Is this rally for real?

haha said:



Over and over it has been shown that unusually good 10 to 20 year results come from an investment made when PEs were low, and sold when they were high. Contrariwise, buying high PE and selling anything other than an equally high of higher PE results in either lackluster or disastrous results over these very meaningful timeframes.

So right now PE10 is almost 22; this is not as high as it has been, but other than the recent bubble it is very high indeed. The top in 1929 was around this level, as was the top in 1966.



A lot of things can happen, but IMO one of the least likely is that a new real bull market started in March 09. Perhaps Zimbabwean inflation might make stocks fly, but the history of inflation at the levels that we have experienced before in the US is that they lower PE ratios enough to more than counteract any good effect of the inflation on corporate profits.

Deflation also kills PEs, and profits. So we are in a sweet spot, where of all the things that can happen, only one is good and it is very unlikely. The one positively good outcome is that inflation stays low but positive, and that PEs continue to surge higher.

We are in a tough spot. Returns on quality fixed instruments are very low, taxes are likely to go higher, and equities at best offer rewards only by taking large risks.

Eventually we will once more have a following wind, and that will be the time for much more adventurous allocations.

Ha
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Ha Ha, you expressed my market sentiment more cogently than I could. Thanks this really clarified my thinking, lots of things can happen from here most of which are pretty bad for equities. The flip side is there aren't great alternative investments. Being younger, I can and probably should be more aggressive than you. However, my 80/20 is too aggressive so I am going to be taking ~2% off per 100 point increase in the Dow, so if we see Dow 12K by the end of the year I'll be back down to a 60/40 AA. If on the other hand we see Dow 9K, I'll have generated a modest amount of option premium for the covered calls I've written.
 
clifp said:
Being younger, I can and probably should be more aggressive than you. However, my 80/20 is too aggressive so I am going to be taking ~2% off per 100 point increase in the Dow, so if we see Dow 12K by the end of the year I'll be back down to a 60/40 AA. If on the other hand we see Dow 9K, I'll have generated a modest amount of option premium for the covered calls I've written.
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Yeah, I'm 44 now and after seeing what I saw in 2008-09, I'm not sure I can stomach much more than 60/40 even though that's probably a wee bit on the conservative side for a couple who probably have a collective 40-45 year joint life expectancy remaining.

But at this point I've recovered enough of my losses that when I rebalanced and the market rebounded to get me back to about 67/33 a couple months ago, I rebalanced back down to 60/40 and I'm pretty comfortable there. I ran the numbers and I don't think I *need* to take much more risk than that at this point. I just need to hold that AA for another decade or so and keep maxing out contributions as long as I still have this j*b.

Plus, my wife may be preparing to enter the ministry later this year or next, and should that happen I suspect our need to take risk would decline even further.
 
I continue to buy more stocks every month. I have been putting money into a Europe index (VGK) for most of the year and will probably do so again at the end of April. They have been the most beaten down this year among my funds. Maybe I will get lucky and Greece will flare up some more. >:D

Lots of stocks still look attractive to me. You can still buy lots of blue chip, dividend achievers with a current div yield of 3% or so. Just use the top 20 holdings of VIG as your stock screener.

I also continue adding large chunks of money to cash. I got my cash back up to 6 months living expenses and will keep at it until it hits a year's worth. It pains me getting only 1% nominal on it when I see so many good stocks out there.
 
Over and over it has been shown that unusually good 10 to 20 year results come from an investment made when PEs were low, and sold when they were high. Contrariwise, buying high PE and selling anything other than an equally high of higher PE results in either lackluster or disastrous results over these very meaningful timeframes.
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A low price and PE is easier to detect than a high one. Current PE may signal it's not a good time to buy but it doesn't say sell. I’m not challenging you – just trying (like you) to determine if the current PE is high because the numerator (price) is high and likely to fall or the denominator (profit) is low and likely to continue to rise.

I’ve taken some money off the table – dropped my equity to 45% by reducing in the higher risk areas, such as ISV, EM, PM/energy and keeping large blue chip type equities at over half my total allocation. My focus is on expected return and withdrawal rate and I think this allocation (for me) keeps me pretty safe either way. I think we are more likely than not to see at least another quarter, maybe two, of positive news. Not just profits but tax revenues, trade numbers and employment, and is the type of environment where large corporations tend to make their revenue and profit targets.


