Valuation-based market timing with PE10 can improve returns?

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yobria
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Post by yobria » Mon Jun 20, 2011 10:59 am

letsgobobby wrote:I think a PE10 approach does improve returns but more importantly I think it does so at lower risk levels.
Buying stocks during economically rough times is risky business. When stocks have low P/Es they have them for a reason.

Twenty years ago valuations in Japan declined as the economy weakened. You could have doubled down there and hoped stocks were due for a rebound.

But the rebound never happened.

Nick

Roy
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Post by Roy » Mon Jun 20, 2011 11:43 am

yobria wrote:
letsgobobby wrote:I think a PE10 approach does improve returns but more importantly I think it does so at lower risk levels.
Buying stocks during economically rough times is risky business. When stocks have low P/Es they have them for a reason.

Twenty years ago valuations in Japan declined as the economy weakened. You could have doubled down there and hoped stocks were due for a rebound.

But the rebound never happened.

Nick
Absolutely. Stocks are risky, and have continued to decline for years even at reasonable PEs. If one lacks the time (not to mention the fortitude) to wait-out continued decline, buying yet more equities can be a crippler. If one is in retirement this can be disaster.

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Post by fredflinstone » Mon Jun 20, 2011 11:53 am

yobria wrote:
letsgobobby wrote:I think a PE10 approach does improve returns but more importantly I think it does so at lower risk levels.
Buying stocks during economically rough times is risky business. When stocks have low P/Es they have them for a reason.

Twenty years ago valuations in Japan declined as the economy weakened. You could have doubled down there and hoped stocks were due for a rebound.

But the rebound never happened.

Nick
No. Valuations in Japan were ridiculously high 20 years and even after being cut in half remained high throughout the 1990s and early 2000s. Not until the past few years have valuations finally come down to a "normal" range. Someone using valuation-based timing probably would have exited Japanese equities in the mid 1980s and probably would have stayed out until 2009 or so. (The Japanese stock market is up significantly since early 2009.)

See http://www3.grips.ac.jp/~wpfau/images/japan1.JPG

Source: http://wpfau.blogspot.com/2011/03/could ... ation.html

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Post by letsgobobby » Mon Jun 20, 2011 12:03 pm

fredflinstone wrote:
yobria wrote:
letsgobobby wrote:I think a PE10 approach does improve returns but more importantly I think it does so at lower risk levels.
Buying stocks during economically rough times is risky business. When stocks have low P/Es they have them for a reason.

Twenty years ago valuations in Japan declined as the economy weakened. You could have doubled down there and hoped stocks were due for a rebound.

But the rebound never happened.

Nick
No. Valuations in Japan were ridiculously high 20 years and even after being cut in half remained high throughout the 1990s and early 2000s. Not until the past few years have valuations finally come down to a "normal" range. Someone using valuation-based timing probably would have exited Japanese equities in the mid 1980s and probably would have stayed out until 2009 or so. (The Japanese stock market is up significantly since early 2009.)

See http://www3.grips.ac.jp/~wpfau/images/japan1.JPG

Source: http://wpfau.blogspot.com/2011/03/could ... ation.html
thank you fred. Yes, the point is that stocks can go from outlandishly expensive to extremely expensive to very expensive to pretty expensive and it can take decades, and yet a disciplined PE10 investor could have successfully avoided all of that.

PE10 investing basically requires reversion to the mean. If RTM fails, then so will this approach, so it is not risk-free.

Also Nick, when I say 'risk' I should have said 'volatility.'

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Post by yobria » Mon Jun 20, 2011 12:09 pm

fredflinstone wrote:No. Valuations in Japan were ridiculously high 20 years and even after being cut in half remained high throughout the 1990s and early 2000s. Not until the past few years have valuations finally come down to a "normal" range.
In fact, due to accounting differences, a Japanese stock with the same characteristics will show a far higher P/E than it would have in the US. So P/E were actually quite low in the 1990s and 2000s.

Korea is another example, with it's extremely low P/Es vs other EM stocks 10-15 years ago, but its lack of outperformance in practice.

Nick

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Post by SP-diceman » Mon Jun 20, 2011 12:12 pm

yobria wrote: Buying stocks during economically rough times is risky business. When stocks have low P/Es they have them for a reason.
Unless one is a Boglehead, than its called rebalancing.


Thanks
SP-diceman

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Post by yobria » Mon Jun 20, 2011 12:28 pm

SP-diceman wrote:
yobria wrote: Buying stocks during economically rough times is risky business. When stocks have low P/Es they have them for a reason.
Unless one is a Boglehead, than its called rebalancing.


Thanks
SP-diceman
Right, and you can see from the posts during the recent crisis how many Bogleheads (who should be the most experienced investors) were actually rebalancing into stocks in March 2009. That was when we started getting those "100% bond allocation posts".

