Shiller PE Ratio

[mjones1234]

Throughout the years, I've leaned on the Shiller PE ratio to get me out of equities due to far exceeding fair value. Does anyone have any arguments for or against using this as a reliable investing tool? It sent me to cash months ago. I'm waiting for values to arrive at median levels before going back in. Am I being too conservative?

[MDM]

Am I being too conservative?

You'll know in hindsight.

[BicycleB]

Throughout the years, I've leaned on the Shiller PE ratio to get me out of equities due to far exceeding fair value. Does anyone have any arguments for or against using this as a reliable investing tool? It sent me to cash months ago. I'm waiting for values to arrive at median levels before going back in. Am I being too conservative?

Median on what timeframe?

[Huskers1]

Throughout the years, I've leaned on the Shiller PE ratio to get me out of equities due to far exceeding fair value. Does anyone have any arguments for or against using this as a reliable investing tool? It sent me to cash months ago. I'm waiting for values to arrive at median levels before going back in. Am I being too conservative?

If you can use some mathmatics to figure this market out , great. I've been researching the opinions of so called experts in finance for the past week. I've learned alot , but much of it too late to put into practice. you can't time the market, your best bet is to dollar coast average your way in.

And aren't we now past that point?

[hodedofome]

The market has generally been expensive since the early 90s. Those waiting for it to get really cheap got a little time in ‘09 and maybe this year and missed out on all the gains before and since.

[MustacheAndaHalf]

Larry Swedroe has written numerous investment books which use historical data to prove their points.  His take on Schiller PE is informed by history and data.
https://www.etf.com/sections/index-investor-corner/swedroe-ratio-need-context?nopaging=1

To capture one example from Swedroe's article:
"Another reason the Shiller CAPE 10’s full-period mean may be an inappropriate benchmark is because accounting rules have changed, impacting how earnings (and thus price-to-earnings, or P/E, ratios) are determined. In 2001, the Financial Accounting Standards Board (FASB) changed the rules regarding how goodwill is written off."

[vand]

Shiller's CAPE is a well respected valuation tool that has held up well in correlating LONG TERM returns (~10yr) to current valuations. I like it very much, along with the Buffett indicator. Ignore them at your peril.

But they also need to be interpreted correctly. Using the long term CAPE ratio is pretty useless. Much better to use a long term moving average so that more weight is given to more recent data to reflect the economy as it is evolved into today, not as it was in 19-dickertydoo.

[Buffaloski Boris]

I’m kind of a zealot about the CAPE ratio and have viewed US equities as very overpriced.  To a certain extent it saved my butt here as I wasn’t much invested in equities and have plenty of reserves to buy when I think the prices are within reason.  I think it’s a good tool, but also agree with some critics that the median is actually higher due to accounting method changes. I don’t think it’s a huge difference and even Prof. Shiller has acknowledged that it might be an influence.

PE ratios and the CAPE tend to revert to the mean. Could this time be different? Sure. I just don’t expect it to be.

[Telecaster]

Throughout the years, I've leaned on the Shiller PE ratio to get me out of equities due to far exceeding fair value. Does anyone have any arguments for or against using this as a reliable investing tool? It sent me to cash months ago. I'm waiting for values to arrive at median levels before going back in. Am I being too conservative?

Schiller PE seems to have stopped working about the time it was discovered.  We've had many discussions about that here.  That said, even Schiller says it isn't a timing tool.  It is a tool to predict future long term returns. 

The last time it was at the median value was back in 2009.  Unless I'm missing something. 

[maizefolk]

Throughout the years, I've leaned on the Shiller PE ratio to get me out of equities due to far exceeding fair value. Does anyone have any arguments for or against using this as a reliable investing tool? It sent me to cash months ago. I'm waiting for values to arrive at median levels before going back in. Am I being too conservative?

With the exception of a brief window in depths of the 2009 crash, the stock market has been above the median Shiller PE consistently for the past 30 years. If a person is using being below the median Shiller PI as their trigger for investing in stocks, they would have stayed out of stocks for 353 of the last 360 months (6 months in 2008/9 and three months in 1990/1 were below the median value for Shiller PE).

My conclusion from that is that the Shiller PE is broken. At least part of the problem can be explained by the changes in accounting rules described above.

Someone else could look at the same data and conclude the USA has been in a constant 30 year stock market bubble that wasn't popped by the dotcom crash, the great recession, and so far also hasn't been popped by the coronavirus shutdown.

