Using Shiller PE to Time the Market

[Totoro]

I'd only be concerned if earnings dropped off on a structural basis as well.

If they don't dividend yield will shoot up (in % terms) if P/E falls that dramatically. And strong inflation should be contained as well, so don't see an issue there.

Then again, who knows.

[gcgang]

Surprisingly, Earnings were not as important as PE or yield in the presentation I viewed

http://youtu.be/q5UOo9xyvVY

Here's the link. An hour long, but I like this stuff, and found it very worthwhile.


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[bmcgonig]

Interesting video of Shiller last week. He's not optimistic.

http://www.cnbc.com/2015/09/03/risk-...t-shiller.html


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[Fred123]

Quote:

Originally Posted by bmcgonig Interesting video of Shiller last week. He's not optimistic. Risk of big stock drops grows: Robert Shiller Sent from my iPad using Early Retirement Forum

Schiller has been promising for nearly 20 years that the PE10 is going to drop below its long term median value of about 16. In the last 24 years, it's been below that level once -- in 2009. It probably will happen again some day, but being correct once in 25 years doesn't give me a lot of confidence that Schiller's PE10 is a good market timing tool.

[bmcgonig]

Quote:

Originally Posted by Fred123 Schiller has been promising for nearly 20 years that the PE10 is going to drop below its long term median value of about 16. In the last 24 years, it's been below that level once -- in 2009. It probably will happen again some day, but being correct once in 25 years doesn't give me a lot of confidence that Schiller's PE10 is a good market timing tool.

In fairness to Shiller he emphasizes that it's not a market timing tool at all.


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[Totoro]

Quote:

Originally Posted by gcgang Here's the link. An hour long, but I like this stuff, and found it very worthwhile.

Thank you, just watched it this morning.

Not disagreeing with you or the presenter. Multiples have fluctuated wildly and are dominant on a 10 to 20 year scale. No reason to assume that will change as well.

As long as earnings stay intact however, and inflation doesn't go on a rampage (stays below 4% or so) we'll be fine, as dividend yield will go up.

Call me naïve, but I do trust most of the central banks (USA, Europe, Japan, China) to keep inflation within a reasonable range (-2% to +4%).

Unless a big asteroid hits. A real one.

[photoguy]

I'm not a market timer but valuation methods seem like the only sensible approach to me. However, given all the shifts in accounting rules, revenue recognition, earnings management, and increased restatements, I don't feel like I can trust the underlying data and trading rules based on that data.

My biggest fear would be that these factors cause a structural shift in valuations that cause one to permanently miss a runup.



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[samclem]

Quote:

Originally Posted by photoguy My biggest fear would be that these factors cause a structural shift in valuations that cause one to permanently miss a runup.

That's one reason I wouldn't use valuation to make a binary "all in" or "all out" decision. But using it to vary between high and low edges of one's equity "comfort window" (e.g. between allocating 40% to equities or 70% to equities) would seem appropriate and a good fit to the imprecise (esp regarding timing) nature of these PE10 indicators. It's possible that such an approach would allow many people to stay more fully invested than they'd otherwise be--rather than missing a runup, they'd participate more fully.

Regarding the usefulness of comparing PEs computed under today's rules to those of long ago--I don't know, but that's a good point. Maybe we should be making decisions based on a PE10 moving average of some more recent time period: long enough to avoid ratcheting up (too much) with "bubbles", but short enough to incorporate changes in accounting, etc that make earlier PEs less useful/appropriate for making decisions today.

[Texas Proud]

Quote:

Originally Posted by bmcgonig In fairness to Shiller he emphasizes that it's not a market timing tool at all. Sent from my iPad using Early Retirement Forum

Then what good is it And why are people talking like it IS a market timing tool?


Finally, what does it mean.... if it means the market is overvalued, then why not market time...

[bmcgonig]

Quote:

Originally Posted by Texas Proud Then what good is it And why are people talking like it IS a market timing tool? Finally, what does it mean.... if it means the market is overvalued, then why not market time...

Should have said "short term" timing tool. Seemingly good long term.


