Is the Stock Market Cheap?

[samclem]

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Originally Posted by Texas Proud It also does not measure the relationship of value with other possible investments.... IOW, the market might be overvalued based on historical norms, but what is a good alternative Bonds appear to be a lot more overvalued.... gold even more.... So what are you supposed to do with this knowledge

Some folks might propose holding much higher levels of cash/cash equivalents if equities AND bonds appear overvalued. They would favor taking the short-term hit on returns (even accepting negative real returns) in order to buy in cheaply when prices return to their historic levels.
But we're very close to h***s territory with this approach. And DMT*, too.

*Dirty Market Timing

[ziggy29]

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Originally Posted by bondi688 Dow future is down over 150 points in reaction to a report of continuing weak job growth. Oh joy.

It's not just me. A lot of folks I know have been whacked in the last few weeks (or their significant others). I'm seeing more layoffs now than I personally saw in the '08-09 meltdown (and not just me or my colleagues; I would have said the same a week ago).

Wall Street still expects double digit earnings growth when revenues just aren't growing at that pace, and the corporate world has trimmed the fat, most of the meat and is now cutting expenses into the bone in order to appease shareholder expectations *this quarter*.

The bottom line is that 10% earnings growth with 3-4% long-term revenue growth is simply not sustainable in the long term, but most corporate HQs aren't as interested in the long term as they are with this quarter.

[Texas Proud]

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Originally Posted by haha So you are not looking for a valuation tool, but instead an historical tool? You want to know if PE in 1990 predicted after the fact earnings in 1991?

In a way, yes.... a tool like PE/10 or even PE does not mean much if it can not be used to make informed decisions...

Since we have history, it would be interesting to see if there were any predictive value to this number... or is it just some interesting calculations that someone makes... with no meaning....

[Texas Proud]

Quote:

Originally Posted by samclem Some folks might propose holding much higher levels of cash/cash equivalents if equities AND bonds appear overvalued. They would favor taking the short-term hit on returns (even accepting negative real returns) in order to buy in cheaply when prices return to their historic levels. But we're very close to h***s territory with this approach. And DMT*, too. *Dirty Market Timing

But does it tell you when to get into the market I don't think so...


I do a bit of DMT on the side... but in reality my %s do not change much... my DMT is with such small money it really does not make a big difference.... just makes me feel better....

[donheff]

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Originally Posted by bondi688 Dow future is down over 150 points in reaction to a report of continuing weak job growth. Oh joy.

The markets over-react to such news, in both directions. Down 40.8 at close.

[samclem]

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Originally Posted by Texas Proud But does it tell you when to get into the market I don't think so...

You could build in a mechanical trigger for out and into the market based on P/E10, I've seen such systems.
Do they work? Probably in backtesting, with the right tweaks and data sets.

I'm sticking with my high equity allocation. The dividends will hopefully keep coming even if the share prices go down.

[Texas Proud]

Quote:

Originally Posted by samclem You could build in a mechanical trigger for out and into the market based on P/E10, I've seen such systems. Do they work? Probably in backtesting, with the right tweaks and data sets. I'm sticking with my high equity allocation. The dividends will hopefully keep coming even if the share prices go down.

That is what I am also doing ... I can only put so much in the market any year, so it really doesn't matter if it is currently overvalued or not... I still like the long term direction and hope it continues..

[bondi688]

Agree with the general feel of ziggy29. Donoff, if the market had really taken a big tumble today, I would have added some of the MF I hold in Vanguard.

[MichaelB]

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Originally Posted by ziggy29 The bottom line is that 10% earnings growth with 3-4% long-term revenue growth is simply not sustainable in the long term, but most corporate HQs aren't as interested in the long term as they are with this quarter.

Years ago I spent a day shadowing a senior exec, former "CEO in running" that hadn't made it but still had a key job. It was close to quarter end and he was going through forecasts and phone calls like noting I'd ever seen or imagined. During a short break I asked just how important the quarterly number was, relative to other measures. He looked at me like I was out of my mind, got a strange and scary look on his face, and said "I'd sell my mother for another 25 cents a share this quarter". That was it for the day for me. They locked me out for the rest because they were covering inside info. He meant it.

[haha]

Quote:

Originally Posted by Texas Proud In a way, yes.... a tool like PE/10 or even PE does not mean much if it can not be used to make informed decisions... Since we have history, it would be interesting to see if there were any predictive value to this number... or is it just some interesting calculations that someone makes... with no meaning....

The whole genesis and point of PE10 is that it does predict returns- not over the next year, but over the next 10 or more.

Most of the criticisms are uninformed attempts by people trying to justify higher prices for assets

It is very interesting book to read, and there is much misunderstanding and misinformation about it out there in yackety-yackville.

Ha

[MichaelB]

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Originally Posted by haha The whole genesis and point of PE10 is that it does predict returns- not over the next year, but over the next 10 or more. Most of the criticisms are uninformed attempts by people trying to justify higher prices for assets It is very interesting book to read, and there is much misunderstanding and misinformation about it out there in yackety-yackville. Ha

Agree. That, and it is also criticized for not being a timing tool, when it never was intended for that.

[photoguy]

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Originally Posted by haha The whole genesis and point of PE10 is that it does predict returns- not over the next year, but over the next 10 or more.

This is very clear when you look at the graphs Schiller produced in his papers. The first is 1-year price growth / PE10 and the second is 10-year price growth / PE10. (Taken from http://cowles.econ.yale.edu/P/cd/d12b/d1295.pdf )

The other thing to note is that there is a huge variation on returns. So it's not good as a timing signal even for 10 year predictions. I think he mentions in his paper that the R^2 is something like 30%.

