P/E ratios and an over-valued stock market: Retirement Bubble?

[TopHatFox]

I've been learning more about P/E ratios and how they, as far as I understand it, show that the US Stock market is currently overvalued; the cost of each share in a large and varied mutual fund is too high for the return. This over-value has been happening mostly since 401ks/IRAs were invented in the 1970's, incentivizing mostly boomers and Gen-Xers to blindly and likely mechanically place their money into, say, stock market mutual funds, regardless of what the fund returns (perhaps complying to keep HR and their run-of-the-mill financial advisers happy).

So, if the stock market's "value" keeps going up simply because boomers and Generation Xers are placing their money into it--thereby jacking up the price even if GDP, for example, remains stagnant or keeps up with inflation--wouldn't the value of the stock market plummet down in a sort of "retirement bubble" once boomers and eventually Xers retire en-masse and start selling their stocks? I suppose then it'd be the turn of millenials and even Generation Zers to buy; a generational wealth transfer of sorts.

[IlliniDave]

This line of thought has been around for almost 25 years now.

Other things have changed over the last ~50 years that affect the Shiller PE10 calculation besides the existence of tax-advantaged personal savings accounts (see second link below).

The first link below takes a more detailed look the Baby Boom generation as investors and what it might mean for equity markets. Some key takeaways:

-Boomer ownership of equities isn't much different than that of the age 55-64 cohort in the past
-Boomer ownership of equities is highly concentrated, meaning those that own the bulk of what's held by that age group are the least likely to be selling it off to make ends meet
-Foreign ownership of US stocks is steadily on the rise, so US demographics are not the only ones to consider.

There will almost certainly be another crash in equity prices sometime in the future. That's one of the safest blanket statements one can make in the world of investing. When and why tends to be what catches people off-guard.

Equity prices are a bit on the high side and it will probably be a long time before we see 11% nominal annualized returns again, maybe longer than some of our lifetimes.

https://personal.vanguard.com/pdf/s825.pdf

http://www.etf.com/sections/index-inves ... nopaging=1

[vraxxos]

Brooklyn Investor has a series of articles about the current state of the market. I recommend you read all three recent articles.

http://brooklyninvestor.blogspot.com/

As a whole, the S&P index is being driven by a few companies with nosebleed valuations. The majority of companies though are reasonably priced. I do think a theme has developed though where momentum and index funds are driving money into the mega cap companies. There is a growing problem in investing right now where the market as a whole is less driven by fundamentals and more driven by size.

Also, people talk about the US market being expensive. If you feel that way, there is a whole world out there with cheaper markets. Why limit yourself?

[Lucky C]

Yes, US stocks are overvalued based on the CAPE, which has plenty of investors arguing against it or arguing for a different way to calculate it. However, US stocks are also overvalued based on other metrics with high (inverse) correlation to future returns, such as:
- Crestmont Research P/E ratio
- Tobin's Q ratio
- Market cap to GDP ratio
- Hussman's market cap to gross value added

None of these valuation metrics tell us anything about an upcoming crash, just that the expected returns over the next decade or so are much lower than average. This can play out with or without a crash, but whatever path your returns take, you can expect close to zero real returns in the next decade - or at least much closer to 0% real than the historical 6-7% real.

Yes, demographic changes can help trigger a crash, but that's not all. The biggest drawdowns in the past have had nothing to do with demographic shifts. There's always the risk of a crash from some unexpected reason, but high valuations add the bonus risk of a larger expected drawdown when there is a crash, and baby boomers retiring adds the bonus risk of low returns on top of the already expected low returns due to high valuations.

The market could bubble up to record high valuations before it comes crashing down, or a crash could be imminent, or the market may just end up being less volatile than normal over the coming years. Whatever path it takes, the expected real return is about 0% plus or minus a few percent over the next ~10 years. I don't own any US stocks or US bonds right now, not because I'm worried about a crash, but because I'm confident that I can get better risk-adjusted returns with other investments.

Two questions:
If you're right about baby boomer retirements causing a stock market crash, are you comfortable holding US stocks at these valuations?
If you're wrong about baby boomer retirements causing a stock market crash, are you comfortable holding US stocks at these valuations?

[jacob]

This is a good intro to the CAPE or Market/GDP reversion school of investing: http://www.gurufocus.com/stock-market-valuations.php

The key problem for this strategy is to figure out which market/gdp ratio is the right (future) one. Historically, it's been about 80% for the US but since 2000, it stayed more around the 100% range. Other countries aren't much help in terms of outside comparisons. Switzerland has a really high ratio. Russia a really low one. It's all over the map.

