It is time to get Very BULLISH !

[CorpRaider]

From what I've read Ray is busy with an internal pissing contest/voting campaign.

 

Nah. I used to work there - that's just how things are and the media is likely blowing it way out of proportion. There were regular internal spats, even high up, when I was there and they were generally resolved reasonably.

 

Interesting.  Thanks for sharing.  So did you make it to "the other side"?

[watsa_is_a_randian_hero]

The U.S. "market" doesn't seem especially cheap to me based on CAPE, Tobin's Q, Trailing P/S, P/B, etc...

[/quote

What's your fair value or intrinsic value for the "US market" before you dip your toes to buy the index ?

 

Caveat - posting this as devil's advocate argument - not necessarily something I fully believe myself

 

(1) Download Shiller PE data from his website

(2) Invert CAPE (so it is an earnings yield)

(3) take difference between earnings yield and long term interest rates (in his dataset, column G)

(4) Median difference between CAPE earnings yield and long term interest rates over 135 years is 2.16%.  We are currently at 2.24%, implying the market is slightly cheaper than its long term average.

 

Also, another devil's advocate argument for this is that this dataset begins in 1871.  The US was an emerging market at that point.  So much is different today in terms of financial controls, governance, regulations, liquidity, transparency, data availability, costs of trading, precedents for certain events existing that the US market today is very different than it was in the 1800's or early 1900's and deserves to trade at a premium. 

 

Think of where China is today and where it might be 50 years from now - if it progresses in terms of financial controls, governance, regulations, liquidity, transparency, data availability, costs of trading, etc, won't it deserve to trade at a premium to the CAPE it trades at today? 

 

It always baffles me that people think that a historical dataset is gold and that things must revert to the same mean through all of history...

 

That said, my personal take on it is that many pockets of the market feel rich (notably US large caps), but value can be found in many areas. 

[bbarberayr]

Anyone who pays attention to CAPE has missed out on one of the best bull markets in years (look at John Hussman).  It is not a useful metric and I would say the 10 year timeframe was arbitrarily picked to support a theory.

 

Many stocks are quite cheap now and, unless we are getting into a recession, which seems quite unlikely, this downturn is closer to the end than the beginning.

 

I wouldn't say it is time to get "Very BULLISH", but if you have a longer timeframe, you want to be looking for places to buy.

[CorpRaider]

They posture was "get very bullish", not should i go to cash if CAPE exceeds median or any of these other strawmen.  Also, did someone above just basically say we are at a "permanently higher plateau" for equity valuations?  I've heard that before, somewhere... :D

 

Selection of 5 or 7 years for earnings smoothing period yields similar results from what I've read.  Didn't Graham use a five year period?

[petec]

 

How can you not be bullish when you see how much under-utilized capacity there is in European economies?

 

Because that excess capacity is indicative of a demand problem and the very real potential for a deflationary cycle - not good for equities either.

 

 

Quite.  I seem to remember excess capacity in Miami condos turned out not so bullish, not so long ago.

[petec]

Interesting because even in this thread negativity abounds...

 

...but not on this board... http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/recession-in-2016/

[bbarberayr]

Great article on CAPE and why it is not a useful predictive model:

 

"At around 20 years, the correlations start to break down.  By 30 years, no correlation is left.  What we have, then, is clear evidence of curve-fitting.  There is a coincidental pattern in the data from 1935 to 2004 that the model latches onto.  At time horizons between roughly 10 years and 20 years in that slice of history, valuation and growth happen to overshoot their assumed means in equal and opposite directions, such that the associated errors cancel, and an attractive fit is generated.  When different time horizons are used, such as 25 years or 30 years or 35 years, the overshoots are brought into a phase relationship where they no longer happen to cancel.  With the quirk of cancellation lost, the correlation unravels."

 

 

http://www.philosophicaleconomics.com/2014/06/critique/

[petec]

Great article on CAPE and why it is not a useful predictive model:

 

"At around 20 years, the correlations start to break down.  By 30 years, no correlation is left.  What we have, then, is clear evidence of curve-fitting.  There is a coincidental pattern in the data from 1935 to 2004 that the model latches onto.  At time horizons between roughly 10 years and 20 years in that slice of history, valuation and growth happen to overshoot their assumed means in equal and opposite directions, such that the associated errors cancel, and an attractive fit is generated.  When different time horizons are used, such as 25 years or 30 years or 35 years, the overshoots are brought into a phase relationship where they no longer happen to cancel.  With the quirk of cancellation lost, the correlation unravels."

