What if I'd gotten out of stocks in 1996 based on PE10?

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Lbill
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What if I'd gotten out of stocks in 1996 based on PE10?

Post by Lbill » Sat Mar 17, 2012 6:25 pm

The Shiller PE10 valuation metric has crossed above 24 approximately 3 times (1929, 1996, and last Feb, 2011). We know what happened in 1929. I was wondering how it would have turned out as of March 2012 if an investor had used the crossover on 12/1995 as a timing signal, trading all his shares in the S&P500 for intermediate-term Treasurys at the beginning of 1996. He would have missed the huge runup in stocks that occurred over the next 4 years.

It turns out, not so bad. His average annual nominal return from the S&P500 for the 16 years 1996-2012 would have been about 8.6%, with about 2.5% of that coming from reinvested dividends. His average nominal annual return from 5-yr Treasuries would have been about 6%. In other words, he would have had no gains above 5-year Treasury returns due to capital growth in his stock holdings - the excess average annual return over safe intermediate Treasurys was entirely attributable to dividends (meager as they were). For that, he got to experience an average annual volatility of 20% (vs. 3% for Treasurys), with annual drawdowns of 10.5%, 11%, 21%, and 37% in 2000, 2001,2002, and 2008 respectively. Now, I wonder how the crossover in 2011 is eventually going to turn out down the road?
Last edited by Lbill on Sat Mar 17, 2012 7:36 pm, edited 1 time in total.
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by dad2000 » Sat Mar 17, 2012 6:49 pm

Going into 1996, would you have decided on PE10>24 as your timing signal, or something else? If so, why?

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by bob90245 » Sat Mar 17, 2012 7:39 pm

I know in some parts of the galaxy, their world revolves around the S&P 500. Others choose to include other asset classes like small, value, REITs and international and an appropriate amount of fixed income. Then they ignore the noise of the market, rebalance as necessary, and stay the course.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by momar » Sat Mar 17, 2012 8:18 pm

In what world is a 43% increase in annual returns "not a lot"?
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by letsgobobby » Sat Mar 17, 2012 8:28 pm

It's not hypothetical for me. I was cash, TIPS, nominals, gold, and less than 25% stocks from 1996 til jan 2008. Based mostly on PE10. By fall 2009 I was nearly 70% stocks. I think it worked out well and I think the astute investor can and should profit from secular trends in mispricing that only come along a few times in a lifetime.
Now my question is, what happened in Feb 2011 that you are comparing it to 1929 and the late 1990s?

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by dumbmoney » Sun Mar 18, 2012 12:08 am

The annualized returns were 6.46% for S&P 500 and 6.15% for Barclays Aggregate.

The yield to maturity of the Barclays Aggregate is currently about 2%.
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Lbill » Sun Mar 18, 2012 12:44 am

I looked at a simple PE10 timing system using the data from Simba's spreadsheet from 1972 - 2011. Using this system, the investor is either 100% TSM or 100% 5-year Treasuries, depending of the value of PE10 at the beginning of each year.

(1) Allocate 100% to TSM whenever PE10 falls below 10 at the beginning of the year. Remain 100% in TSM for each subsequent year that PE10 remains below 24 at the beginning of the year.
(2) If PE10 is above 24 at the beginning of the year, then sell TSM and allocate 100% to 5-year Treasuries. Remain 100% in Treasuries each subsequent year until PE10 falls below 10 at the beginning of the year.

Applying these decision rules resulted in the following allocations for 1972-2011:

1972-1974: 100% Treasuries (3 years) [note: 100% Treasuries was signalled in 1966 when PE10 was above 24 at the beginning of the year]
1975-1995: 100% TSM (21 years) [note: PE10 was 8.92 at the beginning of 1975]
1996-2011: 100% Treasuries (16 years) [note: PE10 was 24.76 at the beginning of 1996]

At the end of this 40-year period, the PE10 timing system produced a total return of 6,461%.
By comparison, a 100% allocation to TSM throughout the 1972-2011 period produced a total return of 4,032%, or 40% less than the PE10 timing system. Of course, the PE10 timing system has produced considerably less average volatility, since it was 100% in treasuries for 19 of 40 years. The worst annual loss for the timing system was -6.2% (1990) and for 100% TSM it was 37.1% (2008); TSM also produced losses of -18.3% and -27.3% in 1973-74 and -10.6%, -11%, and -21% in 2000-2002.

