Anyone taking money off the table?

[Gone4Good]

That's the point that almost always gets missed in these AA discussions. The lower AA fans point out the big drops, but often ignore that the drop is from a point that would not have been realized at the lower AA. If you are still higher after that drop, you are better off, no?

That will certainly be true in a case where markets rise, drop, and rise to new highs. That's the history on which everyone's retirement plan is based.

And if history simply repeats, I don't have anything to worry about regardless of whether my stock allocation is 50%, 60, 70, 80, 90, or 100. It's all just a question of how much gravy I get served.

My retirement concern isn't that history will repeat. It's that it won't.

 

[ERD50]

That will certainly be true in a case where markets rise, drop, and rise to new highs. That's the history on which everyone's retirement plan is based. ...

It could also be true if the market rises, drops, and just stays there, with no real recovery.

The drop from the high with an aggressive AA might still leave you higher than the smaller drop from a lower high with the less aggressive AA.

My retirement concern isn't that history will repeat. It's that it won't.

Yep, we could get all sorts of scenarios where one AA will radically out perform another. We can guess, but I think I'll use history as a guide.

-ERD50

 

[Gone4Good]

Yep, we could get all sorts of scenarios where one AA will radically out perform another. We can guess, but I think I'll use history as a guide.

-ERD50

I use history as a guide too. And what it tells me now is that a bunch of things like equity and bond valuations & corporate earning's share of national income are all off the map. Here be Dragons.

 

[redduck]

Anyone Taking Money Off the Table?

Getting back to the OP's question: it looks as if this guy is taking money off the table.

 

[FUEGO]

I'm close to taking some profits. Maybe $10-20k, which is 3-6 months worth of expenses roughly.

I'm trying to maintain 1-2 years as a cash buffer and have around a year right now (maybe 1.5-1.75 years including the brokerage account dividends I'll be receiving over the next 1.5-1.75 years).

I'm virtually 100% invested in equities other than my small cash buffer, so I will still have plenty of "skin in the game" even if I sell off a couple $10k of stocks.

 

[Lsbcal]

I think that equities are still looking good here. My reasoning with the most important first:

1) The yield curve is steep i.e. the Fed is in accommodative mode.
2) PE10's are at reasonable levels. I use an accounting adjusted number and compare that to the last 30 years. The rank is right now is at 60% and 90% would have me worried a bit.
3) Unemployment is heading down.
4) Equity returns over the last 12 months have been mildly positive (SP500 up about 0.8%). Certainly not signaling wild abandon.

 

[Gone4Good]

I took a rough cut at calculating 10-year real returns for the S&P 500 by starting CAPE value (a.k.a. Shiller's PE-10, unadjusted). Here's the results sorted by CAPE quintile (where the highest 20% of staring PE values are grouped in the 5th quintile and the lowest 20% are in the 1st quintile).

CAPE Quintile		10-yr Average Real Return
1st		11.60%
2nd		7.46%
3rd		6.27%
4th		5.02%
5th		1.79%

The current CAPE of 26.2x is at the 93.7 percentile, which puts it at the very top end of that 5th quintile and at the very bottom of the chart above.

So if past is prolog, we'll be lucky to get 2% real from stocks over the next 10 years. Of course we can expect to do only a quarter as well in bonds.

 

[Lsbcal]

...
The current CAPE of 26.2x is at the 93.7 percentile, which puts it at the very top end of that 5th quintile.
...

I think one has to adjust the current CAPE for accounting changes that have occurred since about 2002. That would make it something like CAPE=22. Here is one reference about this: Morningstar Free Smartpage | News

Even if one is right on roughing out the next 10 years estimate with CAPE, it doesn't say anything about the next 12 month market direction. So I personally assign valuations (except in the extremes like the late 1990's) to be not very helpful in judging near term market dangers.

From my research the yield curve steepness is a better predictor of market dangers for the near term. There was a Fed paper about this some years ago.

 

[W2R]

Getting back to the OP's question: it looks as if this guy is taking money off the table.

OK, everybody, I did it. I moved some money from Vanguard Prime Money Market, to the savings account that I have at my bricks and mortar bank. Surely that counts as taking money off the table.

 

[Lsbcal]

A shockingly bold move W2R.

 

[W2R]

A shockingly bold move W2R.

Yet another shockingly brave act by a member of this bold forum!

