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Over the next 5 years will the S&P 500 with an earnings yield of 3.5% outperform 3-month T-Bills with a yield-to-maturity of 5.4%? How about BRK-B? Thanks for your input.

Over the next 5 years will the S&P 500 with an earnings yield of 3.5% outperform 3-month T-Bills with a yield-to-maturity of 5.4%? How about BRK-B? Thanks for your input.

I think the first problem you'll have with the comparison is that 3-month T bill rates are extremely unlikely to stay as high as they are. They're noticeably higher than inflation at the moment, which is a relatively rare thing. For the time being, I like T-bills, and I have a lot. But I think that preference will change.

I expect Berkshire to do better than the S&P, but then I'm predictable. This is the Berkshire board.
But part of that advantage is that I expect the performance of Berkshire to be very much more predictable. The range out possible outcomes is quite a bit narrower. I think we will probably see inflation plus 7-8% for a few more years as a trend of value generation, but in any case I think one can count on inflation plus 6-7%. Perhaps minus a small one time flat spot--maybe 6%?--as valuations are currently a hair above the average of the last 15 years.

As for what to expect from the S&P 500, that's a very tough game to play. Mainly because it seems that valuations can do anything. It's not so hard to imagine what the value generation will be for S&P 500 firms, but without any confidence at all that the valuation multiples will be within plus or minus 15% of some sort of normal, the actual market return figure is unknowable. But for a starting line of thought on what makes sense as a central expectation, I think this is an excellent line of thinking by Baybrooke
https://www.shrewdm.com/MB?pid=-2&previousPostID=5...

Jim

Jim, that link gets me a "General Error: [java.lang.NullPointerException] java.lang.NullPointerException"

Thank you very much for your input, Jim.

I expect Berkshire to do better than the S&P, but then I'm predictable. This is the Berkshire board.

Jim - What are your latest thoughts on RSP and QQQE?

Per the official RSP site, as of 6/30/24, trailing P/E = 17.99 and forward P/E = 16.45 which looks reasonable relative to SPY.

https://www.invesco.com/us/financial-products/etfs...

For QQQE, the official Direxion site doesn't list P/E. Per Yahoo Finance, which I think is reliable, P/E = 30.79 for QQQE and 40.55 for QQQ.

https://www.direxion.com/product/nasdaq-100-equal-...

In 2022 and 2023, you recommended buying QQQE when prices were much lower. That was an excellent call! Per your post below, you said "fair value is 68 and today's price of 70.56 is not cheap but reasonable". You also said "This sort of valuation exercise certainly won't have you putting your money into the S&P 500 these days, whether cap weight or equal weight."

https://www.shrewdm.com/MB?pid=108867080

Well, that was then. Today QQQE sits at 90. Regarding RSP, I am not sure why you don't favor it. If trailing P/E = 17.99 and forward P/E = 16.45 is correct, isn't RSP reasonably valued? Thanks for your time and expertise which you very generously share!

Jim, that link gets me a "General Error: [java.lang.NullPointerException] java.lang.NullPointerException"

Huh, works for me. Maybe just a fluke?
Anyone else try it?

https://www.shrewdm.com/MB?pid=-2&previousPostID=5...

Jim

"Error" for me also.

In 2022 and 2023, you recommended buying QQQE when prices were much lower. That was an excellent call! Per your post below, you said "fair value is 68 and today's price of 70.56 is not cheap but reasonable". You also said "This sort of valuation exercise certainly won't have you putting your money into the S&P 500 these days, whether cap weight or equal weight."

https://www.shrewdm.com/MB?pid=108867080

Well, that was then. Today QQQE sits at 90.

I would be cautious in calling this an "excellent call" ; returns since March 2022 (when QQQE last traded at 70ish)

QQQE  +28%
QQQ   +53%

tecmo
...

For the link to he reliable, place “www.” at the start of the link url.

Baybrooke’s post:

https://www.shrewdm.com/MB?pid=-2&previousPostID=5...

With “www.” added at the start, everyone will be able to the link above. Without www it may work in some circumstances but with www it will always work.

Also visit Shrewd’m via www.shrewdm.com rather than just shrewdm.com so that any bookmarks you generate will have the correct url.

I’ll may do something to make these errors impossible, though this is the first time I have seen it reported.

- Manlobbi

What are your latest thoughts on RSP and QQQE?
Per the official RSP site, as of 6/30/24, trailing P/E = 17.99 and forward P/E = 16.45 which looks reasonable relative to SPY.
...
In 2022 and 2023, you recommended buying QQQE when prices were much lower. That was an excellent call! Per your post below, you said "fair value is 68 and today's price of 70.56 is not cheap but reasonable". You also said "This sort of valuation exercise certainly won't have you putting your money into the S&P 500 these days, whether cap weight or equal weight."

My comments about those two are that they are great for very long term holds. When I mentioned it, it was a fair entry point for QQQE, less so for RSP. The fact that they've both done well since then could be, in the context of my suggestion, considered just a random blip in a long run trajectory.

The thesis is primarily this: the earnings trajectory for QQQE has been VERY much faster than the earnings trajectory of RSP, for decades. This might not continue, but if it does, that means that it is by far the better very long term hold. Particularly if you don't enter at a worse-than-typical valuation level.

That says relatively little about the short and even medium term. As for RSP's valuation seeming reasonable based on the quoted P/E, I wouldn't put much weight on that. Earnings are cyclical. If you do a cyclical adjustment on earnings it's not such a pretty sight. And if you look at other metrics like price-to-sales that implicitly assume mean reversion of net margins, it looks downright dire. Earnings have risen far, far, far more than sales for a long time. This process can go on only so long, and we seem to be getting a lot closer to the high end limit of net margins than to the low end. And net margins could reverse, both cyclically and in a secular way...who knows?

But if you do want to have a grasp of the likely valuation level of RSP in the current cycle (not to be confused with its true long run value), I will let you in on a wonderful little metric I came up with. Since RSP (and QQQE for that matter) are both equally weighted, the median of any metric is a very good proxy for the average, while neatly avoiding distortions from a few wild outliers. Track down the median free cash flow yield among the S&P 500 companies, and divide by 3.00%, being the typical multiple assigned by the market since 2008. That will get you the likely trading value of RSP, not to be confused with its true fair value versus long run sensible expectations. Using that method (and only that method), RSP is around 10.8% more expensive than usual using "right now" median FCF yield, and about 6.8% more expensive than usual measuring the price against the on trend real median FCF. Using those two methods, you might expect a price of maybe $148-154 this month, versus the current price of $164.35. Again, not to be confused with an estimate actual fair value, this is merely with reference to what one would expect it to be trading at, given the recent very high free cash flow yields. If/when median free cash flow rolls over, the market value might well do so as well. Actual fair value is, in effect, the present value of all future earnings. The cyclically adjusted earnings yield is poorer than average, even if you look only at the high-valuation era since the millennium.

Jim

"Error" for me also.

Hmm, must be some quirk of the site, maybe because I'm in non-threaded mode and you're threaded, or some such?
I was trying to point to post number 8133. You can put that into the blank at the top of any single post and hit "go".