PE10 at the beginning of 2012 was 21.68. It would have to drop by more than 50% by the beginning of 2013 to signal a move from 100% Treasuries to 100% TSM using this decision rule.
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Roy » Sun Mar 18, 2012 9:35 am

dad2000 wrote:Going into 1996, would you have decided on PE10>24 as your timing signal, or something else? If so, why?


A good question, dad2000.

If we use our WABAC machine to 1996 (and this chart http://www.multpl.com/), it looks like it crossed, or neared, PE10>24 on an upswing just once since the depression. Shiller had testified that the markets were behaving irrationally and days later Greenspan mentioned "Irrational Exuberance" to the gang at a Washington dinner, and Hussman was not yet writing his entertaining weeklies that expound on the importance of this and other line of death markers.

So, looking at a PE 10 chart back then, the line of death number would have been lower, after which market declines occurred, until the mid-nineties when that changed. And these days, some say that earnings are a bit depressed due to the recency of the last two bear markets, and thus this needs be taken into consideration with this metric.

One problem with the various metrics as drivers, other than possibly being less useful going forward, is that there are powerful emotional factors at work. It's one thing to sit in the cool calm of ex ante and write-out these battleplans of what to do and when to do it; it's quite another to actually do them in the moment of requisite execution. Given that some folks have problems even with re-balancing during such moments, I wonder how much harder the task might be if it required much larger monetary shifts based on this or some other metric.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by bob90245 » Sun Mar 18, 2012 10:46 am

Lbill wrote:PE10 at the beginning of 2012 was 21.68. It would have to drop by more than 50% [to below 10] by the beginning of 2013 to signal a move from 100% Treasuries to 100% TSM using this decision rule.

With P/E10 having to fall below 10 for you to move back to 100% TSM, I think you'll have a long wait. I doubt it will happen in the next 44 years that I'll be alive. And I'm assuming I'll live to age 95.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by 555 » Sun Mar 18, 2012 11:22 am

letsgobobby wrote:It's not hypothetical for me. I was cash, TIPS, nominals, gold, and less than 25% stocks from 1996 til jan 2008. Based mostly on PE10. By fall 2009 I was nearly 70% stocks. I think it worked out well and I think the astute investor can and should profit from secular trends in mispricing that only come along a few times in a lifetime.
Now my question is, what happened in Feb 2011 that you are comparing it to 1929 and the late 1990s?

This is an incredible story (I mean amazing, not unbelievable). You missed bull-bear-bull-bear in stocks. What did you think when you missed getting in at the beginning of that 2002-2007 bull? I'm guessing it turned out fine for you, but I can see things going wrong with this type of approach.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by danieljquirk » Sun Mar 18, 2012 11:50 am

Lbill wrote:I looked at a simple PE10 timing system using the data from Simba's spreadsheet from 1972 - 2011....

At the end of this 40-year period, the PE10 timing system produced a total return of 6,461%.
By comparison, a 100% allocation to TSM throughout the 1972-2011 period produced a total return of 4,032%, or 40% less than the PE10 timing system. Of course, the PE10 timing system has produced considerably less average volatility, since it was 100% in treasuries for 19 of 40 years. The worst annual loss for the timing system was -6.2% (1990) and for 100% TSM it was 37.1% (2008); TSM also produced losses of -18.3% and -27.3% in 1973-74 and -10.6%, -11%, and -21% in 2000-2002.


Interesting. Can you provide an estimate of the after-tax returns of this process? I imagine the strategy still outperforms by quite a bit, but I'm guessing the tax bite is pretty substantial. By contrast, holding 100% stocks without any rebalancing is very tax efficient. We have a also been in a bond bull market for most of that time period. Interest rates are very low today.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by baw703916 » Sun Mar 18, 2012 11:52 am

letsgobobby wrote:Itwhat happened in Feb 2011 that you are comparing it to 1929 and the late 1990s?


