of planning activity entirely, if that is how you are going to think about any paper losses you experience in stocks you buy.

As a final thought, of course if you KNEW the stock price would go down to $50 tomorrow, you would wait so you could buy two shares instead of just one, thereby doubling the amount of future net revenues to which your $100 would entitle you. So, market timing would absolutely work, if you could successfully predict the future in that fashion.

And maybe you believe you can. There are many reasons to doubt it, though. Instead, mostly what happens is market timers either never see a better buying opportunity, or miss it when one comes along because they are waiting for an even better opportunity, and they just end up losing out in the long run to people who simply invested for the long run whenever they had extra capital to invest.

And again, the general fear of something you buy today being at a much lower price in the near future? That is inevitably going to happen to everyone, many times, in the course of a life of long-term investing. So if you don't have the ability to easily tolerate that sort of paper loss--and to be sure, most people don't--then you should not be in personal, direct charge of your long-term investing.
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Re: If Valuation doesn't matter, what does?

Post by dboeger1 »

CraigTester wrote: Wed Jan 05, 2022 11:07 am But rather am trying to understand why someone out there apparently believes that $1 of SP500 earnings is worth $40 today, where the same dollar of earnings was only worth $15 in 2009.
Because investors don't just buy a snapshot in time of earnings, they buy with expectations of the future in mind, all in the context of prevailing market conditions (interest rates, fiscal and monetary policy, technology trends, etc.).
CraigTester wrote: Wed Jan 05, 2022 11:07 am What is causing so many people to reach this new consensus at the same time?
"Consensus" is kind of messy when it comes to prices. Only a fraction of market participants are transacting at any given time. The rest presumably do not agree (or lack funds) on the current price being a buy/sell point. Price discovery is pretty erratic and only requires a relatively small transaction volume.
CraigTester wrote: Wed Jan 05, 2022 11:07 am Who is "deciding" this for the rest of us...? And what are they basing this decision on?
Related to the above point, it's neither one person/entity nor the entire market, but just the subset that is trading at any given time.
CraigTester wrote: Wed Jan 05, 2022 11:07 am Why doesn't everyone just refuse to pay 3X more today than they were in 2009?
Many do. There's always cash on the sidelines.
CraigTester wrote: Wed Jan 05, 2022 11:07 am Or more broadly, why are they willing to pay more than just about any other time in history for that same $1 of SP500 earnings?
Related to the first point, it could be future earnings expectations, low interest rates, or just plain old irrational exuberance.

Along the lines of what others have said about valuations being a poor market timing tool, I think it's important to recognize that when people personify markets as some sort of logical individual in the aggregate, that is an extreme over-simplification. Markets are chaotic. They can stay irrational longer than you can stay solvent.

One thing to note is that saying stuff like "valuations matter" implies that you expect historical valuation ranges to anchor future valuations to some extent, but there's absolutely no guarantee that will be true in the end. Today's high valuations may very well be the new norm for the next thousand years. Future humans may look back and say today's valuations were stupidly low and anyone who didn't buy go out and borrow cheap money to buy at these crazy low prices was an idiot. I'm like you, I don't think that's the case, but do I really know? I would be very cautious acting on the assumption that I really understand what high and low are going to mean over my investing time horizon. The market doesn't have to care about or agree with my idea of fair prices at all. Furthermore, the market is literally made up of different participants today than at any other time in history. In other words, the market that values things differently today than 50 years ago is indeed a different market. Why should that be any more difficult to accept than 2 different customers walking into a store and having different opinions on the prices of goods for sale?
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