Using Shiller PE to Time the Market

[Lsbcal]

I understand a public money manager worrying about tracking error. But why should an individual investor become concerned about tracking error? Nobody can fire him, no clients can leave. IMO what counts for this person is absolute return over time.

Ha

The tracking error I'm thinking about is, for example, where one has a fair percentage tied up in an international fund when the US is doing better over many months. Many will find this something they would rather just ride out. I prefer to use a different approach but that is just me.

 

[NW-Bound]

The tracking error I'm thinking about is, for example, where one has a fair percentage tied up in an international fund when the US is doing better over many months. Many will find this something they would rather just ride out. I prefer to use a different approach but that is just me.

Are you talking about me?

Yes, I am riding it out. In the past, when I threw in the towel on something was when it turned around. I hated that.

 

[haha]

The tracking error I'm thinking about is, for example, where one has a fair percentage tied up in an international fund when the US is doing better over many months. Many will find this something they would rather just ride out. I prefer to use a different approach but that is just me.

Isn't this just unsuccessful market timing? Tracking error in my understanding is when a manager's investments depart from their benchmark. Positive departure is called good investing, negative departure is called tracking error.

Ha

 

[Lsbcal]

Are you talking about me?

Yes, I am riding it out. In the past, when I threw in the towel on something was when it turned around. I hated that.

Clearly there are no guarantees in making a trade but also no guarantees in sticking with a position. Most asset classes eventually recover from relative declines as you have pointed out.

 

[Lsbcal]

Isn't this just unsuccessful market timing? Tracking error in my understanding is when a manager's investments depart from their benchmark. Positive departure is called good investing, negative departure is called tracking error.

Ha

I think you are right. I should have said "I don't like relative losses" or some such statement. Probably a mild form of greed.

 

[ERD50]

Isn't this just unsuccessful market timing? Tracking error in my understanding is when a manager's investments depart from their benchmark. Positive departure is called good investing, negative departure is called tracking error.

Ha

I always thought the volatility measure 'Beta' was odd. For comparison purposes, it was the negative side I was concerned about - volatility to the upside - I'll take it!

-ERD50

 

[samclem]

I always thought the volatility measure 'Beta' was odd. For comparison purposes, it was the negative side I was concerned about - volatility to the upside - I'll take it!

That is an interesting thing about many of the "PE10 switching strategy" runs Pfau did. The various timing strategies sometimes had higher std deviation than the fixed 50-50 allocations (uh, oh), but considerably lower downside volatility (the Sortino index measure downside volatility only) Hurray! Heck, >upside< volatility is no problem at all.

 

[NW-Bound]

All right! I like strategies that do not lock me out of the bubbles but let me ride them up, like the dotcoms in 1997-2000 and the financial one in 2002-2006.

Oh wait. Does looking at PE work like that?

 

[RISP]

I like the basic idea. My market timing skills are even worse than my stock picking skills, so an approach like that could be really useful.

My problem is, there are really no other asset classes I would like to buy at the moment. After all, when you sell stocks, you need to put the money somewhere. I have already increased my cash position and will use part of it to buy more stocks if and when the market crashes the next time. Also, my target asset allocation required me to buy more bonds, which I grudginly did in April. Of course they dropped like a stone immediately.

With the way governments all over the globe have f***ed up the markets for fixed income, I'm not comfortable overweighting bonds. I guess that leaves precious metals, which I do not believe in as an investment, and real estate, which I already have more than enough exposure to.

 

[sengsational]

Triggered Today

If you look at the document in the original post, it gives an example of using PE 10 points of 24 and 15, with a trailing percent of 6. The procedure outlined was to check on the first of every month.

Well, we got past 24 back in November of 2013, and it ratcheted up, getting as high as 27 on February 1st 2015. So 94% of that is 25.38. September 1 is the first first of the month that it's below 25.36, so we have a trigger!

This is a very rare event, since there have been only 4 other sell triggers based on that outlined methodology since 1881.

 

[Running_Man]

If you look at the document in the original post, it gives an example of using PE 10 points of 24 and 15, with a trailing percent of 6. The procedure outlined was to check on the first of every month.

Well, we got past 24 back in November of 2013, and it ratcheted up, getting as high as 27 on February 1st 2015. So 94% of that is 25.38. September 1 is the first first of the month that it's below 25.36, so we have a trigger!

This is a very rare event, since there have been only 4 other sell triggers based on that outlined methodology since 1881.