A well-constructed doom and gloom narrative always finds some way to equate the present moment with 1929. ;)
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Lbill » Sun Mar 18, 2012 12:00 pm

bob90245 wrote:
Lbill wrote:PE10 at the beginning of 2012 was 21.68. It would have to drop by more than 50% [to below 10] by the beginning of 2013 to signal a move from 100% Treasuries to 100% TSM using this decision rule.

With P/E10 having to fall below 10 for you to move back to 100% TSM, I think you'll have a long wait. I doubt it will happen in the next 44 years that I'll be alive. And I'm assuming I'll live to age 95.

Yeah, that certainly seems true right now. Lowest it got on an annual basis was about 15 on 1/1/2009, which is the long term average of PE10. I think it got down to about 13 on a monthly basis. Hard to imagine what would drive it lower than that, since the world was coming to an end in 2008. But it could happen, can't be ruled out. If it does in my lifetime I'm all-in. Problem with these ex-post findings is that they mostly never work ex-ante. Still, it seems to me that it makes sense to take valuation into consideration. I think that the current monthly value of PE10 of 23.4 is a bit on the high side.
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by letsgobobby » Sun Mar 18, 2012 12:05 pm

bob90245 wrote:
Lbill wrote:PE10 at the beginning of 2012 was 21.68. It would have to drop by more than 50% [to below 10] by the beginning of 2013 to signal a move from 100% Treasuries to 100% TSM using this decision rule.

With P/E10 having to fall below 10 for you to move back to 100% TSM, I think you'll have a long wait. I doubt it will happen in the next 44 years that I'll be alive. And I'm assuming I'll live to age 95.

I disagree. Intraday PE10 fell to about 11 in march 2009. That's close enough that'd I say a single digit figure is highly likely in the future.

The exercise described is not how any sensible investor would use PE10. Investing should not be all or nothing. There's always the chance RTM doesn't occur. You can't place all your money on black. Several of us PE10 adherents have proposed AA models which shift from stocks to bonds and vice versa, but in most models, even at the greatest extremes (like PE10 45 in 1999) one could not be so confident as to be 0% stocks. Some went 100% stocks in 2009 but I was not one if them.

555, it was hard in 2005-07, wondering if I'd missed the best entry point. The real estate bubble was my pocket ace, indicating the credit bubble hadn't died but the speculative froth just transferred from tech stocks to real estate. I read a lot of mises.org, David tice, Robert shiller, to keep me sane. However I did not find it hard to buy stocks in 2009; I found it hard not to buy stocks in 2008. When PE10 fell to 20, 18, 16 I kept thinking I had to buy, I wouldn't get a better chance. I bought early, but I also git to buy later at lower prices. I agree it is not for everyone. I don't think my experience is fundamentally at odds with a boglehead approach, either. Swedroe, bogle, buffett, and many others advocate some form of "don't buy things that are ridiculously overpriced."

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by bob90245 » Sun Mar 18, 2012 12:17 pm

letsgobobby wrote:Intraday PE10 fell to about 11 in march 2009. That's close enough that'd I say a single digit figure is highly likely in the future.

I didn't know there is a ticker symbol that tracks P/E10 in real time.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by pkcrafter » Sun Mar 18, 2012 12:19 pm

I suggest you employ this method along with P/E 7 (optimal, so better than 10)

http://www.distressedvolatility.com/2012/02/applying-fibonacci-to-stock-market.html
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by HomerJ » Sun Mar 18, 2012 12:37 pm

Lbill wrote:The Shiller PE10 valuation metric has crossed above 24 approximately 3 times (1929, 1996, and last Feb, 2011). We know what happened in 1929. I was wondering how it would have turned out as of March 2012 if an investor had used the crossover on 12/1995 as a timing signal, trading all his shares in the S&P500 for intermediate-term Treasurys at the beginning of 1996. He would have missed the huge runup in stocks that occurred over the next 4 years.