Jim

I would be cautious in calling this an "excellent call" ; returns since March 2022 (when QQQE last traded at 70ish)
QQQE +28%
QQQ +53%

I guess my point was, and remains, that QQQE tracks what amounts to a sector, quite well. It's sufficiently diversified that you can make trending macro-type predictions about it with some moderate amount of confidence. The average earnings trend remarkably well.

The returns of QQQ are best thought of as the sum of (a) the returns of QQQE, plus or minus (b) a gigantic random number for how a tiny number of firms have done lately, which is totally unpredictable. (it isn't even cap weighted, nor do the weights make any sense).

True, the random number has been positive lately. But the fact that QQQ has done better than QQQE lately is a fluke. It might continue, it might not. One can't say without doing a deep (and correct) analysis of the future of about five firms. If you can do that, buy them, don't buy QQQ.

The fact that QQQE is doing well was, and remains, pretty predictable over the long haul. It's currently a little more expensive than historically usual, but not all that much. The current valuation level of QQQ is Heisenbergian, so no comment.

So...was QQQE an excellent call? I think it was, in the narrow sense that a "good bet" is not the same as a "winning bet". A good bet might win or lose, but will probably win. A merely winning bet, on the other hand, might have been purely luck. That's how I would characterize QQQ has been in this stretch. I could give you a pretty good estimate of the likely returns of QQQE in the next 5-10 years. I don't think there's anyone on the planet could say the same for QQQ.

Jim

I think that most web sites ignore the "www." prefix. It's a leftover standard that became obsolete in the early days of the internet.

Almost nobody ever puts in the "www." when they type out a web URL, just "whatever.com"

So...was QQQE an excellent call? I think it was, in the narrow sense that a "good bet" is not the same as a "winning bet". A good bet might win or lose, but will probably win. A merely winning bet, on the other hand, might have been purely luck. That's how I would characterize QQQ has been in this stretch. I could give you a pretty good estimate of the likely returns of QQQE in the next 5-10 years. I don't think there's anyone on the planet could say the same for QQQ.

No argument that QQQE is more predictable than QQQ, but that doesn't necessarily make it a better investment choice; and clear the past few (5 ish?) years have favored QQQ - not exactly a blip.

tecmo
...

No argument that QQQE is more predictable than QQQ, but that doesn't necessarily make it a better investment choice; and clear the past few (5 ish?) years have favored QQQ - not exactly a blip.

Backtesting on testfol.io for CAGR:
last 5 years, QQQ 21.93%, QQQE 13.99%
last 10 years, QQQ 18.97%, QQQE 13.25%
last 12 years, QQQ 18.77%, QQQE 14.30%
(limited by QQQE inception 3/21/2012)


QQQE may be better someday. But today is not that day.

No argument that QQQE is more predictable than QQQ, but that doesn't necessarily make it a better investment choice; and clear the past few (5 ish?) years have favored QQQ - not exactly a blip.

Were the late 1990s a blip? Sure. A blip can be several years long. My comments are purely about long term returns.

As for whether predictability is a prerequisite for something being prerequisite for something being a good long term investment choice, no. But I would say you absolutely need one or both of two things: a relatively predictable future value range, and/or a big margin of safety on your entry. A margin of safety can come from a low price relative to expected value, or (less often mentioned) from asymmetrical payoffs: heads I win big, tails I lose only a little. I don't think QQQ offers either of those at the moment, though opinions differ.

Again, these are comments about long term positions. Playing short term momentum or other "nimble" strategies is neither fattening nor illegal. I have positions in Nvidia and Apple at the moment, despite not having any conviction of good return prospects over the next few years given current valuation levels. One of my quant screens has managed a CAGR of 65%/yr since the start of last year. Given the short average holding period, I should call it the "greater fool" screen : )

Jim

But the fact that QQQ has done better than QQQE lately is a fluke.

Yahoo has QQQE first starting March 21, 2012. Below is a table showing total returns (not annualized) for QQQE and QQQ with various start dates until now. As an example, starting in March 2015, you would be 60% better with QQQ vs QQQE. 12 years is a pretty long trend for out performance.

Start QQQE Return QQQ Return Ratio QQQ/QQQE

3/21/2012____5.2____8.3____1.6
3/21/2013____4.8____8.1____1.7
3/21/2014____3.6____6.1____1.7
3/21/2015____3.0____4.9____1.7
3/21/2016____3.2____4.9____1.6
3/21/2017____2.6____4.0____1.5
3/21/2018____2.1____3.1____1.5
3/21/2019____2.0____2.8____1.4
3/21/2020____2.3____3.0____1.3
3/21/2021____1.2____1.6____1.3


Aussi

Apologies for formatting. How can tables be posted form Excel

QQQE may be better someday. But today is not that day.

Correction:
QQQE may be better someday. But yesterday was not that day.

Well, technically you're right, in that QQQ is down a hair less today, but more generally, we don't know what will happen next.

My point is that the relative performance of the two is wholly unpredictable, as it depends on the specific fortunes of maybe 3-5 companies. No macro or top-down metric can inform you about that gap, one way or the other. Will Zuck cancel the blue app tomorrow? Beats me.

Without a doubt the very highest weighted firms in this set (not the same as the largest by market cap BTW) have been outstanding performers lately, but that is not a law of nature, and in fact is statistically the anomaly though history. To choose QQQ over QQQE is to wager on rolling dice. Why would you? Yes, those dice have just come up boxcars several times in a row, but they are loaded very very slightly against you. Neither of those insights tells you what the next roll will bring.

Jim

But the fact that QQQ has done better than QQQE lately is a fluke
...
Start QQQE Return QQQ Return Ratio QQQ/QQQE...

No one disputes that QQQ has done better in the past, including many sub-periods.
The point is that this observation has zero predictive power.

This great has been the result of several tosses of the dice. Great for those who rolled the dice, but it can not be extrapolated. The performance of QQQ has an extremely large random component which most people, if they were fully aware of it, would probably not want from their investments. The top few stocks in QQQ dominating the difference between the two choices. If you have strong and well informed ideas about the future long term returns of those specific stocks, then you should place wagers on those specific stocks, not QQQ. Nobody else should have a position in QQQ, because they'd be investing in a very concentrated way in something they can't assess. The biggest 9 positions are half the assets, even after the recent weight pruning and rebalancing.

Though I can't say it describes this specific future--my theme is its unpredictability--it's worth noting that the very largest cap firms in the whole market have historically performed *considerably* worse than those that are a bit smaller. The recent result might continue or might not, but it is a historical anomaly.

Jim

Though I can't say it describes this specific future--my theme is its unpredictability--it's worth noting that the very largest cap firms in the whole market have historically performed *considerably* worse than those that are a bit smaller. The recent result might continue or might not, but it is a historical anomaly.

For the NDX100or equivalent back to 1972, the equal weight has roughly out perfomed the Marketcap weight in only 20years out of 52 years. Overall in the 52 years, marketcap has out performed by a factor of 3.

https://discussion.fool.com/t/etf-compare-equal-we...

For NDX100 since 1972, the marketcap has performed better than the equal weight, not worse. Note, for the SP500 this is reversed. The SP500 equal weight has performed 2 times better than the marketcap.

