tag:blogger.com,1999:blog-8152901575140311047.post8630166128148615279..comments2024-03-29T02:52:00.870-04:00Comments on Musings on Markets: Superman and Stocks: It's not the Cape (CAPE), it's the Kryptonite(Cash flow)!Aswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comBlogger17125tag:blogger.com,1999:blog-8152901575140311047.post-16114445276973572622016-08-30T16:27:07.548-04:002016-08-30T16:27:07.548-04:00Great post and insight. One main issue jumped out ...Great post and insight. One main issue jumped out though...<br /><br />Comparing T.Bond P/E to CAPE is comparing apples to elephants. The bond "earnings" is an automatic cash flow. And only a small sliver of company earnings will flow to stockholders.<br /><br />Still an interesting way to think about it though.Brian Kehmhttp://kehmresearch.comnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-75384304001756907612016-08-30T05:37:36.613-04:002016-08-30T05:37:36.613-04:00Almost every time CAPE got widly extended from his...Almost every time CAPE got widly extended from historical norms pundits came up with a 'new normal' valuation method of understanding the markets.<br />Studies clearly show when CAPE is between 24-28 the expected returns are circa 3% pa over the next 15 years.<br />Now if you are taking 17-18% volatility to make 3% and hope your stock selection methods will 'shield' you that is not good risk management.<br />Bonds are terrible yes, hedge funds too, but your alternative to Bonds is infrastructure which offers higher expected returns than equities with far less volatility for what is still an immature asset class.<br />If you watch Buffet carefully his cash and cash equivalents are rocketing to circa 70B which is basically passively bearish and he's allocating more capital to infrastructure projects. It naturally hedges against downturns in equity markets due to its lower correlation (.37) to equities (unlisted). The really smart investors like Buffet are using infrastructure plays in place of bonds.<br />The list of new normals historically (and why overvaluation was acceptable):<br />1) 1901--The introduction of mass production<br />2) 1928--The Telephone<br />3) 1966--Departure from Gold Standard<br />4) 1996-- Computer Age<br />5) 2016--Fed Money Printing and Low Rates??<br /><br /><br /><br /><br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-16298367336454794632016-08-26T19:56:44.615-04:002016-08-26T19:56:44.615-04:00CAPE's future track record simply will not hol...CAPE's future track record simply will not hold up to its past record. The key reason here being the US economy is no longer a cyclical manufacturing-based economy. Think about this at the individual stock level. Using average 10 earnings to value a company might make sense on a steel or oil company, but would you really use say a growth stock like Visa's EPS 5 years back for the "E" in the equation? That would be ridiculous. Now ask yourself what type of companies are most heavily weighted in the S&P 500... It's a secular bull ride with the occasional shock/recession. Characteristics not fit for CAPE.<br /><br />RyanUnknownhttps://www.blogger.com/profile/14963697592838804988noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-1839385535676744032016-08-26T15:34:29.961-04:002016-08-26T15:34:29.961-04:00Hi Professor,
Great article as always. In additio...Hi Professor,<br /><br />Great article as always. In addition to the pitfalls of relying on a metric such as CAPE for market timing (or trying to market time at all), I noticed you did not mention one of the inherent problems of CAPE itself that Jeremy Siegel recently outlined in FAJ, the changes in the calculation of GAAP earnings that make the ratio look overly pessimistic:<br /><br />http://www.cfapubs.org/doi/pdf/10.2469/faj.v72.n3.1<br /><br />I hope your incoming Stern students enjoy your classes as much as I did.<br /><br />Sam<br /><br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-15155115745804382352016-08-25T17:59:53.786-04:002016-08-25T17:59:53.786-04:00Professor-- Thanks for the excellent piece. I mus...Professor-- Thanks for the excellent piece. I must confess, I wrote a piece for my firm two years ago titled "CAPE-Useful for Superman, Not So Useful for Investors." <br /><br />Like you, I think "market aggregate" indicators are useless, and I have commented that CAPE has cost more people more money than any other thing because of its esteemed source and its simplicity. But it makes no sense on real examination. <br /><br />In my view, Shiller is no different than the market timers that get it right once--that being his excellent work on housing. I have half joked that they should revoke his Nobel Prize for CAPE.<br /><br />Oddly, I don't think you address my largest complaint about CAPE and I am curious as to your thoughts on the following: The CAPE proponents stand on the reversion to the long term mean. But the S&P 500 universe has a very strange history through most of the past 100 years-- excluding many industries and companies for much of that time. There weren't even 500 stocks in it until 1957! Also, the nature of the companies has changed so dramatically, as you write about frequently. Is today's economy of service and intellectual property companies really comparable to that of 2006 or 1996, not to mention 1936? I don't think so at all. So to lump the data together and claim the long run average is meaningful as a potential mean strikes me as simply ridiculous.<br /><br />I read your blog because of the superb analysis of companies and industries, which is the only real way to be a successful investor. Thanks so much for your work!Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-31872988380848728062016-08-25T17:33:42.844-04:002016-08-25T17:33:42.844-04:00Noel,