It turns out, not so bad. His average annual nominal return from the S&P500 for the 16 years 1996-2012 would have been about 8.6%, with about 2.5% of that coming from reinvested dividends. His average nominal annual return from 5-yr Treasuries would have been about 6%. In other words, he would have had no gains above 5-year Treasury returns due to capital growth in his stock holdings - the excess average annual return over safe intermediate Treasurys was entirely attributable to dividends (meager as they were). For that, he got to experience an average annual volatility of 20% (vs. 3% for Treasurys), with annual drawdowns of 10.5%, 11%, 21%, and 37% in 2000, 2001,2002, and 2008 respectively. Now, I wonder how the crossover in 2011 is eventually going to turn out down the road?


This is why I invest 50/50... Not sure why anyone would go 100% one way or 100% the other way based on some "signal".

Plus, if you rebalance and have nerves of steel (or at least hard plastic), the volatility of the stock market can actually be quite profitable. I know I have made significantly more money from 2008-2012 than I would have if the market had just stayed flat that whole time. That 50% crash was quite good to me.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Boglenaut » Sun Mar 18, 2012 12:48 pm

rrosenkoetter wrote: Plus, if you rebalance and have nerves of steel (or at least hard plastic), the volatility of the stock market can actually be quite profitable. I know I have made significantly more money from 2008-2012 than I would have if the market had just stayed flat that whole time. That 50% crash was quite good to me.


I bet it was!

I was 85/15 going into it. I (correctly) marked my risk tolerance as being able to emotionally handle the drop.

What I did not anticipate was that I did not have enough "dry powder" to rebalance with. I had the risk tolerance to rebalance into the crash, but not as much funds as I would have liked. But to over-balance into the crash would have been reckless, so I stuck to my planned 85/15.

I also made money on the crash, but not as much as if I had been more conservative like you. I am now 75/25, mainly because I add 1.25% a year to my bonds per my investment policy, and also very gradually raised my bond glidepath per rules I have set so as to not do it in the heat of the momment.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by mwm158 » Sun Mar 18, 2012 12:51 pm

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by 555 » Sun Mar 18, 2012 12:57 pm

letsgobobby wrote:555, it was hard in 2005-07, wondering if I'd missed the best entry point. The real estate bubble was my pocket ace, indicating the credit bubble hadn't died but the speculative froth just transferred from tech stocks to real estate. I read a lot of mises.org, David tice, Robert shiller, to keep me sane. However I did not find it hard to buy stocks in 2009; I found it hard not to buy stocks in 2008. When PE10 fell to 20, 18, 16 I kept thinking I had to buy, I wouldn't get a better chance. I bought early, but I also git to buy later at lower prices. I agree it is not for everyone. I don't think my experience is fundamentally at odds with a boglehead approach, either. Swedroe, bogle, buffett, and many others advocate some form of "don't buy things that are ridiculously overpriced."

Well, that's not for me. I like gradual moves. It may be true that valuations matter, but maintaining an AA (or glide path) somewhat takes care of this.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by jeffyscott » Sun Mar 18, 2012 9:39 pm

letsgobobby wrote:
bob90245 wrote:
Lbill wrote:PE10 at the beginning of 2012 was 21.68. It would have to drop by more than 50% [to below 10] by the beginning of 2013 to signal a move from 100% Treasuries to 100% TSM using this decision rule.

With P/E10 having to fall below 10 for you to move back to 100% TSM, I think you'll have a long wait. I doubt it will happen in the next 44 years that I'll be alive. And I'm assuming I'll live to age 95.

I disagree. Intraday PE10 fell to about 11 in march 2009. That's close enough that'd I say a single digit figure is highly likely in the future.

The exercise described is not how any sensible investor would use PE10. Investing should not be all or nothing. There's always the chance RTM doesn't occur. You can't place all your money on black. Several of us PE10 adherents have proposed AA models which shift from stocks to bonds and vice versa, but in most models, even at the greatest extremes (like PE10 45 in 1999) one could not be so confident as to be 0% stocks. Some went 100% stocks in 2009 but I was not one if them.


