Are stocks dangerously overvalued? Not according to new Vanguard yardstick

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vineviz
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Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by vineviz » Mon Jul 30, 2018 6:43 am

Vanguard has an article on their website summarizing their recent paper, Improving U.S. Stock Return Forecasts: A "Fair-Value" CAPE Approach, published in the Winter 2018 issue of The Journal of Portfolio Management.
At the end of 2017, the Shiller CAPE (cyclically adjusted price to earnings) ratio was flirting with all-time highs, surpassed only by the peaks that preceded the collapse of the dotcom bubble. It stood at about 33; its historical average is about 16. A reversion to the ratio's long-term average would bode ill for future stock returns.

Vanguard's "fair-value" CAPE ratio paints a less alarming picture, suggesting that valuations are indeed high but not in the "bubble" territory implied by the conventional CAPE. We expect the returns of U.S. stocks to fall below their historical averages over the next ten years. The most likely outcome, according to our projections, is annualized returns of 3%–5% for the coming decade.
In short, Vanguard proposes an "enhancement to standard CAPE-based forecasts that conditions mean reversion in the CAPE ratio on real (not nominal) bond yields, expected inflation rates, and financial volatility in a VAR model".
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by Bacchus01 » Mon Jul 30, 2018 7:11 am

If nothing changes at all, and 2008 is removed from the data, what does CAPE look like?

Edit: interesting article

https://www.google.com/amp/s/earlyretir ... -fear/amp/

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by aristotelian » Mon Jul 30, 2018 8:07 am

I agree that low interest rates are a factor in the elevated CAPE we are seeing today. The question is whether interest rates will normalize and what happens when they do. This article's model seems to assume that interest rates will stay level.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by typical.investor » Mon Jul 30, 2018 8:08 am

vineviz wrote:
Mon Jul 30, 2018 6:43 am
The most likely outcome, according to our projections, is annualized returns of 3%–5% for the coming decade.
Can you tell if Vanguard means real or nominal?

The Journal of Portfolio Management stated:
the model proposed by the author predicts nominal U.S. stock returns centered near 5% over the next decade.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by KlangFool » Mon Jul 30, 2018 8:15 am

OP,

Another point of view:

https://www.peakprosperity.com/blog/114 ... -coal-mine

The recent stock run is driven by the FAANG aka 5 stocks.

KlangFool

P.S.: Unless you are 100% stock, none of this matters to you. You just buy according to your AA. You would not be buying the stock now due to your AA. If you are 100% stock, I wish you the best of luck.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by AlohaJoe » Mon Jul 30, 2018 8:35 am

Their model is academically interesting -- and apparently a clear improvement over other methods -- but let's keep in mind that it still isn't a good method.

They say their average error is 4.1%. So if they're saying 3-5% they mean something like "returns will be between 0% and 8%". I'm not sure what action real investors actually take based on forecasts that wide.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by jadd806 » Mon Jul 30, 2018 8:47 am

KlangFool wrote:
Mon Jul 30, 2018 8:15 am
OP,

Another point of view:

https://www.peakprosperity.com/blog/114 ... -coal-mine

The recent stock run is driven by the FAANG aka 5 stocks.

KlangFool

P.S.: Unless you are 100% stock, none of this matters to you. You just buy according to your AA. You would not be buying the stock now due to your AA. If you are 100% stock, I wish you the best of luck.
How is this any different than the stock markets of any other era? Historically, a minority of stocks in the S&P 500 have accounted for the majority of the gains.

Even if Amazon "dies," that probably won't concern you. Their market cap would flow to other companies in the index such as Walmart or some other upstart that hasn't even been invented yet. The market for the services they provide is there and thanks to capitalism, that need will be filled (or succeeded by something else entirely). If you are a true index fund investor, you really do not need to care about things like this.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by KlangFool » Mon Jul 30, 2018 9:11 am

jadd806 wrote:
Mon Jul 30, 2018 8:47 am
KlangFool wrote:
Mon Jul 30, 2018 8:15 am
OP,

Another point of view:

https://www.peakprosperity.com/blog/114 ... -coal-mine

The recent stock run is driven by the FAANG aka 5 stocks.

KlangFool

P.S.: Unless you are 100% stock, none of this matters to you. You just buy according to your AA. You would not be buying the stock now due to your AA. If you are 100% stock, I wish you the best of luck.
How is this any different than the stock markets of any other era? Historically, a minority of stocks in the S&P 500 have accounted for the majority of the gains.