Aussi

No one disputes that QQQ has done better in the past, including many sub-periods.

Do you have the data for this? ie: How many sub-periods in the past 10 years has QQQE out performed QQQ?

tecmo
...

For NDX100 since 1972, the marketcap has performed better than the equal weight, not worse. Note, for the SP500 this is reversed. The SP500 equal weight has performed 2 times better than the marketcap.

True, but the largest weighted firms in the Nasdaq 100 have not (historically) been pretty much the exact same list as the largest market cap listed firms in the US as is currently the case give or take, so the general rule may still apply these days when it's almost precisely the same top N. Or not...it's unpredictable, just a statistical skew.

As an aside, just a reminder that QQQ isn't market cap weighted. Which is sometimes better, sometimes worse, but yet more randomness.

To me it's plain as the nose on your face that it makes no sense to buy a fund which is hugely overweight a few stocks unless you think you personally have a very good reason to be overweight those specific stocks at their current valuations. I guess 2001 is a long time ago--it's a dwindling population of current investors who remember their investments' behaviour the last time the market was this concentrated in a few "can't lose at any price" names : )

Jim

Do you have the data for this? ie: How many sub-periods in the past 10 years has QQQE out performed QQQ?

It's probably not worth bothering. The last ten years have been basically one long gigacap bull market.

One reversal in 2022. Tinier hiccups around end 2018 and end 2020. But anyone not overweight the super-gigs has underperformed any cap weight index, much like the late 1990s.

A graph of ratio of the two, nominal total return series for each
https://stockcharts.com/h-sc/ui?s=QQQ%3AQQQE&p=D&s...

Again, the point is that there is no economic reason to believe that the outperformance of the gigacaps in this recent bull has any predictive value for the future. Something happened in the past. It might continue, it might not.

Of course, I have a hunch, but that's not something you want to take to the bank. Consider the last decade that you mention:
Microsoft was trading at a P/E of 16 a decade ago and that was considered normal and fair. Now it's 40, but that is considered normal and fair now.
Apple from 16 to 36.
Nvidia from 22 to 77.
Broadcom 25 to 75, though their earnings aren't very smooth so it's not a great metric.
Costco 27 to 55.
Tesla from meaningless to 77.
Are they all worth that much more as a function of contemporary earning power? Back to my point: I don't know, so I'm unwilling to place a big or long term bet on them. Nobody who doesn't have a well informed view should place big long term wagers on them. QQQ is a big wager on them.

Maybe their multiples will all be in the hundreds in a few years and I'll look like the patsy. I'm cool with that, as I won't have gambled on a wager for which I have no edge.

Jim

How many sub-periods in the past 10 years has QQQE out performed QQQ?

I just grabbed the data to see. Compared the 12-month total returns for every rolling 12-month period March 2012 (QQQE begin) to July 2024

QQQE beat QQQ 28 times.
QQQ beat QQQE 108 times.


One month returns over the same period.
QQQE beat QQQ 55 times.
QQQ beat QQQE 81 times.

To me it's plain as the nose on your face that it makes no sense to buy a fund which is hugely overweight a few stocks unless you think you personally have a very good reason to be overweight those specific stocks at their current valuations.

I guess the current reason would be because that handful of stocks has been in a very strong trend. Remember: "The trend is your friend."

And, actually, why not just buy those top ~10 stocks instead of the fund, since they dominate just about _all_ of the major funds.



I guess 2001 is a long time ago--it's a dwindling population of current investors who remember their investments' behaviour the last time the market was this concentrated in a few "can't lose at any price" names : )

Perhaps it is just wishful thinking, but.....

The Growth Trend Timing that I use now (and didn't know about back then) had you sell on 1/7/2001 at S&P500 1318.55, and had you out (except for a couple of short whipsaws) until 4/21/2003 at S&P500 898.81. (Adj close from Yahoo)


The 43 week SMA instead of GTT would take you out sooner, on 10/8/2000 at 1374.17

I just grabbed the data to see. Compared the 12-month total returns for every rolling 12-month period March 2012 (QQQE begin) to July 2024

QQQE beat QQQ 28 times.
QQQ beat QQQE 108 times.


One month returns over the same period.
QQQE beat QQQ 55 times.
QQQ beat QQQE 81 times.


We get it, the biggest companies have done very well in the last 12 years. You can slice it and dice it as finely as you want, and you will always reproduce the last 12 years' outperformance of QQQ over QQQE. But none of this contradicts the fact that the biggest companies don't USUALLY do better than the average.

Fair odds for rolling two dice and getting two ones would be 11/1 (or 1100, using the American (Moneyline) odds, meaning that for $1 bet each time, you would make $11 for each snake eyes and lose $1 for any other roll. So in 144 rolls, you would win 12 times (with winnings of $132), but you would lose 132 times (for losses of $132), breaking even. If you had been offered worse odds, like 9/1 (or 900), with fair dice you should have expected to win 9 times (winning $81) and lose 132 times (losing $132), and you would have been well behind, losing 35c on average on each $1 bet. But if you took those bad 9/1 odds and happened to get 20 snake eyes instead of 12, then you would have done well despite the probabilities, with $180 in gains offset by $124 in losses.

Now you have to decide how to bet for the next 12 years. You are going to go for snake eyes again?

Maybe the dice are not fair after all. Or maybe you just go lucky. It's your bet, you can do as you choose, but counting how well you did each month or each trimester or each year by betting with odds that do not reflect the long-term average is not a convincing argument.

dtb

Thanks for sharing, the 1M returns are a lot closer than I would have guessed.

tecmo
...

Maybe the dice are not fair after all.

I think this is the point that is nagging at me - that the current structure of the economy is favoring extremely large, highly profitable companies. Maybe their ability to generate excess cash and reinvest it in products that only they can scale effectively is an "unfair" advantage that is self re-enforcing.

Of course - the economic backdrop could change, they could get in trouble with the government, etc... (ie: the dice could get swapped out) but simply arguing that things are required to revert seems simple minded.

tecmo
...

To me it's plain as the nose on your face that it makes no sense to buy a fund which is hugely overweight a few stocks unless you think you personally have a very good reason to be overweight those specific stocks at their current valuations.
...
I guess the current reason would be because that handful of stocks has been in a very strong trend. Remember: "The trend is your friend."

No argument at all. I own a few of the biggest zoomers for that very reason, which I would not plan to hold long term.

The emphasis in my post is "long term hold", which is the original reason I was suggesting QQQE for consideration. It's one main "leg" of what I suggest in my will for my spouse, for example.

The reasoning has to do with two perceived advantages
* Very low risk. The top 9 stocks are 9% of capital instead of 50% with QQQ: lower individual security risk and it can't overweight individual bubble stocks; and
* The historical data strongly suggest to me both high predictability and rapid growth of value based on trend real average earnings since 1997. Because of top heavy concentration (and arbitrary weightings and weighting changes), no such extrapolation exercise is meaningful for QQQ.

Perhaps it is just wishful thinking, but.....
The Growth Trend Timing that I use now (and didn't know about back then) had you sell on 1/7/2001 at S&P500 1318.55,...

