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Jeremy Siegel: Don't Put Faith in Shiller PE Ratio


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In stocks for the long run Siegel uses more than a century of data to explain why stocks are where to be all the time but then he says to ignore Shiller P/E because they are lower pre-1990? I remember that Munger called him demented a while ago (at a Berkshire annual meeting): http://www.valuewalk.com/2012/02/charlie-munger-i-think-jeremy-siegel-is-demented/

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it's true. the shiller p/e ratio is simply a device of the bears. market could care less about it.

 

The market could care less about a lot of things. It didn't care about the increasing volume of defaulting mortgages in the U.S. in 2006. Value investors prosper from situations that the market doesnt care about. I think we can certainly agree the market isnt always right. It's been above average for two decades and in the last 13 years we've had two 50% corrections in the U.S. with the tobin's Q and the Shiller P/E suggesting that we might see another one soon. I think it's dead on.

 

In stocks for the long run Siegel uses more than a century of data to explain why stocks are where to be all the time but then he says to ignore Shiller P/E because they are lower pre-1990? I remember that Munger called him demented a while ago (at a Berkshire annual meeting): http://www.valuewalk.com/2012/02/charlie-munger-i-think-jeremy-siegel-is-demented/

This. +1.

 

In our lives we we see dozens of small cycles, but only a few of the overarching ones. Bear markets and bull markets that last 20 years often times encompass the majority of a manager's investment experience until they believe the last 20 years represents the norm. We had stock valuations that were way out of wack in 1998-2000 to skew the results of much of the past decade. Now you have had the Federal Reserve maintaining 0% interest rates for last 5 years also arguably inflating stock market indices. Is it any wonder that the last 20 years have remained above average and have been punctuated my massive corrections?

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Guest wellmont

I don't see market timing working very well. but others may find some enjoyment in it. hasn't really worked that well for followers of tobin, shiller, and of course Koo. I think one of the most rational guys looking at market valuation is Omega. the other is oaktree. both think we're pretty close to fairly valued at the moment.

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I don't see market timing working very well. but others may find some enjoyment in it. hasn't really worked that well for followers of tobin, shiller, and of course Koo. I think one of the most rational guys looking at market valuation is Omega. the other is oaktree. both think we're pretty close to fairly valued at the moment.

 

Look Wellmont I just do not want to argue with you and spend too much time on this but who spoke of market timing here? It is just a measure of valuation that tries to take away the influence of the earning cycle.

But since you spoke of people that are rational what about market cap to GDP since it is a Buffett approach? It's at 120% right now: http://www.vectorgrader.com/indicators/market-cap-gdp. Maybe the 67% median value doesn't mean anything because it spent most of its time above that in the last 20 years?

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Guest wellmont

berkshire is still finding stuff to buy. buffett has not said anything publicly that stocks are no longer attractive. And he is known to go on the record at market extremes. fairholme is opening the fund again. marks thinks we are 6th or 7th inning (light flashing caution). cooperman thinks stocks are still the place to be for foreseeable future (still finding some cheap stocks). jim rogers has pushed Armageddon back to a 2014 or 2015 event. leon black thinks we probably have at least another 12mo of liquid markets. I don't know what koo thinks right now. My point about market timing stands if you read the thread carefully. I guess my point is if all these guys paid attention to shiller p/e ratios they probably would never do anything.

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berkshire is still finding stuff to buy. buffett has not said anything publicly that stocks are no longer attractive. And he is known to go on the record at market extremes. fairholme is opening the fund again. marks thinks we are 6th or 7th inning (light flashing caution). cooperman thinks stocks are still the place to be for foreseeable future (still finding some cheap stocks). jim rogers has pushed Armageddon back to a 2014 or 2015 event. leon black thinks we probably have at least another 12mo of liquid markets. I don't know what koo thinks right now. My point about market timing stands if you read the thread carefully. I guess my point is if all these guys paid attention to shiller p/e ratios they probably would never do anything.

 

That's going to be my last post here. But Buffett and Berkowitz were buying right before the crash. And Buffett was not trashing the market before the crash either if you remember. Etc...