 

 

http://www.philosophicaleconomics.com/2014/06/critique/

 

Will read - but it is curious that Tobin's Q and other basic measures of valuation have similar back-tested predictive records.  If they don't, then starting valuation has nothing to do with future returns, in aggregate.  Do we really believe that?

[TwoCitiesCapital]

Great article on CAPE and why it is not a useful predictive model:

 

"At around 20 years, the correlations start to break down.  By 30 years, no correlation is left.  What we have, then, is clear evidence of curve-fitting.  There is a coincidental pattern in the data from 1935 to 2004 that the model latches onto.  At time horizons between roughly 10 years and 20 years in that slice of history, valuation and growth happen to overshoot their assumed means in equal and opposite directions, such that the associated errors cancel, and an attractive fit is generated.  When different time horizons are used, such as 25 years or 30 years or 35 years, the overshoots are brought into a phase relationship where they no longer happen to cancel.  With the quirk of cancellation lost, the correlation unravels."

 

 

http://www.philosophicaleconomics.com/2014/06/critique/

 

Will read - but it is curious that Tobin's Q and other basic measures of valuation have similar back-tested predictive records.  If they don't, then starting valuation has nothing to do with future returns, in aggregate.  Do we really believe that?

 

Are we really suggesting that because CAPE isn't relevant over a 30-year period that it's not relevant over a 7-10 year period either? I guess since stocks have gone up for the last 100 years, there's no reason to every worry about valuation or potential down years.

[ni-co]

Great article on CAPE and why it is not a useful predictive model:

 

"At around 20 years, the correlations start to break down.  By 30 years, no correlation is left.  What we have, then, is clear evidence of curve-fitting.  There is a coincidental pattern in the data from 1935 to 2004 that the model latches onto.  At time horizons between roughly 10 years and 20 years in that slice of history, valuation and growth happen to overshoot their assumed means in equal and opposite directions, such that the associated errors cancel, and an attractive fit is generated.  When different time horizons are used, such as 25 years or 30 years or 35 years, the overshoots are brought into a phase relationship where they no longer happen to cancel.  With the quirk of cancellation lost, the correlation unravels."

 

 

http://www.philosophicaleconomics.com/2014/06/critique/

 

Will read - but it is curious that Tobin's Q and other basic measures of valuation have similar back-tested predictive records.  If they don't, then starting valuation has nothing to do with future returns, in aggregate.  Do we really believe that?

 

Are we really suggesting that because CAPE isn't relevant over a 30-year period that it's not relevant over a 7-10 year period either? I guess since stocks have gone up for the last 100 years, there's no reason to every worry about valuation or potential down years.

 

I agree. Sounds like he's really overthinking it. The Shiller PE, that was invented by Ben Graham btw., is just that: a (smoothed) PE. Is he really arguing that a PE is irrelevant for the forward returns of a stock on average?

[petec]

 

Are we really suggesting that because CAPE isn't relevant over a 30-year period that it's not relevant over a 7-10 year period either? I guess since stocks have gone up for the last 100 years, there's no reason to every worry about valuation or potential down years.

 

Quite.

 

It's absurd to believe that P/normalised earnings on an individual stock basis might be meaningful (and as value investors we all believe that) but P/normalised earnings for the market isn't.

[ni-co]

At around 20 years, the correlations start to break down.  By 30 years, no correlation is left.  What we have, then, is clear evidence of curve-fitting.  There is a coincidental pattern in the data from 1935 to 2004 that the model latches onto.

 

Ok. I think his curve fitting test example is just bananas. 30 years is a much too long time frame when you think about the average lifecycle of a company. In 30 years everything can happen.

[TwoCitiesCapital]

 

Are we really suggesting that because CAPE isn't relevant over a 30-year period that it's not relevant over a 7-10 year period either? I guess since stocks have gone up for the last 100 years, there's no reason to every worry about valuation or potential down years.

 

Quite.

 

It's absurd to believe that P/normalised earnings on an individual stock basis might be meaningful (and as value investors we all believe that) but P/normalised earnings for the market isn't.