It also makes no sense to say that, for example, at PE10=15 I would be either 100% stocks or 100% bonds, depending on whether the most recent extreme value of PE10 was high or low.
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by letsgobobby » Mon Mar 19, 2012 1:22 am

bob90245 wrote:
letsgobobby wrote:Intraday PE10 fell to about 11 in march 2009. That's close enough that'd I say a single digit figure is highly likely in the future.

I didn't know there is a ticker symbol that tracks P/E10 in real time.

I don't know either.

The following site lists daily closes, but I wasn't aware of it 3-4 years ago:
http://www.multpl.com/

Shiller's data is updated monthly and using daily S&P500 values I extrapolated it daily and even intraday to guesstimate real-time PE10:

http://www.econ.yale.edu/~shiller/data.htm

A series of NY Times articles at the time also gave me some moral support to buy at the time:

November 2008: PE10 13 http://economix.blogs.nytimes.com/2008/ ... he-bottom/
February 2009: PE10 13.7 http://economix.blogs.nytimes.com/2009/ ... ent-cheap/
follow up here: http://economix.blogs.nytimes.com/2009/ ... p-e-ratio/

On Feb 23 the S&P500 closed at 743. At the low on March 9 the S&P got as low as 677. If PE10 was 13.7 on 2/23, then I estimate it was about 9% lower or 12.47 on Mar 9.

Anyway, that was my thinking at the time.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Lbill » Mon Mar 19, 2012 1:33 am

I wouldn't suggest (or personally ever use) any system that moved from 100% A to 100% B under any circumstances. Shouldn't be too difficult to discern that my point was to illustrate the effectiveness of using PE/10 to shift allocation between stocks and bonds. If this simple method worked, then any method of reallocating between TSM and Treasuries would have worked also, such as more modest allocation shifts. BTW, it produced far better returns than simply weighting 50/50 and rebalancing. Not the same thing at all.
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by HomerJ » Mon Mar 19, 2012 8:35 am

Lbill wrote:BTW, it produced far better returns than simply weighting 50/50 and rebalancing. Not the same thing at all.


But it will work in the future? Every great failed strategy at one point back-tested very well. That said, I do see some value in a basic PE10 examination.

But remember, most of us aren't trying to max out our returns. We're perfectly happy just getting market returns. The whole beauty of buy and hold is that you don't have to deal with a "system". Rebalancing is reacting to what has already happened... Most systems try to predict the future.

Buy and hold, stay the course... That works pretty well and is easier. Rebalancing only happens during extreme swings... I found the rebalancing back to my AA during the last crash was difficult emotionally. I think it would be even harder and more dangerous (emotions, wise) to have changed my AA to be MORE aggressive during such a chaotic time as PE10 would have indicated.

You seem pretty conservative. I can't imagine you wouldn't be second-guessing this "system" if there was an extended down-turn and PE10 kept indicating that you should bet more and more of your future into stocks.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Lbill » Mon Mar 19, 2012 10:12 am

rrosenkoetter wrote:
Lbill wrote:BTW, it produced far better returns than simply weighting 50/50 and rebalancing. Not the same thing at all.


But it will work in the future? Every great failed strategy at one point back-tested very well. That said, I do see some value in a basic PE10 examination.

But remember, most of us aren't trying to max out our returns. We're perfectly happy just getting market returns. The whole beauty of buy and hold is that you don't have to deal with a "system". Rebalancing is reacting to what has already happened... Most systems try to predict the future.

Buy and hold, stay the course... That works pretty well and is easier. Rebalancing only happens during extreme swings... I found the rebalancing back to my AA during the last crash was difficult emotionally. I think it would be even harder and more dangerous (emotions, wise) to have changed my AA to be MORE aggressive during such a chaotic time as PE10 would have indicated.

You seem pretty conservative. I can't imagine you wouldn't be second-guessing this "system" if there was an extended down-turn and PE10 kept indicating that you should bet more and more of your future into stocks.

