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CAPE, Shiller P/E, or P/E 10 ratio

4,181 Views | 29 Replies | Last: 5 yr ago by AgBank
AgBank
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AG
Is anyone else in here starting the slow process of moving (dollar cost average) from an overweight in equities to an overweight in fixed income?

I don't really follow CAPE / Shiller P/E, and honestly at 28, the Shiller PE ratio isn't anything compared to the dot com days, but it seems like it is time for me to start moving equities into fixed income. If things change, I will slow the process and even stop the transition, but for now I am slowly moving towards fixed income securities.


What say you TexAgs?

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AgBank
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Quote:

confirm that valuations are overvalued.

Isn't it too late by that point?
Casey TableTennis
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If you followed these measures religiously, you would have done that 3 years ago. While it will likely be right eventually, trying to time it is typically a losing proposition.
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Old Buffalo
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I think the problem with following these indicators is that it assumes the historical is the mean, rather than now being the new normal. Businesses have changed a lot over that time frame, as well as multiples. We've also never seen a sustained period of low rates which further props up valuations.

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AgBank
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Old Buffalo said:

I think the problem with following these indicators is that it assumes the historical is the mean, rather than now being the new normal. Businesses have changed a lot over that time frame, as well as multiples. We've also never seen a sustained period of low rates which further props up valuations.



I guess we are speaking a bit different about timing. I am playing the longer game with this shift in asset mix over time.

Comments like "Business have changed a lot over time" is a great indicator of an overinflated market. Now all I need is a stock tip or two from the "shoeshine boys" and I will be confident when I liquidate everything.
Old Buffalo
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I'm not arguing for or against a bubble, I just think history is not reflective of the new normal.
Harkrider 93
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What is interesting about the economists/money managers that are big believers in CAPE is that they feel bonds are worse than stocks right now.

I have heard them talk about high yield bonds as an option (convertibles, etc included).

In other words, if you think the stock market is overvalued, wait till you look at bonds.

AgBank
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Harkrider 93 said:

What is interesting about the economists/money managers that are big believers in CAPE is that they feel bonds are worse than stocks right now.

I have heard them talk about high yield bonds as an option (convertibles, etc included).

In other words, if you think the stock market is overvalued, wait till you look at bonds.



I can see this. This is why CAPE has been irrelevant for so long. The interest rate risk is significant (I am not smart enough to follow credit quality). It has been almost 20 years since the 10 year treasury was over 6%. It is hard to invest in anything with a long duration.
Harkrider 93
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http://www.advisorperspectives.com/commentaries/2017/01/09/on-my-radar-the-bond-market-is-facing-the-perfect-storm-plus-latest-equity-market-valuation-c


Haven't really followed the author above for very long. I think chart #7 is one that I have seen someone argue before. Their finding was that % of stocks owned was a better indicator of future stock performance. Unfortunately, it is currently low (better than bonds and CAPE).

The author appears to be reasonable with his forecasting. He isn't always positive or always negative. I haven't challenged his calls by reviewing old articles, but he has been fairly accurate in the last few years with what I can recall.

Wanted to edit for clarification: I haven't checked his advice on in or out of the market on a daily/monthly basis. I have heard him say for several years that the probability of a recession is really low based on charts he favors.
AgBank
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Thank you for sharing! I was skeptical until I saw chart 7 (see below) is kicking around a Correlation coefficient of .92. I will dig into this further.

Unfortunately Blumenthal ruins his credibility for me when he moves to "Bond Market Perfect Storm". He casually refers to a research paper as "Academic studies show", which implies accuracy of the stud and is insulting to the reader. In these "studies" when Reinhart and Rogoff speak of 90%, they are referring to government debt, which they clearly state in the first sentence Link. He seems to loosely confuse total debt with public debt. Also, I don't really think "we" are deleveraging anymore (Blumenthal's bullet at the beginning). Maybe we should be, but the feeling I get is we are not.

Either way, thank you again for sharing, the Ned Davis chart "Household Equity Percentage vs. Subsequent Rolling 10-Year S&P 500 Index Total Return".