It's true that a little bit of timing can go a long way, at least in big bears.
I put rather a lot of money into a bear fund, in both Sept and Oct 2000. That was six months after the real S&P 500 total return peaked in March 2000, but (not noticed by most people) 8 months before the real S&P 500 equal weight total return peaked in May 2001. It made me a lot of money by 2002. I was a bit slow closing it, I closed out the last bit of it in March 2003.

Jim

I think this is the point that is nagging at me - that the current structure of the economy is favoring extremely large, highly profitable companies. Maybe their ability to generate excess cash and reinvest it in products that only they can scale effectively is an "unfair" advantage that is self re-enforcing.

This is entirely possible. I don't really disagree. If you think that trend will last, then you would be being well informed, sensible and consistent to want to overweight the very largest such firms. Perhaps by buying a fund that is overweight them, if that's your style.

My own point is merely that most people *don't* have a good idea what's going to happen next with specifics, or at least not ideas that are well enough grounded to be smarter than the average market participant, so they probably shouldn't be making big wagers on individual stocks. Whether by buying them individually, or by accident by buying very heavily concentrated funds.

From the 1987 annual report
“If you’ve been in the [poker] game 30 minutes and you don’t know who the patsy is, you’re the patsy.
...
...
“If you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game.”

Phrased another way, the guy with the real edge will be the one to make the others bleed.

Jim

But none of this contradicts the fact that the biggest companies don't USUALLY do better than the average.

I don't get it. How did the biggest companies become the biggest if they weren't better than average? Seems to me that they became biggest BECAUSE they were better than average.

All this reminds me of a Forbes column I ripped out and saved in the late 90's. He said that (at that time) that you needed to be in the mega-cap stocks because that's what was working best.

Anyway....I ran that QQQ vs. QQQE comparison to answer his question. We are limited by the QQQE inception date.

For grins, I just ran the same comparison of RSP vs. SPY. RSP began May 2003
For all rolling 12-month periods,
RSP beat SPY 119 times.
SPY beat RSP 124 times.
SPY has been beating RSP since 4/2023.

Looking at the portfolio values on testfol.io, RSP was clearly superior for most of the time, although they are about equal now.



but counting how well you did each month or each trimester or each year by betting with odds that do not reflect the long-term average is not a convincing argument.

Yeah, well, we are all smarter than the average bear. The thing to do is when there is a trend we should hop on until the trend stops.
Yes, some day this trend will end. Perhaps we will jump off then.

But none of this contradicts the fact that the biggest companies don't USUALLY do better than the average.
...
I don't get it. How did the biggest companies become the biggest if they weren't better than average? Seems to me that they became biggest BECAUSE they were better than average.


Think of it this way:
Being the best business over a long time will get you to being one of the biggest in terms of true intrinsic value, say into the top 30.
But the easiest way to get that boost to the top 5 by market cap within that group is to become overvalued for a while.
Consequently, the odds that one of the top 5 is currently overvalued is considerably higher than the odds for any other size of firm.

If you accept the possibility that companies *can* be overvalued and undervalued, that's pretty much a mathematical certainty. Create any sequence of numbers with 1/n (Zipf's Law) distribution to represent true IV sizes of a hypothetical set of companies, add or subtract (say) 40% from each one randomly, sort, and see how much the top 5 had been boosted by the random addition. At any other size range the average of several consecutive over/under percentages will tend towards zero, but not at the top where they will tend to be large. (and at the very bottom where they will tend to be small, but nobody pays attention down there)

The only exception is if the top 5 firms have true intrinsic values that are so much higher than all the others in the top slice that even if every firm is +/- some big random number, the top 5 don't change to other ranks when sorted. It is possible that we are seeing a bit of that in recent years. Or not.

Without a doubt, the recent result is very good for the biggest, and also without a doubt that is unlike deeper history. Compare the top N by market cap to the S&P 500 (a fair part of which is the same 5!)

1986 - 1992  (7.0 years) Top 5 underperformed by -3.7%/year, top 4 by  -4.8%
1993 - 1999  (7.0 years) Top 5 underperformed by -3.5%/year, top 4 by  -2.7%
2000 - 2006  (7.0 years) Top 5 underperformed by -5.7%/year, top 4 by  -6.8%
2007 - 2013  (7.0 years) Top 5 underperformed by -4.7%/year, top 4 by  -4.8%
...but then...
2014 - 2018  (5.0 years) Top 5  outperformed by  +5.8%/year, top 4 by  +8.7% (breakdown of the usual rule)
2019 - 2024  (5.4 years) Top 5  outperformed by  +9.8%/year, top 4 by +14.2% (HUGE breakdown of the usual rule)

So, the recent outperformance of the very largest is some currently unknown mix of (a) a breakdown in the Zipf Law type distribution of company sizes due to things like some winner-takes-all effects, and/or (b) gigacap valuation bubble like the late 1990s, and/or (c) pure coincidence that these firms just happen do be doing well, for reasons unrelated to their size. It's not all (b), that's for sure, since the very largest firms are, with a couple of exceptions, extremely profitable and cash generative, so it's not as bubbly in that sense compared to the tech bubble.

Jim

I think the discussion was about QQQ vs QQQE rather than SP500 and the top 5. QQQ vs QQQE has the opposite outcome compared to SPY vs RSP. QQQ outperforms QQQE,RSP outperforms SPY

However, you mentioned the following:

1986 - 1992 (7.0 years) Top 5 underperformed by -3.7%/year, top 4 by -4.8%
1993 - 1999 (7.0 years) Top 5 underperformed by -3.5%/year, top 4 by -2.7%

Using GTR1, for the period 1993 to 1999, the SP500 plus dividends markecap weighted performed 21.5% per year. Equal weight 17.0%.

1986 to 1992 inclusive, marketcap and equal weight both averaged 14.6% per year. My guess is that stocks 6 to 10 must have been really good.

Aussi

Fair odds for rolling two dice and getting two ones would be 11/1 (or 1100, using the American (Moneyline) odds, meaning that for $1 bet each time, you would make $11 for each snake eyes and lose $1 for any other roll. So in 144 rolls, you would win 12 times (with winnings of $132), but you would lose 132 times (for losses of $132), breaking even.

I'm not sure those are the correct snake eye odds. 1/6 chance of rolling a "1" with each die, so 1/36 (1/6 x 1/6) of rolling snake eyes.

From Sports Geek - https://www.thesportsgeek.com/blog/snake-eyes-crap...

Snake Eyes Prop Bet

Prop bets are known as single-roll bets. A snake eyes prop bet is a wager that the next roll will be snake eyes. This is also referred to as an Aces bet.

The payout is 30:1 against your wager. Since there is a 2.78 percent chance [Ed note: 2.78%=1/36] of the next roll being a two, it’s not a great bet from a probability perspective.
-------------------------------------------

But back to QQQ vs QQQE, why do you have to choose? We've had some good recent discussions of using moving averages to flip between "Cap weight" and equal weight, and Jim threw out a set of MA's for SPY vs RSP (I think he settled on 20/90 EMA?). I played around with it and will implement something slightly shorter for both numbers. And you can play around with QQQ:QQQE and come up with something reasonable too. I'm going to do a 75%:25% portfolio weight (in IRA's) based upon those MA's.
Here's a QQQ:QQQE ratio from stockcharts you can start playing around with:
https://stockcharts.com/h-sc/ui?s=QQQ%3AQQQE&p=D&y...

