Revisiting Shiller PE 10 AA Strategies

[foxfirev5]

How can you make any reliable prediction when all the government has to do is ship out another $600, $1200, $2400, $5000 to every man woman child or whatever it takes and the economy is running like a unregulated diesel engine.

I correctly predicted the market would take a hit from COVID back in Feb 2020 while it was still rising...I made a little bit from puts but fortunately I did not pull everything out because the response from the government to just dump money everywhere had the desired effect.

Wake me up when we get to PE80 or so.

Yeah, that's pretty much why I'm taking the back seat and seeing how it unfolds. Neither a buyer or a seller.

 

[24601NoMore]

Wow, those poor saps in 1900 and 1964 didn't even have a high Shiller and they got their butts handed to them.

Not sure I follow..the CAPE 10 was more reasonably valued in the 60s and 1900s..and stocks went (way) up.

Generally speaking, a high CAPE 10 is an indicator of lower returns going forward. A lower CAPE 10 (like the 1900s or 1960s) is favorable to higher returns going forward. Although anything can and will happen.

 

[corn18]

Not sure I follow..the CAPE 10 was more reasonably valued in the 60s and 1900s..and stocks went (way) up.

Generally speaking, a high CAPE 10 is an indicator of lower returns going forward. A lower CAPE 10 (like the 1900s or 1960s) is favorable to higher returns going forward. Although anything can and will happen.

The CAPE 10 wasn't low in 1900s or 1960s. Not by their standards.

 

[GrayHare]

FWIW, despite not needing to raise cash, valuations caused me this momth to lighten up on equities, for only the second time in my life. The other time was 2 years ago after covid began but before it spooked markets. Both liquidations were small, around 10% of holdings. I now have dry powder to buy on a dip.

 

[24601NoMore]

The CAPE 10 wasn't low in 1900s or 1960s. Not by their standards.

I guess I see your point, but in 1900, there was only 20 years or preceding data, so hard to get a decent historical / long term perspective.

We now have 140 (or so) years of data. And the Shiller PE is the second highest EVER, in 140 years.

To me, that's a big clanging, neon lit bell, loudly yelling "Run, You Fools!" (TM - Gandalf, Lord of the Rings). But we all need to evaluate all the data available to us and make our own decisions..

The party could easily continue into and throughout 2022. My own personal prediction FWIW (which is worth diddly) is that it won't. There are way too many factors working against that happening. But everyone can put their chips on Red or Black and see what happens..

 

[corn18]

I guess I see your point, but in 1900, there was only 20 years or preceding data, so hard to get a decent historical / long term perspective.

We now have 140 (or so) years of data. And the Shiller PE is the second highest EVER, in 140 years.

To me, that's a big clanging, neon lit bell, loudly yelling "Run, You Fools!" (TM - Gandalf, Lord of the Rings). But we all need to evaluate all the data available to us and make our own decisions..

The party could easily continue into and throughout 2022. My own personal prediction FWIW (which is worth diddly) is that it won't. There are way too many factors working against that happening. But everyone can put their chips on Red or Black and see what happens..

I agree. I picked my AA of 50/50 because we can lose 70% of our equity value followed by the worst 30 years of returns in history and still have a nice retirement. Now, a 100% drop along with high inflation and SS being cut, that would make things tough.

 

[foxfirev5]

Great points. All I hope for is to be here to see how it works out in 20 to 30 years.

 

[24601NoMore]

I agree. I picked my AA of 50/50 because we can lose 70% of our equity value followed by the worst 30 years of returns in history and still have a nice retirement. Now, a 100% drop along with high inflation and SS being cut, that would make things tough.

Wow. You've got a stronger stomach than me. I'd be throwing up at 50+% down on my equity allocation.

Best of luck. Sounds like you have things pretty well figured out. But I just have to ask..if you can weather a 30+ year drought..why take ANY risk? I assume you're just looking to leave as big a kitty as you can for heirs? We're not..I personally believe each has to earn their own way and not thinking of heirs one bit.

 

[corn18]

Wow. You've got a stronger stomach than me. I'd be throwing up at 50+% down on my equity allocation.