Even if Amazon "dies," that probably won't concern you. Their market cap would flow to other companies in the index such as Walmart or some other upstart that hasn't even been invented yet. The market for the services they provide is there and thanks to capitalism, that need will be filled (or succeeded by something else entirely). If you are a true index fund investor, you really do not need to care about things like this.
jadd806 ,

<<Historically, a minority of stocks in the S&P 500 have accounted for the majority of the gains.>>

Is this true? Is it at the same scale as the FAANG?

<<If you are a true index fund investor, you really do not need to care about things like this.>>

I am not a 100% stock person. So, it won't matter to me whether the stock market is overvalued.

KlangFool

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grayfox
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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by grayfox » Mon Jul 30, 2018 9:13 am

vineviz wrote:
Mon Jul 30, 2018 6:43 am
Vanguard has an article on their website summarizing their recent paper, Improving U.S. Stock Return Forecasts: A "Fair-Value" CAPE Approach, published in the Winter 2018 issue of The Journal of Portfolio Management.
Look at the chart 1970 through 2016. There is something wrong with that chart.

The blue line claims that it shows Shiller CAPE-based regression. Look at around 2009. From multpl.com CAPE (P/E10) was about 15 in 2009 which is about the long term average CAPE. 1/CAPE = E10/P = 0.0667 so CAPE was predicting about 6.67% expected real return. Their chart shows -15 !?! Makes no sense.

In fact, all the normal CAPE predictions I see here on BH never predict a negative return. Some predictions, like GMO, that assume reversion to mean in 7 years, sometimes show a negative return. But most don't assume that. Maybe this authors are creating a strawman.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by Sandtrap » Mon Jul 30, 2018 9:19 am

vineviz wrote:
Mon Jul 30, 2018 6:43 am
Vanguard has an article on their website summarizing their recent paper, Improving U.S. Stock Return Forecasts: A "Fair-Value" CAPE Approach, published in the Winter 2018 issue of The Journal of Portfolio Management.
At the end of 2017, the Shiller CAPE (cyclically adjusted price to earnings) ratio was flirting with all-time highs, surpassed only by the peaks that preceded the collapse of the dotcom bubble. It stood at about 33; its historical average is about 16. A reversion to the ratio's long-term average would bode ill for future stock returns.

Vanguard's "fair-value" CAPE ratio paints a less alarming picture, suggesting that valuations are indeed high but not in the "bubble" territory implied by the conventional CAPE. We expect the returns of U.S. stocks to fall below their historical averages over the next ten years. The most likely outcome, according to our projections, is annualized returns of 3%–5% for the coming decade.
In short, Vanguard proposes an "enhancement to standard CAPE-based forecasts that conditions mean reversion in the CAPE ratio on real (not nominal) bond yields, expected inflation rates, and financial volatility in a VAR model".
Interesting Vanguard article.
Thanks for posting.
. . . .
My simple brain reads it as . . . sort of. . .moving the yardstick.
Stocks over-valued. . . based on what time frame in the past and going forward?

OTOH: the recent interview from Jack Bogle seems to agree with the flattening of returns going forward.
Thoughts?
j

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by vineviz » Mon Jul 30, 2018 10:35 am

aristotelian wrote:
Mon Jul 30, 2018 8:07 am
This article's model seems to assume that interest rates will stay level.
I haven't read the full paper from The Journal of Portfolio Management, but I think it'd be more accurate to say that the model doesn't make any assumptions about future interest rates at all.

Rather, the model appears to be using the current values of three additional variables (real interest rates, expected inflation, and financial volatility) to modify the traditional calculation of CAPE.

Historically, adding these variables to the CAPE model has resulted in more accurate forecasts of future stock returns
Last edited by vineviz on Mon Jul 30, 2018 10:38 am, edited 1 time in total.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by vineviz » Mon Jul 30, 2018 10:37 am

typical.investor wrote:
Mon Jul 30, 2018 8:08 am
vineviz wrote:
Mon Jul 30, 2018 6:43 am
The most likely outcome, according to our projections, is annualized returns of 3%–5% for the coming decade.
Can you tell if Vanguard means real or nominal?

The Journal of Portfolio Management stated:
the model proposed by the author predicts nominal U.S. stock returns centered near 5% over the next decade.
From the abstract I think it's clear that the 3-5% return forecast is a nominal forecast.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by vineviz » Mon Jul 30, 2018 10:41 am

AlohaJoe wrote:
Mon Jul 30, 2018 8:35 am
Their model is academically interesting -- and apparently a clear improvement over other methods -- but let's keep in mind that it still isn't a good method.