I do not think people here use the Shiller P/E to make investment decisions but Siegel seems to have selective memory to prove his points.

Finally I bow to your opinion and you are right.

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berkshire is still finding stuff to buy. buffett has not said anything publicly that stocks are no longer attractive. And he is known to go on the record at market extremes. fairholme is opening the fund again. marks thinks we are 6th or 7th inning (light flashing caution). cooperman thinks stocks are still the place to be for foreseeable future (still finding some cheap stocks). jim rogers has pushed Armageddon back to a 2014 or 2015 event. leon black thinks we probably have at least another 12mo of liquid markets. I don't know what koo thinks right now. My point about market timing stands if you read the thread carefully. I guess my point is if all these guys paid attention to shiller p/e ratios they probably would never do anything.

 

That's assuming they ONLY use the Shiller P/E, nothing else, and are trying to time the market exactly with it. I tend to use it as a guideline for my investment allocation. I think the market is over-valued right now, but I don't want to be fully out of stocks if I'm wrong. With the CAPE and Tobin's Q being so overvalued on a long-term basis, I decided to move 35% of my portfolio to bonds and cash, 15% to European stock exposure, and a 5% short on select U.S. equities. The remaining 55% is in U.S./Canadian multi-nationals and other value plays. As the Shiller/PE ratio becomes more expensive, I'll begin allocating more to cash and bonds and increase my shorts. With each substantial market correction - 15-20% or more - I'll allocate more back

U.S. equities regardless of what the CAPE.

 

For me it's not a sign to time the market - it's a measure of the risk inherent in the market that may not be so obvious from 1 or 3 year earnings. I use it to adjust my equity exposure based on the risk in the market. I wouldn't every be 90%-100% in equities without a single-digit CAPE.

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Would you buy less of a 50 or 30 cent dollar if Shiller PE was high?  Would you buy more if it is low?  I think the true signal is when you no longer find 50 cent dollars and only can find 79 and 80 cent dollars.  The Shiller PE is interesting if you are buying the entire market (lets say S&P 500 Index Fund) but how many of us are doing that.  I think that performing asset allocation is tempting using for example the Shiller PE but I have yet to see a study that it helps much more than an index fund.  The only method I have seen demonstrated is buying 50 cent dollars.  Maybe I am too simple minded but I would be interested to see if there have been any active asset allocation studies using the Schiller PE, GDP/Mkt Cap or any other indicator.

 

Packer

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The Shiller PE may well have been above its LT average for nearly all of the last 22 years...but for nearly 15 of those years the market (SP 500) has barely gone up despite incredibly cheap money.  To get an above average return (7% nominal without dividends) you have to go back to 1990 which is...23 years ago.  So as far as I am concerned the Shiller PE retains its predictive power (simply stated, >average Shiller PE implies <average LT returns).  This is not to say that it helps with market timing - I suspect nothing does.

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Would you buy less of a 50 or 30 cent dollar if Shiller PE was high?  Would you buy more if it is low?  I think the true signal is when you no longer find 50 cent dollars and only can find 79 and 80 cent dollars.  The Shiller PE is interesting if you are buying the entire market (lets say S&P 500 Index Fund) but how many of us are doing that.  I think that performing asset allocation is tempting using for example the Shiller PE but I have yet to see a study that it helps much more than an index fund.  The only method I have seen demonstrated is buying 50 cent dollars.  Maybe I am too simple minded but I would be interested to see if there have been any active asset allocation studies using the Schiller PE, GDP/Mkt Cap or any other indicator.

 

Packer

 

As I recall from my forays in 2008, 30-50 cent dollars often become 15-25 cent dollars as the general market falls 30-50%. Also, in such a steep downturn, there are usually economic implications that affect the viability of 30-50 cent dollars anyways given they're often in some sort of "temporary" trouble. I'm investing my money in what I view to be undervalued securities period - regardless of what the market is doing - but if the CAPE and Tobin's Q suggest the market is 30-40% overvalued then I will choose to a significant portion of my money in cash and bonds as opposed to investing in 30-50 cent dollars which will likely become even cheaper in the future.