Tails

Over the next 5 years will the S&P 500 with an earnings yield of 3.5% outperform 3-month T-Bills with a yield-to-maturity of 5.4%? How about BRK-B?

Well, there's no way to know for sure. First of all, the 13-week T-bill is 5.337% now, but will be lower later this year, and even lower next year, and likely lower for the next few years. It is very likely that the S&P500 and Berkshire will outperform T-bills over 5 years. However, we haven't had a real recession since 2009, and that's a long time, so we are kind of due for a recession. Some people believe that recessions have been "cured" forever by using Federal Reserve supplied money judiciously, but those people are almost definitely wrong.

Over the next 5 years will the S&P 500 with an earnings yield of 3.5% outperform 3-month T-Bills with a yield-to-maturity of 5.4%? How about BRK-B?
...
Well, there's no way to know for sure. First of all, the 13-week T-bill is 5.337% now, but will be lower later this year, and even lower next year, and likely lower for the next few years. It is very likely that the S&P500 and Berkshire will outperform T-bills over 5 years.

As you say, there's no way to know. But FWIW I would expect the odds of T-bills beating the S&P in the next 5 years to be a little greater than even. It's hard to make money with a low conviction expectation like that, though. The markets can do anything, for a while.

If it's a five year outlook, one might do better buying 5-year TIPS today rather than rolling T-bills. Current yield inflation + 1.89%. I think the return might be higher, and it has the advantage of avoiding taking a gamble on the resurgence of inflation.

Jim

I would expect the odds of T-bills beating the S&P in the next 5 years to be a little greater than even.

Maybe. But historically it VERY rarely happens.

Let's say T-bills are 5%, 4.5%, 4%, 3.5%, and 3.5% for the 5 years (and that's being very generous because there is likely to be a recession at some point and they will be lower), so roughly a cumulative 20% or so. How often has the S&P500 5-year return been below 20%? Not very often. Furthermore, if the S&P500 will have a dismal 5-year period, it is almost surely associated with a concurrent recession, probably a deep recession, and that means T-bill rates during the period would be far lower than my generous allocation above. So, even if the chance of T-bills outpacing S&P500 over a 5-year period actually occurs, it isn't likely to outpace it by much anyway.

How often has the S&P500 5-year return been below 20%? Not very often.


For all 60 month (5 year) rolling periods, 1950 to 2017,
520 of 731 had more than 20% total return.
211 of 731 had below 20% 5-year return.

Sadly, 139 of 731 had a 5 year negative return.

For all 60 month (5 year) rolling periods, 1950 to 2017...

I think the salient question is something more like this: what percentage of five year rolling periods did the S&P 500 and cap weighted predecessors beat rolling T-bills, averaged across only those starting dates that the median firm was trading above (say) two times trailing sales as is currently the case?

Mr Bayes should not be ignored. If the starting situation is not historically typical, there is no good reason to expect the historically typical outcome.

Jim

Between 19491230 and 20190717 there have been 17,503 trading days. Of those days, 1,834 days have been at all-time highs.

Mr Bayes may say, given an all-time high, there were 1,565 occurrences when the SP500 (^S5T in GTR1 speak) 5 years later exceeded a 20% total return. There were 269 days when the total return of the SP500 5 years later did not exceed a 20% return. (The worst 5 year total return after investing at an all-time high was -18%).

So yes, an all-time high is not typical (about 10% of the time), but given an all-time high investing is generally more profitable than a 20% total return.

Aussi

There are so many ways to say "Buy the total market and hold."

And they all say pretty much the same thing.

I think the salient question is something more like this: what percentage of five year rolling periods did the S&P 500 and cap weighted predecessors beat rolling T-bills, averaged across only those starting dates that the median firm was trading above (say) two times trailing sales as is currently the case?

Mr Bayes should not be ignored. If the starting situation is not historically typical, there is no good reason to expect the historically typical outcome.

That only addresses half the equation. The trend is for the USD to be an increasingly poor store of value. Look at its value over the last five years compared to other assets like gold, real estate and stock.

As an example, imagine that your portfolio is half gold and half USD. Over the last five years gold has gone up 50%. Therefore, combined, your portfolio has gone up 25% in value. Everybody agree? Well, I say your portfolio has gone DOWN 25% in value. You still have the same amount of gold and the USD has gone down 50%. The gold was the proper benchmark, not the USD.

The S&P 500 may be expensive (I don't even look at that stuff, I buy individual assets) but it looks better than T-Bills to me over the next five years.

As an example, imagine that your portfolio is half gold and half USD. Over the last five years gold has gone up 50%. Therefore, combined, your portfolio has gone up 25% in value. Everybody agree? Well, I say your portfolio has gone DOWN 25% in value. You still have the same amount of gold and the USD has gone down 50%. The gold was the proper benchmark, not the USD.

Is the last 5 years typical? It included a pretty major event, and in the 20+ years prior gold has been a dud (2012-2020 was down 10%)

Gold is not "the proper benchmark"; its one of many.

tecmo
...

Mr Bayes may say, given an all-time high, there were 1,565 occurrences when the SP500 (^S5T in GTR1 speak) 5 years later exceeded a 20% total return.

A fun stat, to be sure, but it is pretty irrelevant. A market can hit all time nominal highs at low valuation multiples (as after a long secular bear) or at high valuation multiples (as at the dying end of a bubble). Your figure makes no distinction, so it can and should be ignored.

The past is quite clear on one thing: for time frames longer than the current market move, more than a couple of years, average market returns are terrible starting from high valuation levels, and excellent starting from low valuation levels. It isn't random, so stats starting from random dates in the past, or subsets of dates that don't correspond to the current valuation situation, have no merit. Just "broker economics": )

The logic is simple. The future trajectory of company earnings will be what it will be. That is the source of the value of equities. If you pay more for the same old set of future earnings, you get back less per dollar invested.

Jim

The logic is simple. The future trajectory of company earnings will be what it will be. That is the source of the value of equities. If you pay more for the same old set of future earnings, you get back less per dollar invested.

I think your logic is missing a step which is what to invest in now and how it impacts total return. Your Bayes comment is not practical in real terms as the time required to get to an acceptable price is unknown.

The question is, invest in "x" now, or invest in "y" (perhaps T-bills) and wait until "x" is at a price that matches your evaluation of good value and then invest in "x".

From what I have looked at, it is better on average to invest now, rather than wait in T-Bills.

As an example. Say you have an income stream of $1/day since the beginning of 1950. You can invest the $1 in the equivalent of SPY everyday, or you can invest in T-bills at 5% p.a. and when the market is a fixed amount below the maximum previous value, you can take all the money from T-bills and invest. Subsequent $1/day will be invested in the market if it is below your threshold, or held in T-bills until it again drops below the threshold.