But P/E market timing goes beyond rebalancing, you're overweighting stocks when times are bad.

I think, in practice, people who attempt to do this during the next crisis are going to be able to convince themselves that "this time it's different".

Nick

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Post by bob90245 » Mon Jun 20, 2011 12:41 pm

yobria wrote:But P/E market timing goes beyond rebalancing, you're overweighting stocks when times are bad.

I think, in practice, people who attempt to do this during the next crisis are going to be able to convince themselves that "this time it's different".

Nick
Alternatively, they will convince themselves and others that P/E10 is wont to undershoot and head to the cellar, not merely return to median value. Thus, they might never catch the low buy point they imagined as stocks recover without them boarding the train.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Post by Rodc » Mon Jun 20, 2011 1:46 pm

bob90245 wrote:
yobria wrote:But P/E market timing goes beyond rebalancing, you're overweighting stocks when times are bad.

I think, in practice, people who attempt to do this during the next crisis are going to be able to convince themselves that "this time it's different".

Nick
Alternatively, they will convince themselves and others that P/E10 is wont to undershoot and head to the cellar, not merely return to median value. Thus, they might never catch the low buy point they imagined as stocks recover without them boarding the train.
Yes. See 2009.

Any reasonable student of history (pre the lost decade) knows that when markets crash big time they always go to P/E10 in the single digits: such a student would never buy in before that.

Only whoops, did not work that way for the last 10 years. :)

Of course now that we know that we can adjust our plans to it would work well on past data. :)
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Post by Lbill » Mon Jun 20, 2011 2:38 pm

Any reasonable student of history (pre the lost decade) knows that when markets crash big time they always go to P/E10 in the single digits: such a student would never buy in before that.

Only whoops, did not work that way for the last 10 years.

Of course now that we know that we can adjust our plans to it would work well on past data. Smile
Is that the Fat Lady singing? Well, No... Single digit PE/10 may yet be in the cards, Grasshopper. Stick around. :)
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Post by Rodc » Mon Jun 20, 2011 2:39 pm

Lbill wrote:
Any reasonable student of history (pre the lost decade) knows that when markets crash big time they always go to P/E10 in the single digits: such a student would never buy in before that.

Only whoops, did not work that way for the last 10 years.

Of course now that we know that we can adjust our plans to it would work well on past data. Smile
Is that the Fat Lady singing? Well, No... Single digit PE/10 may yet be in the cards, Grasshopper. Stick around. :)
Well, there is that.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Post by letsgobobby » Mon Jun 20, 2011 2:44 pm

Rodc wrote:
Lbill wrote:
Any reasonable student of history (pre the lost decade) knows that when markets crash big time they always go to P/E10 in the single digits: such a student would never buy in before that.

Only whoops, did not work that way for the last 10 years.

Of course now that we know that we can adjust our plans to it would work well on past data. Smile
Is that the Fat Lady singing? Well, No... Single digit PE/10 may yet be in the cards, Grasshopper. Stick around. :)
Well, there is that.
there is that; there is that PE10 was 10.5 or 11 in 3/09 certainly close enough for most; and that any serious investor would not be 'all or nothing' - he would have more in stocks at PE10 15 than 20, more at PE10 10 than 15, more at PE10 5 than 10. So by 3/09, he should have been somewhat overweighted stocks relative to his baseline AA, since PE10 was 1/3 less than its long term average.

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Post by bob90245 » Mon Jun 20, 2011 3:14 pm

letsgobobby wrote:there is that PE10 was 10.5 or 11 in 3/09 certainly close enough for most
You must have been looking at P/E10 data set different than the one on Shiller's website. His data set says P/E10 was 13.3 on 3/09.

www.econ.yale.edu/~shiller/data/ie_data.xls
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Post by GenghisKhan » Mon Jun 20, 2011 3:46 pm

Lbill wrote: Is that the Fat Lady singing? Well, No... Single digit PE/10 may yet be in the cards, Grasshopper. Stick around. :)
I've been running a series on my blog called Real (inflation adjusted) S&P 500 Stock Bear Markets http://retirementinvestingtoday.blogspo ... kedin.html . It compares the real bear markets that started in 1906, 1929, 1968 and the real bear market we are currently in which started in 2000. This chart shows that there is still plenty of time for single digit PE10's to appear Image

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Post by Rodc » Mon Jun 20, 2011 4:37 pm

FWIW: to get from P/E10 of 22 to 10 is a 55% drop in price, assuming no change in E.

If earning fall which seems likely if the market drops significantly (though I have not seen what is getting ready to drop of the tail of E10 over the next few years) it will take a greater drop.