They say their average error is 4.1%. So if they're saying 3-5% they mean something like "returns will be between 0% and 8%". I'm not sure what action real investors actually take based on forecasts that wide.
One possible action you could take is to start saving more money if your current retirement plan is based on an assumption of 10% or 12% stock returns over the next decade.

Don't laugh: there are people doing this.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by asif408 » Mon Jul 30, 2018 10:52 am

Assuming their yardstick is true, does this mean that foreign markets are even cheaper? If we make a fair value CAPE for the US, I am assuming it should also be applied globally, unless we think the US stock market is special.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by frankmorris » Mon Jul 30, 2018 10:52 am

I usually like to remind people that rates of return are generally not "smoothed" as experienced over time, so the entire CAPE conversation affects different investments differently. The 3-5% expected annualized return, for example, could involve a 40% loss next year, followed by 10-12% gains the following nine. In this scenario, the market looks very undervalued for 9 of the next 10 years. If the question is "how much can I make from the stock market," obviously this question is based on when you enter the market. If your question is "how much will my current investments grow," that's a different question.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by aristotelian » Mon Jul 30, 2018 11:07 am

vineviz wrote:
Mon Jul 30, 2018 10:35 am
aristotelian wrote:
Mon Jul 30, 2018 8:07 am
This article's model seems to assume that interest rates will stay level.
I haven't read the full paper from The Journal of Portfolio Management, but I think it'd be more accurate to say that the model doesn't make any assumptions about future interest rates at all.

Rather, the model appears to be using the current values of three additional variables (real interest rates, expected inflation, and financial volatility) to modify the traditional calculation of CAPE.

Historically, adding these variables to the CAPE model has resulted in more accurate forecasts of future stock returns
Right, but if it says valuations are in line with current interest rates, what happens if interest rates rise?

It would be like a climate scientist saying the world isn't warming if you adjust for CO2.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by Valuethinker » Mon Jul 30, 2018 11:30 am

asif408 wrote:
Mon Jul 30, 2018 10:52 am
Assuming their yardstick is true, does this mean that foreign markets are even cheaper? If we make a fair value CAPE for the US, I am assuming it should also be applied globally, unless we think the US stock market is special.
Generally I think that US GAAP is more conservative than IFRS accounting. I say that very generally - it's not as if US GAAP is not abused. A major abuse is non GAAP earnings measures, which presumably CAPE strips out?

So international markets:

- may look less cheap if we adjust for accounting standards

- there are significant sectoral effects. The US has a lot more tech stocks than anyone else, and I would argue better tech companies. That's getting harder to say about Facebook ;-). But Facebook Apple Amazon Netflix Google Microsoft are phenomenal companies that are doing phenomenal things. And Google in particular is a money machine (as is Apple and Microsoft). Contrast to the sometimes torrid tales of Samsung and Sony (remember when Sony was the preeminent tech-entertainment stock?) and Nokia (remember when that was the world's leading tech stock?).

We can see the downside bite of that, too. But the "bubble" in tech this time seems more around the VC backed pre IPO stocks (like Uber) the so-called "Unicorns". Maybe the big quoted tech stocks are overvalued, the FB share price reaction suggests that they are.

But, overall, the outperformance of the US is in large part probably explained by that. The US market deserves a higher multiple (I got this call very wrong, and it has hurt-- could never bring myself to market weight USA). In addition, US banks wrote off assets more quickly post 2009, and have therefore recovered faster than their European counterparts. To the extent that US companies have high exposure to the US domestic economy, its recovery has been stronger than that in Europe and Japan.

US companies are also more prone to buying back shares, thus reducing the supply of equity for investors.

International (non US) stocks are cheap. But that cheapness is for a reason. The market is not being irrational here, it is correctly pricing in the better performance of major chunks of the US stock market.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by david1082b » Mon Jul 30, 2018 12:29 pm

grayfox wrote:
Mon Jul 30, 2018 9:13 am
From multpl.com CAPE (P/E10) was about 15 in 2009 which is about the long term average CAPE. 1/CAPE = E10/P = 0.0667 so CAPE was predicting about 6.67% expected real return. Their chart shows -15 !?! Makes no sense.
The chart is *trailing* 10-year rolling, they are comparing actual realised returns for the *previous* ten years with returns expected from CAPE regression models. So the 2009 minus 15 value is based on expected returns from 1999 to 2009 using CAPE .

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by triceratop » Mon Jul 30, 2018 12:54 pm

KlangFool wrote:
Mon Jul 30, 2018 8:15 am
OP,

Another point of view:

https://www.peakprosperity.com/blog/114 ... -coal-mine

The recent stock run is driven by the FAANG aka 5 stocks.