For the investment in the market everyday, ending balance July 18, 2024 is $5,806,214. For thresholds of 0.5 to 0.9, the balances are below. Waiting for the market to come to your expectations could be significant lost opportunity.



0.5_________$859,832
0.6_________$4,211,864
0.7_________$3,905,114
0.8_________$4,707,752
0.9_________$5,640,156


Aussi




Aussi

Gold is not "the proper benchmark"; its one of many.

Choose whatever you want ... as long as it's denominated in USD and not actual USD. Saving in actual USD is a loser over the next five years. IMHO.

From what I have looked at, it is better on average to invest now, rather than wait in T-Bills. As an example. Say you have an income stream of $1/day since the beginning of 1950. You can invest the $1 in the equivalent of SPY everyday, or you can invest in T-bills at 5% p.a. and when the market is a fixed amount below the maximum previous value, you can take all the money from T-bills and invest. Subsequent $1/day will be invested in the market if it is below your threshold, or held in T-bills until it again drops below the threshold.

You are right that, with all else ignored and only looking at the change in quotation (and with absolutely no regard with the amount of earnings you are receiving for each dollar invested), the 5 year return is on average higher (as well as the 1 year return) than average when starting from market highs. This can be considered to be a corollary of price momentum spanning multiple years (though rarely more than 15 years, as we have - until now - experienced.

On the other hand, the price/sales ratio and the CAPE ratio of the S&P500 is near an all-time high.Since 1880 the market has been at a lower valuation of 10 year real average past earnings more than 97% of the time.

So investing from this particular market high likely won't have an above average 5 year return.

You are observing an investment advantage for a particular strategy (in this case a variation of price momentum) as observed through all market conditions. You are then making projection that from this point, under average valuation conditions (making no distinction) you will have an investment advantage on average.

However we are far from having an average valuation condition. Valuations can be just about ignored when projecting 1-year returns, as the valuation has such a small effect, however the valuation really starts to matter for a 5 year return (and matters more so again for 10 year returns) and you can use that information in your favour, even combining with your observation that we are at an all time high.

For example, if you take all of the points in the past in which the market was at an all time high, and then sorted them into return deciles ranked by the CAPE, you will likely find that the 5-year returns (when starting from a market high) are very sensitive to the starting CAPE ratio. The 5-year returns starting from market highs, but the CAPE ratio in the upper 3% range will, will almost by definition, have resulted in significantly negative real returns.

- Manlobbi

For example, if you take all of the points in the past in which the market was at an all time high, and then sorted them into return deciles ranked by the CAPE, you will likely find that the 5-year returns (when starting from a market high) are very sensitive to the starting CAPE ratio. The 5-year returns starting from market highs, but the CAPE ratio in the upper 3% range will, will almost by definition, have resulted in significantly negative real returns.

A good point worth investigating.

So I can check, is the algorithm not to invest when the CAPE is in the upper 3% range and funds should be invested when it drops below the 3% range, or should the funds be invested at a much lower CAPE. Is there a sell criteria such that you get out of the market when the CAPE exceeds 97% of previous values?

Aussi who is in search of historical CAPE values.

Nobody knows nothing.
DCA into VT and live happily. If you are American (you are not) DCA into VTI+VXUS instead of VT so you can claim the dividend tax credit. Individual stocks are For losers who want to pretend they are winners. Yes even Brk.

DCA into VT and live happily........
Individual stocks are For losers who want to pretend they are winners. Yes even Brk.

Divi(dends20) lives?

On the other hand, the price/sales ratio and the CAPE ratio of the S&P500 is near an all-time high.Since 1880 the market has been at a lower valuation of 10 year real average past earnings more than 97% of the time.

So investing from this particular market high likely won't have an above average 5 year return.

Based on monthly data, starting the beginning of 1950, the rolling 5 year average SP500 (GTR1 ^S5T) return is 1.77. The median is 1.74. The range is 0.67 to 3.58.

When CAPE exceeds the 97th percentile, the 5 year average return is 1.32 and median is 1.10. The range is 0.833 to 2.93

So yes, the average subsequent 5 year return is less when CAPE exceeds the 97th percentile, but is it less than the alternative investment?

The most recent time when CAPE exceeded 97th percentile with a subsequent five year return was Nov, 2017. SPY was 236.95 and 5 years later was 397.22. Interest rates were low, so in hindsight, taking the SPY investment resulted in a higher return.

As a timing model, being out of SP500 when CAPE exceeds the 97th percentile is not as good as being fully invested all the time. From the beginning of 1950 $1 becomes $3,576 when fully invested and becomes $1,233 when out of the market and getting 5% pa when CAPE exceeds the 97th percentile.

Aussi

I haven’t had a chance to try replicating the simulation, but there is a fundamental issue I believe is unaddressed:

1950 is close to a CAPE low; July 2024 close to a CAPE peak.

If we’re testing a a timing model that takes CAPE as its guide, we’d want neutral starting and endpoints. As is, both the points chosen would undersell CAPE-based timing, and inflate the S&P results, comparatively speaking. Briefly, we’re looking at the results from a climb from CAPE trough to CAPE peak, historically speaking. Right?

1950 is close to a CAPE low; July 2024 close to a CAPE peak.

If we’re testing a a timing model that takes CAPE as its guide...

CAPE is useless as a timing guide*. You probably shouldn't even think of it that way. However it has outstanding predictive power for what you'll likely make over the longer term. For example, expectations for the 5-10 year horizon. It is the best single input for retirement planning, for example.

CAPE often gives you a pretty good idea of the likely returns from now until half way up the NEXT bull. Or half way down the next bear.

Jim

*The only exception is that when things are very cheap based on CAPE, it tends to pay off very quickly and pretty reliably.

1950 is close to a CAPE low; July 2024 close to a CAPE peak.


I chose 1950 as somewhere up thread there was discussion about 1950 onwards.

Jan 1950, CAPE was at the 20th percentile of previous readings at 10.5, rose to 23 in Feb 1966, fell to 6.6 in Jul 1982, rose to 42 in June 2000, fell to 13 in Mar 2009, rose to 37 in Sep 2021, fell to 27 Oct 2022 and is currently 35. So CAPE has trended upwards with a few downward dips.

Aussi

To me, the only question is "Is it actionable?"
If it isn't actionable then it's nothing more than an interesting bit of information.

And Jim says that it's not actionable, but just a bit of information.

Based on monthly data, starting the beginning of 1950, the rolling 5 year average SP500 (GTR1 ^S5T) return is 1.77. The median is 1.74. The range is 0.67 to 3.58.

To see how CAPE effects the performance of buying during new market highs, you'll need to have a lot more samples. By only looking at data where the CAPE is above 35 you only have two significant sample periods (the first in 1998-2001) and the second in 2020-2021). Though you are testing back to 1950, the CAPE ratio being below your target nearly constantly is causing your sample size to be so small as to lose its utility.

https://www.multpl.com/shiller-pe

That isn't enough data to draw any conclusions by looking at CAPE values > 35 in the chart above. But you can solve as follows: If you take all the dates where the market reached a new high (for all CAPE values) and then (from this subset of all returns) chart the 5-year forward annual on the Y axis, with the CAPE ratio on the X axis, you will then encapsulate all the data (rather than just two short distinct sample periods, which should strictly should not be extrapolated).

