I’ve posted Entry #372 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called The Bull Market Has a Long Memory of Bearish Times — and That’s Okay!
Juicy Excerpt: More importantly, I don’t think that Shiller would say that the P/E10 metric offers precise guidance. Using the median for earnings rather than the mean pulls the number from the very, very scary high of 31 down to just the very scary high of 28. That’s not much of an improvement. The 32 reading is especially alarming because it is so close to the reading that applied in the days just prior to the Great Depression. But the full reality is that there has never been a time when the P/E10 rose to 25 when we did not suffer an economic crisis in the days that followed. The mean-adjusted reading of 28 is plenty dangerous itself.
Anonymous says
“But the full reality is that there has never been a time when the P/E10 rose to 25 when we did not suffer an economic crisis in the days that followed.”
What’s your sample size there? In other words, how many times has the P/E 10 risen above 25, followed by a crisis, in your data set?
Rob says
This is s good question. Thank you for that.
We are today near the end of the fourth bull/bear cycle in the record. The first ended with the economic crisis of the early years of the 20th Century. The second ended with the Great Depression. The third ended with the stagflation of the 1970s. The fourth is today, a situation where we have already experienced an economic crisis and where we still need a 50 percent price drop to get to fair-value price levels.
The suggestion in your question is that four instances of a phenomenon is not enough to prove that it will always apply. I certainly agree. But this isn’t a case where the phenomena under consideration is something odd or unexpected or hard to explain. Our common sense tells us that, since price matters with everything else we buy, price SHOULD matter with stocks too. All that the historical return data is doing is CONFIRMING that what common sense tells us must be so really is so. Yes, price matters when buying stocks just as it does when buying anything else. It’s just that the effect is delayed a bit — the only thing that is even a tiny bit hard to understand here is the length of the delay, which strikes most of us as highly counter-intuitive.
We are four for four. There have been four time in U.S. history when the Buy-and-Hold concept (that price doesn’t matter when buying stocks) became popular. There have been four times when we reaches a P/E10 above 25. There have been four economic crises. Four cases isn’t enough to prove anything beyond a reasonable doubt. But it is strong supporting evidence for what common sense tells us must be so — that stocks must be a lot more risky when they are priced insanely high than they are when they are priced reasonably or when they are priced insanely low, that those of us who want to keep our risk profiles roughly constant over time need to be sure to adjust our stock allocations in response to big price swings.
And at the very, very, very minimum, going four for four is enough to show that we should be permitting honest posting re these matters at every investing discussion board and blog on the internet, that we should absolutely and without exception be permitting all investors to hear both sides of the story before deciding what to do with their retirement money. To play it any other way would be criminal and SHOULD be criminal.
This is my sincere take re this terribly important matter, in any event.
Rob
Anonymous says
“We are today near the end of the fourth bull/bear cycle in the record. ”
OK. When n=30, let me know.
Rob says
Will do, Anonymous.
You hang in there, man.
Rob