 

[Gone4Good]

I think one has to adjust the current CAPE for accounting changes that have occurred since about 2002. That would make it something like CAPE=22. Here is one reference about this: Morningstar Free Smartpage | News

Even if one is right on roughing out the next 10 years estimate with CAPE, it doesn't say anything about the next 12 month market direction. So I personally assign valuations (except in the extremes like the late 1990's) to be not very helpful in judging near term market dangers.

From my research the yield curve steepness is a better predictor of market dangers for the near term. There was a Fed paper about this some years ago.

A couple of points on all of this. I discussed my thoughts on Livermore's adjustments to CAPE in another thread. And basically he seems to be using pro-forma earnings instead of GAAP earnings. That's not an improvement.

Pro-forma earning are a fairly recent invention and they're basically management's attempt to get analysts to agree to a higher earnings number than what GAAP requires them to report. So obviously any PE ratio using "pro-forma" earnings will always be lower than one produced with GAAP earnings. It's not obvious to me that that is an improvement, though.

And I wouldn't put too much faith in the yield curve as a good indicator now that short rates are constrained by the 0% lower bound. It's not likely we can get a negatively sloping yield curve which signals a weakening economy when the front end is already near zero. I think we're pretty much stuck with positively sloping curves until the short-end gets somewhat above zero. So while the yield curve was a good indicator in the past, it's probably a bit of a nothing burger given the current situation.

I do agree that CAPE is not useful as a market timing tool. It does seem to be useful in forecasting future returns over longer periods though. And that's pretty much what I'm making retirement asset allocation decisions around. I'm not trying to grab the absolute top tick of the market. I'm trying to earn my withdrawal rate with the least amount of risk. And higher CAPE's, regardless of how you calculate them, indicate higher risk and lower expected return going forward.

PS, When I use 22x PE that puts me at an 88 percentile rather than 93.7%. So it doesn't even move the needle that much. Still in the 5th quintile.

 

[MichaelB]

OK, everybody, I did it. I moved some money from Vanguard Prime Money Market, to the savings account that I have at my bricks and mortar bank. Surely that counts as taking money off the table.

A shockingly bold move W2R.

Yet another shockingly brave act by a member of this bold forum!

I'm definitely taking a second look at my asset allocation tomorrow.

 

[Lsbcal]

A couple of points on all of this. I discussed my thoughts on Livermore's adjustments to CAPE in another thread. And basically he seems to be using pro-forma earnings instead of GAAP earnings. That's not an improvement.

I had to hunt for it but here is the Livermore article: Fixing the Shiller CAPE: Accounting, Dividends, and the Permanently High Plateau | PHILOSOPHICAL ECONOMICS

One quote from that article:
[FONT=&quot]

Unfortunately, the earnings data on Dr. Shiller’s website, which are used to build the Shiller CAPE, are not based on a consistent definition of “earnings” across time. The data are taken from S&P “reported” earnings, which are formulated in accordance with Generally Accepted Accounting Principles (GAAP). But the standards of GAAP have changed significantly over the last few decades.

[/FONT]
[FONT=&quot]I'll add the I'm no accounting guru. Siegel was the first one I saw that tried to adjust the Shiller CAPE. Swedroe wrote an article that seemed to take the Siegel and Livermore critique seriously.
[/FONT]
...

I do agree that CAPE is not useful as a market timing tool. It does seem to be useful in forecasting future returns over longer periods though. And that's pretty much what I'm making retirement asset allocation decisions around. I'm not trying to grab the absolute top tick of the market. I'm trying to earn my withdrawal rate with the least amount of risk. And higher CAPE's, regardless of how you calculate them, indicate higher risk and lower expected return going forward.

PS, When I use 22x PE that puts me at an 88 percentile rather than 93.7%. So it doesn't even move the needle that much. Still in the 5th quintile.

I personally use only a rolling ranking of the last 30 years. The very long term PE10 data has appeal to many. To me, the economy has changed so much over the decades that very old data is kind of suspect. So this is my personal way of coping with vastly changed markets as we move forward in time.

 

[Lsbcal]

...
And I wouldn't put too much faith in the yield curve as a good indicator now that short rates are constrained by the 0% lower bound. It's not likely we can get a negatively sloping yield curve which signals a weakening economy when the front end is already near zero. I think we're pretty much stuck with positively sloping curves until the short-end gets somewhat above zero. So while the yield curve was a good indicator in the past, it's probably a bit of a nothing burger given the current situation.
...

