Shiller PE at 31.49

[Lucky C]

The Shiller PE would never have this 70.91 data point as part of its calculation. You are implying it's an average of a series of P/Es from the past 10 years, but it's actually the current price divided by the average of just the earnings over the past 10 years.

Earnings were abnormally low in late 2008 / early 2009, but they are also abnormally high now. Since 2014 we have seen >10% profit margins in the S&P 500, which was not achieved in previous market cycles. This multi-year span of abnormally high profits could result in a lower CAPE than maybe it "should be," moreso than the poor earnings in the recession could result in a higher CAPE than it "should be." Or maybe these two abnormally low & high earnings scenarios more or less cancel each other out, which would mean the CAPE is serving its job as a smoothing function nicely.

[arcyallen]

Lucky C: I consider myself a pretty smart guy when it comes to investing details, but you're right. Despite me doing a lot of research on what it is and what data is used, I was assuming an incorrect formula for calculating the Shiller PE. Thanks for clarifying.

liberty: Relax. I -was- referring to the trailing 12 month PE. Usually if someone refers to a PE generically they're referring to the trailing 12 months, or sometimes the estimated forward.

I think one of the reasons I like this forum over others is that it seems more civil. Thanks Lucky C for keeping it that way.

[Seppia]

Either way, staying the course and not trying to time your investments based on sentiment is the only way to go. If everyone is giddy, or sad, or whatever, it's just noise.


Having said that, if everyone (aka Mr. Market) is super sad and willing to sell you their investments ridiculously cheap and you happen to have the money, buy!

These two statements seem to be at least partially in contradiction. If you can tell when it's cheap you can also tell when it's expensive.

I'm personally in the camp of "timing the market is impossible, but I try stay a little more prudent when valuations are historically way above the norm, and aggressive anytime else".
By any possible value measure, US stocks are now very expensive. Doesn't mean they can't go up even more, but the chances of having the "historically average" 6.5% real returns over the next 10-15 years at these levels are very slim.

[arcyallen]

I agree that sounds a bit contradictory, it accurately describes my sentiments. I think if you have access to cash after a large market drop it's perfect to go all in on stocks. That's rare, but for an example in 2008 I was tempted to sell a car to invest the cash. I wouldn't do that today!

What I'm finding now is people moving to cash for some of their investments, so they'll have "dry powder" after the next correction. That sounds good but just doesn't work. There's too much to lose between now and then.

Stock market valuations are a funny thing regarding "cheap and expensive". As their prices over time are always going up generally, expensive today will likely be cheap ten years from now. If someone sold today at apparently expensive prices and the market went up only 1-2% a year, those same expensive/sell prices would be looking pretty attractive! But we can't tell what's going to happen over the next few years.

[classical_Liberal]

...

[Seppia]

What ERN analysis on cash cushions is missing, in my opinion, is the psychological aspect.
I know that at least for me, having some "dry powder" is of great help in avoiding panic selling.
I lived through it in 2008-9 (though with much less money than now), and having that extra cash to buy Axa stock at 15€, then at 10€ and lastly at 5,9€ when I initially had bought it at 20€ helped me stay sane and avoid stupid mistakes.

I ended my 2017 saving 75% of what I make, and I now have a relatively large sum of money invested (around 20 years of expenses). A few percentage points of missed gains are nothing if thanks to that I can "buy" downside protection.

I think (maybe because there's so many engineers?) that the ERE-FIRE communities often underestimate the impact their brains/instincts can have on their future behavior.
It's very easy to "stay the course no matter what" when your investing life started after 2009.

[liberty]

@arcyallen I see. Should have phrased that differently - sorry.

[classical_Liberal]

...

[Farm_or]

@sepphia Well put. Living through the 40% decline was different from looking at the graph after the fact.

I still remember the distraught of my peers riding the coaster down. On the graph, it doesn't look that long before that 40% came back, but it seemed a lot longer while the stomach acids were eating ulcers.