I would love to see the data on equity percentage (includes mutual funds and pensions).
Harkrider 93
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http://www.philosophicaleconomics.com/2013/12/the-single-greatest-predictor-of-future-stock-market-returns/

Maybe the above will help.

As for your other comments, I really don't understand it enough to debate it one way or another. I also have seen two exceptionally bright economic minds argue different sides. How can two intelligent people argue different sides of a chart or set of data?

I have read elsewhere that we are still deleveraging. It may depend on who you or I define "we". It may also depend on how you or I define deleverage. The Fed has reduced their balance sheet on bond holdings. These are the same bonds that they bought during QE. I don't know if that is what folks are meaning by we or deleverage. I am not trying to argue that someone is right or wrong, because I don't think it is that defined. I do think it is wise for everyone to be open to data and arguments because of the complexity and impossibility to know how everything reacts in certain situations.
AgBank
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Agreed. Regardless of my concerns with his post, chart 7 is compelling to me.
Harkrider 93
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Same here. The second article I posted is saying the same thing about accuracy being better than the others.
agnatgas
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The market can stay irrational longer than you can stay solvent.
AgBank
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agnatgas said:

The market can stay irrational longer than you can stay solvent.

This isn't a margin trade, but I appreciate the advice Mr. Keynes.
pfo
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Bonds have enjoyed a 35 year bull market that has just ended. Trump is going to lower tax rates, reduce regulations and get big government off American's backs. Interest rates are going up. I wouldn't touch bonds in this environment.
AgBank
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pfo said:

Bonds have enjoyed a 35 year bull market that has just ended. Trump is going to lower tax rates, reduce regulations and get big government off American's backs. Interest rates are going up. I wouldn't touch bonds in this environment.
I hear you on the interest rate risk. I am trying to move the money into something with more of a 5-6 year average duration. If interest rates move up 200bps, I will likely loose 10-12% of my market valve of the bonds (excluding any interest paid in that time). 2% is a pretty large interest rate move relative to current inflationary pressures, especially since inflation projects to be only have a modest increase for 2017.

The current interest rate hardly warrants the risk, but I haven't been very lucky at predicting the end of the bond bull market in the past...
jh0400
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AgBank said:

pfo said:

Bonds have enjoyed a 35 year bull market that has just ended. Trump is going to lower tax rates, reduce regulations and get big government off American's backs. Interest rates are going up. I wouldn't touch bonds in this environment.
I hear you on the interest rate risk. I am trying to move the money into something with more of a 5-6 year average duration. If interest rates move up 200bps, I will likely loose 10-12% of my market valve of the bonds (excluding any interest paid in that time). 2% is a pretty large interest rate move relative to current inflationary pressures, especially since inflation projects to be only have a modest increase for 2017.

The current interest rate hardly warrants the risk, but I haven't been very lucky at predicting the end of the bond bull market in the past...


I haven't researched it, but I'd think you'd be able to find some good credits in the crossover range that would benefit from improvements in the overall business environment such that any loss due to changes in interest rates would be partially offset by tightening spreads.
Harkrider 93
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To me, junk or bonds that can buy junk and short would be a better way to go. Duration is just one part of price movement. You will have lots of trading and average people who leave in groves because they read that bonds are on a bear market. Then, they will see the negative returns and run to the hills. Even junk bonds may suffer a bit from this.
AgBank
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Ok. I have transitioned into 55% stock and 45% bonds / fixed income (or close) for my general portfolio excluding about $70k that I have in individual stocks that I have had for a while and a DB stock that I purchased mid last year and some cash that I have in an etrade account from some bonds maturing.

I plan to continue the process / transition towards fixed income at a slower pace.

Is there anyone else trying to transition towards an underweight of stocks?
AgBank
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CAPE Shiller just hit 27.77

As you can see from my post above, I have been sitting in about 50% stocks and 50% fixed income for 2 years. If things continue, I am going to start transitioning back into equities.


