Down Day in the Market !

[copyright1997reloaded]

On Feb 1, CAPE10 had reached 34.1

By Fed 9 it had only dropped to 31.7 - still in nosebleed territory exceeding any other time except mid 1997 - mid 2001. This is still above the Nov 1 2017 value of 31.2.

Far be it from me to think that I know more than Shiller. But (isn't there always a but) the Cape 10 measurement has some interesting characteristics as measured:
1. Graham & Dodd in their 1936 Security Analysis work: https://www.amazon.com/Security-Analysis-Foreword-Buffett-Editions/dp/0071592539 originated the idea of eliminating economic cycle swings in analyzing PE ratios and suggested looking back over a longer period of time. But (there it is) they weren't saying 10 years was the only period, but also suggested smaller time frame measurements (e.g. 5 or 7 years). There is nothing magical about a 10 year look back period.

2. CAPE10 uses GAAP earnings, which are generally lower than operating earnings and also which are more severely impacted by the 2008-2012 "great recession". (I would also guess that they will impact earnings now as companies take one time tax hits to deal with non-repatriated funds).

3. There have been other accounting changes which makes the comparison of earnings today different than long ago. For instance, FAS 142 changed the way goodwill is accounted for.

As you mention above, the CAPE 10 value topped 30 during 1997-2001. It first topped 30 in June of 1997, and topped 36 in March of 1998...a full two years before the market topped.

Having said all of that, your point is valid and a high CAPE 10 value is certainly a warning signal that we should all be aware of.

 

[NW-Bound]

Ahh. i had just focused on the part that noted that millionaires comprised 0.2% of the global population. No desire to exist in the ruck, but I need to remember where I am.. Good fortune.

Yes, I am happy to get to where I am now too. We are a small percentage of the US, let alone the world.

But as I recall, during the scary period of the Great Recession, haha wrote something that reminded me that there were time periods when workers could maintain their purchasing power better than people living off their investment like ourselves.

 

[audreyh1]

So this is different from the forward earnings of the SP500 and Nasdaq, and the Dow? Is that correct? I think they are a different way of measuring the PE ratios of the market. I have no idea which one is better or even how either one is calculated. Do you have any thoughts on that?

I am not sure but I saw somewhere where it said the SP500 had a pe ratio on Feb, 9,2018 of 24.46. I think that is forward earnings. I am not making a case for/against as I don't understand it really.

Yes. This is the 10 year inflation adjusted earnings CAPE10.

Forward earnings - that is the analysts' pie in the sky guess and useless, IMO. They are constantly corrected. I don't use it.

 

[audreyh1]

Far be it from me to think that I know more than Shiller. But (isn't there always a but) the Cape 10 measurement has some interesting characteristics as measured:
1. Graham & Dodd in their 1936 Security Analysis work: https://www.amazon.com/Security-Analysis-Foreword-Buffett-Editions/dp/0071592539 originated the idea of eliminating economic cycle swings in analyzing PE ratios and suggested looking back over a longer period of time. But (there it is) they weren't saying 10 years was the only period, but also suggested smaller time frame measurements (e.g. 5 or 7 years). There is nothing magical about a 10 year look back period.

2. CAPE10 uses GAAP earnings, which are generally lower than operating earnings and also which are more severely impacted by the 2008-2012 "great recession". (I would also guess that they will impact earnings now as companies take one time tax hits to deal with non-repatriated funds).

3. There have been other accounting changes which makes the comparison of earnings today different than long ago. For instance, FAS 142 changed the way goodwill is accounted for.

As you mention above, the CAPE 10 value topped 30 during 1997-2001. It first topped 30 in June of 1997, and topped 36 in March of 1998...a full two years before the market topped.

Having said all of that, your point is valid and a high CAPE 10 value is certainly a warning signal that we should all be aware of.

I have run the scenarios such as CAPE8 - it maybe drops things 3 points. Averaging out 2008 is not going to help that much.