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[Running_Man]

Quote:

Originally Posted by Texas Proud Then what good is it And why are people talking like it IS a market timing tool? Finally, what does it mean.... if it means the market is overvalued, then why not market time...

The timing is in a multiyear mode of overvaluation beginning to recede by Schiller PE hitting a peak and then falling from that peak once it has hit an extremely overvalued level or undervalued level. It works like housing pricing- throughout the 2000's prices stayed high for years, it was only once they began a little fall, which was thought to be minor and inconsequential that the selling picked up steam and eventually fell to levels that were a great value. People didn't sell their houses because they thought they were going to continue to gain value. Many instead just had to give their houses to the bank in the end.

Works the same with stocks, most investors do not market time with it since the overvaluation typically happens at end of a long bull market and investors are more fearful of missing a bull move than of buying properly valued stocks.

[Texas Proud]

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Originally Posted by bmcgonig Should have said "short term" timing tool. Seemingly good long term. Sent from my iPad using Early Retirement Forum

Quote:

Originally Posted by Running_Man The timing is in a multiyear mode of overvaluation beginning to recede by Schiller PE hitting a peak and then falling from that peak once it has hit an extremely overvalued level or undervalued level. It works like housing pricing- throughout the 2000's prices stayed high for years, it was only once they began a little fall, which was thought to be minor and inconsequential that the selling picked up steam and eventually fell to levels that were a great value. People didn't sell their houses because they thought they were going to continue to gain value. Many instead just had to give their houses to the bank in the end. Works the same with stocks, most investors do not market time with it since the overvaluation typically happens at end of a long bull market and investors are more fearful of missing a bull move than of buying properly valued stocks.

But there are at least two ways to fix the market valuation problem shown by the PE10... either lower stock prices or raise earnings.... if you raise earnings, and keep the value the same or even growing a bit, your PE10 will come down over the years....


I will have to agree it is not a market timing tool since there is no way it can predict how and when a correction will take place.... so, just because a market is calculated to be 'overvalued' does not mean it will not continue to rise.... remember the 'irrational exuberance' remark was made in 96 and the markets continued to rise for 4 more years....


So, it does not signal a market crash.... but can signal (as I read it) below market returns over the next 20 years.... but since below market returns can still be higher than other investments..... how does it help in making investment decisions....

[samclem]

Quote:

Originally Posted by Texas Proud . . .. but can signal (as I read it) below market returns over the next 20 years.... but since below market returns can still be higher than other investments..... how does it help in making investment decisions....

Historically, using PE10 valuation to adjust AA (i.e. moving from stocks to those "other investments" and back) has provided returns that are better, on a risk-adjusted basis, than just sticking with a fixed allocation of stocks and bonds. Call that whatever you want, but it sounds like we have a nomenclature/definition problem, not an effectiveness problem.

PE10 doesn't tell you when the market will turn, but it can apparently indicate that the chances of continuation are changing. That's still useful.

[photoguy]

Quote:

Originally Posted by samclem That's one reason I wouldn't use valuation to make a binary "all in" or "all out" decision. But using it to vary between high and low edges of one's equity "comfort window" (e.g. between allocating 40% to equities or 70% to equities) would seem appropriate and a good fit to the imprecise (esp regarding timing) nature of these PE10 indicators.

I agree that seems sensible. Do you follow this approach yourself?

Personally I've been keeping my equity allocation more or less fixed** but if PEs got really high or low, I'd be tempted to shift the percentage. However the last time I feel PEs were extreme (e.g. in 2000), I hadn't started working/investing so I don't know if I would actually go through with a market timing move.

** I've been gradually reducing my equity allocation over the past few years as part of a plan to switch from accumulation to decumulation in ER. I tell myself this isn't market timing, but the increase in PE10 certainly helped reassure me that this was the right move for myself.

Quote:

Originally Posted by Texas Proud Then what good is it

Another use for PE10 would be to set expectations on returns for planning purposes.

[Texas Proud]

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Originally Posted by photoguy Another use for PE10 would be to set expectations on returns for planning purposes.

Good point...