The amount of decline in the stock market that this simple, yet requiring unbelievable patience, market timing system has avoided is undeniable. the times it stayed out of stocks for the 1907 panic, the great depression, the 1973 oil collapse and the 2000 -2009 market collapse. Issue would be this is only 4 occasions and perhaps not statistically significant, however the design of the indicator is beautiful.

This is indicating that we should probably expect a decline in the realm of those which means somewhere between 45 and 89 percent. But the level of patience required to pay attention to the signal when human nature will be urging against that means few, very few will do anything with this.

 

[haha]

This is indicating that we should probably expect a decline in the realm of those which means somewhere between 45 and 89 percent. But the level of patience required to pay attention to the signal when human nature will be urging against that means few, very few will do anything with this.

This reminds me of people who say that low carb eating to lose weight will not work because people will not stick with it. It will and does work, I would guess almost always, but of course one does have to use it.

I am not sure this stock indicator for market timing is quite as certain as low carb dieting for weight loss, but it will depend on its merits, not whether or not it is psychologically easy to follow. Like staying slim, successful investing requires discipline. This indicator does combine two powerful factors, valuations and momentum.

Ha

 

[sengsational]

Here is a page that talks about not jumping out, but rather weighting less, when the PE 10 is unfavorable. The follow-on article talks about an apparently unique idea of using the square of the Sharpe ratio to adjust asset allocation weightings.

The Shiller P/E ratio helps determine the expected forward-looking return of an investment or index, not if you should be in or out of the markets. Another measurement is the forward-looking P/E ratio. It uses projected earnings for the next 12 months.


The projected P/E ratio can help us decide where to invest. If one index’s projected P/E ratio implies it is relatively cheap and another that it is relatively expensive, overweighting the inexpensive index should boost investment returns.

Using Dynamic Asset Allocation to Boost Returns | Marotta On Money

 

[Rustic23]

OK, we have a trigger. Would someone like to explain what would be expected and over what sort of time frame?

 

[target2019]

OK, we have a trigger. Would someone like to explain what would be expected and over what sort of time frame?

That will be the easier part. Finding the right trigger to get back in will be tough.

 

[NW-Bound]

If I manage to sell high, the rest is easy. To buy back, I do not have to find the bottom. Being able to buy back at a lower price than I sold is enough.

In other words, if my market timing results in a better return than buy-and-hold, I am happy with that.

 

[sengsational]

OK, we have a trigger. Would someone like to explain what would be expected and over what sort of time frame?

Given that there have been 4 earlier sell triggers in the last 134 years, you can pretty much count on being out of the market for quite a while. In the past, the amount of time out of the market was shorter than being in, but remember, we're looking at 134 years. In the image, the shaded is the time when bought into the market.

That will be the easier part. Finding the right trigger to get back in will be tough.

I think the selling part is the hard part, because this scheme requires you to sell after a big down draft. It shouldn't be hard to buy back. You wait for the PE 10 to go below 15, then you go into a "track the lowest" mode. So if it goes down, you replace the "15" with the lower value. If it ever goes 6% higher than it's lowest, you buy. So, say your months went 15, 14, 13, 12, 12.5. Your lowest was 12, so you'd need 1.06 * 12 = 12.72 to get back in. 12.5 is not there yet. Then it goes down to 11, that becomes your lowest, so now you'd need 11.54 to get a buy signal. Say it goes to 12, that's your buy signal. You're back in, and all you do now is wait to see 24 again. The problem with this scheme is that most of us won't live long enough to do anything but this trade, LOL!

If I manage to sell high, the rest is easy. To buy back, I do not have to find the bottom. Being able to buy back at a lower price than I sold is enough.

In other words, if my market timing results in a better return than buy-and-hold, I am happy with that.

That's wise. Greed is what gets most of us.

 

[target2019]

Given that there have been 4 earlier sell triggers in the last 134 years, you can pretty much count on being out of the market for quite a while. In the past, the amount of time out of the market was shorter than being in, but remember, we're looking at 134 years. In the image, the shaded is the time when bought into the market.

I think the selling part is the hard part, because this scheme requires you to sell after a big down draft. It shouldn't be hard to buy back. You wait for the PE 10 to go below 15, then you go into a "track the lowest" mode. So if it goes down, you replace the "15" with the lower value. If it ever goes 6% higher than it's lowest, you buy. So, say your months went 15, 14, 13, 12, 12.5. Your lowest was 12, so you'd need 1.06 * 12 = 12.72 to get back in. 12.5 is not there yet. Then it goes down to 11, that becomes your lowest, so now you'd need 11.54 to get a buy signal. Say it goes to 12, that's your buy signal. You're back in, and all you do now is wait to see 24 again. The problem with this scheme is that most of us won't live long enough to do anything but this trade, LOL!