In terms of taking into account accounting rule changes in 2001, etc. they don't bring it down enough. 2 points maybe? And personally I don't make any comparisons to the almost 100 year mean, or whatever of ~16. I just compare since 1995 and look at how far above 20-22 it is.

In 2008 it only made it above 27 before having the worst crash in decades - it crossed above 27 10 months before the market topped. Sure our current CAPE10 only crossed 30 in Aug 2017, but I'm not convinced you can predict that levels stay high for a certain amount of time before a big selloff.

 

[NW-Bound]

If one maintains a constant AA and does indexing, of what use is knowing the P/E or interest rate? I can see why some people tune out the news and do not care about any of this, or have an interest in any discussion. It has absolutely no bearing on how they invest.

And for some, they do not need to know any of this even for withdrawing money, as their WR is already predetermined.

 

[audreyh1]

If one maintains a constant AA and does indexing, of what use is knowing the P/E or interest rate? I can see why some people tune out the news and do not care about any of this, or have an interest in any discussion. It has absolutely no bearing on how they invest.

And for some, they do not need to know any of this even for withdrawing money, as their WR is already predetermined.

I’m running a CAPE10 modified AA now. Worked it all out last year and started it this Jan.

Even if I didn’t modify my AA I still monitor interest rates and measures of market valuation as a matter of interest. Yet I sit on my hands, because my predictive ability is nil. Yet I still find it interesting to observe and measure and make a few guesses. Entertainment, if you like.

 

[NW-Bound]

OK. I recall that FIREd had something like that, where the stock AA is varied with P/E. He posted his simple formula here. I remember thinking that it looked quite reasonable, in that it limits the AA to within reason, and will not go to 0 or 100% stock.

This reminds me of the fun I had a while back playing with FIRECalc data set to see what an optimum portfolio looks like.

See: http://www.early-retirement.org/forums/f28/optimal-firecalc-portfolio-69523.html

I read what I wrote. At the conclusion of the introductory post, I wrote "I really think this is something I can implement in real life!". I was apparently excited.

Did I exactly implement that? No. I have quite a bit of foreign stocks, and FIRECalc has none in its dataset. And I already had a mixture of small and large caps, growth and value stocks. The current composition is not as the "golden" formula I squeezed out of FIRECalc, and I already forget what that was.

 

[NW-Bound]

There are many reasons I can think of that does not allow one to fine-tune any method.

There's only so much one can get out of a limited set of stock data. One of the first exercises to a student of statistics is to find out how many tosses it takes to be sure to a certain level that a coin is a fair one (meaning having a 50/50 chance of head/tail). Unless a coin is heavily loaded and obviously wrong, you would not be able to know with just 10 tosses.

The market is not a stationary process. Its characteristics change with time. Take something as fundamental as the P/E. Some people say that high P/E is here to stay, some say it may go back. Who knows? International stocks used to be uncorrelated with US stocks. Globalization now drives them up/down together.

Just now, the people who bet that low volatility is the new paradigm made good money for 2 years, and lost their pants overnight when volatility came back.

So, as long as one does not take an extreme position, he will survive. He may be right one year, then wrong the next. He will not be wiped out.

Entr'acte for Dylan's music.

Come writers and critics
Who prophesize with your pen
And keep your eyes wide
The chance won't come again
And don't speak too soon
For the wheel's still in spin
And there's no telling who that it's naming
For the loser now will be later to win
Cause the times they are a-changing

 

[audreyh1]

Kitces and Pfau published an interesting paper a while back. And there have been a few others over the years.

My AA change is quite modest ramping between 50/50 to 60/40 as CAPE10 drops from 25 down to 18, but we are so far above my top threshold of CAPE10 25 that I’ll be stuck at 50/50 for a long while yet unless there is a huge move down this year.

My AA was just a couple of percent higher when I switched, so it was a small change. In general it just means I’ll be slightly more aggressive than I would have been if CAPE10 drops below 24.