Given the last two big drops since 2000, I certainly would not say it can't happen.

I sure hope it does not, but if it once again does, I'll once again buy all the way down.

And pray a little too.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Post by TLC » Mon Jun 20, 2011 4:59 pm

Rodc wrote:If earning fall which seems likely if the market drops significantly (though I have not seen what is getting ready to drop of the tail of E10 over the next few years) it will take a greater drop.
As of 6/16, the next 24 months of real earnings to fall off are:

Code: Select all

Date	Real Earnings
2001.06	46.92
2001.07	43.44
2001.08	39.82
2001.09	36.05
2001.1	34.63
2001.11	33.14
2001.12	31.72
2002.01	31.65
2002.02	31.53
2002.03	31.36
2002.04	32.05
2002.05	32.90
2002.06	33.74
2002.07	35.22
2002.08	36.61
2002.09	38.05
2002.1	36.84
2002.11	35.70
2002.12	34.62
2003.01	35.61
2003.02	36.46
2003.03	37.37
2003.04	39.19
2003.05	41.00
The latest 12-month real earnings are 80.12.

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Post by bob90245 » Mon Jun 20, 2011 5:02 pm

Good riddance! :twisted:
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Post by GenghisKhan » Mon Jun 20, 2011 5:56 pm

TLC wrote:
Rodc wrote:If earning fall which seems likely if the market drops significantly (though I have not seen what is getting ready to drop of the tail of E10 over the next few years) it will take a greater drop.
As of 6/16, the next 24 months of real earnings to fall off are:

Code: Select all

Date	Real Earnings
2001.06	46.92
2001.07	43.44
2001.08	39.82
2001.09	36.05
2001.1	34.63
2001.11	33.14
2001.12	31.72
2002.01	31.65
2002.02	31.53
2002.03	31.36
2002.04	32.05
2002.05	32.90
2002.06	33.74
2002.07	35.22
2002.08	36.61
2002.09	38.05
2002.1	36.84
2002.11	35.70
2002.12	34.62
2003.01	35.61
2003.02	36.46
2003.03	37.37
2003.04	39.19
2003.05	41.00
The latest 12-month real earnings are 80.12.
At my last calculation the PE10 was 22.7. If price stayed the same and those 24 months of real earnings were replaced by 80.12 the PE10 would reduce to 19.7 (a drop of about 13%).

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Post by Bongleur » Mon Jun 20, 2011 7:36 pm

GenghisKhan wrote: I've been running a series on my blog called Real (inflation adjusted) S&P 500 Stock Bear Markets http://retirementinvestingtoday.blogspo ... kedin.html .
Why did you choose 60% as the definition of a bear market?

You should do a table showing the data at 10% steps. You might find a discontinuity that gives a good excuse for defining some drop as a bear. And it could be comforting to look at the table and cross reference any current drop with the historic times to recover.

>
So in 13 and a bit years we have seen absolutely no capital gain other than fake gains brought about from the devaluation of money through inflation.
>

TIPS anyone ???
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Post by Rodc » Mon Jun 20, 2011 8:30 pm

GenghisKhan wrote:
TLC wrote:
Rodc wrote:If earning fall which seems likely if the market drops significantly (though I have not seen what is getting ready to drop of the tail of E10 over the next few years) it will take a greater drop.
As of 6/16, the next 24 months of real earnings to fall off are:

Code: Select all

Date	Real Earnings
2001.06	46.92
2001.07	43.44
2001.08	39.82
2001.09	36.05
2001.1	34.63
2001.11	33.14
2001.12	31.72
2002.01	31.65
2002.02	31.53
2002.03	31.36
2002.04	32.05
2002.05	32.90
2002.06	33.74
2002.07	35.22
2002.08	36.61
2002.09	38.05
2002.1	36.84
2002.11	35.70
2002.12	34.62
2003.01	35.61
2003.02	36.46
2003.03	37.37
2003.04	39.19
2003.05	41.00
The latest 12-month real earnings are 80.12.
At my last calculation the PE10 was 22.7. If price stayed the same and those 24 months of real earnings were replaced by 80.12 the PE10 would reduce to 19.7 (a drop of about 13%).
Thanks
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Post by SmithIndex » Mon Jun 20, 2011 8:50 pm

Rodc wrote:Looking at the full history of data, P/E10 shows about the same thing: it predicts (more technically correlates) with returns best out around 20 years, much smaller correlation at 10 years, very little correlation for less than 10 years. (note really this is only a handful of independent points so could be noise driven). So this very slow mean reversion (if it exists at all, could be noise) is nothing new to the past 20 years: it is standard market behavior.
When PE10 is high, a mean reversion is expected. Prices will crash, but when? Maybe not next year, but probably in the next 10 years. This is seen in regressions using Shiller's data. PE10 does not predict next year's return. PE10 does a much better job predicting 10 year returns.