[Running_Man]

Quote:

Originally Posted by Texas Proud But there are at least two ways to fix the market valuation problem shown by the PE10... either lower stock prices or raise earnings.... if you raise earnings, and keep the value the same or even growing a bit, your PE10 will come down over the years.... I will have to agree it is not a market timing tool since there is no way it can predict how and when a correction will take place.... so, just because a market is calculated to be 'overvalued' does not mean it will not continue to rise.... remember the 'irrational exuberance' remark was made in 96 and the markets continued to rise for 4 more years.... So, it does not signal a market crash.... but can signal (as I read it) below market returns over the next 20 years.... but since below market returns can still be higher than other investments..... how does it help in making investment decisions....

I can only speak for myself, my goal is not to exceed market returns but inflation by 2-3 percent per year. When I feel stocks are too expensive I cut back the percentage that I own for the valuation I feel it is worth, while not totally eliminating that class (25%). It is true that stocks could continue for the next 20 years to over perform other asset classes and not have a major correction to bring the valuation back to either fair value or even undervalued, but I do not fear this, instead I would hope that to be the case as that would mean a continued low inflation environment and solid returns enough to offset inflation in my portfolio for the long term. However, this would be a highly unusual occurrence in stock market history and I think far less likely than a move down by selling pressure to fair value or under in the coming year(s)

[big-papa]

Quote:

Originally Posted by Texas Proud Good point...

+1

Though I would really like to see the same type of PE analysis performed on other US indices instead of just the SP500.

[sengsational]

Quote:

Originally Posted by bmcgonig Interesting video of Shiller last week. He's not optimistic. Risk of big stock drops grows: Robert Shiller

CAPE Crusader, LOL!

Quote:

For people living in retirement, I think this is a dangerous time. --CC"

Quote:

Originally Posted by samclem That's one reason I wouldn't use valuation to make a binary "all in" or "all out" decision. But using it to vary between high and low edges of one's equity "comfort window"

True that! Let's say I can sleep well at night with a 60% equity allocation, but only when the PE10 is X or less. Otherwise, I can't sleep well, so I cut my allocation to 40% equities. As long as you have a definite, non emotional rule that you can follow for reverting to the higher equity allocation.

How about this...When the 25/6% down PE10 triggers, add 20 years to your age and pull the recommended asset allocationallocation for that age. When the 14/6% up rule triggers, go back to the allocation for your real age.

Does changing your asset allocation very occasionally based on a measured parameter (and not on emotion) make one a DMT? I wouldn't think so.

[samclem]

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Originally Posted by sengsational Does changing your asset allocation very occasionally based on a measured parameter (and not on emotion) make one a DMT?

I'm afraid most here would throw this into the DMT bin.

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Originally Posted by photoguy I agree that seems sensible. Do you follow this approach yourself?

No, but I think I may. Our AA "window" devoted to equities will stay fairly high (we are comfortable with this due to other aspects of our finances), but I can see using PE10 to toggle between two levels.

[FIREd]

Quote:

Originally Posted by samclem That's one reason I wouldn't use valuation to make a binary "all in" or "all out" decision. But using it to vary between high and low edges of one's equity "comfort window" (e.g. between allocating 40% to equities or 70% to equities) would seem appropriate and a good fit to the imprecise (esp regarding timing) nature of these PE10 indicators.

That's what I have been doing for the past 5+ years. My comfort window is 30-70% equities. I vary my equity allocation inside that window based on valuation - PE10 mostly but I do give a little bit of weight to other factors like the current interest rate environment. I recently described my strategy here. I do not use triggers so there are no abrupt allocation changes in my portfolio based on gut feelings. As the market gets more expensive, I gradually decrease my equity allocation towards 30%. As it gets cheaper, I gradually increase it towards 70%.

According to FIREcalc, most of the benefits of owning equities on portfolio longevity is achieved with at least 30% allocated to equities. After that point, the benefits of a higher equity allocation become more marginal, so I figure that as long as I stay in that 30-70% range, I am not taking a lot of longevity risk by experimenting with this strategy.