Best of luck. Sounds like you have things pretty well figured out. But I just have to ask..if you can weather a 30+ year drought..why take ANY risk? I assume you're just looking to leave as big a kitty as you can for heirs? We're not..I personally believe each has to earn their own way and not thinking of heirs one bit.

The risk is for the kids. All I have to do is make it to SS in 15 years. My COLA military pension + SS will cover us nicely. $114k / year of COLA income with free health care for life makes it fairly easy.

If all goes fairly average, the kids will inherit a metric boatload of Roth. If it goes south, they might not get anything.

 

[Montecfo]

I guess I see your point, but in 1900, there was only 20 years or preceding data, so hard to get a decent historical / long term perspective.

We now have 140 (or so) years of data. And the Shiller PE is the second highest EVER, in 140 years.

To me, that's a big clanging, neon lit bell, loudly yelling "Run, You Fools!" (TM - Gandalf, Lord of the Rings). But we all need to evaluate all the data available to us and make our own decisions..

The party could easily continue into and throughout 2022. My own personal prediction FWIW (which is worth diddly) is that it won't. There are way too many factors working against that happening. But everyone can put their chips on Red or Black and see what happens..

In the meantime there is record liquidity, record low rates and record corporate margins.Cash on corporate balance sheets also a record. Buybacks a record.

Imagine what could happen when the economy gets fully open.

Now, FED actions will matter. They always have. In fact the greatest risk is the FED makes some huge mistake. That possibility does concern me.

No one rings a bell at a market top. They are seen only in retrospect. And despite the cap weighted averages, many stocks have already experienced meaningful corrections and are well off their highs.

I do expect the FED normalization of interest rates to take a while. I will be concerned if they raise four times in 2022. I do not expect that.

I do expect PEs to begin to normalize with rates but steadily over time, with earnings rising.

And when the selloff comes it will be short-lived. They usually are. And you lose more trying to predict them than by just buying great stocks for the longtern and expecting selloffs to happen.

 

[DrRoy]

I have been slowly reducing my equity AA as the market has risen over the last 4 years. This year I went from 58% to 54%.

 

[OverThinkMuch]

I view CAPE 10 the way 24601NoMore described it: in combination with other signals, it can be interesting. Schiller himself said it's not an asset allocation signal, but CAPE has only hit 40 once before: the dot-com crash. It's not an entirely fair comparison, because P/Es from the 1970s used different accounting rules than today - they're not comparable.

Besides CAPE 10, inflation is still running higher than expected. The Fed has been wrong on inflation for months, only recently catching up to the market. The current expectation is 3 rate hikes in 2022 to combat inflation. That inflation comes from supply side problems, which the market expects to resolve in the next 6 months. But if Covid-19 is worse than expected, supply chains could be more impacted than expected. Or if Covid-19 is less of a problem, demand could surge back in more countries than expected. I'm guessing the market is being overly optimistic about supply chain problems getting resolved, which in turn means inflation running high for longer than expected. I guess we'll see in mid 2022.

 

[target2019]

Bill Bengen: Revisiting Safe Withdrawal Rates
https://www.morningstar.com/articles/1072229/bill-bengen-revisiting-safe-withdrawal-rates
approximately 60 minutes in length, also available on Spotify podcast "The Long View"

• current environment is off the charts. unprecedented. valuations are ridiculous.
• high inflation now affects all future withdrawals. when you retire and the coming inflation in 10 years sets up the rest of your years
• most advisers missed the last inflation period (age)
• is inflation transitory or here to stay? does not know
• the effect of ranges of inflation on the safe withdrawal strategy. considers 3 tranches of inflation 0-2.5, 2.5-5.0, 5.0+
• uses independent Risk Management Service as part of decision making for allocation strategy. Risk Management, not return is his recommendation.
• uses tactical asset allocation strategy
• rebalance 4-5 year periods
• CAPE is one of his prime indicators. [https://www.multpl.com/shiller-pe]
• 3 bear markets in last 20 years have shown that buy and hold is vulnerable
• emphasizes your entry date into the stock market and also the date you retire for decision making.
• Has added more diversification to his own portfolio. Gold. BTC. Commodities.
• Has extended his study of 4% to include the effect of more diversification, such as small cap. 5% is probably the limit once can expect.
• 2013 retired. used 4.5% withdrawal rate. now 3.5%
• central bank policy causes distortion in the market, and buy and hold could leave you with a large loss at the wrong time.
• central banks can hold onto a policy even when it is no longer effective, and lead to a long depression.