KlangFool

P.S.: Unless you are 100% stock, none of this matters to you. You just buy according to your AA. You would not be buying the stock now due to your AA. If you are 100% stock, I wish you the best of luck.
This is poor analysis: if you remove the stocks which grew the most in market cap (due to a combination of earnings growth and multiple expansion) in a market-cap weighted index you're going to get that result. Talking about FAANG is a distraction.

However, SP600 has also performed very well which completely undermines the thesis of that article; In fact in H1 2018 which is the time period the article considers, SP600 outperformed SP500. SP600 holds no FAANG+ stocks, obviously.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by KlangFool » Mon Jul 30, 2018 1:08 pm

triceratop wrote:
Mon Jul 30, 2018 12:54 pm
KlangFool wrote:
Mon Jul 30, 2018 8:15 am
OP,

Another point of view:

https://www.peakprosperity.com/blog/114 ... -coal-mine

The recent stock run is driven by the FAANG aka 5 stocks.

KlangFool

P.S.: Unless you are 100% stock, none of this matters to you. You just buy according to your AA. You would not be buying the stock now due to your AA. If you are 100% stock, I wish you the best of luck.
This is poor analysis: if you remove the stocks which grew the most in market cap (due to a combination of earnings growth and multiple expansion) in a market-cap weighted index you're going to get that result. Talking about FAANG is a distraction.

However, SP600 has also performed very well which completely undermines the thesis of that article; In fact in H1 2018 which is the time period the article considers, SP600 outperformed SP500. SP600 holds no FAANG+ stocks, obviously.
triceratop,

Please provide the numbers for comparison.

Thanks.

KlangFool

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by triceratop » Mon Jul 30, 2018 1:13 pm

"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by vineviz » Mon Jul 30, 2018 1:50 pm

aristotelian wrote:
Mon Jul 30, 2018 11:07 am
Right, but if it says valuations are in line with current interest rates, what happens if interest rates rise?
Then valuations will change.
aristotelian wrote:
Mon Jul 30, 2018 11:07 am
It would be like a climate scientist saying the world isn't warming if you adjust for CO2.
It's NOTHING like that. I think you're misunderstanding the way this kind of model is used.

The calculation of "modified CAPE" is made based on current data. If the data change, then obviously the result of the calculation will change too but that doesn't mean the model has no utility.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by vineviz » Mon Jul 30, 2018 1:55 pm

asif408 wrote:
Mon Jul 30, 2018 10:52 am
Assuming their yardstick is true, does this mean that foreign markets are even cheaper? If we make a fair value CAPE for the US, I am assuming it should also be applied globally, unless we think the US stock market is special.
Again, I haven't read the actual paper but I presume they limited their modifications to US stocks because - in addition to needing to control for international accounting variances - the new variables (especially expected inflation) would be more challenging to model on a global basis.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by grayfox » Mon Jul 30, 2018 2:13 pm

david1082b wrote:
Mon Jul 30, 2018 12:29 pm
grayfox wrote:
Mon Jul 30, 2018 9:13 am
From multpl.com CAPE (P/E10) was about 15 in 2009 which is about the long term average CAPE. 1/CAPE = E10/P = 0.0667 so CAPE was predicting about 6.67% expected real return. Their chart shows -15 !?! Makes no sense.
The chart is *trailing* 10-year rolling, they are comparing actual realised returns for the *previous* ten years with returns expected from CAPE regression models. So the 2009 minus 15 value is based on expected returns from 1999 to 2009 using CAPE .
OK, let's say that the -15% return prediction was for 1999 to 2009

CAPE was 40.57 in Jan 1999. In 1999, forecasters using CAPE would have been predicting 1/40.57 = +2.46% real return.

Maybe somebody somewhere predicted -15% in 1999. But I would say that it's a strawman. They should compare their forecast to the typical CAPE forecast Expected Return = 1/CAPE, i.e. earnings yield E10/P.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by WanderingDoc » Mon Jul 30, 2018 2:20 pm

People come up with all sorts of "models" to make themselves feel better, it helps them sleep better at night. That is human nature. Similar to changing how the way unemployment was calculated/reported, changing how quarterly earnings are reported, changing how CAPE is reported, changing how the trade deficit is reported, changing how the federal balance sheet is reported, etc. Of course someone wants to feel better about a situation. We simply convince ourselves that it isn't as "bad" as we think.
vineviz wrote:
Mon Jul 30, 2018 6:43 am
Vanguard has an article on their website summarizing their recent paper, Improving U.S. Stock Return Forecasts: A "Fair-Value" CAPE Approach, published in the Winter 2018 issue of The Journal of Portfolio Management.
At the end of 2017, the Shiller CAPE (cyclically adjusted price to earnings) ratio was flirting with all-time highs, surpassed only by the peaks that preceded the collapse of the dotcom bubble. It stood at about 33; its historical average is about 16. A reversion to the ratio's long-term average would bode ill for future stock returns.