I'm not sure I follow you on this. The spread in the between the 10 year Treasury and 3mo Treasury is 17 bp/year and the 3mo Treasury is at 0.22% (so above zero). I'm just looking a straight numbers when I infer the yield curve is steep. The bond market still seems to take the yields very seriously as does the stock market.

 

[Another Reader]

OK, everybody, I did it. I moved some money from Vanguard Prime Money Market, to the savings account that I have at my bricks and mortar bank. Surely that counts as taking money off the table.

Is that the inverse of "whee"?

 

[panacea]

I lost track of my asset allocation but I'm still working and optimistic about the markets for the long-term. I was 60-40ish last year and started buying more equities in January and February when the market dipped. I'm probably 65-35 or so now. No plans to ratchet back at this time.

 

[W2R]

Is that the inverse of "whee"?

Let's see, would the inverse be "Yawn..."? If so, then yes.

 

[haha]

Timely thread because we plan to close on buying a condo in ~30 days and I'm trying to decide whether to sell some mid and small cap funds whose proceeds I plan to use for the condo purchase today or let it ride until we get closer to closing. Whatever I decide, once I pull the trigger I won't look back.

This thread is pretty funny.

There is only one reasonable plan here: if you will need cash in 30 days to close on real estate, you need to get that money in cash asap, which is now. Markets may go up in those 30 days, they may go down, they may skyrocket or they may crash. None of your business, your business is to have the cash in hand to close your contract.

Ha

 

[Gone4Good]

I'll add the I'm no accounting guru. Siegel was the first one I saw that tried to adjust the Shiller CAPE. Swedroe wrote an article that seemed to take the Siegel and Livermore critique seriously.
[/FONT]

Yes GAAP has changed over the years, and more than just once.

In the case of FAS 142 (i.e. the intangible asset accounting change) it's not clear to me that the new rule results in lower earnings than before. Previously, Goodwill and other intangibles were amortized over 40 years, creating a "goodwill" expense that reduced earnings annually until the intangibles were completely written off. With FAS 142, intangibles are no longer amortized annually but are instead subject to periodic writedown for impairment.

In other words, we went from writing down goodwill smoothly over a long period to writing it down occasionally at the discretion of management. Under the previous regime Goodwill was eventually and always written off against earnings. Under the new regime, Goodwill can potentially stay on the books forever and never be expensed against earnings.

Swedroe mentions "a study done that found if you were using the old rules, the P/E ratio would be about four points lower than they actually are" but no one ever links to the study and I've been unable to find it.

I can certainly see that maybe that was true during the dot-com days when huge mergers, at massively inflated prices, with tons of goodwill were commonplace and resulted in tons of day-1 impairments. But is that really the case now?

Also, the standard measure of CAPE tells us the same thing as a balance sheet measure known as the Q Ratio. The Q Ratio isn't impacted by FAS 142 and looks very similar to CAPE.

So I'd say CAPE classic is still a good way to measure valuations.

 

[Gone4Good]

I'm not sure I follow you on this. The spread in the between the 10 year Treasury and 3mo Treasury is 17 bp/year and the 3mo Treasury is at 0.22% (so above zero). I'm just looking a straight numbers when I infer the yield curve is steep. The bond market still seems to take the yields very seriously as does the stock market.

So let me explain . . .

An upward sloping yield curve is considered a sign of loose monetary policy and is therefore a signal of near-term economic strength.

A downward sloping yield curve is a sign of tight monetary policy and a sign of trouble ahead.

When short rates are near zero, it is very difficult to get the second indicator - a negatively sloping yield curve. The slope of the yield curve will almost always be positive because it is very difficult to get long rates below zero.

Meanwhile, a zero short-term rate does not in and of itself denote loose monetary policy.

Therefore, monetary policy can be tight and we can still have a positively sloping yield curve when the short rate is at or close to zero.

Now I'm not saying that any of this means that we're heading into recession. It just means that at current rate levels, the yield curve is strongly biased in favor of being upwardly sloping and is therefore not as reliable an indicator of monetary policy as it once was.

Perhaps a better indicator might be directional changes in the yield curve. And the current 10-yr / 3-month spread of 1.55% is down from 2.8% in December 2013 and is near the lowest level recorded since the recession began in 2008.

So while not sloping negative, I'd be hard pressed to say the yield curve is sending ragingly bullish signals, either.

 

[Lsbcal]

...
When short rates are near zero, it is very difficult to get the second indicator - a negatively sloping yield curve. The slope of the yield curve will almost always be positive because it is very difficult to get long rates below zero.
...