Definitely a must-listen. Draw your own conclusions.

 

[OverThinkMuch]

In the meantime there is record liquidity, record low rates and record corporate margins.Cash on corporate balance sheets also a record. Buybacks a record.

Imagine what could happen when the economy gets fully open.

A trillion dollars of that liquidity is from the Fed, which is ending it's quantitative easing ("the taper") next year.

The economy is already open so much that supply chains can't keep up. That's why we have supply side inflation now, which is running somewhere in the 5-6% range. The Fed raising rates 1% isn't that much of a stretch, which I believe is what 4 rate hikes would mean. A CNBC poll of Fed members suggests 3 rate hikes now, but it was 1-2 just months ago.

I agree that predicting crashes is bad practice. I keep mostly invested, and will in 2022. But given high interest rates, slow Fed reactions in 2021, and CAPE at 40 ... it does seem like there's a higher risk of a crash than usual.

On the contrary side, the total stock market (VTI) has a P/E ratio of 20.4 right now. Maybe earnings will pick up dramatically and cause CAPE to fall to a more normal value? I'm not sure why there's a big gap between the market's P/E and CAPE, and I'd like to understand it.

 

[OverThinkMuch]

• current environment is off the charts. unprecedented. valuations are ridiculous.
• high inflation now affects all future withdrawals. when you retire and the coming inflation in 10 years sets up the rest of your years
• CAPE is one of his prime indicators. [https://www.multpl.com/shiller-pe]
• 3 bear markets in last 20 years have shown that buy and hold is vulnerable

Different websites seem to have different P/E ratios. For example the S&P 500 over time shows 30 P/E ratio now:
https://www.multpl.com/s-p-500-pe-ratio/table/by-year

But State Street, which runs "SPY" ETF (SPDR S&P 500) show a 26 P/E ratio. So does Yahoo Finance.
https://www.ssga.com/us/en/intermediary/etfs/funds/spdr-sp-500-etf-trust-spy
https://finance.yahoo.com/quote/SPY/holdings?p=SPY

Another consideration: that first website shows P/E fell from 36 to 30 this year (2021), when the S&P 500 went up +15%. Even if things are overvalued, it might be tricky to spot the exact peak. My approach is to shift some high P/E assets elsewhere, but keep a high equity allocation.

 

[target2019]

Yes, there are different P/E ratios. CAPE (shiller-pe) is described on the page I linked:

Price earnings ratio is based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted PE Ratio (CAPE Ratio), Shiller PE Ratio, or PE 10.

.
Your S&P 500 P/E is explained on the page you linked.

 

[24601NoMore]

Bill Bengen: Revisiting Safe Withdrawal Rates
https://www.morningstar.com/articles/1072229/bill-bengen-revisiting-safe-withdrawal-rates
approximately 60 minutes in length, also available on Spotify podcast "The Long View"

Interesting quote from Bengen during the interview with regard to high CAPE and high inflation, and the predictive power of looking at both together..

Bengen: Back in 2008, Michael Kitces, a renowned advisor, developed a chart which showed there was a strong correlation between stock market valuation, or CAPE, and the safe withdrawal rate for a particular year. I thought that was an amazing discovery. When you look at it closely though, it's very hard to use the CAPE to predict what a safe withdrawal rate is, because it's only about a 74%, 75% correlation. And you can choose several years that had identical market valuations and have a variation of up to 50% in the safe withdrawal rate. So, although it was a big step forward, it wasn't enough to provide predictive power. Last summer, I made a breakthrough when I found that if you add inflation, the starting inflation regime, into the picture, you get a much higher correlation. And using stock market valuation and using inflation together, you get a really good fix on what a safe withdrawal rate should be, at least historically.