If a person subscribes to the second explanation and were using the stock market being below the median Shiller PE ratio as a trigger for their investing decisions then they should not be investing in (US) equities. In order for someone who has stayed out of the market since 1990 to catch up to a buy and hold investor over that same time frame (assuming they have otherwise been holding their money in something which tracks inflation), the S&P 500 would need to fall to 385, a decline of about -90% from the peak, an additional approx. -65% from where it stands today.

If that happens, I will be happy to admit that I drew the wrong conclusion about the median Shiller PE.

[waltworks]

I'd say that a "median" value for the modern CAPE should be somewhere around 20, because of the accounting changes others have already mentioned. That's not to say the market ever has to return to that value, or that you should refuse to invest at any higher number.

But as Maizeman says, it's also possible that the last 30 years or so are just one big bubble and we'll see CAPE in the single digits.

Generally speaking having an optimistic bias/buying when in doubt is beneficial, though.

-W

[AdrianC]

Throughout the years, I've leaned on the Shiller PE ratio to get me out of equities due to far exceeding fair value. Does anyone have any arguments for or against using this as a reliable investing tool? It sent me to cash months ago. I'm waiting for values to arrive at median levels before going back in. Am I being too conservative?

What was the Shiller PE when you got out of stocks, and why did you choose that level? If it was months ago, it was at something like 30.

Do you have a range? e.g. Out at > 30, in at < 16?

[ChpBstrd]

I don't think you're necessarily being too conservative, assuming you are at least invested in bond funds and not sitting in CDs or money market funds.

However, you'll probably want to pounce the moment CAPE reaches a level you are comfortable with. In 2009, it only dropped around the long-term median for a couple of months. Getting left behind by the next 10 year bull market and being stuck with 1-2% bond yields is a very real risk.

https://www.multpl.com/shiller-pe/table/by-month

You might consider selling put options at a level where you would be happy to buy stocks. For example, the S&P would have to fall another 31% to reach a CAPE of 16.7, the historical mean. For the exchange traded fund SPY, this would be a strike price around $179 (current is 259.60). So the strike price minus the premium received should equal about $179. You could sell a December 31, 2020 put at the $185 strike price for about $8.25. If assigned, you would have essentially bought the stock for (185.00-8.25=) $176.75, which is 48% down from the peak. If you are not assigned, you'd keep the $8.25 which is a 4.45% 9-month return on the cash you must set aside to cover the put, equal to a 5.9% annualized yield. Bet your bonds don't yield that.

This would only be an option if you have the stomach to watch your short options soar in value several hundred percent as the stock market tanks, and not buy them back in a panic. You'd have to keep the objective in mind: getting assigned at 48% down.

[waltworks]

I would also be curious about the "sent me to cash months ago" comment. CAPE has been hovering at ~30 or higher for 3 years (until recently, obviously). The peak, AFAIK, was in January 2018. Did that send you to cash? If not, why would the (relatively) lower CAPEs the last couple years do so? Did you buy back in at CAPE 31 or something?

I'm not arguing with your strategy, which I think is fine as long as you have some solid rules in place and stick to them. I'm wondering if that's actually the case based on your offhand "months ago" comment.

-W

[J Boogie]

I don't think you can effectively use this as shorthand anymore.

Amazon is a great example why.

Many cheap investors stayed away under some faulty assumptions - namely, that Amazon wasn't profitable.

Amazon intentionally operated/operates near breakeven. It makes their margins appear razor thin and their valuation appear insane to those who don't look under the hood.

When you look under the hood, you see they are using their revenue to make massive but calculated investments in growth.

By doing this they can avoid using debt or issuing capital.

Meanwhile companies like Apple, Microsoft, and Google are criticized for hoarding cash and shareholder pressure them to do things like buy shares back or increase the dividend. People point out they don't have anything good to do with the money but they're still posturing as though they're growth companies.

I own all 4 minus Apple.



If you want to invest in a more straightforward way, invest in REITs and LPs where their yield and payout ratio can give you a clear idea of how well they're valued.

[Full_Beard]

The question has been studied:

https://www.brandes.com/docs/default-source/brandes-institute/2018/the-cape-ratio-and-future-returns-a-note-on-market-timing.pdf

And note that changes in GAAP has skewed the mean somewhat:

http://www.philosophicaleconomics.com/2013/12/shiller/

[MustacheAndaHalf]

J Boogie - Amazon's preference of growth over profit spawned a joke about it (this was in Amazon's early years): "Amazon loses money on every sale... but they make it up in volume."

