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Ftse 100 Reaches 7,000


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Chris Williamson retweeted

A New-And-Improved Shiller CAPE: Solving the Dividend Payout Ratio Problem http://www.philosophicaleconomics.com/2015/03/payout/

We are left with the question: if the distortions associated with the dividend payout ratio are not significant, then why does the Shiller CAPE show the U.S. equity market to be so expensive relative to history? We can point to three explanations.

  • First, on its face, the market just is historically expensive–even on a non-Shiller P/E measurement. Using reported EPS, the simple trailing twelve month P/E ratio is roughly 20.5, which is 53% above its historical average (harmonic) of 13.4. Using S&P corporation’s publication of operating EPS, the simple trailing twelve month P/E ratio is 18.8, which is 40% above that average.
  • Second, the accounting writedowns associated with the 2008-2009 recession are artificially weighing down the trailing average 10 year EPS number off of which the Shiller CAPE is calculated. Prior to 2014, this effect was more significant than it is at present, given that the 2001-2003 recession also saw significant accounting writedowns. The trailing 10 year average for the years up to 2014 therefore got hit with a double-whammy. That’s why the the increase in the Shiller CAPE in recent years has not been as significant as the increase in market prices (since December 2012, the CAPE is up roughly 30%, but prices are up roughly 50%). 2014 saw the 2001-2003 recession fully drop out of the average, reducing the CAPE’s prior overstatement.
  • Third, as the chart below shows, real EPS growth over the last two decades–on both a regular and a Total Return basis–has been meaningfully above the respective historical averages, driven by substantial expansion in profit margins. Recall that high growth produces a high CAPE, all else equal.

profmarginincluded.jpg?resize=640%2C287

These last two factors–the effects of accounting writedowns and the effects of profit margin expansion–will gradually drop out of the Shiller CAPE (unless you expect another 2008-type recession with commensurate writedowns, or continued profit margin expansion, from these record levels). As they drop out, the valuation signal coming from the Shiller CAPE will converge with the signal given by the simple ttm P/E ratio–a convergence that is already happening.

We conclude with the question that all of this exists to answer: Is the market expensive? Yes, and returns are likely to be below the historical average, pulled down by a number of different mechanisms.

Should the market be expensive? “Should” is not an appropriate word to use in markets. What matters is that there are secular, sustainable forces behind the market’s expensiveness–to name a few: low real interest rates, a lack of alternative investment opportunities (TINA), aggressive policymaker support, and improved market efficiency yielding a reduced equity risk premium (difference between equity returns and fixed income returns).

Unlike in prior eras of history, the secret of “stocks for the long run” is now well known–thoroughly studied by academics all over the world, and permanently seared into the brain of every investor that sets foot on Wall Street.

For this reason, absent extreme levels of cyclically-induced fear, investors simply aren’t going to foolishly sell equities at bargain prices when there’s nowhere else to go–as they did, for example, in the 1940s and 1950s, when they had limited history and limited studied knowledge on which to rely.

As for the future, the interest-rate-related forces that are pushing up on valuations will get pulled out from under the market if and when inflationary pressures tie the Fed’s hands–i.e., force the Fed to impose a higher real interest rate on the economy. For all we know, that may never happen. Similarly, on a cyclically-adjusted basis, the equity risk premium may never again return to what it was in prior periods, as secrets cannot be taken back.

Edited by R K
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I think Greece is secondary to the UK general election.

Can't see a satisfactory outcome, but then I always see the glass half empty.

Best result for the FTSE 100 would be the same arrangement as the present with the Lib Dems blocking Brexit. However, it aint likely to happen.

Cameron on his own will crash the Market on Brexit fears, Salmond/ Milibot (with the former hell bent on economic sabotage) also a crash scenario.

Wind back five years and in March 10 the Market is set fair at 5700, then the election adjustment to circa 4900 by July. The same could happen again.

...may be 7250- 6500.

Sold three quarters of my tracker fund 5 minutes ago. May be I am making the classic error of not running with the profits, but have been trading the volatility and I have gone for the smash and grab option.

Alex Salmond 'hell bent on economic sabotage'? There's nothing left to wreck.

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Chris Dillow, the Marxist economist who writes for The Investors Chronicle, argues that the S&P 500 isn't particularly overvalued. His point is that the CAPE scores (Cyclically Adjusted P/E ratio, probably the best single measure of if a market's under or over valued) is excessively influenced by the ultra low valuations of the 1930's and to a lesser extent the 1970's. Looking at the S&P through the lens of contemporary policy he believes the S&P could go a lot, lot higher.

What I like about Chris Dillow's writing is that he's smart, evidence driven, and has if anything a negative instinct towards a rising S&P.

