My Photo
Note: Jeff does not accept guest blog posts on A Dash of Insight.

For inquiries regarding advertising and republication, contact main@newarc.com

Follow Jeff on Twitter!

Enter your email address:

Delivered by FeedBurner

Certifications

  • Seeking Alpha
    Seeking Alpha Certified
  • AllTopSites
    Alltop, all the top stories
  • iStockAnalyst
Talk Markets
Forexpros Contributor
Disclaimer
Copyright 2005-2014
All Rights Reserved

« Investment Lessons from 2010 Lists: Prosaic, Profound, Predictable, Pornographic, and Provocative | Main | Weighing the Week Ahead: Stormy Weather? »

January 05, 2011

Comments

oldprof

qwsp -- You are absolutely right. These are not contrasting predictions for the same time frame. On a theoretical basis, both could be correct.

At least they provide a time frame, unlike many of those making dramatic calls.

I would still take "over" on Shiller and "under" on Birinyi in this little exercise on evaluating "big" calls. How about you?

Jeff

qwsp

Actually, you cannot compare these two predictions because they are 2 different time frames. Certainly Shiller understands that irrational exuberance can take the market higher over the next 2 years. Maybe Birinyi also suspects the index could trend down to Shiller’s number by 2020. Also note that Birinyi’s target for 2011 of 1333 is actually lower than the consensus of 1371. His real outlier is that 52% of the gains begins in July of 2012! You gotta give him props for this kind of precision! One final comment, Birinyi’s numbers are obviously actual print, but Shiller is probably referring to a real return of 1430 minus inflation but it’s not made clear in that sound bite.

oldprof

j'adoube -- Thanks for pointing this out. I hate mistakes like this. I apologize to Mr. Birinyi and to readers for the error.

Other bloggers work during the day, but I can only write at night. I wish that I did not make any mistakes, and found the ones that I did make. I have learned that many errors are corrected the next morning.

I feel especially bad about this one, since I have been a Ticker Sense participant for many years.

The first time I wrote about Maria I also spelled her name wrong. It was before she became famous, and she sent me an email correcting me!

Anyway, mea culpa -- spelling fixed.

Good job, J'adoube (and good name!)

Jeff

j'adoube

Dude, it's

Birinyi

not

Biryini.


Geesh.

Rushabh

Interesting piece. I wonder if you have read any of John Hussman's work? I see you state:

"I have an open challenge to anyone to show that Shiller's backward looking method is better than the one-year forward estimates by analysts at predicting next year's earnings. This is a simple factual challenge with no takers so far."

I am very sure if you read some of the stuff on Hussman's website the two of you would have a very intense conversation on historical market analysis vs. forward estimates and multiples.

Here is his website: http://www.hussmanfunds.com/

Great read either way. -Rushabh

rich

Hi Jeff -- I agree completely with your point that the Shiller PE isn't sufficient as a binary buy/sell signal used entirely in isolation. I definitely did not use it that way, as you point out.

I guess I interpreted your initial post as saying that the Shiller PE was useless. This is the idea I objected too, because I think it's very useful to have an idea of secular "expensivess" as an indicator of potential long term upside and downside (and thus, whether to look outside the S&P 500 for better risk-adjusted returns).

But you are absolutely right that by itself it is not useful as a buy/sell indicator. Sorry if I misunderstood the meaning of your post.

Rich

oldprof

rich -- I congratulate you on your successful decisions, but I am writing with investors in mind. You have used Shiller as one input, not really waiting for the official 'buy' signal.

I certainly agree that it is better to buy when the P/E ratio is low. I just prefer to look forward rather than backward, and I am comfortable with a one-year time frame. I also think that ignoring interest rates weakens the Shiller approach.

Please take a look at this comment from George Vrba, who writes that the Shiller approach is theoretically correct, but not practical. He has a very nice chart to illustrate his point: You might only get a buy signal every twenty years.

http://advisorperspectives.com/newsletters11/Letters_to_the_Editor-01042011.php

Thanks for your thoughtful comments.

