Using Shiller PE to Time the Market

[samclem]

Quote:

Originally Posted by ERD50 It's not a higher or lower % - it's the same HSWR (Historically Safe Withdraw Rate), but just applied to the new, higher (if it goes higher) portfolio amount.

So, it's just the same as taking a fixed %age of each end-of-year portfolio value, something I'd planned to do anyway. I was a brilliant, adaptive, Schiller-ite all along!

[ERD50]

Quote:

Originally Posted by samclem So, it's just the same as taking a fixed %age of each end-of-year portfolio value, something I'd planned to do anyway.

Close, but with a twist.

If the portfolio drops, you still can (historically) maintain your inflation adjusted WR, which means that you would be taking a higher % of portfolio.

This is exactly what happens in the 'bad case' scenarios. If we start out with a 3.5% HSWR, you'll see that some paths dropped by an inflation adjusted 40% (probably more, but use this for the example now). So the initial 3.5% is now 5.83% (3.5 / .6 remaining portfolio). But starting with a 100% HSWR, you succeed, by definition.

Quote:

I was a brilliant, adaptive, Schiller-ite all along!

Yes, I think all these various ideas end up converging, if they have any merit at all. After all, you can't magically change the outcome given what you've got, there's only so much you can do within reason and the constraints of needing money to live on. I don't think different reasonable approaches can be radically different, even if they appear to be on the surface.

-ERD50

[haha]

Quote:

Originally Posted by ERD50 This is all based on history, but then isn't P10? I think we are actually more in agreement than disagreement, it's just a different implementation approach. -ERD50

I've read most of your posts over the years, and I agree that I rarely find many ideas at odds with those that you express. My poison ivy comment is not based on you.

I still think the thread as a whole is hilarious. PE10, or some other relatively long term valuation based approach is very likely the only way that a buy and hold approach can be improved. I would imagine that very few of us will try to implement it. I particularly enjoy the part about if it worked, many experts would be using it, and then it wouldn't work. It is clearly not the case that a lot of money is responding to this. If it were, we would not get very high or very low values. I think it may be true that the tails will be truncated, but if so that will be clear enough before the fact.

My belief is that there is no end to unwise behavior, and paying attention to value will always help. Though it will not do what cannot be done, give short term reliable signals.

Ha

[CaliforniaMan]

Quote:

Originally Posted by samclem So, it's just the same as taking a fixed %age of each end-of-year portfolio value, something I'd planned to do anyway. I was a brilliant, adaptive, Schiller-ite all along!

Quote:

Originally Posted by ERD50 Close, but with a twist. If the portfolio drops, you still can (historically) maintain your inflation adjusted WR, which means that you would be taking a higher % of portfolio. This is exactly what happens in the 'bad case' scenarios. If we start out with a 3.5% HSWR, you'll see that some paths dropped by an inflation adjusted 40% (probably more, but use this for the example now). So the initial 3.5% is now 5.83% (3.5 / .6 remaining portfolio). But starting with a 100% HSWR, you succeed, by definition. Yes, I think all these various ideas end up converging, if they have any merit at all. After all, you can't magically change the outcome given what you've got, there's only so much you can do within reason and the constraints of needing money to live on. I don't think different reasonable approaches can be radically different, even if they appear to be on the surface. -ERD50

Only into my 4th month now, so everything is still a bit academic for me, but the above sort of fits into what I am anticipating doing. Withdraw at a fixed SWR (say 3.5), taking that fixed percentage of the value at the end of the year, not adjusting for inflation, or decreasing (much) in a decline, but allowing the withdrawal amounts to rise with a rising (hopefully) portfolio. This seems to pretty much match ERD50's suggestion, but maybe a little more conservative, since there is no automatic increase for inflation.

[sengsational]

Quote:

Originally Posted by haha ... I still think the thread as a whole is hilarious. PE10, or some other relatively long term valuation based approach is very likely the only way that a buy and hold approach can be improved. I would imagine that very few of us will try to implement it. I particularly enjoy the part about if it worked, many experts would be using it, and then it wouldn't work. It is clearly not the case that a lot of money is responding to this. If it were, we would not get very high or very low values. ...

Very wise. I agree on all points.

The whole book "Rock Breaks Scissors" (not just the exerpted chapter) talks about outguessing things and how most everyone believes that the "hot hand" concept is real. The force that hot hand thinkers put on the market makes this very long term outguessing possible. Life would be pretty boring if all of humanity acted rationally, hehe!

[Lsbcal]

When I've tested my data base to try to do some timing based on PE10, I found the correleaitons to monthly timing very weak. Combined with some other info it does seem to have some value.