 

I'm beginning to appreciate the idea of taking calculated risks and managing my downside as opposed to trying to maximize my upside at all times. Keeping 30-40% in cash/bonds makes sense to me when the general market is overvalued, even if there are opportunities. Chances are that there will be better opportunities during the correction and I still get to participate at a 60-70% level in the markets if I'm wrong.

 

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I used to look at this stuff a lot but some aspects of it never made sense to me.  Sorry I don't study this stuff too much so my questions may be silly. But,

 

1. do any of these metrics take leverage into account?  Is there long term data for EV value/EBIT or something of that sort anywhere? 

 

2. Why should we expect corporate profits to fall in some narrow range as a % of GNP? 

 

3.The quote that I remember seeing from buffett compared GNP to the value of ALL publicly traded securities.  Did he mean that we should include bonds too?  I don't see that included anywhere where people mention this metric, they just look at total stock capitalization.

 

My main thought on all this: I don't think most businessmen look at these ratios before purchasing whole businesses, so if I believe that should be my attitude towards stock investing, maybe I shouldn't spend a lot of time on it either.

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I think the 2008 decline are once in a decade or even every 25 year decline.  As Howard Marks has said if you built a portfolio to do well in 2008, you wouldn't have much of a portfolio (gold and treasuries).  Holding cash in reserve is a good idea but the question I have is can you "time" that amount using any historical measures and end up with a larger portfolio in the end.  I am assuming the portfolio we are talking about is money not needed for 10 to 20 years and given that you are not concerned about what the portfolio looks like until then and volatility will not cause to sell.  Now cash as a sanity buffer is important if that is required. 

 

The other input is from a guy like Marks (who I view is more rational than either Shiller or Grantham who always appear to be crying wolf), he thinks we are in the early late innings based upon his combination of indicators.  I think the one thing he has not seen is the reckless lending and euphoria of a typical bull market but has seen some bullish behavior based upon QE3.  The real question is can we have a large decline when sentiment is negative or neutral at best.  Based upon my reading of history the answer is no but it may be different this time.

 

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I think the 2008 decline are once in a decade or even every 25 year decline

The 2000-2002 decline was not too far from the 2008 decline.

 

The real question is can we have a large decline when sentiment is negative or neutral at best.  Based upon my reading of history the answer is no but it may be different this time.

When did we see another instance of QE3 in history? Where does sentiment matter when professionals feel they have to buy no matter what? There was no volatility whatsoever in the last 6 months almost.

 

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There was a decline in 2000-2002 but it was really concentrated in tech/telecom.  I remember buying BRK in 1999 at a price close to book and it recovering nicely in the decline.  Many value investors did very well during that period as people rotated out of tech/telecom (which many rolled into in 1998/99) into other sectors such as financials.  The 2008 decline was across just about all asset classes.

 

I think we may decline but if we do it will be similar to the late 1970s/early 1980s (another era of low expectation).  I think decline will not be as great as 2008/2000 because the two levers of increased asset prices are absent, namely high levels of leverage (debt in housing market and cheap capital via IPOs for tech/telecom stocks) and high levels of investor enthusiasm (negative fund flows for mutual funds since 2000 and especially since 2008).  Using the 1970s analogy, the late 1960s was similar to the tech bubble and the subsequent nifty 50 was similar to the housing boom (no lose propositions).  It took 6 to 7 years for sentiment to pick up again in 1982/83 and stock began to rise.  These are some other historical data points to considered.  I think I have seen quite a few great stock pickers ruin an otherwise excellent records by trying to become asset allocators and going into cash.  Out of about a half a dozen I have only see one work and that is Prem and Fairfax.  He hedged and did not go to cash so at least he retains the alpha to the market. 