[frommi]

Now since a lot of you guys believe in indexing and EMH, does it make sense to worry about the Shiller PE?
If the market is efficient, can there be an overvalued market?

[IlliniDave]

Now since a lot of you guys believe in indexing and EMH, does it make sense to worry about the Shiller PE?
If the market is efficient, can there be an overvalued market?

Those don't necessarily go hand-in-hand. The champion of indexing, Jack Bogle, is "skeptical" towards the EMH, for example.

Also "efficient" and "accurate" are not synonyms. FWLIW, my way of thinking about EMH is that it would assert securities are continually priced in accordance with the aggregate belief of market participants based on all publicly available information. That doesn't mean market participants are not incorrect, or that new information (or other stimuli) won't come along that drastically changes the aggregate opinion.

People that like to own index funds come in many stripes.

Those that are devoted to "buy and hold" would say don't worry about Shiller, studies show that historically people who try to time the market underperform noticeably in the aggregate. If you're investing for the long haul you're better off just closing your eyes and gutting it out. If you're in it for the short run, your stock exposure should be low enough that a tumble won't hurt too much.

Those who are a little more fidgety (like me) might change their AA moderately to lean away from stocks (something I am doing) but not bail entirely, despite what those studies say.

Others will bail entirely. Too many will do so after the plunge if that turns out to be the scenario that will cause valuations to unwind.

I think the main value of something like the Shiller pe (or similar metrics) is that it is a decent way to gauge future returns if you want to look over a 10-20 year horizon. When it's high, returns in the next decade or two will probably be lower, if it is low the converse is true. I recently redid my forward-looking planning number and came up with something 2% real for stocks over the next 15ish years (assuming the period ends with Shiller PE at 22, which is just a blatant guess on my part, but not unreasonable). Pretty bleak and it has me looking at adding another year or two to my work life beyond my current planned date.

I buy index funds because the drag of management costs is about as low as it gets, and their tax efficiency is typically very high in comparison to higher turnover funds. There really is no magic to them, or folly if properly understood. They are just baskets of stocks (or bonds). They don't need "strong" EMH to do their job.

[frommi]

I was just trying to be a bit provocative. I use Tobin`s Q, Shiller P/E, Marketcap/GDP and Trendline regression to define a fair value for the stock market and adjust my net long exposure according to that measure. All four methods point to overvaluation of roughly 40%-45% right now, so it is not just the CAPE ratio alone. I am just a little amused by index investors that talk about market timing.
At the moment most of my money flows into REIT`s, asian value stocks and shorts.
I am not sure if just working longer does it, that one year can turn out to be 4-5 years, because you won`t earn money on your invested funds when your forward market return estimation is true. Doesn`t it make more sense to use the time to learn about how to find investments with higher returns?

[IlliniDave]

I am just a little amused by index investors that talk about market timing.

Why? Index funds are just portfolio pieces, not religious vows. I don't know if it is still true, but at one time recently SPDR was among the most frequently traded securities in the world. Maybe it was at the top.

I am not sure if just working longer does it, that one year can turn out to be 4-5 years, because you won't earn money on your invested funds when your forward market return estimation is true. Doesn`t it make more sense to use the time to learn about how to find investments with higher returns?

I don't have any idea how much my investments will go up or down in the next year or two ("irrational exuberance" was called 4 years before the markets actually unwound). I won't bore you with all the details, but once I get beyond the minimum retirement age at my employer, my pension goes up rapidly each year I delay taking it. Plus, each year I wait is one year I don't need the portfolio to support me. 5 years from now (3.5 after my planned exit date) I would not need to spend a penny of my portfolio and would be adding to it from excess pension income (and later SS). So it's just a matter of finding a comfortable place on that curve that balances with lower expected returns. All my plans were drawn up with a 3.5% expectation, so a little under 2% (to account for bonds detracting from a guess of 2% for stocks) is not all that far off.