 

If anything, the later should be MORE useful as it's an average and the idiosyncratic risks would largely cancel out to give you a more meaningful understanding of the valuation of the market. I understand that the CAPE is a terrible timing metric - probably for many of the flawed assumptions pointed out in that article.

 

But what I can't wrap my head around is that every single long-term indicator, that has shown past predictive power for 7 and 10 year forward returns, suggests that we are significantly over valued and at risk of a 50-70% drop just to reach longer-term averages (without assuming a recession, economic destruction, etc). and that we write it off because what is meaningful over a 7-10 year period in markets doesn't appear to be meaningful over a 30 year period in markets?

 

I'll give you some evidence why it may not be meaningful over 30 years - because we have a Federal Reserve that manipulates markets and blows bubble after bubble to prevent the damage from the last one bursting, compounding the damage that each future bubble causes. At the valuations in 2000, 30-year forward returns would have probably been pretty terrible if we just left things alone, but instead the Federal Reserve blew the real estate bubble to preserve asset values and now we have a risk-asset bubble that is being blown. If this thing collapses by 50-70%, you can be damn sure the 30-year returns from 2000 will still be terrible and that the model will fit again over a 30-year time frame, but we're just not there yet.

 

Also, the article suggests that the data from 30-year periods should be a tighter fit because it averages out the extremes, but I don't know if I buy that either. The CAPE is already supposed to be smoothing out extremes in valuations/profits so to do so again by extending the duration seems like it might be overkill. Further, there are far fewer 30-year periods witnessed than 10-year periods suggesting that a single occurrence of the model being "wrong" has a much larger impact on the overall fit and reliability than does a 10-year period in which it was "wrong." Granted, it should have a larger impact if the model was wrong over a 30-year period, but my point is that you have 1/3 the data points and that the current impact may be very, very exaggerated.

[CorpRaider]

Yeah I read his stuff.  If memory serves, this was actually about Hussman's use of the data set and his strong consclusions derived therefrom (Shiller never does this) this blogger later went on last year with a much more detailed and focused set of posts about the CAPE and potential/alleged problems with it and attempted to revamp the CAPE only to conclude it worked as is (as well as anything does).  I do not make dramatic changes based on overall valuation metrics (don't want to sit on the sidelines for the entire decade of the 90's); maybe I should ignore them.  In the end, however, I think returns are going to be a function of the earning/potential cash flows generated by the investment and changes in valuation thereof (just like they are in treasuries, real estate, gentlemen's clubs, ok maybe not gentlemen's clubs, etc...).

 

Also, can I just say Nobel > Wordpress?  haha. Just kidding, I love this guy's blog, but Shiller's hair....

[petec]

Yes - having actually read the piece (sorry!) it's entirely about Hussman's model for predicting future returns and not about CAPE.  CAPE is merely one possible input to that model.

[TwoCitiesCapital]

Food for thought - AXP now trades for the same price it traded for back in 2000. That's 16 years of 0 price return and a paltry dividend. It's 10% below where it traded in 2007. A negative return price return over 8 years! That's what equity bubbles do - destroy value measured in decades. The general market in 2015 was more expensive than the general market was in 2000...

 

You could say I'm cherry picking a top - but it's to prove a point. Valuations matter and the CAPE was screaming terrible value long-before 2000 and not just for tech. Sure, you can make the argument that anyone who watches CAPE missed the entire rally from 2009. Realistically, if they followed CAPE religiously, they've missed everything since 2000 and did way better in bonds than equity holders did over that entire 16 year period. I don't think they'd be too mad about that. Missing the rally isn't that bad when you miss the subsequent bust as well. Also, we likely haven't seen equity market lows because we haven't seen a recession or multiple contraction yet.

 

Further, AXP isn't the only company exhibiting this type of weakness. Energy is there. Materials are there. Retail is there.

 

We're back to registering 0 price returns over a decade plus for many equities AFTER a 7-year bull market that saw values more than triple and only a 12% correction in the index? Something seems seriously wrong with that picture. You can look at this and twist it to be very bullish or see it for what I believe it is which is a warning sign.

 

If equities could have gone nowhere for 16 years since 2000, and the general market is more expensive than it was in 2000, then we could go easily another 16 years with 0 returns again for the general market. I doubt that we get to those 0 returns by staying flat for the next decade plus...