So, use PE10 to decide 10 year investments: either 10 year bonds or stocks. Hold for 10 years then repeat. Evaluate the portfolio using 10 year returns.

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Post by Rodc » Mon Jun 20, 2011 9:23 pm

SmithIndex wrote:
Rodc wrote:Looking at the full history of data, P/E10 shows about the same thing: it predicts (more technically correlates) with returns best out around 20 years, much smaller correlation at 10 years, very little correlation for less than 10 years. (note really this is only a handful of independent points so could be noise driven). So this very slow mean reversion (if it exists at all, could be noise) is nothing new to the past 20 years: it is standard market behavior.
When PE10 is high, a mean reversion is expected. Prices will crash, but when? Maybe not next year, but probably in the next 10 years. This is seen in regressions using Shiller's data. PE10 does not predict next year's return. PE10 does a much better job predicting 10 year returns.

So, use PE10 to decide 10 year investments: either 10 year bonds or stocks. Hold for 10 years then repeat. Evaluate the portfolio using 10 year returns.
No.

You should never look at investments in isolation. Stocks may be high, and at the same time bonds are even worse. You have to operate at the portfolio level, not the asset class in isolation level.

P/E10 can be high because E10 is low or because P is high.

Please look carefully at the data GenghisKhan provided and analyze it.

Right now P/E10 is as high as it is in part because E was low 8-10 year ago. And bonds are also very highly priced. Not at all clear how this turns out.

Also, even if a high P/E10 predicted a crash (in general it does not, rather it correlates with lower long term total return), you can't really expect to make short term moves (ie new asset allocations every few years as valuations shift) based on 20-year correlations (where P/E10 is most strongly correlated with returns). One could do as you suggest, though the 10-year correlations are not nearly as strong as the 20-year correlations. But I'm going to reevaluate my financial life, how is my job doing, how are my investments doing, refine my goals, assess changes in needs and desires more often than every 10 years and that will drive my investing more than P/E10.

As for regressions, there are only about three times when P/E10 was say above 25 or so (eyeballing the graphs from shiller's website) and only three periods in single digits. Not to mention the strongest correlation is out 20-years and we only have 7 independent 20-year periods, assuming data from the 1800s is even useful today. Not a meaningful amount of data to regress.

Valuations matter. But if you want to use them you better look at and compare the valuations across asset classes, you have to understand the metrics and not look at them as simple single numbers, you should understand their limitations and understand the amount of noise in the system.

I don't think simplistic use of P/E10 in isolation it going to be terribly useful. IMHO.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Post by SmithIndex » Mon Jun 20, 2011 9:49 pm

Rodc wrote:
SmithIndex wrote:
Rodc wrote:Looking at the full history of data, P/E10 shows about the same thing: it predicts (more technically correlates) with returns best out around 20 years, much smaller correlation at 10 years, very little correlation for less than 10 years. (note really this is only a handful of independent points so could be noise driven). So this very slow mean reversion (if it exists at all, could be noise) is nothing new to the past 20 years: it is standard market behavior.
When PE10 is high, a mean reversion is expected. Prices will crash, but when? Maybe not next year, but probably in the next 10 years. This is seen in regressions using Shiller's data. PE10 does not predict next year's return. PE10 does a much better job predicting 10 year returns.

So, use PE10 to decide 10 year investments: either 10 year bonds or stocks. Hold for 10 years then repeat. Evaluate the portfolio using 10 year returns.
No.

You should never look at investments in isolation.
Obviously, the portfolio will hold more than just one investment. The question is what timeframe PE10 is useful for. PE10 is only one imperfect indicator, but I think it can be useful.

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Post by BlueEars » Mon Jun 20, 2011 9:52 pm

Rodc wrote:...(snip)...
P/E10 can be high because E10 is low or because P is high.

Please look carefully at the data GenghisKhan provided and analyze it.

Right now P/E10 is as high as it is in part because E was low 8-10 year ago. And bonds are also very highly priced. Not at all clear how this turns out.
...
Back some months I started a thread about the current high standard deviation of PE10 here: http://www.bogleheads.org/forum/viewtop ... 610#954610

Here is the 1st chart again:


Image

Never really resolved why one should accept such a high historical standard deviation in PE10.