I've been at this investing thing for a long time, and know my strengths and shortcomings pretty well. I don't think in a year or two I'm going to discover some new thing to invest in that will meet my willingness to take risk at this juncture and provide superior returns. All my new money is going into bonds. The nice thing about them is that although they won't make me rich, they are predictable (since I don't trade them). Once I get a big enough pile of them that they dovetail with the pension I should be good. If I go beyond that it means I've succumbed to greed.

[frommi]

I think the main value of something like the Shiller pe (or similar metrics) is that it is a decent way to gauge future returns if you want to look over a 10-20 year horizon. When it's high, returns in the next decade or two will probably be lower, if it is low the converse is true. I recently redid my forward-looking planning number and came up with something 2% real for stocks over the next 15ish years (assuming the period ends with Shiller PE at 22, which is just a blatant guess on my part, but not unreasonable). Pretty bleak and it has me looking at adding another year or two to my work life beyond my current planned date.

I buy index funds because the drag of management costs is about as low as it gets, and their tax efficiency is typically very high in comparison to higher turnover funds. There really is no magic to them, or folly if properly understood. They are just baskets of stocks (or bonds). They don't need "strong" EMH to do their job.

I apologize, i shouldn`t have started this discussion. I always forget that there are people out there that are not interested in investing and that are using index funds for convenience. Thats fine!

[bryan]

Now since a lot of you guys believe in indexing and EMH, does it make sense to worry about the Shiller PE?
If the market is efficient, can there be an overvalued market?

Two economists are walking down the street and one of them notices what appears to be a $20 bill (or a $100 bill—the monetary amounts vary) on the sidewalk. “It’s not a real $20 bill,” the other economist declares. “If it were a real $20 bill, someone would have picked it up off the sidewalk already.” (a joke that's been around since '84)

I like to think of "Efficient Market Hypothesis" as an economist (misnomer) joke. I (and probably everyone else since it was coined) use the term as short-hand to communicate that certain meaning, concept. If one actually "believes" in it...

As for "can there be an overvalued market", it depends on whose viewpoint, knowledge, prediction you take.

[IlliniDave]

I apologize, i shouldn`t have started this discussion. I always forget that there are people out there that are not interested in investing and that are using index funds for convenience. Thats fine!

How many people who are not interested investing take the time to make forward-looking estimates of equity returns based on the Shiller PE or even know what the Shiller PE is or how to make the calculation reasonably?

No need to apologize. In general I am quite interested in investing and enjoy talking about it. I think the majority of my participation on this site is in discussions related to investing. I recently mentioned in a different thread that for many years I was engaged in trying to "beat the market". In 30 years I've come out about 0.2% ahead of the SP500. I am skeptical that I can equal that going forward, much less beat it. The reason is that I'm hitting that stage in life where my temperament will not allow me to simultaneously take as much or more risk as I did as a younger man with decades of professional employment ahead and, as they say, sleep well at night. Exposing myself to potential losses larger than I can afford for maybe 0.1% or 0.2% of extra return doesn't make sense.

I did not voluntarily get into index funds. A number of years back my employer redid the roster in the 401k plan to include only low cost funds, the majority of which are index funds. Prior to that they did the "performance chasing" dance of selecting funds with high Morningstar ratings and then dumping them a few years later when the returns inevitably began to lag. When Morningstar themselves concluded that their own ratings were poor predictors of relative future performance, and that the only reliable predictor of relative future performance they could find was the cost of the fund, my employer made the switch. Jack Bogle calls this (sort of tongue-in-cheek) the "Cost Matters Hypothesis", and CMH, rather than EMH, is the secret sauce to index funds, insofar as there is one.

I was initially angry about the makeover. I did not want to quit my job and the plan does not allow in-service rollovers into an IRA, so I was stuck. This happened 2 months after my idle daydream of early retirement solidified into The Plan. My 401k was a substantial component of that plan so I was at least interested enough in the topic of investing that I spent several months investigating index funds.