Full_Beard - Very interesting article on CAPE, company earnings and share buybacks - thanks for sharing it.  For those who don't read 80% of the way through, I liked this ELI5 of the stock market:
"The stock market takes on whatever valuation level achieves the required equilibrium between those that want to get in it, and those that want to get out of it."

It looks like interest in a replacement ratio has faded.  Does any site track pro forma CAPE ratio over time, to the present day?

[Full_Beard]

You're welcome. In our 30-second span-of-attention media-verse, these things tend to get short changed.

[vand]

CAPE and other long term valuation tools should absolutely not be viewed as market timing tools, if your idea of market timing is getting within 2-3 years of a major trend change.

The old saying that something that is expensive can always get more expensive and something cheap can always get cheaper holds true most of the time.

But that's not to say that they're not useful - Properly used, CAPE should be a tool in determining a suitable asset allocation strategy given expected returns. If stocks look cheap then go overweight on stocks. If stocks look expensive then go neutral or underweight stocks. To me, that's just smart investing.

[dougules]

Since I feel like being blunt, a high CAPE didn't cause a pandemic.  I like looking at that number, too, but it's been high for years now.  There's no reason to believe the market would have gone down soon if this hadn't happened.   Eventually there would have been some triggering event like this one, but it might have been a few more years down the road when the fundamentals had moved right along leaving cash heavy folks behind.  Even now, if you sold when the CAPE hit 30 back in mid-2017, you have only had a small window of time so far to buy back at a very modestly lower price.  It may very well still go down, but anybody staying in cash is betting against the house.  You may come out ahead, but don't confuse luck and skill. 

[J Boogie]

Properly used, CAPE should be a tool in determining a suitable asset allocation strategy given expected returns. If stocks look cheap then go overweight on stocks. If stocks look expensive then go neutral or underweight stocks. To me, that's just smart investing.

I think growth oriented companies have far too much market cap for CAPE to be a useful tool.  The most valuable companies funnel profits into digging a moat, building a sticky ecosystem, expanding offerings, vertical integration, etc etc.  You might end up underweighting stocks at worst times if you take this approach, and overweighting during periods of stagnation.

For example, I'd much rather invest in tech/cloud/software companies right now than energy companies, though the CAPE would suggest energy companies deserve more investment.

[hadabeardonce]

Value averaging seems like a term you'd be interested in.

Somewhere out there there's a comparison of VA vs. DCA and it pretty much concluded with dollar cost averaging just being easier to pull off for most investors and the returns are so similar that it doesn't really matter.

[ChpBstrd]

Since I feel like being blunt, a high CAPE didn't cause a pandemic.  I like looking at that number, too, but it's been high for years now.  There's no reason to believe the market would have gone down soon if this hadn't happened.   Eventually there would have been some triggering event like this one, but it might have been a few more years down the road when the fundamentals had moved right along leaving cash heavy folks behind.  Even now, if you sold when the CAPE hit 30 back in mid-2017, you have only had a small window of time so far to buy back at a very modestly lower price.  It may very well still go down, but anybody staying in cash is betting against the house.  You may come out ahead, but don't confuse luck and skill.

What if in this universe, with CAPE starting around 32, the pandemic causes a 50% decrease in prices all the way down to the historically typical CAPE of 16.

What if in an alternate universe, where CAPE started at 20, the pandemic causes a 20% decrease in prices all the way down to the historically typical CAPE of 16.

If that were the case, CAPE would be something like a measure of risk. Shocks and recessions would have a bigger impact at a higher CAPE. These inevitable dings would have a greater impact on portfolio performance at a higher CAPE than they would at a lower CAPE. Nothing has to revert to the mean, but investors would need to understand that CAPE is related to long term volatility. A high CAPE is a signal to hedge or reallocate in order to maintain an agreeable risk profile. A low CAPE is the signal to back up the truck and forget about hedging.

[BicycleB]

What if the above model is correct, but the target of historically normal CAPE is no longer very useful?

For example, what if the correct signal were to be 20 or 22 to distinguish between hedged vs fully invested portfolios, because interest rates are structurally lower than the past and will remain so until 2100? (No idea if this particular thing is true, just asking the question.) How long would it take an investor to realize that buying at 22 is profitable and waiting for 16 is not?

[Radagast]

By far the most useful thing and maybe only thing I would do with CAPE is use it as a FIRE goal. Right now it is 24.4! Perfect time for those whose net worth is flashing success at achieving 25X expenses! Earlier in the year it was up to like 33 or something, so people at that time should have only pulled the plug at 33X expenses.