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Post by letsgobobby » Mon Jun 20, 2011 11:30 pm

bob90245 wrote:
letsgobobby wrote:there is that PE10 was 10.5 or 11 in 3/09 certainly close enough for most
You must have been looking at P/E10 data set different than the one on Shiller's website. His data set says P/E10 was 13.3 on 3/09.

www.econ.yale.edu/~shiller/data/ie_data.xls
upthread I posted the links I used - several NY Times article highlighted the late February 09 PE10 at around 13.5, but the S&P500 fell about 15% from there, so call it 11.5 or so at the nadir:

http://economix.blogs.nytimes.com/2009/ ... p-e-ratio/

http://economix.blogs.nytimes.com/2009/ ... ent-cheap/

http://economix.blogs.nytimes.com/2008/ ... re-stocks/

recall that Shiller's data is just once during the month - not on the lowest P of the month - so there can be troughs that don't show on his monthly data. S&P500 fell about 7% from 3/1 - 3/9 2009, which suggest PE10 of around 12-12.5.

The data doesn't all match up exactly, but it was close enough for me. I moved my entire charitable gift fund on 2/14 from money markets to Fidelity's Spartan international stock index fund, which was representative (though an extreme example) of how I utilized PE10 from 1996 through the present:

Transaction ID: 102xxxxx
Transaction Date: 02/14/2009
Amount: $xx,697.75
Transaction Type: Pool Exchange

Previous Allocation
Name Percent Units NAV Net Proceeds
Money Market 100% x79.654 $15.74 ($xx,697.75)
Total: 100%


($xx,697.75)

Rebalanced Allocation
Name Percent Units NAV Net Proceeds
International Index 100% xx,135.279 $5.01 $xx,697.75
Total: 100% $xx,697.75


One more note - in March 09 2 unusual conditions existed simultaneously. First, PE10 was substantially below its long term average - call it 25-35% below its median. Second, the S&P500 had already fallen 50% from its peak. I am not aware of any time in history where buying (overrebalancing) aggressively at a time when both those conditions have been met led to anything less than stellar returns. Plus, everyone was predicting the Second Great Depression. Buying from everybody while they panic sold seemed like the savvy thing to do.

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Post by Rodc » Tue Jun 21, 2011 7:39 am

Les wrote:
Rodc wrote:...(snip)...
P/E10 can be high because E10 is low or because P is high.

Please look carefully at the data GenghisKhan provided and analyze it.

Right now P/E10 is as high as it is in part because E was low 8-10 year ago. And bonds are also very highly priced. Not at all clear how this turns out.
...
Back some months I started a thread about the current high standard deviation of PE10 here: http://www.bogleheads.org/forum/viewtop ... 610#954610

Here is the 1st chart again:


Image

Never really resolved why one should accept such a high historical standard deviation in PE10.
Yes. That was an interesting and insightful observation.

Time and time again folks in many fields get tripped up when they use simple statistics divorced from deep understanding of the phenomenology, and a close look under the hood. This is especially true when the phenomenology changes with time and/or there is not an overwhelming amount of data to train the statistical models.

In the case of simple investment models based on P/E10 you have both problems.

Proceed with caution.
Last edited by Rodc on Tue Jun 21, 2011 7:47 am, edited 1 time in total.
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Post by Rodc » Tue Jun 21, 2011 7:43 am

The data doesn't all match up exactly, but it was close enough for me.
Well, if the statement is that it hit single digits or not, 11 or 12 just isn't single digits.

One can say it hit single digits and try to spin things, to make that sound correct, but by your own numbers it is false.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Post by Lbill » Tue Jun 21, 2011 8:11 am

In 1998, the historical mean of PE/10 was 15.09 and the 1 SD range was 10.13 - 20.05. The most recent historical mean is 16.40 and the 1 SD range is 9.83 - 22.98. So, the historical mean has increased from about 15 to about 16, the lower -1 SD bound hasn't changed notably, and the upper +1 SD bound has changed from about 20 to about 23. The interquartile range in 1998 was 15.08 - 19.05 and most recently is 15.78 - 20.75. The changes in the variance of PE/10 are attributable to the giant market bubble in the latter years of the last century. Unless you think that's about to be repeated, I don't think we're looking at a New Normal for PE/10. Figure a mean/median of about 16 and a low-high bound of about 10-22. Close enough for government work.
Last edited by Lbill on Tue Jun 21, 2011 8:53 am, edited 1 time in total.
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Post by Rodc » Tue Jun 21, 2011 8:28 am

Lbill wrote:In 1998, the historical mean of PE/10 was 15.09 and the 1 SD range was 10.13 - 20.05. The most recent historical mean is 16.40 and the 1 SD range is 9.83 - 22.98. So, the historical mean has increased from about 15 to about 16, the lower -1 SD bound hasn't changed notably, and the upper +1 SD bound has changed from about 20 to about 23. The interquartile range in 1998 was 15.08 - 19.05 and most recently is 15.78 - 20.75. The changes in the variance of PE/10 are attributable to the giant market bubble in the latter years of the last century. Unless you think that's about to be repeated, I don't we're looking at a New Normal for PE/10. Figure a mean/median of about 16 and a low-high bound of about 10-22. Close enough for government work.
Just to add one additional point.