 
MichaelB said:
A low price and PE is easier to detect than a high one. Current PE may signal it's not a good time to buy but it doesn't say sell. I’m not challenging you – just trying (like you) to determine if the current PE is high because the numerator (price) is high and likely to fall or the denominator (profit) is low and likely to continue to rise.
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You are absolutely correct.This is part of reality that I am OK with. It's like the old prayer, "Please God help me stop sinning- but not quite yet." :) Or a more newsy example-

July 10, 2007, 10:54 am
prince1.dealbook.jpg

Citigroup’s chief executive, Charles O. Prince, says his bank hasn’t pulled back from making loans to provide funds for private equity deals, despite a skittish credit market and concerns that the recent run of big buyout deals could be losing steam.
But Mr. Prince used an interesting metaphor to describe his company’s situation as a major provider of financing for leveraged buyouts. “As long as the music is playing, you’ve got to get up and dance,” he told The Financial Times on Monday, adding, “We’re still dancing.”
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With respect to the numerator vs denominator, use of PE10 pretty well guarantees that it is the numerator. To see why this is correct (or not), it may be necessary to read the books and from one's own opinions.


Being younger, I can and probably should be more aggressive than you. (Clifp)
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Yes, I agree. I will however share a good quip by a very smart guy and member here named Ed Easterling-"Risk is not a knob." I think what he means, or at least what this means to me, is that risk inheres in the external reality set, and by deciding to up an equity allocation one will not automatically up his likely returns. Could even be the opposite.

Ha
 
MichaelB said:
A low price and PE is easier to detect than a high one. Current PE may signal it's not a good time to buy but it doesn't say sell. I’m not challenging you – just trying (like you) to determine if the current PE is high because the numerator (price) is high and likely to fall or the denominator (profit) is low and likely to continue to rise.

I I think we are more likely than not to see at least another quarter, maybe two, of positive news. Not just profits but tax revenues, trade numbers and employment, and is the type of environment where large corporations tend to make their revenue and profit targets.


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Intel's report today of better than expected earnings $.43 vs .38, optimistic forecast and plan to hire a couple of thousand people, does bode well for a least a few more quarters of growth on the numerator side of the equation.

However, the last time we had Dow 11K, S&P 1200 in rising market was May, 2005. I haven't gone back and looked at the economic statistic in Q2 2005, but it seems to me that underlying economic situation was much better in May 2005, than in April 2010. In particular we didn't have massive government debt, lots of underwater mortgages, and a badly spooked investor class, all of which are bad from a rising stock market from these levels.
 
MichaelB said:
– just trying (like you) to determine if the current PE is high because the numerator (price) is high and likely to fall or the denominator (profit) is low and likely to continue to rise.

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PE 10 is around 22x. PE based on 2010 expected earnings ($78.12) is 15x. The two are not saying the same thing, although neither is saying stocks are especially cheap.

If PE 10 is right, then 2010 earnings are above 'mid-cycle' levels and should come down. But if 2010 earnings are not above mid-cycle then gradually PE 10 will come down as higher mid-cycle earnings are averaged in (this will take a while given the length of the average).

The question then is whether 2010 earnings are more reflective of peak earnings or something lower. I'm hard pressed to come up with reasons why 2010 earnings should reflect a peak as long as we're truly back to a normal growth phase in the economy and not on the precipice of a double dip. Simply saying that current earnings are above an inflation adjusted 10 year average isn't a terribly convincing argument for peak earnings in my view.

Meanwhile the job losses and productivity gains that have driven recent earnings strength don't appear to be temporary phenomenon. Labor has been ceding its share of corporate revenue to equity holders for at least a decade . . . that doesn't look to be reversing anytime soon. If anything, it appears to be accelerating.
 
clifp said:
Intel's report today of better than expected earnings $.43 vs .38, optimistic forecast and plan to hire a couple of thousand people, does bode well for a least a few more quarters of growth on the numerator side of the equation.
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I think the P/E on Intel is currently 12, so apparently there are still some stocks out there not bid up to excessively high P/Es.

That was quite an impressive quarterly report!

Audrey
 
The above P/E ratio of INTC is actually forward P/E, while the trailing P/E is around 30.

It's OK. Speaking as a holder of Intel shares as well as those of other chip makers, I am not [-]selling[/-] rebalancing. Yes, the glass is half-full, and I am waiting for it to get near full before I will take a sip. :angel:
 
NW-Bound said:
The above P/E ratio of INTC is actually forward P/E, while the trailing P/E is around 30.

