Author Topic: Investing fees and the current CAPE Ratio  (Read 4936 times)

GoodStash BadStache

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Investing fees and the current CAPE Ratio
« on: August 07, 2015, 02:29:59 PM »
Hey Mustachian Investors,

I've been kicking around some investing considerations and wanted to see if anyone had feedback.  It seems like one of the biggest concerns that both early retirees and investors in general have is the high CAPE (Shiller) P/E ratio on the S&P 500, which indicates basically that we're currently paying more per dollar of earnings (based on the previous 10 years) than we have during any time outside of 1929 and from the mid-1990's to 2007.  What I'd propose is that it isn't a coincidence that in the years since index funds, no-load funds, discount brokers, and lower tax rates on investment gains and dividends (early 90's through today) that people are willing to pay more per dollar of earnings because they'll be keeping more of their gains.

The easier way for me to think about it was using the reciprocal of the PE ratio (E/P ratio) to create something more like a Yield on the S&P 500.  At the current PE10 ratio of around 26 you have a yield of 1/26=3.85%, which compared to the median PE10 reading of 16 (1/16=6.25%) seems quite high (http://www.multpl.com/shiller-pe/).  That was when I took a look at what "reasonable" fees would have done to your yield prior to the investing improvements we've seen in the last 25 years.  If 50 years ago you paid 2.00% in fees, loads, commissions, etc., your 6.25% yield on the S&P 500 would be down to 4.25%.  The introduction of qualified dividends removed another drain from investor earnings and a less visible boost to returns (by eliminating a subtraction).

Overall, it seems like it's a great time to be an investor with regard to availability of low-cost investment choices, but I've got to think that those improved choices may require us to alter our expectations for returns moving forward.  In looking at what's been published I've seen references to changes in the economy from industrial to consumer/technology and more information about individual companies being responsible for an increased PE10, but little about the changes in the investing environment.  There are many other possible factors that might play into why PE10 ratios have been higher for most of the last two decades (401k's becoming widespread, artificially low interest rates, etc.), but does it seem crazy to think that investors would account for improved investing efficiency and thus pay more for future earnings?

Of course a contrarian view could be that once people start thinking they've figured out why "this time it's different", the market will prove that it isn't.  Thanks for any feedback you've got!

forummm

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Re: Investing fees and the current CAPE Ratio
« Reply #1 on: August 07, 2015, 05:23:55 PM »
There are some reasons why today's high (by historical measures) CAPE could actually be artificially high. But I agree that stocks are "overvalued" versus historical norms. However, so are bonds. And interest rates are very low. So stocks are perhaps reasonably valued by comparison. I think it's fair to expect that stocks (and bonds) will return less in the next 5-10 years than they have historically. But who knows. The point is that if you buy now, in 2030 the market will be up significantly from now, plus you'll have all those dividends being reinvested. Just keep saving and buying funds. You'll get rich enough over time.

PaulMaxime

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Re: Investing fees and the current CAPE Ratio
« Reply #2 on: August 07, 2015, 09:12:18 PM »
I think that people forget that the reason it's so high right now was that corporate profits were extra low during the great recession. Once that moves out of the 10 year window, the CAPE will drop.

Monkey Uncle

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Re: Investing fees and the current CAPE Ratio
« Reply #3 on: August 08, 2015, 04:32:47 AM »
A solid argument can be made that the CAPE is broken:


Quote
Quote from: Jeremy on June 27, 2015, 08:07:07 AM

This article is a good read on pros/cons of CAPE in current environment
http://www.philosophicaleconomics.com/2013/12/shiller/




If you didn't click on this link when Jeremy first posted it, please go back and read the article.  It lays out a pretty clear case that the CAPE is broken due to changes in accounting standards and dividend payout ratios.

One other thing that no one has mentioned yet is US tax policy.  It changed substantially over the last two decades or so such that capital gains and dividends get much more favorable treatment than they did for most of the history of the US stock market.  Seems like this would lead to increased demand for stocks.