There are about 13 independent periods in the dataset before 1998 (a little less)

From the above the SD from 1998 backwards was about 5. Five divided by square root of 13 is about 1.4. So the true mean to about 2 chances in 3 is in the range of 15.1+/- 1.4, so 16.4 is not really a significant change or a new normal, just an update that should be no surprise. Ie no change within the expected noise in the calculation.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Post by peter71 » Tue Jun 21, 2011 8:58 am

One complexity about which I think this board has had exactly one long and acrimonious debate near the 2009 bottom is the one raised by Jeremy Siegel back around that time:

http://online.wsj.com/article/SB123552586347065675.html

Despite his bad-timing (at least as it seemed then), overstatement and perma-bull status, I've always been persuaded that "cap-weighted earnings" might be more meaningful to cap-weighting investors than the earnings we have -- not least of all due to the perhaps more common problem in bull markets of a company like Cisco or Apple having its market cap outrun its earnings . . .

Bottom line: Even though I'm pretty much a P/E 10 bear myself I think fellow bears should check their intution not only by removing the aforementioned "tail" but also by moderating the 2008-2009 outliers . . .

All best,
Pete

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zoot
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Post by zoot » Tue Jun 21, 2011 9:07 am

I found this article pretty convincing for "valuation" timing:

http://advisorperspectives.com/dshort/g ... eturns.php

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Post by BlueEars » Tue Jun 21, 2011 9:08 am

Here is a plot of earlier times that goes together with the chart above. Notice that even in the Great Depression and WW2, PE10 standard deviation did not go to the extremes we see today:

Image

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Post by Rodc » Tue Jun 21, 2011 9:29 am

zoot wrote:I found this article pretty convincing for "valuation" timing:

http://advisorperspectives.com/dshort/g ... eturns.php
Timing asset allocation changes and predicting future 15-year returns are rather different things.

If I believe that returns averaged over the next 15 years are likely to be low, I can certainly adjust my current spending down so I can save more if accumulating. In retirement perhaps buy a SPIA and/or adjust spending down.

However it is unclear that one can time moves into or out of the market (or make significant moves between asset classes) and increase performance (risk, return or both) based on valuations. As the linked article says,
It is worth noting, however, that even this model has very little explanatory power over horizons less than 6 or 7 years, so almost anything is possible in the short-term.
So this perhaps makes some sense for setting up an initial asset allocation when young and you can set and forget for 10-20 years, it is not at all clear it makes any sense for someone who will be adjusting asset allocation on a time scale of less than every 10 years.

This article does not make me think valuations based market timing has a good chance of working going forward. It does make me believe I better plan for low returns.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Post by Bongleur » Tue Jun 21, 2011 9:32 am

Les -- right hand scale for everything except real earnings ?

SO what changed systemically circa 1975 to make the Std Dev of earnings double by 1995 (20 yrs) and then quadruple in the next <20 yrs ?

1970's: US Law regarding ownership of gold, and a change in the world economics of energy prices.

Turn of the millenium: computing power and the resulting effect on... everything. Relationship of labor to production.
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Post by letsgobobby » Tue Jun 21, 2011 9:47 am

Rodc wrote:
The data doesn't all match up exactly, but it was close enough for me.
Well, if the statement is that it hit single digits or not, 11 or 12 just isn't single digits.

One can say it hit single digits and try to spin things, to make that sound correct, but by your own numbers it is false.
Don't believe I ever said anything about single digits... and I certainly never advocated investing in cliff fashion when PE10 magically crossed to 9.99 or lower. Point is that PE10 was fully one-third below its long term average, and sentiment was extraordinarily negative, AND the S&P had already fallen by more than 50%. I agree one cannot take any single statistic in isolation. A rough model considering market history, investor psychology, and PE10 has worked out quite well.

At the end of the day PE10 is largely a measure of sentiment. For the same real 10 year earnings how generously is the investor public willing to pay for those earnings? In 1999, 40 times. In 2009 11 times. That is entirely due to psychology; expectations of the future, how the future relates to the past, etc. Buying at the nadirs of investor sentiment (in a secular, generational sense) has generally worked well, regardless of the asset class. Selling that which everyone knows can only go up forever - mega cap growth stocks in 2000 - is the counterpart.

Perhaps PE10 persists because even very smart Bogleheads say it cannot. Or maybe because it requires long time periods of years or decades to pay off, hedgies and mutual fund managers can't wait out for the alpha. Or maybe its effect is fading; after all, PE10 only got down to 11.5 rather than 5.5 in 2009.