Yes, I'm not convinced that you can duplicate valuation-based strategies that backtest well, going forward. I think Larry makes the point that it just doesn't happen. On the other hand, valuation seems to be such an important factor in determining equity returns that I can't rationalize a blind-eyed "buy and hold" approach that doesn't take it into consideration. I was actually quite surprised to find that you could have sidestepped the monster rally in stocks in the latter 1990s, put your money in safe treasury bonds instead, and you'd be OK in 2012. Strong evidence of the importance of valuation. Of course, it would have been nearly impossible for someone to hold to this strategy while all his neighbors seemed to be getting rich in stocks, while holding to the belief that someday his decision would be vindicated. There's nothing like fear or greed to cause the true believer in any strategy (including buy and hold) to abandon ship.
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by HomerJ » Mon Mar 19, 2012 10:26 am

Lbill wrote:There's nothing like fear or greed to cause the true believer in any strategy (including buy and hold) to abandon ship.


Very good post!

(And again, that's why I love my 50/50 allocation because I'm never really "wrong"... I'm never over-weighting the wrong asset.... so it's easier to not second-guess myself). :)

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by ladders11 » Mon Mar 19, 2012 10:59 am

letsgobobby wrote:A series of NY Times articles at the time also gave me some moral support to buy at the time:

November 2008: PE10 13 http://economix.blogs.nytimes.com/2008/ ... he-bottom/
February 2009: PE10 13.7 http://economix.blogs.nytimes.com/2009/ ... ent-cheap/
follow up here: http://economix.blogs.nytimes.com/2009/ ... p-e-ratio/

On Feb 23 the S&P500 closed at 743. At the low on March 9 the S&P got as low as 677. If PE10 was 13.7 on 2/23, then I estimate it was about 9% lower or 12.47 on Mar 9.

Anyway, that was my thinking at the time.

I am interested in what your thinking is now, specifically about the PE10 of about 14 for MSCI Europe. Or, what your thinking was last month when the PE10 was about 13. (According to http://mrmarket.eu/)

Do you own international stocks? If so, do you utilize the PE10 for their country, region, or continent? Or just use the S&P500 PE10 and apply it to foreign?

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Clearly_Irrational » Mon Mar 19, 2012 1:18 pm

bob90245 wrote:Others choose to include other asset classes like small, value, REITs and international


Just quibbling really, but those are not asset classes, they're just different flavors of equities.

bob90245 wrote:and an appropriate amount of fixed income.


That however is a separate asset class.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by bob90245 » Mon Mar 19, 2012 5:00 pm

Clearly_Irrational wrote:
bob90245 wrote:Others choose to include other asset classes like small, value, REITs and international

Just quibbling really, but those are not asset classes, they're just different flavors of equities.

Your comment is not a small quibble. It seems to be a firm rejection of the theory put forward by Boglehead authors such as Bill Schultheis, Rick Ferri and Larry Swedroe.

We can agree to disagree. But it put my trust in Bill, Rick and Larry.
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Clearly_Irrational » Mon Mar 19, 2012 5:25 pm

bob90245 wrote:
Clearly_Irrational wrote:
bob90245 wrote:Others choose to include other asset classes like small, value, REITs and international

Just quibbling really, but those are not asset classes, they're just different flavors of equities.

Your comment is not a small quibble. It seems to be a firm rejection of the theory put forward by Boglehead authors such as Bill Schultheis, Rick Ferri and Larry Swedroe.

We can agree to disagree. But it put my trust in Bill, Rick and Larry.


I wasn't suggesting that you not have them, just that they are not separate asset classes. I have a small/value tilt in my portfolio and I am holding international (specifically emerging market) stocks, but those come out of my stock allocation, not some other bucket.

Not everyone uses the word "asset class" the same way. For, me bonds are a separate asset class because they are fundamentally different (debt instead of equity) and they aren't correlated with stocks (0.28 since 1972, Simba data). To establish a third asset class I would want it to be fundamentally different from and uncorrelated with both stocks and bonds. So for example gold, a special commodity, is not an equity or debt instrument and had low correlation with stocks and bonds (-0.22, -0.24) so I'd call it a separate asset class. REITs are an equity instrument, though admittedly with some special properties, however their correlation to stocks (0.62) suggests that they are not a separate asset class but merely an equities flavor like small, value, utilities or dividend payers. Obviously if you've defined the words "asset class" to mean something else, we may not agree.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by bob90245 » Mon Mar 19, 2012 6:24 pm

Clearly_Irrational wrote:
bob90245 wrote:
Clearly_Irrational wrote:
bob90245 wrote:Others choose to include other asset classes like small, value, REITs and international

Just quibbling really, but those are not asset classes, they're just different flavors of equities.