 

[NW-Bound]

I still plan to run an AA of anywhere between 50 to 70% stock, depending on economic conditions. If I am wrong or things go really bad that have nothing to do with my AA, there's SS. That early or late SS decision alone may have more effect than my stock AA decision.

 

[Golden sunsets]

I’m running a CAPE10 modified AA now. Worked it all out last year and started it this Jan.

Even if I didn’t modify my AA I still monitor interest rates and measures of market valuation as a matter of interest. Yet I sit on my hands, because my predictive ability is nil. Yet I still find it interesting to observe and measure and make a few guesses. Entertainment, if you like.

Audrey; Would you be willing to share a bit more on how your AA changes within your floor and ceiling vis a vis CAPE 10? Also depending on the changing inter relationship between these factors how often would you consider rebalancing?


Sent from my iPad using Early Retirement Forum

 

[audreyh1]

Audrey; Would you be willing to share a bit more on how your AA changes within your floor and ceiling vis a vis CAPE 10? Also depending on the changing inter relationship between these factors how often would you consider rebalancing?


Sent from my iPad using Early Retirement Forum

It’s pretty simple.

Above CAPE10 25 my AA is 50/50. Below CAPE10 18 my AA is 60/40. There is a linear ramp between the two, so that at CAPE10 23.5 my AA would be 55/45.

These CAPE10 numbers were picked by looking at 1995 and later graphs, so it already captures some of the accounting changes post 2001. In my AA spreadsheet I have an entry for CAPE10 and I get the data from http://www.multpl.com/shiller-pe/ .

I generally rebalance annually (if needed) when I withdraw funds and after distributions are paid out, but if the equity market suddenly dropped 20% or more during the year it would probably trigger another rebalance. It’s the same as my previous rebalancing scheme although it might have me rebalancing very slightly sooner. If you look at CAPE10 swings they tend to be long and gradual. So I don’t expect a large influence on the timing of rebalancing.

Normally AA changes would be very gradual, but if there is a big selloff like 2008, AA would go to 60/40 quickly, and then gradually reduce if the stock market recovered.

 

[Pilot2013]

It certainly is interesting to go through this thread every day or so. What I can surmise:

There are those that are comfortable in the markets, and their allocation, and are mildly interested and watching.

And then there are those that apparently should never be in the market due to a lack of comfortability who are scared $#!&less and need to go to Fischer investments or something along those lines and purchase their annuities.

 

[Hamlet]

Kitces and Pfau published an interesting paper a while back. And there have been a few others over the years.

My AA change is quite modest ramping between 50/50 to 60/40 as CAPE10 drops from 25 down to 18, but we are so far above my top threshold of CAPE10 25 that I’ll be stuck at 50/50 for a long while yet unless there is a huge move down this year.

My AA was just a couple of percent higher when I switched, so it was a small change. In general it just means I’ll be slightly more aggressive than I would have been if CAPE10 drops below 24.

Do you plan on making any adjustment based on the tax bill? It seems like the lowered corporate tax rate should result in a “permanent” increase of earnings that will make CAPE10 lag by more than it normally would.

 

[copyright1997reloaded]

And then there are those that apparently should never be in the market due to a lack of comfortability who are scared $#!&less and need to go to Fischer investments or something along those lines and purchase their annuities.

I'm not a Ken Fischer client, but I thought he was anti-annuity: http://www.thinkadvisor.com/2015/10/26/why-ken-fisher-hates-annuities

 

[Pilot2013]

I'm not a Ken Fischer client, but I thought he was anti-annuity: http://www.thinkadvisor.com/2015/10/26/why-ken-fisher-hates-annuities

I've heard that, and I've heard the opposite, don't really know. But my point was....

 

[copyright1997reloaded]

I've heard that, and I've heard the opposite, don't really know. But my point was....

