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« Thinking Like an Economist: When Does it Pay Off? | Main | ETF Update: The Appeal of Metals and Mining »

April 10, 2010


Mike C

FWIW, I think the dshort article and graph is more descriptive then the Plexus chart regardless of the opinion on the validity of the metric. Others following along like Paul in Kansas City might find the article instructive:

What is your view on Tobin's Q which was developed by an economist?

Mike C


Thanks for the response, and the link to the article. Very interesting article with some cogent points. Some very interesting comments as well. I thought the first commenter had a good response.

Just my opinion, but I think one area where many of us (bloggers, OPM managers, and casual readers) end up talking past each other is in not realizing you have to match the tool to the time frame, and the effectiveness of a particular tool might depend critically on what time frame you are looking at.

I work for a company where the motto is "the plan is the plan is the plan". Well, I think an investment corollary to that is "the math is the math is the math".

So with regard to the Shiller P/E, we know historically that the math shows that 10-year subsequent market returns are highly correlated with the starting Shiller P/E value. Of course, that doesn't tell you diddly squat about the next 1-2 years. As another OPM manager, and economist recently noted long-term market returns since 1998 are well below average and that just so happens to correlate with the Shiller P/E getting above that danger zone of 20.

But for those of us who do this for a living, waiting 10 years to be proven right won't cut the mustard so to speak. As Ritholtz put it recently, if you are a pro you have to participate in a 13-month 75% rally.

My own view that I've sort of settled on (but always open to adaptation) is that the Shiller P/E is not something you can use in isolation to either buy or sell but something to just realize whether the market is in the "opportunity" zone or "danger" zone. I think in 13 months we've gone from the opportunity zone to the danger zone.

Just curious, based on your preferred valuation metrics how high do you think this current upcycle could go before the next bear market hits whenever that is. 1300? 1500? 1800? 2000+? When will it be time to trim/sell?

Paul in Kansas City

Both of these comments plus your article Jeff very helpful. I agreew with you; valuation models cannot help you time the market; markets can stay over valued or undervalued for years; investor may pay a premium or demand a large discount on future earnings; there are time periods where equity prives were at a substantial discount to net cahs liquidations; there is no full proof way to predict those momentsnor their duration. I wish!


Mike C - Do you believe that the 1999-2000 spike in stocks showed that the market was undervalued before the rally? No? I didn't think so.

So why do you think that the post-Lehman selling demonstrates that stocks were over-valued in 2007?

Most valuation models changed dramatically as new economic evidence and new information about corporate earnings became available.

My concern with this approach, which I outlined in the article I linked from last March, is that those following Shiller have no ability to adapt.

You might enjoy reading this article and the discussion.

I appreciate and applaud your desire for better market timing, but I think we need to look well beyond valuation models for that.

Thanks for another interesting comment.


Mike C

You can see that this approach will make sure that you get a chance to buy stocks every thirty years or so.

How did you draw this conclusion?

The interesting question to me, and that I ponder regularly, is if there is an effective way to blend both backwards and forward-looking earnings together because neither seems absolutely effective.

Waiting for the Shiller P/E to get below say the average would keep you out of some very substantial bull runs, yet relying on a forward earnings metric told you the market was "cheap" in October 2007 right before a 60% peak to trough decline. In my mind, an effective valuation metric or combination of metrics should alert you to both upside opportunity and downside risk as looked at over a multi-year time frame. In other words, an effective metric should say opportunity in March 2003, danger in October 2007, and opportunity in March 2009. I would note the Shiller P/E did get below its median value in March 2009 so it is somewhat incorrect to imply it was of no help at the March 2009 bottom in indicating that the market had value.

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