So if you only compare it to periods when good stuff was happening, it looks ok? That doesn't sound like a negative instinct to me, more like "irrational exuberance" and "it's different this time"

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So if you only compare it to periods when good stuff was happening, it looks ok? That doesn't sound like a negative instinct to me, more like "irrational exuberance" and "it's different this time"

Beautifully put, particularly in light of Shiller's involvement. The idea of discounting a stream of dividends and returns from an indefinite future is poppycock, especially since Modigliani and Miller pointed out that dividends don't matter in the valuation of a firm. Nothing could be a bigger waste of time for an investor than trying to guess a flow of future dividends.

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The buying, selling and building of houses makes up a much bigger part of UK national income than is the case almost anywhere else in the world. If buying a house has become a personal indulgence like owning a boat then the UK is holed below the waterline and sinking fast.

hence why Id build a million or so asap. But it aint on the "market" or govt agenda.

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Beautifully put, particularly in light of Shiller's involvement. The idea of discounting a stream of dividends and returns from an indefinite future is poppycock, especially since Modigliani and Miller pointed out that dividends don't matter in the valuation of a firm. Nothing could be a bigger waste of time for an investor than trying to guess a flow of future dividends.

So now you are arguing that debt is irrelevant? Not like you Zugzwang!

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Can't help thinking I might have been a little hasty exiting the market at 7015.22 yesterday, in spite of the fact that the trap door could open any moment.

CPI says it all this morning...not a cat in hell's chance of rate rises for at least a year. And what's the alternative,gold and bonds in the stratosphere.

There's always the disaster on the horizon like Greece or Cameron's Brexit that could destabilise UK plc. But may be the brave will be rewarded.

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Can't help thinking I might have been a little hasty exiting the market at 7015.22 yesterday, in spite of the fact that the trap door could open any moment.

CPI says it all this morning...not a cat in hell's chance of rate rises for at least a year. And what's the alternative,gold and bonds in the stratosphere.

There's always the disaster on the horizon like Greece or Cameron's Brexit that could destabilise UK plc. But may be the brave will be rewarded.

Deflation has historically been bad for stock markets.

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Deflation has historically been bad for stock markets.

In the days of allowing Markets to achieve fair value. But that is clearly not the case with bonds and property in an era of quantitative easing. So it's a case of choosing the least worst option or just have eye watering sums on cash deposit.

Edited by crashmonitor
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It's supported asset prices, may be that was the covert plan. But as far as CPI targetting, absolutely, a complete disaster.

But perhaps zirp and qe 'worked' to support asset prices through the generation of negative real interest rates. If inflation is zero or negative this isn't possible anymore.

Wasn't covert either. Bernanke admitted it.

Edited by growlers
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It's supported asset prices, may be that was the covert plan. But as far as CPI targetting, absolutely, a complete disaster.

Wasnt covert at all. It was explicitly stated.

So what would CPI have been for the last 6 yrs in the absence of QE? Bearing in mind UK stopped QE 2 yrs ago.

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Can't help thinking I might have been a little hasty exiting the market at 7015.22 yesterday, in spite of the fact that the trap door could open any moment.

CPI says it all this morning...not a cat in hell's chance of rate rises for at least a year. And what's the alternative,gold and bonds in the stratosphere.

There's always the disaster on the horizon like Greece or Cameron's Brexit that could destabilise UK plc. But may be the brave will be rewarded.

Fwiw a BoE hike not priced in until mid 2016. Even US Fed Funds futures now don't fully price 25bp move until next year. Obviously doesn't mean that's what will happen.

7jUdFb7.jpg?1

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If a dip presents I will no doubt be back, if it does just go up from here well i will have missed the boat. Volatility trading you take the chance.

Fair enough but I think your original idea was better! I'm sticking with vanilla trackers for the forseeable in the expectation of lower rates/more QE. I've pretty much done a 180° in my appreciation of market efficiency in recent months. No more noise trading!

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Fair enough but I think your original idea was better! I'm sticking with vanilla trackers for the forseeable in the expectation of lower rates/more QE. I've pretty much done a 180° in my appreciation of market efficiency in recent months. No more noise trading!

I've been with vanilla trackers and time in the market not timing the market for 7.5 years now. It's boring but all those lovely dividends and a bit of capital gain make up for the boredom somewhat.

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I've been with vanilla trackers and time in the market not timing the market for 7.5 years now. It's boring but all those lovely dividends and a bit of capital gain make up for the boredom somewhat.

From 2009 to the middle of 2013 I did the same, and it paid off handsomely. Then I got it into my head that rising rates would crash the market and started looking for opportunities to get short. There haven't been many. And rates haven't gone anywhere either, of course. I called it wrong. Increasingly it looks as as if 0% is the 'new normal'. Meanwhile, even though BoE and the Fed have paused, the BoJ, ECB, and PBoC are all still printing dementedly. Until those circumstances changes it's hard to see why stock markets should fall. Reading Fisher Black's famous paper on noise sealed the deal. I need more science and fewer hunches.

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