Vanguard's "fair-value" CAPE ratio paints a less alarming picture, suggesting that valuations are indeed high but not in the "bubble" territory implied by the conventional CAPE. We expect the returns of U.S. stocks to fall below their historical averages over the next ten years. The most likely outcome, according to our projections, is annualized returns of 3%–5% for the coming decade.
In short, Vanguard proposes an "enhancement to standard CAPE-based forecasts that conditions mean reversion in the CAPE ratio on real (not nominal) bond yields, expected inflation rates, and financial volatility in a VAR model".
I'm not looking to get rich quick (stocks), I'm not looking to get rich slow (indexing), I'm looking to get rich, for sure (real estate) | Don't wait to buy real estate. Buy real estate.. and wait.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by vineviz » Mon Jul 30, 2018 2:24 pm

WanderingDoc wrote:
Mon Jul 30, 2018 2:20 pm
People come up with all sorts of "models" to make themselves feel better, it helps them sleep better at night. That is human nature. Similar to changing how the way unemployment was calculated/reported, changing how quarterly earnings are reported, changing how CAPE is reported, changing how the trade deficit is reported, changing how the federal balance sheet is reported, etc. Of course someone wants to feel better about a situation. We simply convince ourselves that it isn't as "bad" as we think.
Also, some people are inherently intellectually curious and seek to deepen their understanding of how the world works.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by aristotelian » Mon Jul 30, 2018 2:37 pm

vineviz wrote:
Mon Jul 30, 2018 1:50 pm
aristotelian wrote:
Mon Jul 30, 2018 11:07 am
It would be like a climate scientist saying the world isn't warming if you adjust for CO2.
It's NOTHING like that. I think you're misunderstanding the way this kind of model is used.

The calculation of "modified CAPE" is made based on current data. If the data change, then obviously the result of the calculation will change too but that doesn't mean the model has no utility.
I guess I don't see the difference, since interest rates are one of the primary factors driving valuation. How is the model useful if it uses assumes current interest rates that are known to be in flux?

You can make an argument that there is some utility in a "fair value" metric that is relative to interest rates, but the first paragraph talks about investors worried about substantial correction. I don't see how the model can help make any predictions about likelihood of correction if it assumes current interest rates.
Last edited by aristotelian on Mon Jul 30, 2018 3:30 pm, edited 2 times in total.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by vineviz » Mon Jul 30, 2018 2:52 pm

grayfox wrote:
Mon Jul 30, 2018 2:13 pm
david1082b wrote:
Mon Jul 30, 2018 12:29 pm
grayfox wrote:
Mon Jul 30, 2018 9:13 am
From multpl.com CAPE (P/E10) was about 15 in 2009 which is about the long term average CAPE. 1/CAPE = E10/P = 0.0667 so CAPE was predicting about 6.67% expected real return. Their chart shows -15 !?! Makes no sense.
The chart is *trailing* 10-year rolling, they are comparing actual realised returns for the *previous* ten years with returns expected from CAPE regression models. So the 2009 minus 15 value is based on expected returns from 1999 to 2009 using CAPE .
OK, let's say that the -15% return prediction was for 1999 to 2009

CAPE was 40.57 in Jan 1999. In 1999, forecasters using CAPE would have been predicting 1/40.57 = +2.46% real return.

Maybe somebody somewhere predicted -15% in 1999. But I would say that it's a strawman. They should compare their forecast to the typical CAPE forecast Expected Return = 1/CAPE, i.e. earnings yield E10/P.
I think you'd benefit from tracking down a copy of the paper to fully understand that graph, but I can say it definite is NOT plotting the results of a simple 1/PE formula. The footnotes do provide some of the details of the regression results that are being plotted:
For the real-time analysis, the regression coefficients are determined recursively, starting with 10-year trailing annualized returns from January 1901–December 1959 data and re-estimating the regression coefficients with the addition of data for each month thereafter.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by WanderingDoc » Mon Jul 30, 2018 3:12 pm

