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Old 08-14-2011, 03:10 PM   #41
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So what you're saying is that annual earnings have become far more volatile, which stands to reason considering we've had the 2000 and 2008 debacles within the last 10-yr window. That probably makes PE-10 somewhat less reliable, but I'd also argue that it makes normal PE completely unreliable.

I'd continue with the thought that if earnings are now far more volitile than was true in the past, equities are far more risky than was true in the past. Therefore higher risk premiums (lower PE's, however measured) seem appropriate. No?
PE10 was suppose to be more reliable because it used a smoothed "E", i.e. real earnings over a 10 year past. I'm just saying that this has too be viewed with suspicion when the standard deviation of the E10 is so much higher then historical numbers.

What we care about is the near term future earnings. The estimated PE1 that I mentioned above comes from a Wall St. firm. It's true that these estimates have to be taken with a grain of salt -- some may say a large grain. But note that even if those estimated values are off by 20%, forward PE's would be reasonable.

Also the SP500 dividend yield is quite good now compared with bond yields. Yes, dividends could be cut in a recession. Are we headed into a recession? Some say we are at "stall speed" i.e. just treading water but not headed down yet.

I'm optimistic that things will get better. That's my bet anyway.
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Old 08-14-2011, 03:33 PM   #42
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PE10 was suppose to be more reliable because it used a smoothed "E", i.e. real earnings over a 10 year past. I'm just saying that this has too be viewed with suspicion when the standard deviation of the E10 is so much higher then historical numbers.
Go back to your chart and compare the dotted blue line (E-10) with the green line (E). If increased volatility of that blue line is to be viewed with suspicion, then the green line needs to be viewed with absolute terror. Whatever predictive power Wall Street had with respect to PE1 over the long-term (not so good, BTW) it is orders of magnitude worse over the recent past.

If you want to discount PE-10 as a measure because of increased volatility in E, that's fine. But then you have to accept that PE or PE1 needs to be discounted even more heavily.

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Also the SP500 dividend yield is quite good now compared with bond yields.
True. But bond yields stink like poo. And while it's likely that stock valuations are more attractive than bond valuations, that's not so impressive when you realize that what you're really saying is that stocks are more attractive than poo.

Edit to add: After a second thought, I'm not so sure that increased volatility has much bearing on PE-10's usefulness. The idea wasn't to smooth earnings for smoothing sake, but to average earnings over a business cycle. The problem with PE is that 'cheap' or 'rich' really depends on where you are in the business cycle. Late in the earnings cycle, a low PE is justified because you're at peak earnings. In the middle of a recession, higher PEs can be tolerated because presumably earnings growth will be higher coming out of the trough. But because we don't know until after the fact whether we're late or early in the earnings cycle, PE is a difficult measure to evaluate. That's even more true if the amplitude of the cycle has increased, which it has, as you've pointed out.
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Old 08-14-2011, 03:40 PM   #43
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Here's a discouraging article: Savers Stuck With Recovery Bill - WSJ.com
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Old 08-14-2011, 04:06 PM   #44
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...(snip)... But because we don't know until after the fact whether we're late or early in the earnings cycle, PE is a difficult measure to evaluate. That's even more true if the amplitude of the cycle has increased, which it has, as you've pointed out.
Well Gone4Good, I cannot disagree with what you've said. You bring up some good points. I think PE is just one facet of the market.

I personally use it (PE10) along with another valuation measure plus stock/bond comparisons and momentum to decide my course of action. Whatever I use has been backtested for 80 years or so. But I could be wrong. I'm just trying to be data driven in a modest way, rather then hunch driven. Unfortunately there is no science to this stuff. The test of a good model in science is predictability, but in the stock/bond markets we have to be satisfied with highly imperfect models.

FWIW, my current model says to stick with the market. The model will not work well for sharply declining (panic like) markets like Oct 1987 or Sept 1998.
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Old 08-14-2011, 04:56 PM   #45
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FWIW, my current model says to stick with the market.
FWIW, I'm not a seller of equities today.

Was a seller in Nov 2010 and April 2011. Sold a big chunk of 30 year bonds last week. That money may find it's way into the equity market to buy back some of those equity sales at better prices, but I don't feel pressured to do anything. The prices still aren't that good.

Sometimes, when the table odds don't look favorable, the best thing to do is sit on your wallet and watch.
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Old 08-14-2011, 05:01 PM   #46
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I will contend that, while equities as a whole seem expensive, there are pockets of value in this market.
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Old 08-14-2011, 05:11 PM   #47
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I have been buying CD's from Apple Federal Credit Union . 10 Yr. 3.5% . Maybe it is foolish. But I can't invest in this crazy market. Inflation may eat me up, just have to save more now. If the rates go up, figure the hit and go from there. If I owned a bank I wouldn't lend at these rates, too risky.
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Old 08-14-2011, 07:30 PM   #48
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FWIW, I'm not a seller of equities today.

Was a seller in Nov 2010 and April 2011.
Same here. "Harvested" the YTD gains on the same month/year as you and added to DW/my respective cash bucket (for retirement income).