Jeff

rich

Also, Jeff, as to your critique of Shiller's prediction. You are basically saying that it's hard to trade based on Shiller's valuation metric, and therefore that his 10 year forecast is invalid. But that doesn't follow. It is well documented that the Shiller PE is very predictive of long term (ie 10 year) returns. For near term returns, it has no predictive value (hence it being tough to "trade" on) -- but that does not invalidate a long term forecast based on the Shiller PE.

I would agree with your summary if you said that Shiller's work provides no real guidance for traders. For investors, who by definition should be most concerned with long term returns, I completely disagree.

rich

Per your invitation I will comment that I have had very good results using the Shiller PE as a key input into my investing approach. Not as a sole focus, but certainly as an input.

My serious investing timeline starts around 2004, so take that for what it's worth. But I kept very low US stock exposure in the mid-2000s, added in late 08/early 09 when the Shiller PE got back near/under fair value, and have scaled back on the way up. I guess we will see how that last part goes. I didn't go to cash, I've gone to other investments I thought had better value than US stocks (hence my statement that I don't look solely at the S&P500 Shiller PE, but use it to guide my US stock exposure). My returns have been tremendously market-beating and the Shiller PE has served me well... with the caveat that I am not judging my returns based on a quarter or a year, but over a multi-year timeline.

As for this comment by burt:

Schiller's data omit a slow structural change that has skewed the big caps: the increasing importance of non-US earnings. Many multinationals get most of their income from this. I believe that this is the reason for the trend upward in Schiller-like valuation indicators since 1950 or so. It would be instructive to get a series of US-only earnings and do the analysis on that.

What does that have to do with anything? The Shiller PE is about how much you pay for earnings, not where earnings come from. (Also, people might take your criticism more seriously if you could spell the guy's name right).

oldprof

DE -- This is a tricky methodological issue. You cannot test the proposition by looking for a correlation between "year-over-year changes in earnings and changes in stock prices."

You need to look at changes in expected earnings versus changes in stock prices. I have done this for various time periods and there is a relationship. It gets strained at times, and there is also a correlation with economic changes.

Zacks does a lot of work on this question as it pertains to individual stocks. They have plenty of data, and it seems pretty convincing.

And we also know that virtually any analyst talking about a stock speaks in terms of forward earnings.

So to answer your "who cares?" question, I think nearly everyone does, and they probably should.

Jeff

DE

"2.Shiller's approach does not successfully predict next year's earnings, the most interesting data for nearly every stock analyst and market forecaster. I have an open challenge to anyone to show that Shiller's backward looking method is better than the one-year forward estimates by analysts at predicting next year's earnings. This is a simple factual challenge with no takers so far."

Who cares about next years earnings? The link between near-term earnings and stock direction is tenuous. Outside of very large changes in earnings, there is essentially no correlation between year-over-year changes in earnings and changes in stock prices.

A.N. Other

Maybe the most accurate forecast is simply to take the current S&P 500 earnings yield and compound it out to 2020. That gives us about 6-7% per annum, assuming no earnings growth. Add in earnings growth at around 3% per annum and you get 9-10% returns for stocks.

Anyway, that is besides the point. Forecasting is a poor technique because the future is inherently difficult to predict. The decision to invest is far, far simpler. Simply look at the main investment alternatives. We have:

i) cash - yielding almost nothing, no growth
ii) bonds - yielding little, no growth
iii) stocks - earnings yield 6-7%, growth 3% per annum.

Wow, tough call - should I invest at 9-10% returns, or 0% for cash or 4% for Treasuries or 6% for corporate bonds? This one is obvious - you should have the vast majority of your investment in the stock market. Stocks are cheap, end of story.

burt

I just found your blog. Good work; I will put it into my reader.

Like you, I am amused by the pack of Schiller followers. They do simple analysis on his long term spreadsheet and come out bearish.

Schiller's data omit a slow structural change that has skewed the big caps: the increasing importance of non-US earnings. Many multinationals get most of their income from this. I believe that this is the reason for the trend upward in Schiller-like valuation indicators since 1950 or so. It would be instructive to get a series of US-only earnings and do the analysis on that.

The comments to this entry are closed.