Your comment is not a small quibble. It seems to be a firm rejection of the theory put forward by Boglehead authors such as Bill Schultheis, Rick Ferri and Larry Swedroe.

We can agree to disagree. But it put my trust in Bill, Rick and Larry.

I wasn't suggesting that you not have them, just that they are not separate asset classes. I have a small/value tilt in my portfolio and I am holding international (specifically emerging market) stocks, but those come out of my stock allocation, not some other bucket.

Not everyone uses the word "asset class" the same way.

Then this is a real problem if you use one definition and every one else uses a different definition.

There is no justification for you to hold small/value if you didn't think it would perform differently. This is what different (or the term "separate" you use) asset classes are: they perform differently from one another. [1]



[1] The exception when a severe bad economic event causes all equity asset classes to fall as one.
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Clearly_Irrational » Mon Mar 19, 2012 11:20 pm

bob90245 wrote:There is no justification for you to hold small/value if you didn't think it would perform differently. This is what different (or the term "separate" you use) asset classes are: they perform differently from one another.


Yes, but the amount of difference helps to determine whether its a different "asset class" in it's own right or member of a class. Coal mining stocks perform differently than the total market, that doesn't make them a separate asset class, just a different member of the "equities" class.

I expect small/value to be different than TSM, but only in small ways, they're still equities and will tend to have a large portion of their price determined by the fluctuations of the overall market. Bonds on the other hand are a completely different animal. This is why people who hold ten different stock funds (and nothing else) and think they're well diversified are in for a big disappointment.

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by LH » Mon Mar 19, 2012 11:40 pm

This all sounds great.

I am sure a mutual fund will use this approach.

Let me know when one does.

I will watch it expectantly fail -=going forward=- versus passive indexing like everything else.

I like PE11 better myself : ) (just kidding)

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by letsgobobby » Tue Mar 20, 2012 1:21 am

Obviously retail investors panic at the bottom and sell.

And even Bogleheads reject overrebalancing, as a rule.

So who, exactly, is buying at the bottom, sufficient to cause a bottom?

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by riskreward » Tue Mar 20, 2012 7:09 am

What's the bond equivalent of the PE10 rule?

Wouldn't a 10 yr treasury 2% yield translate into the inverse of PE10 for bonds?

Why isn't there a rule for bonds too?

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by SP-diceman » Tue Mar 20, 2012 7:43 am

letsgobobby wrote:Obviously retail investors panic at the bottom and sell.

And even Bogleheads reject overrebalancing, as a rule.

So who, exactly, is buying at the bottom, sufficient to cause a bottom?


Everyone else. :)

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by bob90245 » Tue Mar 20, 2012 10:38 am

Clearly_Irrational wrote:Coal mining stocks perform differently than the total market, that doesn't make them a separate asset class, just a different member of the "equities" class.

I don't think anyone would categorize coal mining stocks as a separate asset class. Instead, it would be called an "equity sector". In fact, some use the sector approach to differentiate among equity types. But as far as I know, the academics don't approach it this way.

As far as I know, the academic approach to differentiate between equity asset classes is along the lines of big and small, value and growth along with their counterparts in international.
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Clearly_Irrational » Tue Mar 20, 2012 11:32 am

bob90245 wrote:As far as I know, the academic approach to differentiate between equity asset classes is along the lines of big and small, value and growth along with their counterparts in international.


That doesn't match what I've seen, citation? Most of the time when I see it labeled in that fashion it's some random blog where the person only sort of knows what they're talking about. All the definitions I can find look something like this:

"A broad group of securities or investments that tend to react similarly in different market conditions. Individual asset classes are also generally governed by the same rules and regulations. There are three basic asset classes: equity securities (stocks), fixed-income securities (bonds), and cash equivalents (money market vehicles). Real estate, commodities and derivatives are also considered asset classes by some." (Financial Times Lexicon, "Asset Class Definition")

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Snowjob » Tue Mar 20, 2012 11:37 am

SP-diceman wrote:
letsgobobby wrote:Obviously retail investors panic at the bottom and sell.