 

See the following for a good discussion of confidence: http://news.morningstar.com/articlenet/SubmissionsArticle.aspx?submissionid=175276.xml

 

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I think the 2008 decline are once in a decade or even every 25 year decline.  As Howard Marks has said if you built a portfolio to do well in 2008, you wouldn't have much of a portfolio (gold and treasuries).  Holding cash in reserve is a good idea but the question I have is can you "time" that amount using any historical measures and end up with a larger portfolio in the end.  I am assuming the portfolio we are talking about is money not needed for 10 to 20 years and given that you are not concerned about what the portfolio looks like until then and volatility will not cause to sell.  Now cash as a sanity buffer is important if that is required. 

 

The other input is from a guy like Marks (who I view is more rational than either Shiller or Grantham who always appear to be crying wolf), he thinks we are in the early late innings based upon his combination of indicators.  I think the one thing he has not seen is the reckless lending and euphoria of a typical bull market but has seen some bullish behavior based upon QE3.  The real question is can we have a large decline when sentiment is negative or neutral at best.  Based upon my reading of history the answer is no but it may be different this time.

 

Packer

 

I think there is a lack of appreciation for how much damage a large decline could cause. You could make 7% ever year for 5 years straight and hit a 25-30% correction will all but wipe out your gains over the previous 5 years. For 5 years the portfolio of cash and bonds would "lose" only to end up ahead in the last year AND would be significantly ahead after the 5 subsequent years of a recovery when assets were moved over to risk assets.

 

I still participate in the markets but am wary of the effects of this trickle-down wealth effect that Bernanke is trying to institute.  Think about it, interest rates are already at historic lows, margins are at historic highs, valuations based on multiple measures are historically high,  and there are still the potential for great threats between China and Europe and even the U.S. IMO. I'm not saying a crash is imminent and I have only been in the bear camp AFTER fully participating in the recovery in 2009, 2010, and 2011.

My point is risks are high, positive catalysts can only run so much further,  and there are tons of potential negative shocks. I think a "guarded" approach is warranted.  Its not like I'm all in cash, just have been taking gains off the table and moving 30-40% to cash and bonds over time.

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Also,  in regards to your comment about easy credit:

 

I have a friend who is a new graduate who works part time. She was able to get a 20, 000 car loan with no money down and 0% interest for the first year or something like that.

 

Sure it's only one instance,  but I wouldn't necessarily dismiss it as an isolated instance either. 

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You are correct about auto credit but cars have a much higher residual value because they are made better and last longer.  In addition, the loan may be an incentive to purchase and if she got it from an OEM auto finance sub she probably had to get a co-signer. 

 

I am not saying go all in for stocks but buy what is cheap enough to meet your criteria and ignore the macro because sentiment is not euphoric.  Sentiment is what drives the majority of the pricing of securities (that is why value investing works) and as long as it is negative/neutral if there is a decline there is not much air to come out of the ballon.

 

As to cash and bond portfolios, this would have gotten killed this year.  Most bond funds are down considerably. So the only way to play this is with a pure cash portfolio.  The other question has there been a major decline with negative/neutral sentiment? None that I can find in history.

 

Packer 

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Packer - institutions are virtually all in due to the TINA effect. Individuals are out, but institutions control 80% of invested assets. Plus margin debt is at record highs. I just have a hard time seeing broad based pessimism toward stocks. Whether investors want to be in or not, they are in due to low rates...

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You are correct about auto credit but cars have a much higher residual value because they are made better and last longer.  In addition, the loan may be an incentive to purchase and if she got it from an OEM auto finance sub she probably had to get a co-signer. 

 

I am not saying go all in for stocks but buy what is cheap enough to meet your criteria and ignore the macro because sentiment is not euphoric.  Sentiment is what drives the majority of the pricing of securities (that is why value investing works) and as long as it is negative/neutral if there is a decline there is not much air to come out of the ballon.

 

As to cash and bond portfolios, this would have gotten killed this year.  Most bond funds are down considerably. So the only way to play this is with a pure cash portfolio.  The other question has there been a major decline with negative/neutral sentiment? None that I can find in history.

 

Packer

 

So how much cash are folks carrying?  I was almost 0 cash 6 months ago, now i am up to 22% cash as I trim and cannot find things to buy that I like. 

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