An interesting side note: index funds in a roundabout way led me to bogleheads.org. After a while there I began to feel like a resident of the Island of Misfit Toys because my plan to retire early was based much more on an ability to be content/happy with a frugal life than amassing a great fortune at a young age. There is a small minority of frugal souls over there and long story short, participation there is what ultimately led me here, after I heard whispers of this guy named Jacob who was like MMM on steroids.

Anyway, I'm veering too far off topic. In time I concluded I could make things work with index funds, and as a few years have passed I've concluded further that they are the best choice for me for the core of my portfolio. The point being: it wasn't laziness or disinterest that led me to that conclusion.

I'm not sitting with all my money in an SP500 index fund (the universal straw man of owning index funds). I don't consider my portfolio to be sophisticated, but beyond the standard US total market exposure, I have significant equity exposure to overseas developed markets, emerging markets, and US small caps. So within my willingness to put my money at risk, I'm making some plays for a little extra return. But I'm also increasingly concerned about stability, so I'm incrementally ratcheting up my bond holdings. That's a painful thing for me to do. It's a substantial drag on the return of my portfolio but it is something that in all likelihood will limit my downside risk. I'm coming into the phase of my investing life were I am most vulnerable to sequence of returns risk.

The one place I do throw caution to the wind and allow myself to have a little fun indulging in trying to beat the market is in my little backdoor Roth IRA. So far in 5 years the approximate score is SP500 15.5%/yr, iDave 9.9%/yr. Five years isn't very long, but when I look at that tally and contemplate leaving work under conditions dependent on me beating the market for success, I get a little queasy.

For all that I recognize that there are many roads that lead to Dublin and that the approach to investing that works best for me is only that. What is truly optimal is only knowable in hindsight. My personable belief is that for the vast majority people successful investing is much more a game of behavior and emotion than of intellect. The conclusion from that is different people can reasonably come up different approaches that are both best suited for them and reasonably likely to lead to successful outcomes. I don't consider other approaches "wrong". I hope everyone here has successes beyond their wildest dreams with their investments. That said, I admit to having a bit of a compulsion to rise and take the bait when I see little quips tossed around implying people who use index funds as an element of their financial strategy are an inferior species. But to me it's all in good fun and is educational. I don't need or want a safe space when my ideas are challenged. A little fire refines and strengthens them.

Last thing (I promise!) is that I anticipate a time in the future where I will not want to spend any meaningful portion of time managing investments. For me investing is a means to an end, and as the end is realized my patience for allowing the management task to detract from it will wane. There are a few things I might try for fun. I've never bought a stock in my life (only mutual funds/investment trusts). Someday I might take a little dollop of my taxable account money and make a game of trying my hand at putting together a little stock portfolio. It seems like a healthier activity than going to Las Vegas. But the part of the stash that will be keeping me warm and fed I foresee gradually maneuvering so it can operate on near-autopilot.

[ThisDinosaur]

+1 IlliniDave
I buy index funds for the low cost diversification, not because I believe in strong EMH.

[arcyallen]

Why? Index funds are just portfolio pieces, not religious vows.

It's been my experience with most indexers that it's MORE than a religious vow! Even if you give every reason in the world why there may be a better alternative, most just put their fingers in their ears rock back and forth and repeat "No,no,no" over and over...

[IlliniDave]

Why? Index funds are just portfolio pieces, not religious vows.

It's been my experience with most indexers that it's MORE than a religious vow! Even if you give every reason in the world why there may be a better alternative, most just put their fingers in their ears rock back and forth and repeat "No,no,no" over and over...

Maybe it is not their ears, but the list of reasons. My experience has been that most people who try to talk people who buy index funds out of them really don't understand what index funds are, nor do they understand the goals of people who buy them. If I'm putting on my Muck boots to go work in the garden and somebody tells me they are no good for sailing so I should change into something else, I'm unlikely to give them much of my attention.

[liberty]

@IlliniDave you don't need to take on more risk in order to beat the market. Trend following, for example, gives (slightly) higher returns with much lower risk. Why not choose a rule based strategy (that has worked historically) and follow that?