Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:
The market is valued today according to what all the people holding stocks think it’s worth. What the market is valued tomorrow, the next day or any day in the future depends on the collective individual decisions of those who participate in the market by owning stocks. CAPE or PE10 is not some magical metric which tells you exactly what the market value should be or when market valuations will shift. Only in the Bat$hit Crazy Wide World of Hocomania has PE10 been elevated to the status or a religious belief.
The people who comprise the market cannot price stocks properly without access to the information needed to do so. As of today, honest discussion of the implications of the last 36 years of peer-reviewed research is banned at every major investing site. So it is not even possible for today’s investors to price stocks properly. They would need to gain the ability to post honestly to do that.
P/E10 tells you the proper price of stocks presuming that the market continues to behave in the future at least somewhat as it always has in the past. It is possible that the market will behave differently in the future. If that’s what you believe, you can make whatever adjustment you feel you need to make to reflect your personal belief.
There is no question but that emotion plays a huge role in the setting of the daily price and that that price does not last into the long-term to the extent that it reflects only emotions and not economic realities. This is why knowing today’s P/E10 level permits you to have a much better idea of what the price will be in 10 years or 15 years or 20 years than you would have if you did not look at today’s P/E10 level. The P/E10 level tells you how much of today’s price reflects emotional cotton-candy nothingness and how much of it reflects economic realities. You can count on the portion of the price that reflects the economic realities. You cannot count on the portion of the price that reflects only emotional cotton-candy nothingness. It is the market’s job to price stocks properly. So the cotton-candy nothingness just gets blown away in the wind in time.
Do you think that stocks offered the same value in 1982, when they were priced at one-half of fair value, as they did in 2000, when they were priced at three times fair value? I sure don’t. The research shows that the safe withdrawal rate was 9.0 in 1982 and 1.6 in 2000. For a retiree with a portfolio of $1 million, that’s the difference between living on $90,000 per year and living on $16,000 per year. That is too big a difference to overlook in any study purporting to identify the safe withdrawal rate. Aspiring retirees need accurate numbers. If you give them inaccurate numbers, you are going to hurt them in very serious ways.
We agree that P/E10 does not tell you WHEN prices will return to fair-value levels. That is determined by investor emotion. No metric that I know of can tell you that. P/E10 tells you HOW MUCH prices need to correct. But the correction takes place only in the long-term and there is no way to know in advance when it will take place. That is why short-term timing does not work. If you could know in advance WHEN the price correction would take place, you could engage in short-term timing successfully. It just doesn’t work that way.
But, if you are a long-term investor, you certainly need to know the real long-term value of your portfolio. It is not possible to engage in effective financial planning without getting the basic numbers at least roughly right. When stocks are priced at three times fair value, as they were in 2000, using unadjusted portfolio statement numbers won’t get you anywhere even remotely in the neighborhood of having accurate numbers. People were using the incorrect numbers in the Greaney study to determine when to turn in resignations from high-paying corporate jobs. Those people’s lives were destroyed by the errors in that study. I believe strongly that Greaney should have corrected the study within 24 hours of the moment when he became aware of the errors in it.
There is no excuse for the death threats. And the death threats show that Greaney did not believe that it would be possible for him to justify the methodology used in his study in civil and reasoned debate. People who are making an honest effort to help investors do not advance death threats when their statements are questioned. People who advance death threats when questioned are working some sort of con. I mean, come on. I can accept that Greaney worked a con on himself before he worked it on others. But the con that he worked still did a great deal of harm to those others.
You say that today’s market price is determined by the assessment of today’s investors as to what the market is worth. If that were so, how would it be possible for P/E10 to effectively predict the market price that will apply 10 years into the future for 145 years running now, the entire history of the U.S. stock market for which we have records? You are wrong. The market price is set partly by the factors that you refer to. But there is another factor that you and all Buy-and-Holders ignore that was revealed by Shiller’s “revolutionary” research findings of 1981. The factor that we did not know about until 1981 is that the market always eventually closes the gap between the emotionally determined price and the real, economic price. When you know the extent to which today’s price differs from the real, economic price, you know in which direction prices are headed in the long term. That’s very important information for investors planning retirements which will extend for more than 10 years into the future, which is the vast majority of them.
These are my sincere thoughts re these terribly important matters in any event, my good friend. I naturally wish you all the best that this life has to offer a person.