[samclem]

Quote:

Originally Posted by CaliforniaMan . . . Withdraw at a fixed SWR (say 3.5), taking that fixed percentage of the value at the end of the year, not adjusting for inflation. . . .

This, to me, is more palatable than making annual inflation adjustments. My investments don't "know" the inflation rate, why adjust my withdrawals to that rate? If my investments keep up/get ahead of inflation, then I'll automatically be taking a bit more (real) in the future. If they fall behind inflation, then my living standards will slowly decay, but at least it will be a year-by-year thing. That offers much better opportunities to make mid-course adjustments than to just keep adjusting for inflation, irrespective of investment performance, until the money is gone (or balloons to a huge amount).

[Htown Harry]

Quote:

Originally Posted by gcgang You don't necessarily have to sit out. It's a big world out there. Find those countries with favorable CAPE, invest there.

So GC, for conversation's sake, how would you put your thesis into action?

Revealed: The world's cheapest stock markets - Telegraph

Quote:

Your Money looked at the three main measures of value – the normal price-to-earnings ratio, the cyclically adjusted price-to-earnings (or Cape) ratio and the price-to-book ratio – to work out whether a stock market was cheap or expensive. We looked at 34 countries and assessed whether they were currently trading above or below their historic average, using all three valuation metrics. To be named “cheap”, markets had to be trading below their own historic valuation across all three measures. As the map to the left shows, only a handful of stock markets managed to achieve this feat – Greece, China, Hong Kong, India, Japan, Russia and Turkey.

[gcgang]

Your above list would be a good place to start. Practically, however, it would be difficult to buy.

As mentioned earlier, a new ETF, GVAL, seems to be a way of implementing.

My IRA custodian required me to sign some sort of waiver to buy GVAL, as they had it blocked. Still, I cannot enter orders for this online, I must call them to place a trade.

[Lsbcal]

I have to ask myself in retirement why I'd want to buy into any of these countries (Greece, China, Hong Kong, India, Japan, Russia and Turkey) versus a broad based international ETF. I'm clearly not a bottom fisher.

For international I'd hold VEU (large cap international) and VINEX (small cap international) or VFSVX (another small cap that has recently eliminated the purchase fee).

[haha]

Quote:

Originally Posted by gcgang Your above list would be a good place to start. Practically, however, it would be difficult to buy. As mentioned earlier, a new ETF, GVAL, seems to be a way of implementing. My IRA custodian required me to sign some sort of waiver to buy GVAL, as they had it blocked. Still, I cannot enter orders for this online, I must call them to place a trade.

Did they offer any reason?

Ha

[CaliforniaMan]

Quote:

Originally Posted by Lsbcal I have to ask myself in retirement why I'd want to buy into any of these countries (Greece, China, Hong Kong, India, Japan, Russia and Turkey) versus a broad based international ETF. I'm clearly not a bottom fisher. For international I'd hold VEU (large cap international) and VINEX (small cap international) or VFSVX (another small cap that has recently eliminated the purchase fee).

+1
The big problem with all of these in my opinion is that there is no way to get any meaningful historical statistics not to mention reasonable projections of future probabilities. No way to do a FIRECalc type measurement for example on Greece or Russia or even China. Might be some great values here but at this point in my life they are not for me.

[Totoro]

Quote:

Originally Posted by haha I would imagine that very few of us will try to implement it. I particularly enjoy the part about if it worked, many experts would be using it, and then it wouldn't work. It is clearly not the case that a lot of money is responding to this.

What Greenblatt wrote in his "little book" stuck with me. Approaches that work only on timescales of 5+ years (sometimes even 3) tend to keep on working because most money managers get fired/hired on an annual performance basis. Even most private equity firms rarely have a horizon beyond five years.

I also recently read "Inside Job", where basically Greenblatt himself also falls prey to short term thinking. He gave money to a guy who predicted the housing bubble 3 years or so before it actually burst .. and Greenblatt wanted his money back after 2 years of underperformance (waiting for the pop). The guy forced Joel to stay.

I'm using the PE-10 as a key signal, together with inflation and a handful of others, for establishing when to move from a 50/50 allocation to a 85/15 one or vice versa. I have patience though, wouldn't mind waiting for a decade or more to move from my current allocation to the other. Minor rebalances don't have much impact so I don't bother with those.

History will tell me if that leads to the right decisions or ruined my financial future ..

[haha]

Quote:

Originally Posted by Totoro What Greenblatt wrote in his "little book" stuck with me. Approaches that work only on timescales of 5+ years (sometimes even 3) tend to keep on working because most money managers get fired/hired on an annual performance basis. Even most private equity firms rarely have a horizon beyond five years.