vineviz wrote:
Mon Jul 30, 2018 2:24 pm
WanderingDoc wrote:
Mon Jul 30, 2018 2:20 pm
People come up with all sorts of "models" to make themselves feel better, it helps them sleep better at night. That is human nature. Similar to changing how the way unemployment was calculated/reported, changing how quarterly earnings are reported, changing how CAPE is reported, changing how the trade deficit is reported, changing how the federal balance sheet is reported, etc. Of course someone wants to feel better about a situation. We simply convince ourselves that it isn't as "bad" as we think.
Also, some people are inherently intellectually curious and seek to deepen their understanding of how the world works.
Not when all of it goes in the exact same direction.
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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by HomerJ » Mon Jul 30, 2018 3:16 pm

vineviz wrote:
Mon Jul 30, 2018 10:41 am
AlohaJoe wrote:
Mon Jul 30, 2018 8:35 am
Their model is academically interesting -- and apparently a clear improvement over other methods -- but let's keep in mind that it still isn't a good method.

They say their average error is 4.1%. So if they're saying 3-5% they mean something like "returns will be between 0% and 8%". I'm not sure what action real investors actually take based on forecasts that wide.
One possible action you could take is to start saving more money if your current retirement plan is based on an assumption of 10% or 12% stock returns over the next decade.

Don't laugh: there are people doing this.
I laugh.

See, here us why I (and many Bogleheads) don't care about valuations. We don't plan on 10% returns. We plan around 4%-5% returns... And are ready to adjust if returns are even lower.

So when some doom and gloom fellow comes on here and says "CAPE says we might only get 5% going forward!!!", we say "So what?"
The J stands for Jay

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by vineviz » Mon Jul 30, 2018 3:18 pm

WanderingDoc wrote:
Mon Jul 30, 2018 3:12 pm
vineviz wrote:
Mon Jul 30, 2018 2:24 pm
WanderingDoc wrote:
Mon Jul 30, 2018 2:20 pm
People come up with all sorts of "models" to make themselves feel better, it helps them sleep better at night. That is human nature. Similar to changing how the way unemployment was calculated/reported, changing how quarterly earnings are reported, changing how CAPE is reported, changing how the trade deficit is reported, changing how the federal balance sheet is reported, etc. Of course someone wants to feel better about a situation. We simply convince ourselves that it isn't as "bad" as we think.
Also, some people are inherently intellectually curious and seek to deepen their understanding of how the world works.
Not when all of it goes in the exact same direction.
Like I said , some of us are just interested in getting smarter.

If that doesn’t interest you, a forum called “Investing - Theory” probably isn’t going to excite you very much.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by HomerJ » Mon Jul 30, 2018 3:21 pm

vineviz wrote:
Mon Jul 30, 2018 1:50 pm
aristotelian wrote:
Mon Jul 30, 2018 11:07 am
Right, but if it says valuations are in line with current interest rates, what happens if interest rates rise?
Then valuations will change.
aristotelian wrote:
Mon Jul 30, 2018 11:07 am
It would be like a climate scientist saying the world isn't warming if you adjust for CO2.
It's NOTHING like that. I think you're misunderstanding the way this kind of model is used.

The calculation of "modified CAPE" is made based on current data. If the data change, then obviously the result of the calculation will change too but that doesn't mean the model has no utility.
The model has no utility PRECISELY because it doesn't account for all the variables.

A weather model that only accounted for one variable and assumed all other variables would remain the same would be very inaccurate predicting the weather. In fact this is exactly why you don't see weather predictions 10 weeks or 10 months or 10 years in advance.

I do not understand how CAPE proponents do not understand this.
The J stands for Jay

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by CULater » Mon Jul 30, 2018 3:28 pm

The problem is that just about everybody's uncle is agreeing that stocks won't achieve historical returns over the next decade. Unfortunately, the risk of owning stocks will achieve historical levels, as fur as I know. Returns per unit of risk are less favorable going forward. Get used to it...
May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by HomerJ » Mon Jul 30, 2018 3:29 pm

vineviz wrote:
Mon Jul 30, 2018 3:18 pm
WanderingDoc wrote:
Mon Jul 30, 2018 3:12 pm
vineviz wrote:
Mon Jul 30, 2018 2:24 pm
WanderingDoc wrote:
Mon Jul 30, 2018 2:20 pm
People come up with all sorts of "models" to make themselves feel better, it helps them sleep better at night. That is human nature. Similar to changing how the way unemployment was calculated/reported, changing how quarterly earnings are reported, changing how CAPE is reported, changing how the trade deficit is reported, changing how the federal balance sheet is reported, etc. Of course someone wants to feel better about a situation. We simply convince ourselves that it isn't as "bad" as we think.
Also, some people are inherently intellectually curious and seek to deepen their understanding of how the world works.
Not when all of it goes in the exact same direction.
Like I said , some of us are just interested in getting smarter.