When I took a look at the data, I discovered that you could aggregate withdrawal rates by inflation rate--the starting inflation rate creates what I call six inflation regimes. Each regime is about 2.5 points of inflation, like a low inflation regime would be from 0% inflation to 2.5%; modern inflation would be 2.5% to 5%, and so on. You could divide all the historical data into six inflation regimes. And when you sort that, and then within that, by the Shiller CAPE, it's an astoundingly close correlation. When you have low inflation and you have cheap stock market valuations is when you get your very high withdrawal rates as high as 13%, historically. And when you get a scenario like you had in the late ‘60s, early ‘70s, when you have high inflation and coming off high stock valuations, that's when you had your worst withdrawal rates. So, that's the framework that has emerged from all this work.

FWIW..I do think inflation (and Fed actions to combat said inflation) will play a major and likely adverse role with regard to equity valuations in 22. And since we're going into 2022 with the second highest CAPE 10 ever, it does appear that a perfect storm of sorts is brewing..

 

[Montecfo]

Another consideration: that first website shows P/E fell from 36 to 30 this year (2021), when the S&P 500 went up +15%. Even if things are overvalued, it might be tricky to spot the exact peak. My approach is to shift some high P/E assets elsewhere, but keep a high equity allocation.

That was my point earlier. PEs already declining.

Unrelated to your post on PEs
I find it interesting that everyone seems to get at some level that Shiller PE is not useful for market timing. Then a few use it for market timing. But surely they know that market timing is not a wise strategy....

Stay Fully Invested

 

[target2019]

Interesting quote from Bengen during the interview with regard to high CAPE and high inflation, and the predictive power of looking at both together..

Bengen: Back in 2008, Michael Kitces, a renowned advisor, developed a chart which showed there was a strong correlation between stock market valuation, or CAPE, and the safe withdrawal rate for a particular year. I thought that was an amazing discovery. When you look at it closely though, it's very hard to use the CAPE to predict what a safe withdrawal rate is, because it's only about a 74%, 75% correlation. And you can choose several years that had identical market valuations and have a variation of up to 50% in the safe withdrawal rate. So, although it was a big step forward, it wasn't enough to provide predictive power. Last summer, I made a breakthrough when I found that if you add inflation, the starting inflation regime, into the picture, you get a much higher correlation. And using stock market valuation and using inflation together, you get a really good fix on what a safe withdrawal rate should be, at least historically.

When I took a look at the data, I discovered that you could aggregate withdrawal rates by inflation rate--the starting inflation rate creates what I call six inflation regimes. Each regime is about 2.5 points of inflation, like a low inflation regime would be from 0% inflation to 2.5%; modern inflation would be 2.5% to 5%, and so on. You could divide all the historical data into six inflation regimes. And when you sort that, and then within that, by the Shiller CAPE, it's an astoundingly close correlation. When you have low inflation and you have cheap stock market valuations is when you get your very high withdrawal rates as high as 13%, historically. And when you get a scenario like you had in the late ‘60s, early ‘70s, when you have high inflation and coming off high stock valuations, that's when you had your worst withdrawal rates. So, that's the framework that has emerged from all this work.

FWIW..I do think inflation (and Fed actions to combat said inflation) will play a major and likely adverse role with regard to equity valuations in 22. And since we're going into 2022 with the second highest CAPE 10 ever, it does appear that a perfect storm of sorts is brewing..

Thank you for quoting Bengen in sufficient detail. I also found it interesting when he mentioned that new findings don't get incorporated in the software that advisors use today.

 

[RobLJ]

Actually, I'm scraping some (about 1/2) of large US growth gains to move into international and mid/small value. Both are a lower % allocation than I like while large growth is over 5% over-allocated, due to gains in the S&P.

4 years ago, before the COVID crash I moved to 45% stock allocation, then rethought when the stock allocation dipped to about 38% in the crash, which I thought was way too low. I rebought in March and May of the crash some I had sold 6 months to a year before, then have watched the recovery take my stock allocation up (now 54%). Now that SS is less than 3 years away, 55% and eventually 60% allocation seems about right.