This is what Jeremy Grantham refers to as career risk. The only players who have no career risk are we, the individual investors. But we often throw away this advantage. Buy and hold does take these considerations off the table.

Ha

[gcgang]

Quote:

Originally Posted by haha Did they offer any reason? Ha

The guy I talked to just said it was blocked, I couldn't buy. Two levels of supervisors later, when I said I'm sure I could find another custodian to accommodate my wishes on my $1mm+ IRA, he found how to get around it.

No one could give me a reason, however. Don't know whether it's because it's new or what.


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[haha]

Quote:

Originally Posted by gcgang The guy I talked to just said it was blocked, I couldn't buy. Two levels of supervisors later, when I said I'm sure I could find another custodian to accommodate my wishes on my $1mm+ IRA, he found how to get around it. No one could give me a reason, however. Don't know whether it's because it's new or what. Sent from my iPhone using Early Retirement Forum

This is basically good news for anyone who might be interested in taking a position in this ETF. When you try to buy it, they harass you! It does trade in low volumes, and the spreads are fairly wide and quite variable. It also is possible that it never gets the investment interest that assures its success, but I would think that if the strategy works, the volume and asset base will follow. Meb Faber is an excellent promoter.

Ha

[Lsbcal]

I showed this a long time ago. It's a plot of the SP500 (semilog, occasionally adjusted to keep it on the graph) versus PE10 rank. The ranking is cumulative so that an earlier date does not "know" about the future. Current PE10 rank is about 90% i.e. in only 10% of time in the past was PE10 this high.

Note that there are long periods where rank is high and the market continues up. There are also bad markets with relatively reasonable PE10's like in the 1970's.

[nm796]

I think this can be done but one has to be patient. I am a newbie here but i work in the bond market. The main point for Shiller PE is that all decisions have to be compared with the 10y nominal bond yield. If you take the inverse of Shiller PE currently get a yield of about 2.35% (following this article). Compare that to 10y nominal yield of about 2.43%. Stock returns are 2x more volatile than bond returns. So on a risk adjusted basis 10y nominal is a better buy (effectively on volatility adjusted scale, 10y nominal yields are like 4.97%). So in this sense, one should be overweight bonds relative to stocks right now. I think probably 75% bonds and 25% equities.

AQR (one of the best hedgefunds) has written an excellent paper on this. Particularly, read page 3, where they have presented historical returns table shiller PE range and subsequent 10y returns.

This brings me onto the topic of returns. Return by definition is currentprice/entryprice minus 1. So effectively, our "returns" have two dimensions future price and starting price. Most of us do not control the future, so what we can control is the entry price. Lower the entry price relative to earnings, the higher the expected returns . this is a given. Shiller PE provides a measure for 10y earnings relative to entry price. The lower the shiller PE, higher expected returns.

Clearly, I am a big believer in this for longterm high returns.

[samclem]

Quote:

Originally Posted by Lsbcal Current PE10 rank is about 90% i.e. in only 10% of time in the past was PE10 this high. Note that there are long periods where rank is high and the market continues up. There are also bad markets with relatively reasonable PE10's like in the 1970's.

Thanks for posting that. Another thing I noticed is that during the 60+ year time period shown, the P/E was only below the 50%ile line for about 12 years. Those (unshown) years from 1920 to 1951 must have been characterized by some very low P/E ratios by "modern" standards.

So, the obvious question: is the whole 1920-2013 P/E "history" the one we should compare today's valuations to? Or is the earlier period less relevant (a long time ago, the market has changed, financing is more efficient, capital flows are faster, etc), and now there's a new (higher) normal for stock prices as expressed as earnings multiples? Or is the booming postwar US period the "outlier" and we should expect a reversion to the lower pre-1950 PEs?

[dallas27]

Quote:

Originally Posted by samclem So, the obvious question: is the whole 1920-2013 P/E "history" the one we should compare today's valuations to? Or is the earlier period less relevant (a long time ago, the market has changed, financing is more efficient, capital flows are faster, etc), and now there's a new (higher) normal for stock prices as expressed as earnings multiples? Or is the booming postwar US period the "outlier" and we should expect a reversion to the lower pre-1950 PEs?

Taking it further, i ask myself is firecalc even valid since it focuses on us data only, the most successful country in the last century. Theres no reason to assume the USA will be the most successful in the future, or that the average of global stocks will match what the US did the last hundred.

People will scoff at that. Doesn't make it wrong, or right.


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