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Post by SP-diceman » Tue Jun 21, 2011 11:15 am

letsgobobby wrote:Or maybe its effect is fading; after all, PE10 only got down to 11.5 rather than 5.5 in 2009.
No one's said we've seen the bottom yet. :)
2009 could have been just the first bounce.

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Post by bob90245 » Tue Jun 21, 2011 11:27 am

letsgobobby wrote:recall that Shiller's data is just once during the month - not on the lowest P of the month - so there can be troughs that don't show on his monthly data. S&P500 fell about 7% from 3/1 - 3/9 2009, which suggest PE10 of around 12-12.5.
My understanding is that the data is not just once during the month, nor the first of the month as you imply. Rather, Shiller calculates the average P/E10 during the month. And that is the number that you see in his spreadsheet. So 13.3 was the average P/E10 during the month of March 2009. No doubt that the lowest price of the month caused P/E10 to be lower than 13.3. But whether the ultimate low on that date was a P/E10 of 11 or 12 is anyone's guess. Not something I nor anyone else should claim with precision.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Post by BlueEars » Tue Jun 21, 2011 11:30 am

Bongleur wrote:Les -- right hand scale for everything except real earnings ?
....
Yes, the right hand scale is for PE10, 10yr earnings average, and 10yr earnings standard deviation. The left hand one is only for real earnings.

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Post by letsgobobby » Tue Jun 21, 2011 11:48 am

SP-diceman wrote:
letsgobobby wrote:Or maybe its effect is fading; after all, PE10 only got down to 11.5 rather than 5.5 in 2009.
No one's said we've seen the bottom yet. :)
2009 could have been just the first bounce.
I absolutely agree. And with PE10 of 22 or whatever it is presently, and a limited need to take risk, my stock/bond allocation is 55/45.

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Post by floydtime » Tue Jun 21, 2011 1:33 pm

letsgobobby wrote:
SP-diceman wrote:
letsgobobby wrote:Or maybe its effect is fading; after all, PE10 only got down to 11.5 rather than 5.5 in 2009.
No one's said we've seen the bottom yet. :)
2009 could have been just the first bounce.
I absolutely agree. And with PE10 of 22 or whatever it is presently, and a limited need to take risk, my stock/bond allocation is 55/45.
Just for my own edification. The reason to move more of one's portfolio into bonds based on PE10 (for those who do this at all), even if bonds are considered even more expensive than equities...

...is that expensive bonds have less downside risk than expensive stocks?

Disclaimer: I really do not know, and have no emotional attachment to either approach - I am only asking.
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Post by HomerJ » Tue Jun 21, 2011 1:48 pm

fredflinstone wrote:True. But when an investment approach is strongly supported by both empirical evidence (139 years of U.S. data) and common sense (buy when cheap, sell when expensive) then it is probably going to continue to work well in the future.
That is a hugely dangerous assumption...

Dogs of the Dow theory backtested well, and made good sense...

And has failed once everyone knew about it...

Maybe the stock market is like quantum physics. You can change an experiment just by observing it.

You are a typical investor who is excited about a new way to "beat" the market. All good theories in the past backtested well, and they all made good common sense... And they all failed going forward.

Maybe Pfau is right, but there will now be funds out there using his research to trade, and if they are successful, others will emulate their methods, and soon any advantage you could get from his method will disappear.

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Post by HomerJ » Tue Jun 21, 2011 2:14 pm

fredflinstone wrote:
Mel Lindauer wrote:It appears from this thread that at least a few folks think this is the Holy Grail of investing, and leaving this kind of stuff unchallenged is dangerous.
If you ask me, a few folks think the standard Boglehead approach (fixed asset allocation; stay the course regardless of valuation) is the Holy Grail of Investing.
If you stay the course, you will get market returns. There's no magic there.

If you market time based on valuation or whatever, you may get more than market returns or less than market returns. The odds for each possibility vary per method used.

For my retirement money, I will take the market returns. I'm already gambling because no one knows what those returns will be in the future... we assume they will general be upwards over long periods of time...

I'm not going to add yet another gamble on top of that hoping to make more than market returns.

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Post by HomerJ » Tue Jun 21, 2011 2:28 pm

wade wrote:Then you just have to commit yourself to sticking to it no matter what, which means you should take some time and explore the possibilities and make sure you won't be scared away from following through with your plan.
LOL... Yep, based on this study, you'll have to commit to sticking with this new plan for the next 30 years no matter how bad it may seem to be performing at times...

and hope that Dr. Pfau was right.

Dr Pfau... you realize that your studies may impact people lives, right?

Be very careful in your ivory tower.

