Shiller PE Continues To Mislead Investors, S&P 500 Is Fairly Valued In Early 2013 [View article]
My valuation metric uses nominal GDP and corporate bond yields to calculate intrinsic value, so it's not discounting in the sense that you need to plug in a growth rate.
In fact, that's what the market is doing, when it adjusts to suit the prevailing expectation for growth. That way lies Crazy Town.
But to answer your question about the constant (2), the long term median of PYi (Price/GDP*Aaa) is .519, so you're right. The number 2 is a handy rule of thumb when solving for price (PY/2i)
Shiller PE Continues To Mislead Investors, S&P 500 Is Fairly Valued In Early 2013 [View article]
Thanks for the compliment, Hewitt.
To answer your questions, government spending has accounted for 20% of GDP plus or minus 5% in the post-WWII era. Government are wasteful, I agree, but the dollars don't care who spends them, so I don't adjust GDP data for government spending.
Shiller PE Continues To Mislead Investors, S&P 500 Is Fairly Valued In Early 2013 [View article]
I am a Shiller fan and have studied CAPE in depth. As you say in your headline, it IS misleading, to put it politely.
Ben Graham had a better idea. Not only did Ben originate the idea of normalizing E, but he later realized he needed to integrate interest rates or the model wouldn't fly.
I took Ben's idea a step further, replacing earnings with GDP. Capitalizing the long term median of this ratio produces a measure of intrinsic value that is clearly closer to real market behavior than CAPE or any of the other ratios likes P/BV, Q, P/Div et al.
Can They Spare A Penny A Click For International Coverage? [View instapost]
I want to add my voice here. I support Jon's work for the simple reason that I need it badly. I track the Mongolian mining space on a daily basis and read every item I can find. Of all the commentators I follow, Jon Springer is easily the most valuable, both for his unique information and for his straight-forward approach.
As a Canadian with numerous contacts at resource companies and resource technology companies, along with a broad network in the financial community, it's natural to look for opportunities in underexplored regions of the world.
This is an active sector, so any and all coverage is welcome, especially when it is of the caliber that Jon provides.
Charlie, what fascinates me is measuring the degree to which stock markets have ventured into Krazytown. Unfortunately, moving averages wouldn't provide that information at the crucial times when investors need to get their bearings and adjust for what's next.
It could well be an oversimplification to say that low valuations point to good returns in the future. I hasten to add that while my valuation metric points to undervaluation, my other work in market cycles explains why I think the market could stay cheap for quite a while yet.
I have a site at http://lostdecades.com that delves into the behavior of financial markets in the wake of a great collapse.
As a result of my market history lessons I can see that the period of undervaluation we're experiencing now is little different from similar episodes in the 1940s and 1970s. What they have in common is a feeling that stocks are bad news, a preference for income investments, and a desire for austerity – all normal reactions after a bubble has burst and caused a lot of pain.
But eventually, and it does take many years, the problems are corrected and a new secular bull market begins. Most investors will miss it, like they did in 1949 and 1982, the last two great beginnings.
About interest rates, BV accounts for them, with the result that low yields have skewed intrinsic value to the upside. If I plug 6% into the equation instead of 3.6%, fair value for the S&P turns out to be roughly where the market is trading now.
I'm probably as skeptical about the next stretch of time as you are.
Charlie, I appreciate your comments. I can assure there is no confusion in my mind between intrinsic value and market value, even if my explanations suggest to you I have them mixed up.
I could have articulated my argument better, I suppose.
Market value, for better or worse, is observable, while intrinsic value is calculated, and theoretical.
My point is actually dead simple. If a valuation metric claims to model reality, it should be closely correlated with price. For instance, r-squared for BV is 0.91 for the past 61 years.
Only when this condition is true does a valuation metric become useful, because an investor needs to know when the market is not tracking intrinsic value and is trading off-track, so to speak.
For its part, CAPE said the market was overvalued back in the early 1990s and apart from a brief spell in late 2008, that's been the reading. That's not my idea of a sensitive indicator. Woe to anyone who listened to it.
BV doesn't have much predictive value by itself and I caution all investors to treat value-based indicators as information only and not trading signals.