Here's the full thread: http://forum.mrmoneymustache.com/investor-alley/robert-shiller-doesn't-know-what-to-make-of-the-cape/
« Last Edit: August 08, 2015, 04:34:18 AM by Monkey Uncle »

brooklynguy

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Re: Investing fees and the current CAPE Ratio
« Reply #4 on: August 08, 2015, 05:56:49 AM »
A solid argument can be made that the CAPE is broken:


Quote
Quote from: Jeremy on June 27, 2015, 08:07:07 AM

This article is a good read on pros/cons of CAPE in current environment
http://www.philosophicaleconomics.com/2013/12/shiller/




If you didn't click on this link when Jeremy first posted it, please go back and read the article.  It lays out a pretty clear case that the CAPE is broken due to changes in accounting standards and dividend payout ratios.

One other thing that no one has mentioned yet is US tax policy.  It changed substantially over the last two decades or so such that capital gains and dividends get much more favorable treatment than they did for most of the history of the US stock market.  Seems like this would lead to increased demand for stocks.

Here's the full thread: http://forum.mrmoneymustache.com/investor-alley/robert-shiller-doesn't-know-what-to-make-of-the-cape/

I missed that thread the first time around, but people should read Philosophical Economics' subsequent pieces on CAPE as well, where he continues to refine his thinking (including this one, where he constructs a new-and-improved version of CAPE and ultimately concludes that market returns are likely to be below the historical average).

forummm

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Re: Investing fees and the current CAPE Ratio
« Reply #5 on: August 08, 2015, 06:43:02 AM »
I think that people forget that the reason it's so high right now was that corporate profits were extra low during the great recession. Once that moves out of the 10 year window, the CAPE will drop.


This is true. Even just looking at today's PE though (around 20 for S&P500), stocks are somewhat overvalued when compared to the historical norm (15ish but arguments that 17ish is the new norm for various reasons make sense to me as well). Returns will probably be lower than historical norms going forward--but still positive in the medium term. But who knows.

milesdividendmd

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Investing fees and the current CAPE Ratio
« Reply #6 on: August 08, 2015, 02:38:30 PM »
Regardless of the valuation measure you use, domestic stocks are expensive right now.  This is hardly a CAPE specific insight....

http://www.researchaffiliates.com/Our%20Ideas/Insights/Fundamentals/Pages/440_Are_Stocks_Overvalued_A_Survey_of_Equity_Valuation_Models.aspx

The smart money is that long term forward domestic stock market returns will be low relative to historical norms.

So in my view the right questions to ask yourself are:

1.  Are your assumptions about your portfolio's future returns overly optimistic?

And

2.  Are you over allocated to US stocks?  (My opinion is "yes" if more than 50% of your equity exposure is domestic. )

3. And if you are concerned about current valuations, should you consider overweighting foreign/emerging markets?

Monkey Uncle

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Re: Investing fees and the current CAPE Ratio
« Reply #7 on: August 09, 2015, 04:52:53 AM »
I missed that thread the first time around, but people should read Philosophical Economics' subsequent pieces on CAPE as well, where he continues to refine his thinking (including this one, where he constructs a new-and-improved version of CAPE and ultimately concludes that market returns are likely to be below the historical average).

Thanks for that link - a very interesting piece.  Sounds like he now thinks the Shiller CAPE is not that far off after all.  But I wonder why he didn't address the accounting issues that he brought up in his 2013 article.

frugledoc

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Re: Investing fees and the current CAPE Ratio
« Reply #8 on: August 09, 2015, 02:12:55 PM »
In the UK most personal finance/early retirement gurus are underweight USA due to concerns about overvaluation compared to non US stocks.

From a non american view point it seems to me that american's are far more bullish on their domestic stocks than investors in every other country are about their own domestic stocks.

This is the only thing stopping me from putting everything into vanguard lifestrategy or all world etf.










milesdividendmd

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Re: Investing fees and the current CAPE Ratio
« Reply #9 on: August 09, 2015, 02:35:13 PM »

In the UK most personal finance/early retirement gurus are underweight USA due to concerns about overvaluation compared to non US stocks.