 

 

[scorpioncapital]

Didn't the Dow Jones go nowhere the same way from the mid 60s to the early 80s? About the same period of time. Not sure if it's necessary to forecast another 15 years of the same though...

[TwoCitiesCapital]

Didn't the Dow Jones go nowhere the same way from the mid 60s to the early 80s? About the same period of time. Not sure if it's necessary to forecast another 15 years of the same though...

 

I'm not necessarily forecasting another 16 years of the same, but I'm saying that's the result of the 2000 bubble and 2015 was more expensive on a general market level. Maybe it's not another 16 years of 0 returns. Another 8-10 would still be terrible. Especially since investors may not be able to hide out in bonds this time around given that yields are negative in much of the short-to-intermediate universe.

[CorpRaider]

EAFE is like in the 25% percentile cheap....just saying.

[watsa_is_a_randian_hero]

EAFE is like in the 25% percentile cheap....just saying.

 

same with EM

[CorpRaider]

Yeah I'm making like a chinese SOE and buying foreign assets before my currency craters.  But it isn't without pain.

 

I don't trust most EM for direct investment.  Brazil is the country of the future....and it always will be.  ;D  I like a few years of capitalism and some cultural traditions around property rights; lack of tolerance for rampant corruption, at least outside of FIFA.

[TwoCitiesCapital]

EAFE is like in the 25% percentile cheap....just saying.

 

same with EM

 

Exactly.I'm still a net buyer every month of European and Emerging Market assets. On a CAPE basis, EM has only been cheaper like 4% of the time. The U.S. on the other hand is the 94th percentile of its valuation range on a CAPE basis...

[Graham Osborn]

Also, another devil's advocate argument for this is that this dataset begins in 1871.  The US was an emerging market at that point.  So much is different today in terms of financial controls, governance, regulations, liquidity, transparency, data availability, costs of trading, precedents for certain events existing that the US market today is very different than it was in the 1800's or early 1900's and deserves to trade at a premium. 

 

Think of where China is today and where it might be 50 years from now - if it progresses in terms of financial controls, governance, regulations, liquidity, transparency, data availability, costs of trading, etc, won't it deserve to trade at a premium to the CAPE it trades at today? 

 

Yes and no.  China (let's continue calling it an emerging market for the sake) gets a discount for the transparency issues you mention but historically a growth premium for GDP growth (the market's assessment of how much of that was inflated/ leveraged determines the discount).  Since the US is maturing we deserve LESS premium for growth and more for ?more transparency.

 

Once China cleans up their act they'll get a real premium.  Then macro funds will have the ride of their lives reversing the dollar/ yuan trade.  I'm not optimistic in the near term though.

[Graham Osborn]

Anyone who pays attention to CAPE has missed out on one of the best bull markets in years (look at John Hussman).  It is not a useful metric and I would say the 10 year timeframe was arbitrarily picked to support a theory.

 

Many stocks are quite cheap now and, unless we are getting into a recession, which seems quite unlikely, this downturn is closer to the end than the beginning.

 

I wouldn't say it is time to get "Very BULLISH", but if you have a longer timeframe, you want to be looking for places to buy.

 

I gotta agree.  CAPE is a number like any other, but 10 years isn't long enough to average even if you think of the classic cycle as lasting under 10 years which has its own set of problems.  But if you can't average over 10 years can you average over anything?  What does "average" even mean.  If you want to beat yourself over the head with such questions I strongly recommend Antti's Expected Returns.  Anyway, the PE as a market measure has the gaping hole of ignoring leverage which is a key cyclical variable.  One of my many "nice to haves" is a plot of EV/ Rev for the last 100 years (unfortunately companies have gotten awful good at excising "restructuring" charges from EBIDTA as well, but, sans SPEs, debt is harder to hide).

[randomep]

 

 

adding my 2 cents here.......

 

For all the talk about CAPE, we must be mindful of the 10yr interest rate which Schiller includes in his data. It has rarely if ever been this low. Buffett said the future is great for stocks if interest rates stay this low.  And I firmly believe this is the case.

 

Another fact is that the world is awash with money but inflation for consumables isn't there. But there will be inflation of investments assets. So there is money to be made despite low GDP growth.