If that doesn’t interest you, a forum called “Investing - Theory” probably isn’t going to excite you very much.
You may not actually be getting smarter.
The J stands for Jay

gmaynardkrebs
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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by gmaynardkrebs » Mon Jul 30, 2018 3:32 pm

HomerJ wrote:
Mon Jul 30, 2018 3:16 pm
vineviz wrote:
Mon Jul 30, 2018 10:41 am
AlohaJoe wrote:
Mon Jul 30, 2018 8:35 am
Their model is academically interesting -- and apparently a clear improvement over other methods -- but let's keep in mind that it still isn't a good method.

They say their average error is 4.1%. So if they're saying 3-5% they mean something like "returns will be between 0% and 8%". I'm not sure what action real investors actually take based on forecasts that wide.
One possible action you could take is to start saving more money if your current retirement plan is based on an assumption of 10% or 12% stock returns over the next decade.

Don't laugh: there are people doing this.
I laugh.

See, here us why I (and many Bogleheads) don't care about valuations. We don't plan on 10% returns. We plan around 4%-5% returns... And are ready to adjust if returns are even lower.

So when some doom and gloom fellow comes on here and says "CAPE says we might only get 5% going forward!!!", we say "So what?"
Homer, I thought you said :oops:
Last edited by gmaynardkrebs on Mon Jul 30, 2018 3:36 pm, edited 1 time in total.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by deltaneutral83 » Mon Jul 30, 2018 3:34 pm

5% nominal for the next ten years on the S&P would result in the worst rolling 30's for nominal (or real) since before the reliable data was available.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by triceratop » Mon Jul 30, 2018 3:35 pm

HomerJ wrote:
Mon Jul 30, 2018 3:21 pm
A weather model that only accounted for one variable and assumed all other variables would remain the same would be very inaccurate predicting the weather. In fact this is exactly why you don't see weather predictions 10 weeks or 10 months or 10 years in advance.

I do not understand how CAPE proponents do not understand this.
This is not actually why you don't see weather predictions 10 weeks in advance. The real reason has to do with something called chaos theory. Even when we know all the variables it is not enough to make reliable predictions.
You may not actually be getting smarter.
Conversely, "intellectual nihilism", the idea that a better understanding of the world is not possible and attempts to do so are a waste of time, definitely doesn't make you smarter.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by KlangFool » Mon Jul 30, 2018 3:46 pm

CULater wrote:
Mon Jul 30, 2018 3:28 pm
The problem is that just about everybody's uncle is agreeing that stocks won't achieve historical returns over the next decade. Unfortunately, the risk of owning stocks will achieve historical levels, as fur as I know. Returns per unit of risk are less favorable going forward. Get used to it...
CULater,

1) And, why do this matters to a person in term of personal finance?

2) Stock goes up and down. It averages to some numbers. But, to a person, only a particular sequence of returns matters to the person.

A) If the stock market crashes but the person is employed and can buy the stock on the cheap, it works out well for the person.

B) if the stock market crashes and the person is unemployed and he used up all his emergency fund, he has to sell all his stock. Then, he is totally wiped out. It won't matter to him that the stock market recovers 1 year later. You need to survive in order to succeed.

It is a sequence of return problem. A person needs to survive long enough before the average and long-term return matters.

3) The stock market will crash in the future. And, those that are not prepared will be wiped out. Those can buy during the crash will do very well. Life continues.

KlangFool

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by WanderingDoc » Mon Jul 30, 2018 3:57 pm

triceratop wrote:
Mon Jul 30, 2018 3:35 pm
HomerJ wrote:
Mon Jul 30, 2018 3:21 pm
A weather model that only accounted for one variable and assumed all other variables would remain the same would be very inaccurate predicting the weather. In fact this is exactly why you don't see weather predictions 10 weeks or 10 months or 10 years in advance.