I've never been one to count on yields for long term income, but than again, that's only me.

It could be because our joint portfolio runs 50-55 equities most of the time (with a 50/50 AA) and I've found that it's easier to make decisions concerning equity sales to fund expenses at this time.
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Old 08-14-2011, 10:25 PM   #49
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It could be because our joint portfolio runs 50-55 equities most of the time (with a 50/50 AA) and I've found that it's easier to make decisions concerning equity sales to fund expenses at this time.
For me it's the simple fact that I have a very low return bogie to hit . . . my WR. If an asset is up 100%, as many were over the past two years, I can lock in many, many years of withdrawals without needing to take any additional risk. It becomes a pretty simple sell decision when your investment objective isn't to maximize returns, but simply to beat a fairly low hurdle rate.

An example: I bought 30 year TIPS at auction 18 months ago with a real coupon of 2.125% in an IRA. My intention was to hold these to maturity considering that the real return more than covers my need. Last week I sold these bonds at a 41% gain. That gain gives me eight years of 2.125% real returns (assuming today's TIPS breakeven inflation rates). I can bury the cash in the back yard and wait the better part of the next decade for rates to normalize before reinvesting that money. I can wait even longer sticking that cash in low break-fee CDs. I simply don't need to have that money invested in risky assets today because so much of my expected return was front end loaded.

Same story with the equities I bought in 2008 and 2009.
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Old 08-15-2011, 07:32 AM   #50
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For me it's the simple fact that I have a very low return bogie to hit . . . my WR. If an asset is up 100%, as many were over the past two years, I can lock in many, many years of withdrawals without needing to take any additional risk. It becomes a pretty simple sell decision when your investment objective isn't to maximize returns, but simply to beat a fairly low hurdle rate.

An example: I bought 30 year TIPS at auction 18 months ago with a real coupon of 2.125% in an IRA. My intention was to hold these to maturity considering that the real return more than covers my need. Last week I sold these bonds at a 41% gain. That gain gives me eight years of 2.125% real returns (assuming today's TIPS breakeven inflation rates). I can bury the cash in the back yard and wait the better part of the next decade for rates to normalize before reinvesting that money. I can wait even longer sticking that cash in low break-fee CDs. I simply don't need to have that money invested in risky assets today because so much of my expected return was front end loaded.

Same story with the equities I bought in 2008 and 2009.
Yes. But over the longer haul, your average return will probably average out... still a bird in the hand....

I did a similar move by exiting bonds after the increase... thinking that the fed would stop the manipulation sometime shortly after QE II.

So I have some gains from fixed... now what?

I am working on an approach.
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Old 08-15-2011, 07:55 AM   #51
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For me it's the simple fact that I have a very low return bogie to hit . . . my WR. If an asset is up 100%, as many were over the past two years, I can lock in many, many years of withdrawals without needing to take any additional risk. It becomes a pretty simple sell decision when your investment objective isn't to maximize returns, but simply to beat a fairly low hurdle rate.

.

Interesting philosophy and probably completely consistent with a total return investing.

As income investors this bothers me a bit. So for example if my desired WR is 3.5% but my actual income from my portfolio is only 2.8% due to primarily to horrible cash returns. One way of looking at my spending is that is 20% higher than my income (almost as bad as Uncle Sam).

The other way is saying I'm only dipping into my principal by .7% and even after 30 years it is only 20-25% decline not a big deal.

Of course if 2.125% TIPs coupon covers your withdrawal needs than you must have a lot of assets or nice pensions.
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Old 08-15-2011, 07:58 AM   #52
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It becomes a pretty simple sell decision when your investment objective isn't to maximize returns, but simply to beat a fairly low hurdle rate.
For me, that's just another advantage of retirement. If you've hit "your number", you don't need to maximize returns, nor take the risk to do so.

It's better to concentrate on retirement cash flow and ensure that your cash bucket contents are sufficient to get you over the gaps in the market (be it equity or bonds) to ensure that cash flow.
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Old 08-15-2011, 08:23 AM   #53
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So I have some gains from fixed... now what?
Part of the point is by focusing on the right target (earning my WR over the long-term) I don't feel presured to chase short-term returns. Sitting on gains, I don't need to find another winner right away. I have plenty of time, a decade in fact. So 'now what' can very easily be to sit and wait in Ally CDs or something similar. It can also mean changing asset classes altogether, like buying another rental property, which is currently on my radar.

These decisions are a lot easier when evaluated against a specific return threshold. My goal isn't to beat some hypothetical buy-hold-and-rebalance portfolio. My goal is to earn my WR over the long-term and minimize my risk of coming up short. Taking risk off the table when risky assets are priced to return less than my WR is a no brainer as far as I'm concerned.

At the very least it is worth asking the question: "If I'm planning on withdrawing 4% real from my portfolio every year, how can it be a good idea to have 50% of that portfolio invested in the Total Bond Market index, when that fund promises real returns of just 0.5% and nominal returns of 2.35%?"
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Old 08-15-2011, 09:34 AM   #54
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WR? Oh, withdrawal rate!
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Old 08-15-2011, 09:36 AM   #55
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Part of the point is by focusing on the right target (earning my WR over the long-term) I don't feel presured to chase short-term returns. Sitting on gains, I don't need to find another winner right away. I have plenty of time. So 'now what' can very easily be to sit and wait in Ally CDs or something similar. It can also mean changing asset classes altogether, like buying another rental property, which is currently on my radar.

