Revisiting Shiller PE 10 AA Strategies

[DawgMan]

I just finished listening to a podcast on Morningstar where Bill Bengen mentioned he has taken his personal portfolio down to 20/80 about 2 years ago due to the Shiller PE 10 ratio. I also noticed there was some discussion here in 2018, https://www.early-retirement.org/forums/f44/allocation-according-to-cape-94078.html, about the same concerns. Clearly, many folks who made these conservative AA adjustments over the last 2+ years have missed some real gains. Intellectually, I get the argument and when you look at today's ratio of 40, you would think its a no-brainer and we should all be running to the exits! So, now you/we are back to being a market timer having to be right twice. Looking at the historical Shiller PE 10 chart and noted down turns, I'm just not sure I'm really seeing a consistent "marker" that screams sell?? Is it 25, 30, 35... or now 40??

https://www.multpl.com/shiller-pe

So, someone sell me on this strategy as opposed to keeping my boring 60/40 AA until further notice aka dirt nap.

 

[NW-Bound]

Not being an indexer, I can try to dodge the bullet by reducing growth stocks and increasing stocks in defensive sectors.

Going down to 20% stock AA is too extreme. I have never gone that low. About 40% is my lowest stock AA. I usually like it higher, like 70-80%.


PS. Forgot to add, if you hold a conservative balanced fund like Wellesley, you may not need to do anything. They will go even more conservative than normal. You will be safe.


PPS. When I say safe, I don't mean that you will not lose money. What I mean is that you will lose less than the indexers.

 

[Vincenzo Corleone]

As I'm sure you know, everyone's financial situation is different. Because it doesn't appear that I'll be returning to full-time employment, and my wife is planning on calling it quits in less than a year, it was a relatively easy decision given market valuation to take our AA from ~75%/25% to ~50%/50%. I'll revisit this annually. If market performance and annual withdrawals don't automatically do it for us over time, we'll consider bringing the equity % back up a bit when we start collecting some "guaranteed" income (e.g., Social Security). However, I recently read some research (I believe it was Wade Pfau) that indicated that, historically, there wasn't a whole lot of difference in withdrawal rates between a 50%/50% portfolio and a 70%/30% portfolio over a 30-year time horizon. What was different between AAs was median amount of money left at the end of the time horizon, with the higher equity allocation having a higher likelihood of leaving more money at the end. Because my wife and I have no heirs, we may keep it at 50%/50%. Why take the additional risk for little to no withdrawal rate benefit?

Market timing? Meh - I think it's more about making adjustments based on changing life circumstances. If I were young and had my best working years ahead of me, or if we wanted to leave a legacy, I don't think I'd have made any changes.

 

[chassis]

Bill Bengen is 74 years old. His estate goals and current withdrawal rate are not provided in the original post.

Mr. Bengen’s asset allocation has almost zero bearing on anyone who does not have substantially the same situation and goals as Mr. Bengen.

 

[plex]

20/80 has been shown to expose an investor to a significant amount of inflation risk. It is only recommended generally for those with both short investing horizons who are not very concerned about the residual amount, in addition to having a very low risk tolerance. I do understand the desire to market time, but if you overbalance, and get it wrong by multiple years, it can actually expose a very risk averse person to situations they cannot and do not want to see occur.

 

[Montecfo]

Shiller PE is not a useful market timing mechanism. Your comment on Bengen missing out on some huge upside moves is right on.

What I think Shiller PE IS good at is indicating that equity returns could be below trend for the next 5-15 years. I do not use Fidelity but I understand their tool was suggesting 1-3 percent returns for equities.

So it may be a good time to PREPARE to make some adjustments.

But no wholesale changes to AA. At least not in my view.

Always know what you own and why you own it.

 

[Dtail]

Shiller PE is not a useful market timing mechanism. Your comment on Bengen missing out on some huge upside moves is right on.

What I think Shiller PE IS good at is indicating that equity returns could be below trend for the next 5-15 years. I do not use Fidelity but I understand their tool was suggesting 1-3 percent returns for equities.

So it may be a good time to PREPARE to make some adjustments.

But no wholesale changes to AA. At least not in my view.

Always know what you own and why you own it.

Not sure the Cape 10 has been all that accurate since 1995.

 

[MichaelB]

Not sure the Cape 10 has been all that accurate since 1995.

It’s an average. How can it be inaccurate?

 

[USGrant1962]

I've never been enamoured with CAPE and its predictive value for timing has been weak. I cannot rationalize 7-, 8-, 9-, 10-year old earnings having much (or anything) to do with performance going forward. And why include 2020 earnings with all the government Covid actions? Anyway, CAPE does indicate lower returns going forward, but that is not the same as a sell signal.