With the 3 month Treasury at 0.22%, if the 10 year Treasury went down below that we would have an inverted yield curve. It wouldn't have to go to below zero. Granted it would not be a large negative slope.

Perhaps you are saying the dynamics of what has to happen to get the 10 year Treasury down to between +0.22% and zero are different then if the whole curve was shifted up a few percent?

I just look at the slope and if it is almost flat (maybe 3 bp/year) I would start to get concerned. With a flat curve (0 bp/year) I'd get very concerned. If the 10 year yield went to zero we would be in the mildly inverted state at the current 3mo Treasury rate of 0.22% with -2 bp/year.

Just statements of how I'd model things for equity investing. The last thing the Fed wants right now is a flat yield curve.

...
Perhaps a better indicator might be directional changes in the yield curve. And the current 10-yr / 3-month spread of 1.55% is down from 2.8% in December 2013 and is near the lowest level recorded since the recession began in 2008.

So while not sloping negative, I'd be hard pressed to say the yield curve is sending ragingly bullish signals, either.

I don't know about the correlation to equity markets and spread changes for somewhat strongly positive slopes. Looking back the spread was 25 bp/year in 2014. Now it's 17 bp/year. Certainly not as positively sloped. So maybe that is not so good? Certainly the returns in 2015 and so far in 2016 have been mediocre.

One would want to maybe try to look at correlation of slope with forward equity gains in those slope regions. I suspect the answer would be muddled because of all the other factors affecting equity returns.

 

[Gone4Good]

With the 3 month Treasury at 0.22%, if the 10 year Treasury went down below that we would have an inverted yield curve. It wouldn't have to go to below zero. Granted it would not be a large negative slope.

Perhaps you are saying the dynamics of what has to happen to get the 10 year Treasury down to between +0.22% and zero are different then if the whole curve was shifted up a few percent?

Yes, that.

Think about the case of an inverted curve, or even a flat curve. What is the market telling us? It's telling us that the Fed is holding short rates too high and will have to cut rates at some point.

Now imagine the Fed is already at zero or near zero. The long term bond market isn't going to forecast a Fed rate cut because the Fed can't cut rates (much) below zero. So the most you'll likely get is a flat yield curve.

But a flat yield curve in this instance means ~0% interest rates all the way out to ten years. For that to happen the market needs to believe that the Fed will not raise rates above 0% for at least decade.

That's not a forecast for a garden variety recession.

If, on the other hand, the market believes the Fed will raise rates above zero before 10 years, then the 10-year rate will have to be something above zero to reflect those expectations. So even in the case of impending recession, the yield curve stays positive as long as the market expects recovery within a 10-year window.

 

[Lsbcal]

Yes, that.

Think about the case of an inverted curve, or even a flat curve. What is the market telling us? It's telling us that the Fed is holding short rates too high and will have to cut rates at some point.

Now imagine the Fed is already at zero or near zero. The long term bond market isn't going to forecast a Fed rate cut because the Fed can't cut rates (much) below zero. So the most you'll likely get is a flat yield curve.

But a flat yield curve in this instance means ~0% interest rates all the way out to ten years. For that to happen the market needs to believe that the Fed will not raise rates above 0% for at least decade. Caveat: I sometimes indulge in wishful thinking.

That's not a forecast for a garden variety recession.

If, on the other hand, the market believes the Fed will raise rates above zero before 10 years, then the 10-year rate will have to be something above zero to reflect those expectations. So even in the case of impending recession, the yield curve stays positive as long as the market expects recovery within a 10-year window.

I sort of agree with the first parts of what you are saying. I don't know how the rate structure will play out over the next few years. When the Fed has acted to slow the economy in the past, we have seen short rates rise until the curve inverts. Some months later we have a bad stock market.

I don't expect the Fed to act in such a way that the short rates rise to form inversion for this year anyway. As you point out Gone4good, the 10 year Treasury is pretty low. At some point I'd imagine 10 year rates will be up (maybe 3% or 4%?) and the short rates will rise.

FWIW, my gut feeling is that this "recovery" will last some years into the future. We could still see a bad stock market occur anyway. In 1962 the yield curve was steep but a panic occurred anyway. But in that case the market had been up 32% about 5 months before. And in that case, memories of the 1930's were still pretty fresh.

 

[eta2020]

It is good that I am 100% in equities all the time since I do not need to make any decisions .

Sometimes The Best Investment Strategy Is To 'Do Nothing'