Charlie, you raise some good questions. To address the relative usefulness of my metric vs CAPE or traditional ones like PE or price/dividend ratios, I have charted each metric side by side over monthly and weekly timeframes. You probably saw these charts on my site.
Mere visual inspection should tell you what you want to know. In other words, classic ratios and CAPE alike fail to model reality. They don't fit. BV gets a lot closer, so by that token, it's more useful because it's more accurate. For example, sometimes you will find CAPE saying the market is overvalued, when BV says it is undervalued.
As a predictive tool, evidence show that the market's tendency is to trade around BV, except during episodes when investor sentiment runs to extremes.
When the market does not trade in the vicinity of fair value, and spends its trading days either far above (late 1920s, late 1960s, late 1990s) or far below (1940s, 1970s, present day) where it should be trading, you've got a case of mistaken expectation.
Other times, most times, the market gets it right. But sometimes, like now, investors get carried away and imagine a future that is way too bleak, pushing prices down and creating a sizeable gap between fair value and market value, one that will eventually close.
Apart from these special cases, I consider market value metrics quite useless and potentially dangerous. The fact that market extremes exist at all tells you that investors disregard conditions of over and undervaluation and often spend precious energy defending the error.
Thanks for the reply, Tom. You may be interested to know that Ben Graham used Moody's Aaa in his 1974 formula, and out of curiousity I calculated BV with Baa to compare the results. I found no significant difference in fair value and so I deem the two measures of yield interchangeable.
When I tackled the intrinsic value question I started with Buffett's GDP/market value ratio and incorporated elements of Ben Graham's 1974 formula to allow interest rates to influence the outcome.
The upshot was a sturdy metric that is more useful than Shiller's and easier to calculate too.
By its lights the S&P 500 is undervalued by about 40%.
The Intrinsic Value Of The S&P 500 (April 27, 2012) [View instapost]
I compare BV to other valuation metrics all the way back to 1919, if you want to see for yourself which ones struggle to model reality, and which one fits.
ECRI Weekly Leading Indicator: 3rd Consecutive Decline [View article]
The Yo-Yo Years...that's clever. Wish I had thought of that. I was just a kid in the Go-Go era, but I read John Brooks' book to get a sense of the '60s blow-off. No surprise that the Go-Go years gave way to the yo-yo years of the '70s. History says this is normal in the wake of a great collapse. That's why we're limping along now.
Are Dividend Growth Stocks Overvalued? [View article]
An approach to the valuation of dividend stocks you may be interested in was pioneered by Geraldine Weiss, author of Dividends Don't Lie. She compared a stock's current yield to its own yield history to find under and overvalued dividend payers. Another metric to run would be the relationship between the stock's yield and the market's yield.
Or just glance at the Value Line chart. These show PG slightly under, MCD over, and KO well under. What's important to note is that ENB is substantially over the so-called value line, so your sales made fundamental sense.
Shiller PE Continues To Mislead Investors, S&P 500 Is Fairly Valued In Early 2013 [View article]
Shiller PE Continues To Mislead Investors, S&P 500 Is Fairly Valued In Early 2013 [View article]
In fact, that's what the market is doing, when it adjusts to suit the prevailing expectation for growth. That way lies Crazy Town.
But to answer your question about the constant (2), the long term median of PYi (Price/GDP*Aaa) is .519, so you're right. The number 2 is a handy rule of thumb when solving for price (PY/2i)
Shiller PE Continues To Mislead Investors, S&P 500 Is Fairly Valued In Early 2013 [View article]
To answer your questions, government spending has accounted for 20% of GDP plus or minus 5% in the post-WWII era. Government are wasteful, I agree, but the dollars don't care who spends them, so I don't adjust GDP data for government spending.
An interesting idea though.
Shiller PE Continues To Mislead Investors, S&P 500 Is Fairly Valued In Early 2013 [View article]
Ben Graham had a better idea. Not only did Ben originate the idea of normalizing E, but he later realized he needed to integrate interest rates or the model wouldn't fly.
I took Ben's idea a step further, replacing earnings with GDP. Capitalizing the long term median of this ratio produces a measure of intrinsic value that is clearly closer to real market behavior than CAPE or any of the other ratios likes P/BV, Q, P/Div et al.