[vand]

Since I feel like being blunt, a high CAPE didn't cause a pandemic.  I like looking at that number, too, but it's been high for years now.  There's no reason to believe the market would have gone down soon if this hadn't happened.   Eventually there would have been some triggering event like this one, but it might have been a few more years down the road when the fundamentals had moved right along leaving cash heavy folks behind.  Even now, if you sold when the CAPE hit 30 back in mid-2017, you have only had a small window of time so far to buy back at a very modestly lower price.  It may very well still go down, but anybody staying in cash is betting against the house.  You may come out ahead, but don't confuse luck and skill.

What if in this universe, with CAPE starting around 32, the pandemic causes a 50% decrease in prices all the way down to the historically typical CAPE of 16.

What if in an alternate universe, where CAPE started at 20, the pandemic causes a 20% decrease in prices all the way down to the historically typical CAPE of 16.

If that were the case, CAPE would be something like a measure of risk. Shocks and recessions would have a bigger impact at a higher CAPE. These inevitable dings would have a greater impact on portfolio performance at a higher CAPE than they would at a lower CAPE. Nothing has to revert to the mean, but investors would need to understand that CAPE is related to long term volatility. A high CAPE is a signal to hedge or reallocate in order to maintain an agreeable risk profile. A low CAPE is the signal to back up the truck and forget about hedging.

This is what the value investing proponents have long argued - that when stocks are too optimistically priced, bad news has a much bigger downside impact that when the outlook is more modest. History shows us that earnings growth is a very poor correlator to future returns as all the future growth is already factored into the price and the stock is typically at risk from not meeting those high expectations.

Different time horizons matter, too. Valuations give us expected returns; the risk (ie distribution of returns) can be statistically calculated.. but if your expected return increases relative to risk then that is obviously a shift in the risk/reward balance. Now, if your time horizon is 3 months then the risk/reward dynamic may suddenly look awful; the market is going to be very bumpy and your expected return is negligible, but if your time horizon is 10 yrs then the risk/reward balance just shifted markedly in your favour.  In times of panic time horizons get flattened out because the range of possibilities widens, but the level headed investor who can see past the immediate crisis can use everyone else's panic to their advantage.

[ChpBstrd]

By far the most useful thing and maybe only thing I would do with CAPE is use it as a FIRE goal. Right now it is 24.4! Perfect time for those whose net worth is flashing success at achieving 25X expenses! Earlier in the year it was up to like 33 or something, so people at that time should have only pulled the plug at 33X expenses.

If economic growth and inflation were 0%, then 1/CAPE would be a decent proxy for expected portfolio returns. You'd have a steady bond-like yield that could be compared to one's expenses.

However, the past ten years' earnings are less relevant to the price of stocks that are growing their earnings 10-20% per year. These are bargains at much higher PE's than stocks with flat earnings.

Also, the reality of inflation means investors retiring on a 4% WR actually need a long-term return more like 6.5 - 7.5% to keep up with inflation (and even that will eventually fail if inflation is more than [return - WR] for a long enough time - and high inflation & low earnings would likely coincide as happened in the 1970s).

All this is to say, if someone retired at CAPE 25 and a 4% WR, their plan is not bulletproof. They are relying on their portfolio's earnings to grow as fast or faster than long term inflation. That may or may not happen.

[Radagast]

By far the most useful thing and maybe only thing I would do with CAPE is use it as a FIRE goal. Right now it is 24.4! Perfect time for those whose net worth is flashing success at achieving 25X expenses! Earlier in the year it was up to like 33 or something, so people at that time should have only pulled the plug at 33X expenses.

If economic growth and inflation were 0%, then 1/CAPE would be a decent proxy for expected portfolio returns. You'd have a steady bond-like yield that could be compared to one's expenses.

However, the past ten years' earnings are less relevant to the price of stocks that are growing their earnings 10-20% per year. These are bargains at much higher PE's than stocks with flat earnings.

Also, the reality of inflation means investors retiring on a 4% WR actually need a long-term return more like 6.5 - 7.5% to keep up with inflation (and even that will eventually fail if inflation is more than [return - WR] for a long enough time - and high inflation & low earnings would likely coincide as happened in the 1970s).

All this is to say, if someone retired at CAPE 25 and a 4% WR, their plan is not bulletproof. They are relying on their portfolio's earnings to grow as fast or faster than long term inflation. That may or may not happen.