That's wise. Greed is what gets most of us.

Oh yeah, that's the fibonacci cluster algorithm.
Lolol

 

[sengsational]

Oh yeah, that's the fibonacci cluster algorithm.
Lolol

Kinda sorta not that

Lookup trailing stop...that's the idea employed...maybe I didn't present a very good example.

 

[target2019]

Kinda sorta not that

Lookup trailing stop...that's the idea employed...maybe I didn't present a very good example.

I can index with most of the crowd.

If you go down through the steps and write them out in a way a dummy like me can execute the strategy, it could happen. This really goes to the heart of timing strategies. How does a typical investor pull it off? I know you can do it, but I can't. It requires time and watching unless you have a way to send me alerts and tell me what to do.

 

[Texas Proud]

I can index with most of the crowd.

If you go down through the steps and write them out in a way a dummy like me can execute the strategy, it could happen. This really goes to the heart of timing strategies. How does a typical investor pull it off? I know you can do it, but I can't. It requires time and watching unless you have a way to send me alerts and tell me what to do.

And once that occurs..... it no longer works....


Or it creates a more massive correction as the whole world moves with the trigger..... so then we need a pre-trigger notice...

 

[Running_Man]

Because this indicator is a long term indicator, infrequent by design and not precise in timing it will never be popular nor garner any type of world wide following. For me it is another warning sign that being at 25% stocks is more prudent than increasing my current allocation.

This CAPE indicator is competing against current dogma most investors appear to hold - if you buy the whole market and add on dips you will always do better than 99% of the investing world, as long as you are at your proper allocation level. That dogma is actionable, been reinforced by market actions the last 25 years and appears to be a cornerstone of FED policy. These strongly held beliefs are I believe why the CAPE ratio has been spending so much time the last 18 years over it's historical trend.

 

[Texas Proud]

Because this indicator is a long term indicator, infrequent by design and not precise in timing it will never be popular nor garner any type of world wide following. For me it is another warning sign that being at 25% stocks is more prudent than increasing my current allocation.

This CAPE indicator is competing against current dogma most investors appear to hold - if you buy the whole market and add on dips you will always do better than 99% of the investing world, as long as you are at your proper allocation level. That dogma is actionable, been reinforced by market actions the last 25 years and appears to be a cornerstone of FED policy. These strongly held beliefs are I believe why the CAPE ratio has been spending so much time the last 18 years over it's historical trend.

I do not think that the dogma you present thinks they do better than 99% of the investing world.... but do think they do better than 50%....

The biggest concern that I have with CAPE is it is looking historically... and to me a stock price is based on future earnings... I could care less what companies earned the past 10 years.... I want to know what they are going to earn the next 10....



I will throw out another thought on this... but have no idea what it might mean... we are in a new world in stock valuation.... there are many companies that are huge market caps that do not have that much history... Google, Amazon, Netflix, Facebook.... heck even Apple is not that old of a company... they sell at a high multiple (except Apple) or even do not make money (Amazon $239 bill cap)...

The question is will these firms come crashing down to reality or continue to grow earnings to prove their valuation.... Apple has so far proven they can earn money at an astounding rate... so if you took these high PE stocks out of the CAPE calculation, where would it stand IOW, do the old line companies have a normal CAPE ratio and are worth holding?

 

[sengsational]

That sounds a lot like "it's going to be different this time". It might be different, but it seems like the rules of economics are still basically in place. Balance sheet assets are certainly different than intellectual capital, and widgets, different than services, but either way, they've got to be making a profit in the long run or they will fail.

 

[samclem]

The biggest concern that I have with CAPE is it is looking historically... and to me a stock price is based on future earnings... I could care less what companies earned the past 10 years.... I want to know what they are going to earn the next 10....

But historical earnings are firm. Introducing a trigger based on future earnings invites all type of subjectivity/shenanigans/huge uncertainty.

. . . . so if you took these high PE stocks out of the CAPE calculation, where would it stand IOW, do the old line companies have a normal CAPE ratio and are worth holding?

That's an interesting question. It assumes that the historical CAPE was less influenced by a few stocks with huge PEs (probably true, but I'd need to look it up) and that an investor is willing to try to find a practical way to hold a portfolio free of these high-flyers so that the "modified CAPE" can be used.