From a non american view point it seems to me that american's are far more bullish on their domestic stocks than investors in every other country are about their own domestic stocks.

This is the only thing stopping me from putting everything into vanguard lifestrategy or all world etf.

Americans are just like everyone else. We make the ubiquitous cognitive error of home field bias and overweight our own equities. I would wager that Brits are equally irrational and overweight British stocks relative to their world capitalization.

That being said, you should be fine with all world as it is strictly cap weighted, and by definition overweight no country relative to its capitalization.

forummm

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Re: Investing fees and the current CAPE Ratio
« Reply #10 on: August 09, 2015, 03:55:07 PM »

In the UK most personal finance/early retirement gurus are underweight USA due to concerns about overvaluation compared to non US stocks.

From a non american view point it seems to me that american's are far more bullish on their domestic stocks than investors in every other country are about their own domestic stocks.

This is the only thing stopping me from putting everything into vanguard lifestrategy or all world etf.

Americans are just like everyone else. We make the ubiquitous cognitive error of home field bias and overweight our own equities. I would wager that Brits are equally irrational and overweight British stocks relative to their world capitalization.

That being said, you should be fine with all world as it is strictly cap weighted, and by definition overweight no country relative to its capitalization.

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Reido

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Re: Investing fees and the current CAPE Ratio
« Reply #11 on: August 14, 2015, 07:18:44 PM »
@good stash
That's a very interesting point regarding the taxation of investments. Still, I think interest rates and slow growth is largely to blame. As forummm points out, the interest rate environment forces money into the higher risk asset classes. Stocks E/P ratios, as you describe, go down as the opportunity costs of bonds and fixed investments become less attractive.  The concept of (relatively) constant risk/reward is still preserved, albeit with less reward for all investments.

I don't believe CAPE is broken, merely that it reflects what most other metrics show, I.e. Stocks are highly valued and have limited forward return potential.

Subtracting out the Great Recession from the PE10 does little to change the value of the PE10. It simply changes from about 26.5 to about 24. Both values appear to be way out of line with historic norms.

khizr

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Re: Investing fees and the current CAPE Ratio
« Reply #12 on: August 15, 2015, 08:31:01 AM »
I think that people forget that the reason it's so high right now was that corporate profits were extra low during the great recession. Once that moves out of the 10 year window, the CAPE will drop.
Can you explain that one?

From my understanding cape is even higher right now but it appears lower given that corporate profits are at a historical high. I've seen people argue the cape signal should be even worse, except for the very new trend of corp profits going through the roof. This trend seems to be just over the last 10 to 15 years:
https://research.stlouisfed.org/fred2/graph/?g=cSh

Thanks, Ben

PaulMaxime

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Re: Investing fees and the current CAPE Ratio
« Reply #13 on: August 16, 2015, 12:38:23 AM »
I think that people forget that the reason it's so high right now was that corporate profits were extra low during the great recession. Once that moves out of the 10 year window, the CAPE will drop.
Can you explain that one?

From my understanding cape is even higher right now but it appears lower given that corporate profits are at a historical high. I've seen people argue the cape signal should be even worse, except for the very new trend of corp profits going through the roof. This trend seems to be just over the last 10 to 15 years:
https://research.stlouisfed.org/fred2/graph/?g=cSh

Thanks, Ben

It's just that profits were so bad during 2008-2010 or so that its pulling the averages down. That my impression at least. High profits now are offsetting this a bit, sure. I guess I tend to frame things as an optimist. Instead of seeing that high profits now are dragging the CAPE down, I think that a historically rare near depression is driving it up.  After all, aren't corporate profits generally on the rise ovar time, and therefore usually at all time highs?

If it weren't the case, nobody would make money investing in financial markets over time. The general overall growth in asset values is what we are expecting and Hoping for by investing our money, right?