I'd go back to 1871 using the data on Robert Shiller's website.

What I am almost sure you will see is that you will have a distribution of returns that increases as the CAPE ratio decreases, however the 5-year returns will still be on average a little higher than the CAGR of the broad market - in consonance with your thesis.

By accounting for all data, and looking at the continuity of returns over different CAPE starting conditions, you can then extrapolate with more confidence what to likely expect as return returns when starting from today. I continue to expect this to be worse than bonds for 5 years (if we started many times from a CAPE of 35, though there is so much noise that I'd consider each case to still be fairly random). CAPE isn't magic, but more or less just reporting what you are getting in earnings when buying today. If you buy a smaller bundle of earnings (higher CAPE), it is going to be worth less on average (and thus likely less 5 years away) than if you buy a larger bundle of earnings (lower CAPE) for the same price.

For all periods near market highs, the very worst time to invest for 5-year returns (for any given market high) will nevertheless still be when the CAPE ratio is the highest, such as now. Though that doesn't mean you should sell all and move into bonds today, because we still have the advantage from the momentum.

Proximity to recent market highs (and any time within 6 months is pretty good) is about the most reliable momentum strategy out there (if thinking in terms of index investing).

However as Jim has pointed out, and I want to underline - the CAPE ratio isn't useful as a timing device, as it only works over 5-10 year periods, but it is excellent to narrow the range of expectations for you returns to help with your planning, not to mention your sanity.

I'm fully invested right now, for example, despite the CAPE ratio (or the price/book ratio of the broad market, or the price/sales) rarely being this high.

The CAPE chart above is for the S&P500 which is market cap weighted. As it happens, the S&P5600 (small caps) are in a radically different situation. I'm amazed how little press this gets. The small caps, and even the medium caps, I consider valued about correctly right now - neither expensive, nor cheap. I expect the S&P600 (such as IJR) to beat the S&P500 (such as SPY) over the next 10 years - that's not a prediction, but a central expectation (subtly different). The earnings have to go somewhere, and when you are paying a considerably lower multiple, and the EPS is growing faster (small caps historically have grown EPS much faster than large caps, see link below) then the intrinsic value gains pile up over time and eventually show up in the quotation. I wrote a fair bit about the S&P600's relative valuation to the S&P500 here:
https://www.shrewdm.com/MB?pid=764838264

- Manlobbi

Manlobbi: I'm fully invested right now
Jim: sitting on as much cash as not in a long time (or similar it was)

Interesting 😂

Jim: sitting on as much cash as not in a long time (or similar it was)

Don't read *too* much into it. Real short term interest rates are, for this brief moment, much better than usual. Berkshire is more fully valued than usual. And I am presumably suffering at least in part from the endowment effect. I have the pile of cash from having sold a property earlier in the year, and I just didn't see a great opportunity to deploy it yet, so it's still sitting there. If I had been fully invested I might have sat on my hands a bit more rather than yelling "sell sell sell". The endowment effect is a terrible logical flaw, but perhaps (?) it is better to suffer from it and at least be aware you're likely to be suffering from it.

Jim

The endowment effect is a terrible logical flaw
Correct me, but I might see another one, in this:

If I had been fully invested I might have sat on my hands a bit more rather than yelling "sell sell sell"
Shouldn't one act at any time unemotionally and exactly identical no matter whether money currently is invested or not? How is that bias called to not sell something only because you currently own it, while on the other hand you wouldn't buy it if not currently owning it? Mental laziness?

Just (half) kidding, making a bit fun of you (I think you can stand it :)

To see how CAPE effects the performance of buying during new market highs, you'll need to have a lot more samples. By only looking at data where the CAPE is above 35 you only have two significant sample periods (the first in 1998-2001) and the second in 2020-2021). Though you are testing back to 1950, the CAPE ratio being below your target nearly constantly is causing your sample size to be so small as to lose its utility.

I didn't use 35. I used existing 97th percentile based on previous values. So going forward, the CAPE value for the 97th percentile changed. For instance, in April 1964, the 97th value was 22.42.

However as Jim has pointed out, and I want to underline - the CAPE ratio isn't useful as a timing device, as it only works over 5-10 year periods, but it is excellent to narrow the range of expectations for you returns to help with your planning, not to mention your sanity.

Yes, I agree that CAPE is not useful for timing, but it seemed like some people in this thread were saying the CAPE is high, or other factors were high, look for other investments.

I looked at the forward 25 year values from CAPE quintiles. I thought 25 years would be a reasonable number for retirement planning.

The bottom of the returns (I thought best to look at the bottom returns for retirement planning) was 8.8% for the bottom two CAPE quintiles and 7.4% for the top two quintiles. Mid quintile was 8%. So for 25 year retirement planning, assume 7% with a 50% drop somewhere along the journey no matter what the CAPE value is.

The top of the 25 year range was 17% for the bottom quintile and 13% for the top quintile.

Aussi

“Inactivity strikes us as intelligent behavior.”

Based on monthly data, starting the beginning of 1950, the rolling 5 year average SP500 (GTR1 ^S5T) return is 1.77. The median is 1.74. The range is 0.67 to 3.58.
When CAPE exceeds the 97th percentile, the 5 year average return is 1.32 and median is 1.10. The range is 0.833 to 2.93...

Though I don't doubt any of these figures, they're really not needed.

Think of the S&P 500 as one company. It's revenues and earnings are a bit irregular over the business cycle, but they track GDP extremely closely over longer periods of time, and unlike a "normal" company we know that will continue. It won't, and can't, grow at a rate higher than average, but neither will it go bust. There is a modest dividend coupon.

Rather obviously, this steady earner is a better deal when it's cheap (say, 5.6% earnings yield) than when it's expensive (say, 2.8% earnings yield)*. The result is pretty obvious, and it doesn't really matter whether you value based on earnings, dividends, sales, or book value: when you pay twice times as much for something, you get only half as much value in return for your invested dollar. You'll have half the total value at the end, even if you hold for a thousand years. Some metrics might make this obvious conclusion a little bit clearer than others, but if you find a metric telling you something other than the obvious, it's just a mismeasurement. e.g., you're looking at some short intervals that it simply got more expensive for a while.

But the truth is far simpler. If you buy a slow grower at a high price (and hold for longer than a market rally), you will not get a high return. You know in advance what you're going to get, so buy it only when that seems like a decent return on your money. If you're already aware that the forwards returns from here will necessarily be low because of the high current price relative to known future value, and you don't mind a low rate of return, go for it.

Jim


* FWIW, those figures are roughly the 10th and 90th percentile smoothed S&P 500 earnings yields since 1995

If I had been fully invested I might have sat on my hands a bit more rather than yelling "sell sell sell"
Shouldn't one act at any time unemotionally and exactly identical no matter whether money currently is invested or not? How is that bias called to not sell something only because you currently own it, while on the other hand you wouldn't buy it if not currently owning it? Mental laziness?