I do not understand how CAPE proponents do not understand this.
This is not actually why you don't see weather predictions 10 weeks in advance. The real reason has to do with something called chaos theory. Even when we know all the variables it is not enough to make reliable predictions.
You may not actually be getting smarter.
Conversely, "intellectual nihilism", the idea that a better understanding of the world is not possible and attempts to do so are a waste of time, definitely doesn't make you smarter.
The idea I was trying to develop, if all of the "models" that are brought forth, take one concept/value/idea/data and morph it into "its not that bad, its actually better than we thought", and go in this direction for every single one, there is probably factual inaccuracy and misplaced optimism there. Those are things that aren't going to make anyone smarter.
I'm not looking to get rich quick (stocks), I'm not looking to get rich slow (indexing), I'm looking to get rich, for sure (real estate) | Don't wait to buy real estate. Buy real estate.. and wait.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by triceratop » Mon Jul 30, 2018 4:03 pm

WanderingDoc wrote:
Mon Jul 30, 2018 3:57 pm
The idea I was trying to develop, if all of the "models" that are brought forth, take one concept/value/idea/data and morph it into "its not that bad, its actually better than we thought", and go in this direction for every single one, there is probably factual inaccuracy and misplaced optimism there. Those are things that aren't going to make anyone smarter.
Yes, one should always be skeptical about people searching for models to obtain the desired result. But it's also dangerous to use the fact that all models are going one way to argue that they're wrong -- it is at least just as conceivable that it is evidence for the "it's not that bad" case.

Skepticism is always warranted, though.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by Elbowman » Mon Jul 30, 2018 4:21 pm

So the "less alarming" picture is 3-5% nominal? Considering you can get 4% nominal from intermediate corporates, is anyone considering a 15-20% reduction in their stock allocation?

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by MotoTrojan » Mon Jul 30, 2018 4:25 pm

You meant to use IJR; IJH is the SP400. IJR dominated IJH/SP500. IJH appears to have actually lagged the SP500.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by gips » Mon Jul 30, 2018 4:34 pm

fwiw, one of my wall st. ex-colleagues changed his equity allocation to zero based on the current cape ratio. However, there's so much press about poor expected returns, he's thinking it may be time to get back in :wink:

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by triceratop » Mon Jul 30, 2018 4:58 pm

MotoTrojan wrote:
Mon Jul 30, 2018 4:25 pm
You meant to use IJR; IJH is the SP400. IJR dominated IJH/SP500. IJH appears to have actually lagged the SP500.
Sorry, yes; I actually originally used IJR and then messed up for the link. This is the correct link

By the way, for H1 2018 SP400 did outperform SP600. However, you're referring to YTD where it did underperform. Anyway, it isn't the comparison I intended.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by Grt2bOutdoors » Mon Jul 30, 2018 5:08 pm

gips wrote:
Mon Jul 30, 2018 4:34 pm
fwiw, one of my wall st. ex-colleagues changed his equity allocation to zero based on the current cape ratio. However, there's so much press about poor expected returns, he's thinking it may be time to get back in :wink:
We know how precise and accurate Wall Street has been with predictions.
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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by Toons » Mon Jul 30, 2018 5:11 pm

Overvalued.
Undervalued,
Makes no difference.
Keep Investing.

:happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by gmaynardkrebs » Mon Jul 30, 2018 5:19 pm

Toons wrote:
Mon Jul 30, 2018 5:11 pm
Overvalued.
Undervalued,
Makes no difference.
Keep Investing.

:happy
And the effect will be...what?

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by columbia » Mon Jul 30, 2018 6:08 pm

Elbowman wrote:
Mon Jul 30, 2018 4:21 pm
So the "less alarming" picture is 3-5% nominal? Considering you can get 4% nominal from intermediate corporates, is anyone considering a 15-20% reduction in their stock allocation?
I don’t think that would be irrational; others would disagree.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by gmaynardkrebs » Mon Jul 30, 2018 6:38 pm

columbia wrote:
Mon Jul 30, 2018 6:08 pm
Elbowman wrote:
Mon Jul 30, 2018 4:21 pm
So the "less alarming" picture is 3-5% nominal? Considering you can get 4% nominal from intermediate corporates, is anyone considering a 15-20% reduction in their stock allocation?
I don’t think that would be irrational; others would disagree.
Many would say you should increase you allocation to equities, to make up for the lower expected returns of your portfolio overall. Personally, I think this is idiotic, but how does it differ from the line of thought that says "you need to take more risk" (ie., higher allocation to equities) to achieve your long term goals? I believe that the latter view is widely shared here.

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Re: Are stocks dangerously overvalued? Not according to new Vanguard yardstick

Post by Dottie57 » Mon Jul 30, 2018 7:14 pm

gmaynardkrebs wrote:
Mon Jul 30, 2018 5:19 pm
Toons wrote:
Mon Jul 30, 2018 5:11 pm
Overvalued.
Undervalued,
Makes no difference.
Keep Investing.

:happy
And the effect will be...what?
You will own more shares.

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