These decisions are a lot easier when evaluated against a specific return threshold. My goal isn't to beat some hypothetical buy-hold-and-rebalance portfolio. My goal is to earn my WR over the long-term and minimize my risk of coming up short. Taking risk off the table when risky assets are priced to return less than my WR is a no brainer as far as I'm concerned.
I agree with you. I am not going to chase yield on fixed.

My comment was partly rhetorical and partly the question I am wrestling with.

Those low penalty 5 year CDs look pretty good at this point.
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Old 08-15-2011, 09:41 AM   #56
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The other way is saying I'm only dipping into my principal by .7% and even after 30 years it is only 20-25% decline not a big deal.
I'm not sure I agree.

Does a 41% gain in value immediately become 'principal' that is now sequestered in a 'do not touch' silo? I'd say that gain is nothing more than a giant advance on future coupons. If I were to hold those bonds till maturity, eventually that gain depreciates away. All I get back is 100 cents on the dollar, not 141. So if you view a $141 premium bond as your 'principal', you can't consume the entire coupon anyway without consuming $41 in 'principal' along the way. Basically you'd be limited to drawing the yield to maturity, which in the case of those 30-yr TIPS was 0.86% real when I sold them. Not good enough, IMO.

My choice is to lock in that $41 and either redeploy it to something that meets my WR target or, failing that, to live on those 'coupon advances' while I wait for opportunities that meet my withdrawal threshold.
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Old 08-15-2011, 09:45 AM   #57
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That seems to be an ongoing problem with bonds - the capital gains dissappear as the bond approaches maturity. I know of no way around this problem, except to sell the bond, lock in the gain, and then, reinvest it. Of course, the gain is usually caused because rates have gone down, so reinvesting means earning less on your original investment. Right?
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Old 08-15-2011, 10:07 AM   #58
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That seems to be an ongoing problem with bonds - the capital gains dissappear as the bond approaches maturity. I know of no way around this problem, except to sell the bond, lock in the gain, and then, reinvest it. Of course, the gain is usually caused because rates have gone down, so reinvesting means earning less on your original investment. Right?
Basically, yes. Although I'm not advocating selling bonds that I view to be poor investment risks and reinvesting those proceeds in the same market.

There are a several threads running through my thoughts:

1) The current environment of negative real yields is not normal, and likely not sustainable.
2) Because of capital appreciation in the bond market, I don't have to play in that market for years. Cash is just fine when incorporated with the returns I've already banked.
3) Locking in long-term fixed rates of return far below my withdrawal rate is counterproductive to my goals.
4) Near zero duration, low break-fee CDs offer cash-like flexibility with far better yields than bonds or cash. They offer a low-risk place to park fixed income gains while waitng for yields to normalize.
5) A fixed asset allocation may lead you astray if it prevents you from considering other investment alternatives that offer above WR returns . . . rental properties, for example.
6) This is a marathon, not a sprint. Next year's returns are not terribly relevant. What is relevant is whether my returns exceed my withdrawal rate over the next several decades. Current long-term bond yields give me very little chance of doing that; so I wait.
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Old 08-15-2011, 03:30 PM   #59
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I'm not sure I agree.

Does a 41% gain in value immediately become 'principal' that is now sequestered in a 'do not touch' silo? I'd say that gain is nothing more than a giant advance on future coupons. If I were to hold those bonds till maturity, eventually that gain depreciates away. All I get back is 100 cents on the dollar, not 141. So if you view a $141 premium bond as your 'principal', you can't consume the entire coupon anyway without consuming $41 in 'principal' along the way. Basically you'd be limited to drawing the yield to maturity, which in the case of those 30-yr TIPS was 0.86% real when I sold them. Not good enough, IMO.

My choice is to lock in that $41 and either redeploy it to something that meets my WR target or, failing that, to live on those 'coupon advances' while I wait for opportunities that meet my withdrawal threshold.
Ah the light bulb goes on. You are simply taking the profits now instead of collecting the coupons in the future. It also sounds like <1% is below even your WR.

Of course this begs the question of where do you put the money now, since the bond market isn't favorable, and cash pays absolutely nothing. I guess CD's despite the pathetic rates unless you are willing to up your AA.

I guess somebody needs to write a book. How to retire in a deflationary environment even if you fear inflation is just around the corner.
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Old 08-15-2011, 03:46 PM   #60
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3) Locking in long-term fixed rates of return far below my withdrawal rate is counterproductive to my goals.

6) This is a marathon, not a sprint. Next year's returns are not terribly relevant. What is relevant is whether my returns exceed my withdrawal rate over the next several decades. Current long-term bond yields give me very little chance of doing that; so I wait.
Bingo! The same thoughts keep bouncing around in my mind.
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