As mentioned, I am observing myself to determine if I'm suffering from the endowment effect. (the fallacious tendency to overvalue what you currently have, versus what you might trade it for instead which seems rationally to be worth more).

I don't think I'm doing that, but I allow the possibility. Another possibility is that I'm just stubborn. But what I *think* I'm doing is being patient. Sitting on cash, potentially for a long time, waiting for a nice deal to come along with a margin of safety. Hmmm, who does that remind me of...

Jim

To me, the only question is "Is it actionable?"
If it isn't actionable then it's nothing more than an interesting bit of information.
And Jim says that it's not actionable, but just a bit of information.

I think it's actionable information, just not actionable in a market timing kind of way.

For example, when the broad US market is cheap (according to CAPE or any other "good enough" metric), just buy the market. There is no need to be discerning or nimble or smart, just enjoy the ride and you will do well. This is also not bad advice when the valuation level is in the middle range.

But when the broad US market is expensive--i.e., you aren't getting many future dollars of earnings for your money--your choices are more limited. You can live with low returns, or be judicious in your stock selection,or go farther afield, or invest privately, or try your hand at market timing if you're feelin' lucky, or try short term trading by quant or momentum or other methods. Or sit on cash till it's time to pounce.

So knowing the valuation level is definitely actionable in that sense: those are quite different actions. Just not actionable in the sense of telling you whether the market is going to go up or down next.

Jim

Everything in this long thread makes a lot of sense and without disagreeing with any of it I think the piece missing is return on equity of the underlying businesses. Over a long enough period that is the key determinator (is that a word?) of your return.

12% over say 60 years is 1000x your money. If valuations go down 75% over that same period you end up with 250x your money.

6% over 60 years is 33x your money. If you bought cheap and valuations go up 5x over that period (say from pe10 to pe50) you make 165x your money.

There are a number of complications to this simplified example granted, and I don’t own any index funds myself but high or decent underlying returns on capital I think would be the best argument for long term close your eyes and jump or DCA retirement investing for your kids.

Problem is, we live in the present. We cannot invest today's paycheck 3 years ago, we can only decide to invest it now or to wait for some time in the future.

I remember a poster who said that AAPL at 105 was too high and he was waiting until it got to 100 -- which he said it absolutely would -- and THEN he'd buy it. That was before the 4-1 split, so he was waiting for split-adjusted 25. AAPL never hit that and now is 220. And AFAIK he it *still* waiting. But he stopped posting, so who knows.

"actionable" means "strategy that can feasibly be accomplished shortly." or "ready to go or be put into action."

From that standpoint, CAPE is not actionable.

Just not actionable in the sense of telling you whether the market is going to go up or down next.

Yup. But that's exactly the information that we want to know. So all high CAPE tells us is that the expected future returns for the next many years will probably be lower than average. It doesn't tell us what to do, just what to expect.

Everything in this long thread makes a lot of sense and without disagreeing with any of it I think the piece missing is return on equity of the underlying businesses. Over a long enough period that is the key determinator (is that a word?) of your return.
12% over say 60 years is 1000x your money. If valuations go down 75% over that same period you end up with 250x your money...

You're right that the return on the equity is a key determinant, though that isn't quite the right math.
That would assume that the 12% rate is sustained in real terms, and that all owner earnings are successfully reinvested at that rate. Lots of money is paid out as dividends, and lots of money is invested badly, and the 12% number is a little dubious.

A simpler view: I would take it as a reasonable axiom that the value of a collection of equities is some direct function of the (cyclically adjusted) earning power. Relatively few operating firms are appropriately valued based on net assets, so for a broad portfolio they could be ignored. There are complications in that taxes and interest rates and labour relations push the margins up and down over time, but in the end it's really the earnings that matter. Smoothed real earnings are up inflation + 3.83%/year in the last 30 years, which is a pretty good proxy for how much teh value of the index itself has risen. Add the average dividend yield of 1.88% to get a real total return of 5.71%/year, and that's a pretty good idea of how much value was created in that period. It's a fine number, but not close to 12%, nominal or after inflation.

I am a big fan of ROE, though, even if you look at nothing else.
e.g., in the same last 30 years, an equally weighted portfolio of the 50 US-listed firms with the highest ROE beat the S&P by 4.8%/year.
(after trading costs, taking them from the Value Line database, reconstructed and rebalanced quarterly)
I run some money in a quant portfolio that is, more than anything else, basically this strategy.

Jim

Just not actionable in the sense of telling you whether the market is going to go up or down next.
...
Yup. But that's exactly the information that we want to know. So all high CAPE tells us is that the expected future returns for the next many years will probably be lower than average. It doesn't tell us what to do, just what to expect.

The direction of the market's next move may be what you want to know, but it shouldn't be. That's not what's important for a long term portfolio, nor is it something you're ever going to have in any case. The information that you should want to know is how much will the business(es) you're considering buying be earning in the next decade or so, per dollar invested today. Conveniently, that's not nearly so difficult to assess.

However, as it happens CAPE is indeed telling you something very specifically actionable at the moment: do not buy the broad US market now to hold for the next 5-10 years. Unless you are happy with the expectation of a very low rate of return. You might get lucky, we might see bubble valuations at the end dates, but that's not exactly a reliable investment strategy. When you hear hoofbeats expect horses, not zebras.

I don't know what the future will bring, but for whatever it's worth, since 1995 purchases of the S&P 500 at valuations similar to today's based on smoothed real earnings have led to forward real total returns in the subsequent 7 years averaging about inflation + 1%/year. Unless I have a reason to expect something different, which I don't, that makes a good central expectation. In fact that may be unrepresentatively optimistic, considering (a) smoothed earnings have been unusually above trend lately (the basis of the valuation) and (b) the gradual trend of rising valuation multiples which has been implicitly included in the average past return.

Jim

However, as it happens CAPE is indeed telling you something very specifically actionable at the moment: do not buy the broad US market now to hold for the next 5-10 years.


Ahhhh. Now that is (arguably) actionable.


Hmmm, BRK-B it is. ;-)

Problem is, we live in the present. We cannot invest today's paycheck 3 years ago, we can only decide to invest it now or to wait for some time in the future.

It's even worse than just paycheck coming in "now" to invest "now". We generally have only about 30 or 40 years to invest the bulk of our savings. It's generally only over age 30, and for most over age 40, when there is already a substantial amount of savings that needs to be invested, so really you only have 30 years of investing (followed by drawing down those investments in retirement). So, if you stay out of the market until "AAPL reaches 100" (or whatever arbitrary measure of value you are using, you might be out for 5 or 10 or 15 years, a HUGE portion of your primary investing lifetime.

Now if you're going to compare S&P500 to T-bills as we have been doing here, there's yet another thing to take into account. If there are ever such bad economic conditions that cause the S&P500 to have such a dismal 5 years, there is a VERY strong possibility that the Fed would lower rates dramatically during that period. Perhaps they would even lower them to near-zero, it wouldn't be unprecedented [anymore]. So even if the S&P500 has a dismal 5 years and earns only 5 or 6 percent, it is also quite possible that those T-bills don't protect you from that and also earn in the low single digits over that period of time.

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