Current P/E (trailing) is around 25. The flip side, earnings yield, at ~4% is on the low side of average but is competitive when the ten-year Treasury yield is ~1.5%.

While the stock market is "high" in a historical sense, if you are at an appropriate AA you shouldn't need to time the market. Especially when the fixed income alternatives are virtually guaranteed to have negative to zero real return for a while.

 

[Dtail]

It’s an average. How can it be inaccurate?

You are a little brighter than that, as I meant as a long term market indicator.

 

[foxfirev5]

Another reason why I'm an LMP guy. While I keep an eye on AA and the other stuff I really plan and execute based on covering future expenses. I have my cash needs covered and own x# of equity ETF's and MF's. Call it a rising equity allocation. However if my equity portion would get much over 70 -80 % (Roth IRA's) I would probably adjust. This would be a best case scenario. ��

 

[MichaelB]

You are a little brighter than that, as I meant as a long term market indicator.

Probably not brighter, but that’s not the point (and there’s no need to be rude). It wasn’t at all clear what you meant, at least to me.

I think Shiller suggests it’s not a predictive tool, CAPE10 is an indicator, and it can be useful when used as such. IMO it doesn’t make sense to criticize it for not being what it is not. It does tell us that, by historical measures, current US equity valuations are quite high, and that’s hard to debate.

Time to move on ..

 

[Lsbcal]

Two points:

1) I think CAPE is more correlated with the returns 10 years out. Not short term like 1 year out.

2) Shiller now shows an "excess return" of equities over 10 year bonds. So he is recognizing the argument that very low interest rates increases the attractiveness of stocks (SP500). See his Excel data on his site for this.

FWIW, I do not see a good correlation between short term returns and the Shiller CAPE. I have done some data analysis and couldn't see a good timing idea.

 

[Navigator]

I've never been enamoured with CAPE and its predictive value for timing has been weak. I cannot rationalize 7-, 8-, 9-, 10-year old earnings having much (or anything) to do with performance going forward. And why include 2020 earnings with all the government Covid actions? Anyway, CAPE does indicate lower returns going forward, but that is not the same as a sell signal.

This.

A high P/E 10 does historically portend likely lower returns going forward, but this is a long-term trend. I was surprised to read that the early work on the “reversion to the mean” trend in markets looked at 100 year periods, so it is over a very long time. A high P/E 10 does not predict a market crash, which usually occurs due to unexpected events. It would be interesting to see what portfolios have historically done the best when the P/E is high, but I don’t believe the US markets have ever seen the conditions we are in today.

 

[Fermion]

Look at it a different way. Companies are not overvalued, the dollar is overvalued. All we need is the dollar to drop 50% then companies increase prices 100% and everyone is happy and P/E gets back to normal.

 

[NW-Bound]

Yes, the stock market history has not been all that long, yet things don't stay the same. The NYSE started in 1792 with 24 stock brokers. In the 229 years since then, the US and the world have gone through monumental changes.

Using the past to predict the future is not easy, because we don't know which part of the past is still applicable today. The only thing that has been constant forever is the greed and fear motivation of people. This, I watch and try to discern any signal out of the investor sentiment.

 

[SecondCor521]

I thought a long time member here actually stated that they were going to commit to some sort of CAPE10-driven AA or WR%. I want to say @athena53 or @audreyh1, but I'm not certain. I didn't read the linked thread in the OP; maybe the comment was in that thread. I wonder how that person is doing and if they stuck with it. ISTR them saying that they knew it was a strategy that required doing it for several years to get it to work enough (because the signal is noisy).

 

[foxfirev5]

Look at it a different way. Companies are not overvalued, the dollar is overvalued. All we need is the dollar to drop 50% then companies increase prices 100% and everyone is happy and P/E gets back to normal.

Meanwhile should we invest more in international? Just askin.

My hypocrisy knows no bounds. (Doc Holliday)

 

[24601NoMore]

Guess I'll be the lone voice in the wilderness once again saying I'm in agreement that equities are HUGELY overvalued by any objective measure - including CAPE 10.

Sure - we've had a few years of outsized gains. At times, the market becomes irrational in either the up OR down direction. And it's clear (to me) that the market has become irrational in the up direction, largely because of two things: huge pumping of $$$ by the Fed which in turn bids up risk assets just due to there being so much money in the system, and TINA (There Is No Alternative), so people buy stocks.

When the party ends - and I expect it to end in early-mid 2022, so those who want to say "told you were wrong yet again" can mark this post , it's gonna be BRUTAL - because much of the selling will be Algorithmic. And the rapid drop caused by the Algos will cause a cascading Retail rush to the exits like we have not seen since the 1920s. That's what will drive the '22 Bloodbath.