It's OK. Speaking as a holder of Intel shares as well as those of other chip makers, I am not [-]selling[/-] rebalancing. Yes, the glass is half-full, and I am waiting for it to get near full before I will take a sip. :angel:
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Thanks for that important detail. Articles never state which P/E they are using when they make pronouncements - very sloppy!

Audrey
 
OK - so it took a couple of days. But with that impressive Intel report, S&P500 crossed above 1200 first thing this morning.

Audrey
 
Valuations, returns, and math

Just a follow up on what the difference in valuations between PE10 and 2010 PE mean. Is it possible that both Ha and I are right? Possibly.

If we use 2010 earnings as a baseline and assume normal earnings and dividend growth from here for the next decade, what happens to returns and valuations? Based on those assumptions, and a 3% inflation rate, PE10 declines from almost 22x now to 16.2x in 2019 (compared with Shiller's long-run average of 16.4x). Nominal returns for the SPX bought today are almost 8% in that scenario.

So 8% total returns for equity are consistent with declining PE10 valuations, as long as current earnings are a valid baseline for normal future growth.
 
With respect to the numerator vs denominator, use of PE10 pretty well guarantees that it is the numerator. To see why this is correct (or not), it may be necessary to read the books and from one's own opinions.
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The numerator drives the current PE10 calculation but not the predicted outcome of a future lower PE and below average returns for the upcoming decades. If you believe low returns will be the result of sustained low E then the price should eventually fall and stay low. If you believe returns will be low due to high volatility then price will continue to rise and fall. These two scenarios require much different portfolio strategies.
 
MichaelB said:
The numerator drives the current PE10 calculation but not the predicted outcome of a future lower PE and below average returns for the upcoming decades. If you believe low returns will be the result of sustained low E then the price should eventually fall and stay low. If you believe returns will be low due to high volatility then price will continue to rise and fall. These two scenarios require much different portfolio strategies.
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Thank you, that had not occurred to me. As I said, I cannot paraphrase 2 fairly subtle, long books. However, there is an implicit reliance on what has been true of the US economy for many, many years-earnings growth fluctuates around a trendline that over time has been around 3.5% real. There is some discussion that this is now lower, but it has nothing at all to do with the reasoning behind the predictive value of PE10. PE10 is assumed to be a signal with a fairly stable, ten year smoothed denominator, and a more variable numerator. This assumption also conforms to observed reality

People should not assume that I wish to defend the thesis; I don't. My goal was only to clarify my posture for myself. I should have written it, then put it on my desktop rather than on this forum which is perhaps not the best place for this type of post.

If one is interested in this approach to valuation, or even the concept of valuation, he should read the books and decide for himself.

Ha
 
Actually, Ha - I found your post and the resulting discussion highly valuable, so I am very glad you posted it.

Audrey
 
audreyh1 said:
Actually, Ha - I found your post and the resulting discussion highly valuable, so I am very glad you posted it.

Audrey
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Me too, I really found it interesting . I don't comment a lot on certain aspects of investing because I am not as knowledgeable as a lot of our members but I do read all the posts and enjoy the different insights .
 
Well I I went from 20 to 30% stocks this AM...

No need to worry about the tax revenue shortfall, Im gonna send em a LARGE payment tomorrow:(
 
Now the tax payment tomorrow is not related to your change of AA, right?

Otherwise, I'm confused....

Audrey
 
No I just went long SPY and VTI.

I've been waiting for a dip to buy back in but I don't think were gonna see it for a bit longer.

I see no end of easy $$$ from the FED in sight with the CPI number and employment and real estate troubles...

Earnings are coming in good...

Im getting greedy and I think we might see more buying from others on the sidelines...

My stop losses are set and I have LOTS of dry powder to put to work...

Still a long term bear but I like $$$;)
 
Steve O said:
Still a long term bear but I like $$$;)
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Well, it may surprise you, but I'm a long term bear too.

But from the point of view that we are in a secular bear market 2000-2017 or thereabouts until we enter a new secular bull (perhaps).

Meanwhile, even secular bear markets have bull market cycles. We could still have a good market for a while before potentially one more bear cycle before 2017 - or we could just muddle along stuck in a tight trading range until then.

Audrey
 
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