You are welcome to see for yourself at http://brockvalue.com
Can They Spare A Penny A Click For International Coverage? [View instapost]
As a Canadian with numerous contacts at resource companies and resource technology companies, along with a broad network in the financial community, it's natural to look for opportunities in underexplored regions of the world.
This is an active sector, so any and all coverage is welcome, especially when it is of the caliber that Jon provides.
Peter Brock
Where Shiller's Disciples Go Wrong [View article]
It could well be an oversimplification to say that low valuations point to good returns in the future. I hasten to add that while my valuation metric points to undervaluation, my other work in market cycles explains why I think the market could stay cheap for quite a while yet.
I have a site at http://lostdecades.com that delves into the behavior of financial markets in the wake of a great collapse.
As a result of my market history lessons I can see that the period of undervaluation we're experiencing now is little different from similar episodes in the 1940s and 1970s. What they have in common is a feeling that stocks are bad news, a preference for income investments, and a desire for austerity – all normal reactions after a bubble has burst and caused a lot of pain.
But eventually, and it does take many years, the problems are corrected and a new secular bull market begins. Most investors will miss it, like they did in 1949 and 1982, the last two great beginnings.
About interest rates, BV accounts for them, with the result that low yields have skewed intrinsic value to the upside. If I plug 6% into the equation instead of 3.6%, fair value for the S&P turns out to be roughly where the market is trading now.
I'm probably as skeptical about the next stretch of time as you are.
Where Shiller's Disciples Go Wrong [View article]
I could have articulated my argument better, I suppose.
Market value, for better or worse, is observable, while intrinsic value is calculated, and theoretical.
My point is actually dead simple. If a valuation metric claims to model reality, it should be closely correlated with price. For instance, r-squared for BV is 0.91 for the past 61 years.
Only when this condition is true does a valuation metric become useful, because an investor needs to know when the market is not tracking intrinsic value and is trading off-track, so to speak.
For its part, CAPE said the market was overvalued back in the early 1990s and apart from a brief spell in late 2008, that's been the reading. That's not my idea of a sensitive indicator. Woe to anyone who listened to it.
BV doesn't have much predictive value by itself and I caution all investors to treat value-based indicators as information only and not trading signals.
Where Shiller's Disciples Go Wrong [View article]
Mere visual inspection should tell you what you want to know. In other words, classic ratios and CAPE alike fail to model reality. They don't fit. BV gets a lot closer, so by that token, it's more useful because it's more accurate. For example, sometimes you will find CAPE saying the market is overvalued, when BV says it is undervalued.
As a predictive tool, evidence show that the market's tendency is to trade around BV, except during episodes when investor sentiment runs to extremes.
When the market does not trade in the vicinity of fair value, and spends its trading days either far above (late 1920s, late 1960s, late 1990s) or far below (1940s, 1970s, present day) where it should be trading, you've got a case of mistaken expectation.
Other times, most times, the market gets it right. But sometimes, like now, investors get carried away and imagine a future that is way too bleak, pushing prices down and creating a sizeable gap between fair value and market value, one that will eventually close.
Apart from these special cases, I consider market value metrics quite useless and potentially dangerous. The fact that market extremes exist at all tells you that investors disregard conditions of over and undervaluation and often spend precious energy defending the error.
Where Shiller's Disciples Go Wrong [View article]
Thanks for introducing Andrew to me as well.
Where Shiller's Disciples Go Wrong [View article]
The upshot was a sturdy metric that is more useful than Shiller's and easier to calculate too.
By its lights the S&P 500 is undervalued by about 40%.
Excellent article, Tom.
If you want to see my work, please visit http://brockvalue.com
The Best Thing Warren Buffett Has Said All Year [View article]
The Intrinsic Value Of The S&P 500 (April 27, 2012) [View instapost]
The comparison is here: http://bit.ly/KiKuHN
ECRI Weekly Leading Indicator: 3rd Consecutive Decline [View article]
Is The Stock Market Cheap? [View article]
Are Dividend Growth Stocks Overvalued? [View article]
Or just glance at the Value Line chart. These show PG slightly under, MCD over, and KO well under. What's important to note is that ENB is substantially over the so-called value line, so your sales made fundamental sense.