I had a large cash allocation built up so I've mostly drawn from it for withdrawal (sold 1/2 of a zero coupon fund that matures in 2015 for this year's withdrawal).

Meanwhile should we invest more in international? Just askin.

My hypocrisy knows no bounds. (Doc Holliday)

 

[otodd]

Yes, there are different P/E ratios. CAPE (shiller-pe) is described on the page I linked:
.
Your S&P 500 P/E is explained on the page you linked.

Can you elaborate? I see the S&P 500 P/E stated, but not explained. At least its not jumping out to me the difference between ~30 and Shiller's 40

https://www.multpl.com/s-p-500-pe-ratio/table/by-year:
Jan 4, 2022 30.19


Current Shiller PE Ratio: 40.21 -0.03 (-0.06%)
4:00 PM EST, Tue Jan 4
Mean: 16.90
Median: 15.86
Min: 4.78 (Dec 1920)
Max: 44.19 (Dec 1999)
Shiller PE ratio for the S&P 500.

 

[sengsational]

There was a scheme (probably over fit to the data, not to mention this time it's different) proposed in a book called "Rock Breaks Scissors". It showed an improvement over buy and hold. I made a post that has a link to a spreadsheet that is old, but could be updated to show trigger points. The sell signal was many years ago, and no prescribed action since.


https://www.early-retirement.org/fo...t-performance-thread-84822-4.html#post1837897

 

[OverThinkMuch]

Different websites seem to have different P/E ratios. For example the S&P 500 over time shows 30 P/E ratio now:
https://www.multpl.com/s-p-500-pe-ratio/table/by-year

But State Street, which runs "SPY" ETF (SPDR S&P 500) show a 26 P/E ratio. So does Yahoo Finance.
https://www.ssga.com/us/en/intermediary/etfs/funds/spdr-sp-500-etf-trust-spy
https://finance.yahoo.com/quote/SPY/holdings?p=SPY

I hadn't planned on responding, but I wanted to clarify that different websites show different values for P/E. I'm ignoring forward P/E, which is an estimate. Some websites measure P/E up until the present, while others only update monthly. That might explain some of the difference.

Yahoo Finance has a nonsense P/E ratio on it's first page. Take SPY, where it shows "PE Ratio (TTM) 3.29" for the S&P 500, which is nonsense. Click on the "holdings" tab, and it shows "Price/Earnings 26.45", which makes sense. So I use the Yahoo Finance P/E from the Holdings tab, which agreed with another of the websites I used.
https://finance.yahoo.com/quote/SPY/holdings?p=SPY

 

[DawgMan]

That was my point earlier. PEs already declining.

Unrelated to your post on PEs
I find it interesting that everyone seems to get at some level that Shiller PE is not useful for market timing. Then a few use it for market timing. But surely they know that market timing is not a wise strategy....

Stay Fully Invested

+1
As stated in my original post, you have to right twice... that's the hard part. And while I, like many here, like to listen to the prognosticators and evaluate the data/latest mousetraps and why this time "it's different", my sensible gland eventually kicks in and reminds me that the best course is to pick a plan (AA relative your own risk profile/objectives) realizing we are running a marathon, and not a sprint. At least for me, the 2008 bust was a wake up call and has helped me shape my own risk profile, giving me a longer look at performance as opposed to short. It's easier to bite on the sell and feel smart but then get the buy right... that's real talent!. I've read about many folks on this site getting out at a good time in 2008, but many sat idle for years after.

 

[target2019]

Can you elaborate? I see the S&P 500 P/E stated, but not explained. At least its not jumping out to me the difference between ~30 and Shiller's 40

https://www.multpl.com/s-p-500-pe-ratio/table/by-year:
Jan 4, 2022 30.19


Current Shiller PE Ratio: 40.21 -0.03 (-0.06%)
4:00 PM EST, Tue Jan 4
Mean: 16.90
Median: 15.86
Min: 4.78 (Dec 1920)
Max: 44.19 (Dec 1999)
Shiller PE ratio for the S&P 500.

You're on the table page with that link. If you switch to the chart view you'll see the explanation for each.