Just as with the 4% rule this is inflation adjusted 1/CAPE withdrawal rate. Surely you knew. Although as with the 4% rule it is more a "savings goal" than a "withdrawal strategy." As always, it is not applicable to individual companies, only to the whole market.

Most of the time in the past it would have one retire sooner than the 4% rule, but in a few odd times like 1929 and 2000 (and 2018-19) it would have been later. It still would have failed the 1960's test.

[dougules]

Since I feel like being blunt, a high CAPE didn't cause a pandemic.  I like looking at that number, too, but it's been high for years now.  There's no reason to believe the market would have gone down soon if this hadn't happened.   Eventually there would have been some triggering event like this one, but it might have been a few more years down the road when the fundamentals had moved right along leaving cash heavy folks behind.  Even now, if you sold when the CAPE hit 30 back in mid-2017, you have only had a small window of time so far to buy back at a very modestly lower price.  It may very well still go down, but anybody staying in cash is betting against the house.  You may come out ahead, but don't confuse luck and skill.

What if in this universe, with CAPE starting around 32, the pandemic causes a 50% decrease in prices all the way down to the historically typical CAPE of 16.

What if in an alternate universe, where CAPE started at 20, the pandemic causes a 20% decrease in prices all the way down to the historically typical CAPE of 16.

If that were the case, CAPE would be something like a measure of risk. Shocks and recessions would have a bigger impact at a higher CAPE. These inevitable dings would have a greater impact on portfolio performance at a higher CAPE than they would at a lower CAPE. Nothing has to revert to the mean, but investors would need to understand that CAPE is related to long term volatility. A high CAPE is a signal to hedge or reallocate in order to maintain an agreeable risk profile. A low CAPE is the signal to back up the truck and forget about hedging.

This is what the value investing proponents have long argued - that when stocks are too optimistically priced, bad news has a much bigger downside impact that when the outlook is more modest. History shows us that earnings growth is a very poor correlator to future returns as all the future growth is already factored into the price and the stock is typically at risk from not meeting those high expectations.

Different time horizons matter, too. Valuations give us expected returns; the risk (ie distribution of returns) can be statistically calculated.. but if your expected return increases relative to risk then that is obviously a shift in the risk/reward balance. Now, if your time horizon is 3 months then the risk/reward dynamic may suddenly look awful; the market is going to be very bumpy and your expected return is negligible, but if your time horizon is 10 yrs then the risk/reward balance just shifted markedly in your favour.  In times of panic time horizons get flattened out because the range of possibilities widens, but the level headed investor who can see past the immediate crisis can use everyone else's panic to their advantage.

"What if " is exactly my point.  There are a lot of what ifs, and anyone who thinks they can outguess the next guy on a very complicated future is overestimating their ability.  You have no way of knowing that the market will revert all the way to the mean before this crisis is history.  Even in 2009 it only barely did briefly.  You also had no way of knowing when the crisis was going to happen, so you were going on a hunch that something was going to end the bull market this year.  Plenty of people have had hunches that it would have been in 2015, 2016, 2017, etc.  We've seen tons of people come through this forum with their crystal balls and snake oil.  We now have a bunch of broken clocks happening to be right.  Us buy-and-hold, market-efficiency-based investors are quite aware crisis was coming sooner or later.  We also knew the timing was anybody's guess, and there's no way anybody can predict when a non-economic trigger like a major pandemic is going to happen.  If this had happened in 2023 instead of 2020, the fundamentals might have moved along to the point you would have been SOL with the bottom then being higher than April 1, 2020.  If you're holding cash, there are always slightly more what ifs working against you than for you.  The market has already priced in this crisis. 

People seem to misconstrue value investing.  Value investing involves having a very deep understanding of a company's operations and the market they're in.  It involves having enough capital to make it worth hiring a team that has a broad range of specialized expertise to run the numbers on a company's books, get to know the management, see their operations, calculate risk for a broad range of potential crises (e.g. pandemic), do the same for the company's competition, and possibly even get involved in their operations if there are improvements needing to be made.  It also involves having the resources to be able to absorb the risk if your extremely educated guess is wrong.  If that's not what you're doing, please quit adding unnecessary volatility with "technical analysis" and pseudo-educated guesses.  Buy index funds as soon as you have spare cash, and sell them only when you need spare cash. 

[Northman]

Fresh data today on CAPE and PB. European markets look ridiculously cheap right now:

https://www.starcapital.de/en/research/stock-market-valuation/