I'm at ~25-28% equities diversified globally, and plenty nervous even at those levels. Sure - I know I'm losing purchasing power. But I'd rather lose 6% than 50+%, and our ability to pay the bills long term is not going to be affected by those conservative allocations as I can pull from cash to do so.

Guess time will tell. But even if we don't get a 50+% haircut in 2022, I wouldn't expect more than a 5-8% best case nominal annual return from US equities, with a ton of volatility (including some 10-20+% drops) along the way.

BTW, I read an article on Apple News (or somewhere) today that "the rich" (whoever they are) have no desire to take on additional "risk assets" (ie: stocks) at this point, and are in fact on average reducing their positions. FWIW..

 

[24601NoMore]

Case in point...second highest Shiller PE....EVER.

That said, AA is a highly personal decision and there are a lot of factors that go into determining what % stocks you are personally comfortable holding - or "need" to hold. Just be careful of FOMO or allowing "want" to get interpreted as "need", as the party is unlikely IMHO to continue in 2022 and possibly for years to come. The market eventually will return to more normal valuations. The only question is "when" that return to more reasonable valuations begins.

 

[Dtail]

Guess I'll be the lone voice in the wilderness once again saying I'm in agreement that equities are HUGELY overvalued by any objective measure - including CAPE 10.

Sure - we've had a few years of outsized gains. At times, the market becomes irrational in either the up OR down direction. And it's clear (to me) that the market has become irrational in the up direction, largely because of two things: huge pumping of $$$ by the Fed which in turn bids up risk assets just due to there being so much money in the system, and TINA (There Is No Alternative), so people buy stocks.

When the party ends - and I expect it to end in early-mid 2022, so those who want to say "told you were wrong yet again" can mark this post , it's gonna be BRUTAL - because much of the selling will be Algorithmic. And the rapid drop caused by the Algos will cause a cascading Retail rush to the exits like we have not seen since the 1920s. That's what will drive the '22 Bloodbath.

I'm at ~25-28% equities diversified globally, and plenty nervous even at those levels. Sure - I know I'm losing purchasing power. But I'd rather lose 6% than 50+%, and our ability to pay the bills long term is not going to be affected by those conservative allocations as I can pull from cash to do so.

Guess time will tell. But even if we don't get a 50+% haircut in 2022, I wouldn't expect more than a 5-8% best case nominal annual return from US equities, with a ton of volatility (including some 10-20+% drops) along the way.

BTW, I read an article on Apple News (or somewhere) today that "the rich" (whoever they are) have no desire to take on additional "risk assets" (ie: stocks) at this point, and are in fact on average reducing their positions. FWIW..

You could be correct.
What were your predictions for 2019, 2020 and 2021?

 

[24601NoMore]

You could be correct.
What were your predictions for 2019, 2020 and 2021?

I don't recall making any predictions for 2019 or 2020, although I did suspect 2020 would likely be brutal due to COVID which turned out to not be the case with the S&P 500 up 18+% on the year. Go figure. So I admittedly could be TOTALLY wrong about 2022.

Was caught between hopeful optimism of the pandemic ending (go, stocks!) and caution from crazy valuations in 2021. I did expect we'd end the year lower than we have, so admittedly was overly cautions and probably did miss out on some gains. That said, I'm pretty happy with where we did end (up a little over 9% on a 25% equity portfolio) and am content with playing the "tortoise and hare" game. I'm in no hurry to go through another 50+% drop as I know that it could easily take 10+ years to get back to "even" from a drop like that..no thanks.

Rick Ferri wrote a good article for Forbes (IIRC) some years back saying the "Sweet Spot" for Retirees was 30% equities. I'm admittedly below that and realize we are in the minority, but it works for us. I'm even seriously considering dialing back to ~20-22% for 2022 by selling into the "Santa Rally" (sell high..buy low). Could I miss out on yet more gains? Sure..but the risk/reward is in a good place for what we need, as my #1 goal is to fund ER at a lifestyle we desire - not to run up the number as high as I can make it for bragging rights or other reasons.

 

[corn18]

Case in point...second highest Shiller PE....EVER.

That said, AA is a highly personal decision and there are a lot of factors that go into determining what % stocks you are personally comfortable holding - or "need" to hold. Just be careful of FOMO or allowing "want" to get interpreted as "need", as the party is unlikely IMHO to continue in 2022 and possibly for years to come. The market eventually will return to more normal valuations. The only question is "when" that return to more reasonable valuations begins.

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

 

[24601NoMore]

Found the article I mentioned earlier.

https://www.cnbc.com/2021/12/28/mil...-a-little-less-of-everything-bubble-next-year.

 

[Fermion]

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.