New Sunday Times Feature - Diary of a Private Investor

Sarenco

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I clearly referred to the cyclically adjusted price-to-earnings ratio (CAPE) in my posts.
 

letitroll

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The cyclically adjusted price-earnings ratio of the S&P500 currently stands at 32.8 and 10-year US Treasuries are currently yielding 2.8%.

Immediately before the stock market crash in October 1929, the S&P 500’s cyclically adjusted PE ratio had just hit 30 and 10-year US Treasuries were yielding 3.3%.

To be clear, I am not saying that the current valuation of the S&P500 does not represent a sensible multiple of earnings relative to prevailing interest rates. I'm simply saying that it's not immediately obvious to me that it does - so I'm hedging my bets somewhat.
The difference this time is the capital markets are now truly global and while US treasuries provide a level of yield just above inflation & the federal funds rate is 2% don't forget the rest of the world is still running hugely accommodative monetary policies still and those investors in say Germany or Japan are hunting for returns too therefore bidding up the price (& in turn reducing the returns) of all risk assets...................The US stock market by some margin is the largest in the world and attracts huge capital in flows from the rest of the world - a world in which investors have been moved out the risk curve by global central banks.
 

Sarenco

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The difference this time
You might be right but I shiver whenever I hear anybody begin an argument with "this time, it's different..."

Also, bear in mind that non-US investors are also large buyers of US treasuries - they are not just bidding up the price of risk assets.

Again, I'm not saying that US equities are over-valued. I'm saying I don't know whether they are or not. That's why I'm hedging my bets.
 

moneymakeover

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From link i quoted above

July 2017

Summary
  • Robert Shiller's Cyclically Adjusted Price to Earnings (CAPE) ratio is now around the level of 1929, and it was only higher in the late 90s dot-com bubble.
  • Many commentators have pointed to this indicator recently as a danger sign for the stock market.
  • However, this is misleading right now because the CAPE ratio's 10-year back period begins with the Great Recession in 2007.
  • So the 10-year earnings are abnormally low, due to the effect of 2007-2009 on the 10-year average.
  • As the recession years "roll off" the 10-year back period, the 10-year average earnings will increase, and stock prices can rise without making the Shiller CAPE ratio rise excessively.
 

Sarenco

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Ok, so you have a difficulty with my using CAPE as a valuation metric.

The (unadjusted) PE ratio of the S&P500 at the start of October 1929 was 17.81; versus a PE ratio of 24.75 at the start of this month.

That makes today's valuations look even more extreme.

To be honest, I don't have much confidence in any single valuation ratio. But it's hard to argue that current US stock valuations are not elevated - whatever metric you choose.

Again, I'm not saying the S&P500 is necessarily over-valued relative to prevailing interest rates. But it might be, so I'm hedging my bets.
 

letitroll

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You might be right but I shiver whenever I hear anybody begin an argument with "this time, it's different..."

Also, bear in mind that non-US investors are also large buyers of US treasuries - they are not just bidding up the price of risk assets.

Again, I'm not saying that US equities are over-valued. I'm saying I don't know whether they are or not. That's why I'm hedging my bets.
For sure different this time is scary phrase shame on me....but as said there simply aren't enough assets in the world to invest in when the best you can get on the 10yr US is below 3% & Bunds 0.03%. Remember the biggest pension funds in the world 'need' 7,8,9% to make the numbers work they are therefore are forced out the risk curve (exactly what the central Banks wanted by the way) hence inflated prices as investors bid up the price of those assets in turn reducing their return. Agree things are fully valued maybe even slightly overly so but equities undoubtedly provide a superior return profile if your time horizon is more than say 7 - 8yrs.
 

Sarenco

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... equities undoubtedly provide a superior return profile if your time horizon is more than say 7 - 8yrs.
Undoubtedly? Every industrialised country on the planet (including the U.S.) has had 7, 10, even 30 year periods during the past century where domestic long-term government bonds outperformed domestic equities.

History suggests that there is a ~70% probability that US stocks will beat 5-year treasuries over any 7.5 year holding period. I wouldn't describe that as "undoubtedly" and, of course, nobody knows what the future holds.
 

Gordon Gekko

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The counter argument to that, though, is that equities have only had those periods after valuations were toppy.

Also, the US is not the world.
 

Sarenco

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The counter argument to that, though, is that equities have only had those periods after valuations were toppy.
Counter argument to what exactly? That history suggests there's a ~70% probability that US stocks will beat 5-year treasuries over any 7.5 year period? That's not an argument, it's just a factual description of what has happened in the past.

FWIW, S&P500 CAPE has only been higher than its current level once in history - at the height of the dot.com bubble in 1999.

Again, at the risk of repeating myself, I'm not arguing that US stocks are necessarily over-valued relative to prevailing interest rates. But they might be. So I'll hedge my position.
 

Gordon Gekko

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And the 12 month forward P/E for Global Equities is 15.3, which is actually 2% lower than its median.

Citing stats around periods of underperformance is like saying “10% of the time it rains” in circumstances where there are blue skies.

The only thing that is relevant is valuation, and choosing a particular valuation methodology to suit your bearish view of the world is dangerous; you are entitled to your view, but my biggest concern is that you will spook others which will scare them off investing and ultimately prevent them from achieving their life goals. I suspect that you have the financial capacity to be underinvested; most others do not and they certainly don’t need to be spooked further in a world where the media’s mission seems to be to stop people investing.

Of course the counterargument is that being overinvested will cause people to be shaken out once volatility hits.
 

letitroll

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And the 12 month forward P/E for Global Equities is 15.3, which is actually 2% lower than its median.

Citing stats around periods of underperformance is like saying “10% of the time it rains” in circumstances where there are blue skies.

The only thing that is relevant is valuation, and choosing a particular valuation methodology to suit your bearish view of the world is dangerous; you are entitled to your view, but my biggest concern is that you will spook others which will scare them off investing and ultimately prevent them from achieving their life goals. I suspect that you have the financial capacity to be underinvested; most others do not and they certainly don’t need to be spooked further in a world where the media’s mission seems to be to stop people investing.

Of course the counterargument is that being overinvested will cause people to be shaken out once volatility hits.
Completely agree - reminds me of these wise words:

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch
 

Sarenco

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And the 12 month forward P/E for Global Equities is 15.3, which is actually 2% lower than its median.
The forward P/E of a stock relates to predicted earnings - frankly, it's crystal ball gazing.

I've no idea why you think I've a bearish view of the world; you are clearly not reading my posts very carefully. I'm certainly not recommending that anybody should avoid having an allocation to equities in their portfolio that is appropriate to their need, willingness and ability to take risk.

I've already stated that I don't have much confidence in any single valuation metric so I don't see how I could be accused of cherry picking. I've also stated (repeatedly) that I don't know whether or not US equities are over-valued relative to prevailing interest rates.

However, I do think that people should be modest about their ability to predict the future. There may well be blue skies today but that tells us nothing about the weather tomorrow. All we can say with certainty is what has happened in the past.

As aside, I've never understood why some people boast about being 100% in equities. Why not 80% or 120%? What's so magical about 100%?
 
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Gordon Gekko

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But Sarenco, on the one hand you’re critical of people using the past to make assumptions around the future. Then on the other, you cite Shiller and CAPE, which is built on the idea of mean reversion. Which is it?

I didn’t reference US equities, I referenced Global Equities which are most relevant.

Then you throw in a little dig about people “boasting” about being 100% in equities; “What’s so magical about 100%?” Equities deliver to best returns over time. Why not 120%? Because leverage can get you carried out.
 
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