Trying to make sense out of Shiller P/E Ratio

[resjudicata]

@theriversedge This is absolutely beautiful. I'm hoping to file this away in my mind to reference forever.

 

[emilyflowers]

@theriversedge So is it saying that people act in the now exactly opposite to what they should do for the next 10 years of returns? The inverted axis for SPX is surprising to me, as is the close correlation of the two lines.

 

[theriversedge]

@emilyflowers Basically, it's "average investor equity allocation" vs 10 year SPY returns. It's almost a quantified, visualized version of the phrase "be greedy when others are fearful and fearful when others are greedy".

For example, as of 10/1/1990, your average investor had just ~23% of their allocation in equities, indicating fear. Well from 10/1/1990, the next 10 years of the SP500 were ~19% annualized. On the opposite end, on 4/1/2000, the average investor equity allocation was ~52%. This is "greedy", and people were chasing returns in the dotcom bubble. The 10 year return would turn out to be about -0.5% annualized.

The average equity allocation can be found here and the next update showing Q4 2021 will be on March 10th.

You can also read more at the source provided on the original page, here. Interestingly enough, this page said the expected 10 year returns as of 12/20/2013 were somewhere around 6% nominal return, annualized. The SP500 price was $1,818.32 as of closing on that day. Right now, it's at ~$4,464. This is a ~10.4% nominal annualized return (I did to the power of 9.115, not 10, as it hasn't been 10 full years yet). If we adjust for inflation, then real returns have been ~8.2% annualized.

Either way, it's not by any means 100% accurate, but it seems directionally correct at the very least.

 

[koolix123]

@theriversedge I'm just a fledgling when it comes to most of this. If the average investor equity allocation is 50%+ then this information is suggesting I would likely be better off holding a smaller % of equities. Then this is saying I might be better off moving into SPY?

 

[albert68]

@koolix123 It's not talking about you as a single investor, but "everybody". So it's not saying "once you personally are over 50% equities, your returns over the next 10 years are sour". It's "everybody is bought into the market and being greedy, so your next 10 years will sour"

 

[viewerindepth]

@rescued2 The world is not just the US. That are a lot of opportunities in Japan and emerging markets and the smart money will take them.

 

[olly91]

@rescued2 We’ll have to see how inflation plays out but the assumption that the Fed, for political reasons, can’t raise rates is a bad one. Inflation itself is a political reason for them to have to raise rates. If inflation continues at the high levels we’ve been seeing it will become more and more the focus of the public and the government and the Fed will take more and more aggressive actions to address the emergency situation.

People should be honest with themselves about the risk our current inflation situation creates for the long bull market cycle we are in and make sure they are mentally prepaired for a significant reduction in their portfolio’s value if they are committed to the buy and hold strategy.

 

[sherriemae]

@olly91 can you explain to me how raising rates will increase the affordability of normal people?

all I can tell is

1) prices for services and products will stay flat or increase, no one is going to lower prices when money is now harder to obtain

2) home prices are mainly due to limited supply, raising rates wont impact this and immigration hasnt even started in full due to covid.

3) auto is just a supply constraint due to covid and semiconductor supply issues related to increase in demand and usage.

4) companies will lay off people, as they no longer have funding to keep paying paying massively overstaffed divisions (due to low interest debt not being available)

5) stock markets will do whatever, lets say they stay flat or down - people lose out on retirement

6) innovation comes to a stand still. not saying the world is allocating money properly towards humanities progression right now, but even less low interest money floating around means this will go down

7) social issues will take a back seat as there will be a real recession and devolution of human societys who have had it easy realtively for the past 2 decades.

8) meat, produce etc will still cost the same or more, as it still costs the same money to create (workers, resources, shipping etc)

9) taxes are more likely to increase, as goverments need to manage debt in stagnant economy.

i mean everyone is saying they want rates to go up to "lower" inflation, but i see zero bull cases for common people if rates go up. You will lose less actual money by adapting to a low interest world (which imo is here to stay anyways, it would be stupid to raise rates significantly, money is societal construct)

 

[testimony2share]

@rescued2 Why does every comment like this not mention gold?

 

[sherriemae]

@testimony2share no one in the modern world has made money investing in gold. unrealized sure, but gold is a shit investment or inflation hedge.

 

[sherriemae]

@rescued2 if everything is in a bubble, there is no bubble.

same shit happened during the industrial revolution.

Any major turning point in how society operates comes with a boom in companies catering to it.

Technology is exponential (modern humans been around for what 5000 years, it took 300 years to go from kings with swords to spaceships and particle accelerators)

none of this is surprising. coupled with the fact money is a social construct, theres nothing to worry about and the party will go on.

 

[greg67]

@chuckrob I think people misunderstand the competition between stocks and bonds for money. Everyone just think about it as "for me personally, bonds don't make any sense and until they do, bonds won't provide any competition for stocks" Except bonds do compete with stocks and are currently competing with stocks and if you make them more attractive by increasing interest rates, all else equal stock prices will decrease to bring the risk-adjusted return of stocks back in line with the risk-free rate of return provided by bonds. P/E of 36 only makes sense if bond returns are dog shit. Every step they take away from dog shit (through the fed raising interest rates, let's say) is going to decrease P/E to restore equilibrium between the two. To put it quantitatively, the relationship between stock P/E and interest rates is continuous; it doesn't suddenly matter all at once at some crossover point. So if you're expecting rate hikes (reasonable given 7% inflation), expect a decrease in P/E over the short to medium-term.

TL;DR: it's not all or nothing. On margin, making bonds more attractive hurts stock valuations, even if buying bonds still doesn't make sense for you personally and we're all worried the Fed is going to hike up interest rates and deflate that 36 P/E

 

[al1998]

@greg67 P/E is a two sided equation though

if bond yields go from 1% to 2% or 2% to 3%, people will sell off equities lowering their value aka their price

but the earnings side of the equation stays roughly the same for big companies not dependent on financing growth with low interest cheap fed debt… right?

current s&p p/e is like 25x

if prices fall 10-20% but earnings stay roughly the same, that gives us _________

one second let me do the math

current SUM of MarketCap of all stocks in S&P500: 39690002239243

current SUM of EpsTtm*Outstanding of all stocks in S&P500: 1562767516870

current P/E = 25.40

say market cap goes down 10% to 35721002015318

say earnings doesn't move at all

P/E would be 22.85x