And even Bogleheads reject overrebalancing, as a rule.

So who, exactly, is buying at the bottom, sufficient to cause a bottom?


Everyone else. :)


A lack of interested sellers at those prices then changes the dymanic forcing stocks upward too thus starting the rally

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by bob90245 » Tue Mar 20, 2012 11:54 am

Clearly_Irrational wrote:
bob90245 wrote:As far as I know, the academic approach to differentiate between equity asset classes is along the lines of big and small, value and growth along with their counterparts in international.

That doesn't match what I've seen, citation?

I suppose you never read about the Three-Factor Model to explain equity returns. That's were my explanation comes from. You can make a Google search for "Three-Factor Model" and get a ton of references. Even the Wiki here on Bogleheads has an article about it:

http://www.bogleheads.org/wiki/Fama_and ... ctor_Model
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Clearly_Irrational » Tue Mar 20, 2012 12:38 pm

bob90245 wrote:I suppose you never read about the Three-Factor Model to explain equity returns. That's were my explanation comes from. You can make a Google search for "Three-Factor Model" and get a ton of references. Even the Wiki here on Bogleheads has an article about it:

http://www.bogleheads.org/wiki/Fama_and ... ctor_Model


Heh, apparently you haven't followed the recent small/value threads where I've been fairly active. Yes, I've read it. FYI, that link doesn't even mention the words "asset class". Just in case I was forgetting something I went back and reviewed the original paper:

http://www.bengrahaminvesting.ca/Research/Papers/French/The_Cross-Section_of_Expected_Stock_Returns.pdf

I couldn't find a free version that wasn't optically scanned so I couldn't do a computerized search, but a visual scan didn't reveal the words "asset class" anywhere contained therein. They've written a number of papers on the subject though so perhaps you meant one of the other ones?

Here is the official Bogleheads definition:

http://www.bogleheads.org/wiki/Asset_class

A particularly relevant quote from that page "Asset classes and asset class categories are often mixed together. In other words, describing large-cap stocks or short-term bonds asset classes is incorrect. These investment vehicles are asset class categories, and are used for diversification purposes."

At least according the Bogleheads definition small cap is definitely not an asset class, and I would infer that definition would cover value and international as well.

All this seems like excessive semantic precision, yet there is a big difference between diversifying across "asset classes" and "asset class categories" (Personally I don't like that term and would call them sectors, flavors or class members, but you get my meaning)

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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by bob90245 » Tue Mar 20, 2012 1:24 pm

Clearly_Irrational wrote:All this seems like excessive semantic precision, yet there is a big difference between diversifying across "asset classes" and "asset class categories" (Personally I don't like that term and would call them sectors, flavors or class members, but you get my meaning)

If you prefer to use the term "sectors", then you are not distinguishing between a Three-Factor Model and the Coal Sector (your example).
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Re: What if I'd gotten out of stocks in 1996 based on PE10?

Post by Clearly_Irrational » Tue Mar 20, 2012 1:37 pm

bob90245 wrote:
Clearly_Irrational wrote:All this seems like excessive semantic precision, yet there is a big difference between diversifying across "asset classes" and "asset class categories" (Personally I don't like that term and would call them sectors, flavors or class members, but you get my meaning)

If you prefer to use the term "sectors", then you are not distinguishing between a Three-Factor Model and the Coal Sector (your example).


You can slice the market many ways. Depending on the logic behind your slice, that may or may not have a risk factor associated with it. Small and Value have a risk factor story, momentum has a behavioral story. Coal on the other hand is an industry story and as we know industry risk isn't compensated since it is diversifiable. You are correct that calling Small stocks a "sector" would not be appropriate, I was just mentioning that "asset class category" was a cumbersome description and that I would probably use something else depending on what we're talking about.

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