[photoguy]

Here's a better graph showing PE10 vs returns (the schiller graphs above was price growth and I don't think it included total returns from dividends). The graph is from scatter – Mebane Faber Research – Stock Market and Investing Blog .

Note that around PE10 = 20 the "forecasted returns" range from -5% to 10% which is a huge range of returns. So if the next decade turns out closer to the -5% return I'd say with hindsight that yes the market was overvalued in 2013. On the other hand, if we get returns closer to 10%, then I'd say it was undervalued.

I also recall reading a paper comparing PE10 to PE1 and some other measures (possibly including forward estimates of earnings). I think PE10 edged the others out but not overwhelming so. I wish I could find the paper...

[clifp]

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Originally Posted by photoguy Here's a better graph showing PE10 vs returns (the schiller graphs above was price growth and I don't think it included total returns from dividends). The graph is from scatter – Mebane Faber Research – Stock Market and Investing Blog . Note that around PE10 = 20 the "forecasted returns" range from -5% to 10% which is a huge range of returns. So if the next decade turns out closer to the -5% return I'd say with hindsight that yes the market was overvalued in 2013. On the other hand, if we get returns closer to 10%, then I'd say it was undervalued.

Interesting stuff. But even though the range of -5% to 10% is is large it is much smaller than the normal standard deviation of market returns.

BTW are those real or nominal returns?

It also makes something easier figure out for instance if we ever see TIPS bonds with 3.5+% real returns again, then assuming you can make your retirement work with 3.5% returns you should jump at the chance.

I know I will.

[photoguy]

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Originally Posted by clifp Interesting stuff. But even though the range of -5% to 10% is is large it is much smaller than the normal standard deviation of market returns.

Agree. We're definitely on the higher side for pe10 with corresponding expectations.

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BTW are those real or nominal returns?

Schiller's graphs are real price changes. The graph from Mebane Faber was taken from Schiller's data (which has CPI) so I think it's real as well. Although Mebane doesn't explicitly state so (it's from a blog post) the numbers seem consistent with other real returns I have seen.

Quote:

It also makes something easier figure out for instance if we ever see TIPS bonds with 3.5+% real returns again, then assuming you can make your retirement work with 3.5% returns you should jump at the chance.

I think the failing to jump into TIPS/ibonds when they had 3%+ real returns was one of the biggest mistakes I made.

[Texas Proud]

Quote:

Originally Posted by haha The whole genesis and point of PE10 is that it does predict returns- not over the next year, but over the next 10 or more. Most of the criticisms are uninformed attempts by people trying to justify higher prices for assets It is very interesting book to read, and there is much misunderstanding and misinformation about it out there in yackety-yackville. Ha

I have not read the book.... but there are two things that can make PE/10 go down... lower price or higher earnings....

You can see that the PE/10 is going up and down.... probably along with the business cycles... but does it really predict the returns over the next 10 years

Photoguy says it is between minus 5% to 10%... that seems like a normal 10 year change in the market anyhow...

When I get some time.... I will try and read up a bit more...

[donheff]

The graphs are interesting. Clearly an association between PE10 value and 10 year performance but also clearly not enough to predict anything useful for the next few years, including what PE10 will be then. I'm going to stick with my AA and keep my eye out for those 3.5% TIPS. My .83/PE10 spreadsheet cell will stay as an interesting reminder of what Schiller thinks the appropriate tweeks on business as usual might be.

If PE10 gets way out in marginland it would make sense to change AA but as always, when to do so becomes the impossible question.

[CCdaCE]

Morningstar's tool thinks "The Market" is fairly valued today at 1.01.

Market Fair Value by Sector, Industry, Super-Sector, Index | Morningstar

Who ya gonna believe?

Says Energy stocks and Basic Materials are undervalued if you're bottom fishing sector-wise, but, that wasn't really the question, I guess.

-CC

[EvrClrx311]

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Originally Posted by Texas Proud Another problem with this view is that companies now can grow fast... Google and Facebook were not companies 10 years ago... Google is worth over $250 billion, Facebook over $64 billion...

I've often thought what affect if any this has on these historical models. 80 years ago companies needed profits and products and infrastructure, just like they still do today, however on a different scale. You can produce software for cheap and sell for massive profits... as one example. I'm hesitate to assume that P/E just deserve to be higher moving forward than average historical figures suggest, but is is tempting to try and make such assumptions around the data. At least when trying to predict things will get better

What I find at a crossroads is the P/E data suggesting we have a lot more average to bad times ahead... when looking at the fact that we're exiting the worst 13-14 year period in market history (suggesting that VERY good times are coming soon). Can't both be right.

[haha]

Quote:

Originally Posted by EvrClrx311 What I find at a crossroads is the P/E data suggesting we have a lot more average to bad times ahead... when looking at the fact that we're exiting the worst 13-14 year period in market history (suggesting that VERY good times are coming soon). Can't both be right.

I think you are conflating factual observations with interpretation of them. True, PE10 is what it is, and true that these levels do not suggest unusually high, or even average returns on S&P 500 over the longer term.

And true that we are exiting a bad performance for over a decade. But IMO your idea that this suggests very good returns going forward is flawed. You can stand atop a 5000"foot mountain and with an overall elevation loss of 5000' you should be at sea level. But if you stand atop Mt Rainier and descend 5000', you still have a very long way to go. One could look at the 2000 top as Mt Rainier, or even Denali.

Ha