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Post by HomerJ » Tue Jun 21, 2011 2:42 pm

fredflinstone wrote:I don't accept the premise that the "Stay the Course" philosophy precludes valuation-based market-timing. To my mind, "Stay the Course" simply means writing an IPS and sticking to it. If my IPS tells me to reduce equity allocation if PE10 reaches say 40, then Staying the Course means I should reduce equity allocation at a PE of 40. At least that's how I see it.
Until you read some other study 5 years from now that offers "even better returns with less risk!!! With proof!", and you'll change your IPS again.

Good luck.

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Post by peter71 » Tue Jun 21, 2011 2:43 pm

rrosenkoetter wrote:
wade wrote:Then you just have to commit yourself to sticking to it no matter what, which means you should take some time and explore the possibilities and make sure you won't be scared away from following through with your plan.
LOL... Yep, based on this study, you'll have to commit to sticking with this new plan for the next 30 years no matter how bad it may seem to be performing at times...

and hope that Dr. Pfau was right.

Dr Pfau... you realize that your studies may impact people lives, right?

Be very careful in your ivory tower.
Give it a rest. Dr. Pfau and I suspect most participants in this thread understand the case you're trying to make much better than you understand it yourself.

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Post by tadamsmar » Tue Jun 21, 2011 2:44 pm

rrosenkoetter wrote:
wade wrote:Then you just have to commit yourself to sticking to it no matter what, which means you should take some time and explore the possibilities and make sure you won't be scared away from following through with your plan.
LOL... Yep, based on this study, you'll have to commit to sticking with this new plan for the next 30 years no matter how bad it may seem to be performing at times...

and hope that Dr. Pfau was right.
Hope he was right?! :lol:

On page 5 he says:
More research is needed about this.
If you are going to commit to this stuff, you need to hope that he was not right about that!

In my view, PE10 fans need to hope for something more basic. They need to hope for good reading comprehension so they will be able to figure out what these PE10 researchers are even claiming. :lol:

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Post by HomerJ » Tue Jun 21, 2011 2:55 pm

peter71 wrote:
rrosenkoetter wrote:
wade wrote:Then you just have to commit yourself to sticking to it no matter what, which means you should take some time and explore the possibilities and make sure you won't be scared away from following through with your plan.
LOL... Yep, based on this study, you'll have to commit to sticking with this new plan for the next 30 years no matter how bad it may seem to be performing at times...

and hope that Dr. Pfau was right.

Dr Pfau... you realize that your studies may impact people lives, right?

Be very careful in your ivory tower.
Give it a rest. Dr. Pfau and I suspect most participants in this thread understand the case you're trying to make much better than you understand it yourself.
Oh, are we the only people on the Internet who have access to and have ever read this study? He isn't just presenting the data... He's pushing using it as a trading strategy.

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Post by HomerJ » Tue Jun 21, 2011 2:57 pm

tadamsmar wrote:On page 5 he says:
More research is needed about this.
If you are going to commit to this stuff, you need to hope that he was not right about that!
fred's already rewritten his IPS... uh-oh.

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Post by peter71 » Tue Jun 21, 2011 3:03 pm

Whether or not Dr. Pfau is "pushing" anything I don't think it's possible to watch five minutes of CNBC without hearing several harder sells from several less qualified folks . . . in any event, index investing isn't without its own consequences, and people can and do chide bogle and lesser lights for "stockism," for putting too much faith in what you above refer to as "the" market as a synonym for the US cap-weighted stock market, and so on.

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Post by letsgobobby » Tue Jun 21, 2011 3:10 pm

floydtime wrote:
letsgobobby wrote:
SP-diceman wrote:
letsgobobby wrote:Or maybe its effect is fading; after all, PE10 only got down to 11.5 rather than 5.5 in 2009.
No one's said we've seen the bottom yet. :)
2009 could have been just the first bounce.
I absolutely agree. And with PE10 of 22 or whatever it is presently, and a limited need to take risk, my stock/bond allocation is 55/45.
Just for my own edification. The reason to move more of one's portfolio into bonds based on PE10 (for those who do this at all), even if bonds are considered even more expensive than equities...

...is that expensive bonds have less downside risk than expensive stocks?

Disclaimer: I really do not know, and have no emotional attachment to either approach - I am only asking.
yes expensive bonds have less downside risk than expensive stocks - stocks are still much more volatile than bonds even if the returns from both are poor relative to their historic norms. Where I think this all leads (if both stocks and bonds are expensive) is that returns will be poor in both asset classes. Incidentally, more than half of my bonds are in stable value funds, for the reason you said (bonds expensive).

perhaps that's an alternative way to use PE10 - not as a stock/bond allocation tool, but as a "how much I need to save" tool. When PE10 is 5, as in 1981, savings rates can be low because asset class returns will be high. Vice versa in 2000. Or something like that.

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