Yea, I get your point...but it is always good when an example *is* an example of the point.

 

[audreyh1]

Do you plan on making any adjustment based on the tax bill? It seems like the lowered corporate tax rate should result in a “permanent” increase of earnings that will make CAPE10 lag by more than it normally would.

No. Earning are earnings and PE will adjust naturally even though there is lag. I can’t anticipate what will happen, but it sure looks like massive earnings increases have already been baked in. And we don’t really know what corporate effective tax rates will be - they are already well under the stated marginal rate. Other factors could reduce earnings going forward such as higher wages or higher borrowing costs. Other market forces such as rising interest rates will probably force PE compression. It’s just way too complex.

Since the current CAPE10 is still way above my threshold I’m not going to worry about it anyway.

 

[kcowan]

In fact, most millionaires drive a Ford.

Great. With 2 Fords and a Nissan, I guess I am in great shape.

 

[frayne]

It certainly is interesting to go through this thread every day or so. What I can surmise:

There are those that are comfortable in the markets, and their allocation, and are mildly interested and watching.

And then there are those that apparently should never be in the market due to a lack of comfortability who are scared $#!&less and need to go to Fischer investments or something along those lines and purchase their annuities.

With 30K+ members I think we run the gamut of investing types. I also think for most folks here watching the market gyrations is kind of entertaining because we have been to this dance before. OTOH those getting close to or are considering retirement I can understand their apprehension as it is a major life event. Suggesting any types need to take the Fisher/annuity route is a bit condescending and disingenuous in my way of thinking.

 

[Pilot2013]

Suggesting any types need to take the Fisher/annuity route is a bit condescending and disingenuous in my way of thinking.

Suggesting I am being condescending with my statement is, well, condescending. I was just pointing out the "variety" of comments on an extremely long thread.

And as I mentioned on another thread, I STILL think the advice that i have been reading on here for all of the time I have been here, to use Firecalc and see what your current portfolio AA would have done over the last xx years, is very good advice.

Everyone is entitled to their opinion, but it is much better in most cases not to assume someones complete meaning in a written comment.

 

[redduck]

...And then there are those that apparently should never be in the market due to a lack of comfortability who are scared $#!&less and need to go to Fischer investments or something along those lines and purchase their annuities.

... Suggesting any types need to take the Fisher/annuity route is a bit condescending and disingenuous in my way of thinking.

Condescending, disingenuous and dangerous. With the 30,000+members plus all the guests that visit here, some might actually take you (Pilot2013) up on the Fischer/annuity investment advice.

Taking your advice, a Fischer rep. is scheduled to call me Monday at 8:30 AM. He wants me to have compiled a list of everybody I know that has more than $500,000 to invest. Friendly fellow, sounds like the wants to meet some of my friends and neighbors. Would you (Pilot2013) like to be included on the list?

 

[Pilot2013]

Taking your advice, a Fischer rep. is scheduled to call me Monday at 8:30 AM. He wants me to have compiled a list of everybody I know that has more than $500,000 to invest. Friendly fellow, sounds like the wants to meet some of my friends and neighbors. Would you (Pilot2013) like to be included on the list?

No thanks. As I have said several times, I am a good ways out from having to withdraw, so I am comfortable with my current situation and AA.

Sorry this current market has made everyone so touchy. Not trying to be condescending or (actually) suggest Fischer, just that some may need to re-evaluate their tolerance to market swings.

 

[GravitySucks]

This is the first test the market has thrown us since I changed my AA to 60/40.
Sleeping well.... So far.

 

[NW-Bound]

In fact, most millionaires drive a Ford.

Great. With 2 Fords and a Nissan, I guess I am in great shape.

No Ford for me at the moment, but a Mercury is close enough. Then, 1 Honda, 1 Nissan, and 1 GM.

The Lamborghini is reserved to sacrifice at the altar of the market god in case he demands it. He just did. Richer people had to sacrifice up to a Rimac in the past.