Shiller CAPE - Current



AgBank
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Is anyone else out there that is managing their exposure to equities using indicators?
Casey TableTennis
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AgBank said:

CAPE Shiller just hit 27.77

As you can see from my post above, I have been sitting in about 50% stocks and 50% fixed income for 2 years. If things continue, I am going to start transitioning back into equities.


Shiller CAPE - Current




On top of the recent decline in the metric, CAPE Shiller should continue to look a lot better as the very high PEs of 2009 fall out of the formula over the coming year. I haven't modeled out a concrete expectation for CAPE over the next year, but it should experience a significantly positive move assuming valuations and earnings don't change dramatically during 2019.

Not a jab at you, but to a degree I think it is laughable to compare metrics like this to it's 100 year+ history. Economies are so much more diversified, robust and resilient now than the late 1800s or early 1900s that I do not see how we can infer anything by contrasting the two. Dr. Kelly at JPM typically uses 25 year average for comparing CAPE Shiller. When you do so, the current level isn't materially out of line, even before 2009 falls out. I see an argument for using longer than 25 years, but the point remains the same if you simply more heavily weight recent decades than you do the 1800s.

I don't change allocations in a meaningful way based on indicators, but CAPE Shiller and many others go into my outlook and modestly change my tilts from time to time. More so, these indicators influence how quickly I stage into the market when cash is being invested, or out of the market when there are anticipated (not current) needs.
Wrighty
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AgBank said:

CAPE Shiller just hit 27.77

As you can see from my post above, I have been sitting in about 50% stocks and 50% fixed income for 2 years. If things continue, I am going to start transitioning back into equities.


Shiller CAPE - Current






On feb 1, 2017, the S&P 500 index was at 2285.
Today the S&P 500 index closed at 2506.
AgBank
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Wrighty said:

AgBank said:

CAPE Shiller just hit 27.77

As you can see from my post above, I have been sitting in about 50% stocks and 50% fixed income for 2 years. If things continue, I am going to start transitioning back into equities.


Shiller CAPE - Current






On feb 1, 2017, the S&P 500 index was at 2285.
Today the S&P 500 index closed at 2506.

Yes. I guess that represents me missing out on a 4.5% annualized return. I don't think I made that up in the municipal bond market, where much of my fixed income is sitting. An academic would say I enjoyed a friendlier Sharpe Ratio, but I am not sure I care as much about that.
AgBank
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Quote:

Not a jab at you, but to a degree I think it is laughable to compare metrics like this to it's 100 year+ history. Economies are so much more diversified, robust and resilient now than the late 1800s or early 1900s that I do not see how we can infer anything by contrasting the two.
When I posted this originally I based my actions upon a 21.5 trend line that developed. The way I thought about it in early 2017 is that we have more liquidity and transparency than they did back in the 1980s, much less the 1880.

Since then, I wonder how much impact the low rates have had on equity valuation. The best alternative to equities is debt, and low interest rates have made that a hard substitution pill to swallow. Maybe a 28 CAPE P/E makes sense if the 10 year treasury is 2.5% (10 year rate in 2017).

Since I wrote this back in 2017, my wife has inherited a good sum of money comparative to our existing portfolio. That new money is 75% fixed income and 25% equities. So we will be catching falling knives soon because I don't care to time the bottom.
drill4oil78
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Cape Shiller is a backward looking indicator. It uses around 10 previous years of data. Those times could include a recession. The market is forward looking. Shiller has been saying the market is over valued for years. He is like a broken clock.


AgBank
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Good point, I agree that Shiller CAPE isn't terribly predictive in the short run. Its 10 year inflation adjusted average earnings is to reduce the cycle "noise" of earnings.

I am trying to determine some framework that enables me to de-risk based on valuation. Shiller CAPE isn't suppose to predict the next year or two, it's should give an idea about the next 10 to 20 years. It is a bit disingenuous of me to post 2 years later, I guess I should wait until 2027 then post .

The truth is I don't have a solid view or methodology yet on how to overweight my portfolio yet. Over the past couple cycles the fluctuation in my total portfolio value hasn't concerned me much because I was young enough to be accumulating assets through my salary.


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