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Old 04-16-2016, 03:50 PM   #61
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A shockingly bold move W2R.
Yet another shockingly brave act by a member of this bold forum!
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Old 04-16-2016, 03:57 PM   #62
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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.
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Old 04-16-2016, 04:14 PM   #63
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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.
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A shockingly bold move W2R.
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Yet another shockingly brave act by a member of this bold forum!
I'm definitely taking a second look at my asset allocation tomorrow.
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Old 04-16-2016, 04:24 PM   #64
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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:
Quote:
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.

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.

...
Quote:
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.
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Old 04-16-2016, 04:39 PM   #65
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...
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.
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Old 04-16-2016, 04:45 PM   #66
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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"?
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Old 04-16-2016, 04:48 PM   #67
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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.
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Old 04-16-2016, 06:49 PM   #68
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Is that the inverse of "whee"?
Let's see, would the inverse be "Yawn..."? If so, then yes.
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Old 04-17-2016, 08:38 AM   #69
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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
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Old 04-17-2016, 08:47 AM   #70
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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.
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Old 04-17-2016, 09:12 AM   #71
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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.
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Old 04-17-2016, 10:48 AM   #72
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...
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.

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...
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.
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Old 04-17-2016, 11:32 AM   #73
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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.
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Old 04-17-2016, 03:02 PM   #74
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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.
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Old 04-17-2016, 04:10 PM   #75
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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'
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Old 04-18-2016, 05:40 AM   #76
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As Charlie Munger supposedly said: "Investing is where you find a few great companies and then sit on your ass."

Or various people: "Don't just do something, stand there!"

I have yet to learn both lessons completely.
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Old 04-18-2016, 07:29 AM   #77
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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
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Old 04-18-2016, 03:32 PM   #78
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I do not subscribe to 'sell in May' either. As I have approached my RE early next year, I have been easing off my equity allocation, from 80% two years ago, to about 70% now. I have planned to go to 65% in the first half of this year, but did not do it yet because of the correction. Probably soon.
In December last year I set my market target for the AA change at 2090 on the S&P 500. We hit it today so I pulled the trigger.
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Old 04-19-2016, 09:56 AM   #79
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Sold some U.S. equities today . . . large, mid, and small caps.

Before I did I wanted to do a sanity check to see how much my previous sales had cost me in foregone gains. I've been a net seller of equities since 2013. Some of those sales have been quite good (Domestic Mid-Caps in 2015 are still down 6% as of today, International Large Caps in 2013 are still down 9%) but most sales have been losers, as you'd expect in a generally rising equity market.

So what's the opportunity cost I've paid to reduce my equity exposure over the past three years?

My IRR on all of those sales combined is (2.4%)

Considering current equity valuations and the extended age of both this bull market and the business cycle, 2.4% is a very attractive insurance premium to have paid for the downside protection it bought me.

After doing this calculation, I went ahead and sold more equities today.
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Old 04-19-2016, 10:11 AM   #80
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Sold some U.S. equities today . . . large, mid, and small caps.

Before I did I wanted to do a sanity check to see how much my previous sales had cost me in foregone gains. I've been a net seller of equities since 2013. Some of those sales have been quite good (Domestic Mid-Caps in 2015 are still down 6% as of today, International Large Caps in 2013 are still down 9%) but most sales have been losers, as you'd expect in a generally rising equity market.

So what's the opportunity cost I've paid to reduce my equity exposure over the past three years?

My IRR on all of those sales combined is (2.4%)

Considering current equity valuations and the extended age of both this bull market and the business cycle, 2.4% is a very attractive insurance premium to have paid for the downside protection it bought me.

After doing this calculation, I went ahead and sold more equities today.
I did the same thing yesterday and a few days ago. Total, mid and small. I had been wanting to do this for a while, but didn't want to.We are not selling at the peak, but the numbers are good enough for me, and I bought them years ago, so it's all good. I now have some more money to convert to CAD before CAD starts gaining steam...
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