[cmonkey]

I have my 401K in the S&P 500 stock index and have began getting increasingly uncomfortable with that as the S&P 500 keeps bumping up against record highs, as CAPE is sitting at 26+ and that TMC/GDP is so high.

The problem I have is that I am limited to only a handful of funds, but they do range across commodities, realestate, developing markets, etc. I can't pick individual stocks, so I am trying to develop more of a macro picture to see where each of these may go over the next decade.

I definitely want to move out of the S&P as it looks tapped out at this point. I'm sitting at 8+% YTD. It may go higher due to rising consumer spending (higher wages), but I think it'll be very small. Considering a split between commodities (which looks like it has bottomed) and RE. RE is being propped/driven by yield seekers so as long as the Fed keeps delaying hikes, this should continue. Commodities, I'm not so convinced but being as the US is showing signs of late cycle behavior, this might be the time.

[IlliniDave]

Man, real estate is a brave move right now, it's PE's are at about twice the SP500 and I think historically they tend to be lower.

Problem is that pretty much everything is expensive. I'm not making any big moves just yet but my new money is going into intermediate treasuries, EM, and cash (ostensibly to start funding next year's Roth IRA). If PE hits 30 I'll do a significant reallocation, and if it hits 36 I'll do every thing short of running and hiding. At least that's what my plan says.

[cmonkey]

I am also considering just a TIPS index. Turns out the commodities index isn't invested in commodity companies, its actually in the futures markets. That would be brave!

I'm not sure that comparing PE for REITs and other equities is apples to apples??

[jennypenny]

I'm all for capturing gains. I have good cash-equivalent options and use them at times (like now). OTOH, if you're up more than you anticipated, is there a need to move? Will you still be around where you hoped to be, even with a pull back, and without moving any money around or incurring any fees (or stress)? It looks like I moved into cash too early and if the market continues to run up, I'll have potentially missed out on gains, even with a pull back.

Does that make any sense? I feel like it doesn't lol.

[cmonkey]

Yes that makes sense. My thinking is being driven by the flat returns since QE ended back in Nov 2014. I put my cash into the S&P back in Sept 2015 when it had gone down a bit and so I made out pretty well. But at this point I don't see much to support the S&P going much higher.

The RE index looks pretty good, but the top holdings (SPG, PSA, HCN...) are coming down off of some exuberance so 6 months wait might be good...

[IlliniDave]

Pull-backs/corrections don't bother me, I don't try to game those (unless a TLH opportunity presents itself--every nickel I can legally deny the gov't is a good nickel to me), they happen too often and they're difficult to predict. What you're saying makes sense to me. It would probably take a loss of almost 10% in equities to get me down to my desired AA after this Feb-Aug surge. And what I'm sort of doing is avoiding additional purchases of US equities until things settle themselves out and letting things ride in the meantime. But I have my limits. I have decided that I'll probably re-balance in Q4 of this year, and take more speculative action if either of the aforementioned PE thresholds get crossed. In terms of dollars I might get a little behind, but unless the stock market falls and never rises again, I'll get it back someday.

[Riggerjack]

I have a horrible record at individual picks. My last was GASS at 6.21, for the record.

I sold out of my 401k index funds in Feb, down 8.5% on the year at that point, but up overall. Not because a little 8.5% drop was scary, but because I thought it would drop more, and I wanted to buy on sale.

Well we all know how that worked out. Since, I have range traded in company stock, and did well, but the risk reward is off.

I bought into a British pound ETF after brexit. Made a few percent in a few weeks.

Now, my big crazy idea is JJG. An ETF in grains future contracts. Now, I've never played with commodities, nor futures, please factor that in, if you think of following me...

Right now, we are experiencing an anticipated bumper crop, and wheat and corn prices are very low, soybeans are just low.

JJG is under 30$, and has spent quite a bit of time above 60$. Trace prices of commodities back before the formation of JJG, and it still looks very good. It has an expense of 0.75%. So, I am buying and holding, waiting for a bad crop, or a stock market correction. When I bought, $SXP:JJG was 76.

My thoughts are that JJG is far more volitile than the stock market, and currently very low. If the market takes a hit, commodities go up. If next year's crops are not as good, price goes up. The only way I lose, is if stocks climb further and faster than JJG, most likely caused by ever increasing crops. That seems far more unlikely than continual growth beyond record valuations.

In looking for something not inflated, this is what I found. Buy low, sell high, and all that.

Maybe I've watched Rudy too many times, and have a skewed idea of risk and rewards...