First, focusing on any one metric (whether i...Noel,<br />First, focusing on any one metric (whether it be CAPE, PBV or EVEBITDA) without considering the alternatives is dangerous and especially so in market timing. So, I would have the same problem if you told me a story with EV/EBITDA for the market at its core instead of CAPE. Second, if all your using the metric for is to become more realistic about future return expectations and those realistic returns make you also more sensible in your saving/investment decisions, I am all for it. Thus, if you are a 30-year old, the fact that the CAPE is high (and that returns over the next 10 years will be lower) should factor into how much you should be saving for your retirement (probably more than you had planned on originally). Third, it is true that I made it a choice between stocks and T.Bills, but in the highly correlated world we live in, when the CAPE is higher than historical values in the US, the same is often true for other stock markets in the world, but I think it is worth a shot. On the final question, and this is really the crux, if my risk aversion and liquidity needs put me in a 60/40 mix, I would not alter it and that is consistent with my investment philosophy of not timing markets. I am a stock picker and I will try to find stocks that deliver the cash flows that I need to sustain myself through the ten years in market wilderness if need be. Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-81858164078005856082016-08-25T16:58:50.861-04:002016-08-25T16:58:50.861-04:00Professor, a few comments/questions:
1. Is your co...Professor, a few comments/questions:<br />1. Is your concern with CAPE specifically or valuation metrics in general as an approach to time investing decisions? As much research has demonstrated, same/similar decisions would be reached using P/B, P/S (the median SP500 stock’s price to sales is 2x the long-term average), EBITDA/EV, or GDP/Total Makt Capitalization (Buffet’s preferred valuation metric). All of these indicate the SP500 is currently overvalued. Hussman thinks we’re in bubble territory, but Grantham, Faber, et al. think the US stock market is quite overvalued – but not enough to sell. My sense is that you think that using market valuation, instead of stock valuation, to guide investing decisions in a bad approach. Could you clarify if your concern is with all valuation metrics or just CAPE?<br />2. To me, the utility of valuation metrics is setting expectations about future returns. The research I’ve seen for stock price and profit margin mean-reversion is convincing: high current valuations forecast low returns over 7 to 12 year horizons. Research Affiliates, Hussman, Starr, Faber, et al. forecast real SP500 returns of -1% to 4% over the next decade (+/-). To get there – assuming companies continue to grow earnings, stock prices have to fall, probably by 50% or more. Don’t you think that investors should consider how they would respond to that valuation-predicted outcome – think of the dot com and housing/financial crashes of the past decade. If investors couldn’t hold on through 50% to 70% portfolio declines (which is most of them), shouldn’t they be taking action now (hedging, derisking, shifting from US to foreign equities, moving to cash, etc.)? We’ve seen the air pockets caused by everyone rushing to the exits when overvalued markets deflate. Unless you believe that this time is truly different?<br />3. I think staying the course with US equities versus shifting to low-yielding bonds is a false dichotomy. Faber, RA, and Starr recommend global asset allocations that take advantage of cheaply priced emerging market stocks and fairly valued developed market stocks. One does not have to forgo equity risk premia because US equities are overvalued. Or, do you think US investors should limit their portfolios to US stocks?<br />4. I completely agree with the Kryptonite you identify, and I’d add shaky global financial institutions that haven’t fully recovered from 2008 and now struggling with NIRP and geopolitical hotspots everywhere, including LEAVE movements in EU countries. Complacent investors are attending to none of these risks at the moment, but history shows that once they do, they will become all-consuming – with resulting panic selling.<br />5. Lastly, I’ll pose two questions that sort of get at all of the preceding: Suppose you inherited $1 million today. How much of it would you invest in US equities immediately? Suppose you have a $1 million portfolio today allocated 60% to US stocks (ITOT or VTI) and 40% to US fixed income. Would you make any changes based to it because US equities are currently overvalued?<br />Thank you in advance for responding and great blogs. I’ve learned much about valuation from you.<br />NoelAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-68857051242520246232016-08-25T10:57:19.150-04:002016-08-25T10:57:19.150-04:00In defense of CAPE: I think that your backtest is ...<br />In defense of CAPE: I think that your backtest is a little unfair. You use annual investment decisions (ie. market-timing), even though you showed earlier that the signal is useless on a one-year time-horizon. I doubt that Price/(buyback+dividend) shows better statistics if tested the same way.<br /><br />If you use shiller's data set and simply plot valuation vs. forward returns you will see that the r² improves with time-Frame and is significant!<br />Sidenote: if you add the level of long-term interest rates and compute yield-gaps the relationship worsens!<br /><br />agreed with most of the other points - especially on sustainability of cash-flow<br /><br />EuropeanBullnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-80386672739665484502016-08-25T10:49:28.259-04:002016-08-25T10:49:28.259-04:00Since E/P is generally a more effective factor tha...Since E/P is generally a more effective factor than its more popular inverse (P/E); I'm wondering if you examined this issue using the inverse of the CAPE - i.e. CAEP or 1/CAPE?Dan Hallettnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-47487367987983210172016-08-25T07:08:13.531-04:002016-08-25T07:08:13.531-04:00Great post Prof. Damodaran.
A quick question.
...Great post Prof. Damodaran. <br /><br />A quick question. <br /><br />Curious about your conclusion that "In 2015, companies in the S&P 500 collectively returned 105.59% of their earnings as cash flows. While this would not be surprising in a recession year, where earnings are depressed, it is strikingly high in a good earnings year."<br /><br />To me, it doesn't seem too surprising based on the past data you present. Your data show earnings down about 6% y/y in 2007, but still elevated, and that was a year with a triple-digit cash-payout percentage. And as the US recession began in Dec.07, I wouldn't call '07 a recession year. It seems like a pretty similar case in 2015, with earnings down 11% and the cash payout percentage again in triple digits.<br /><br />Just making sure that I'm not misunderstanding something, but it seems like cash payouts simply accelerate to super-high levels as *expansions* get long in the tooth, and then to the extent that you see a continued high percentage in recession years (ie 2008), it's likely just a hangover of companies using up existing buyback authorizations.<br /><br />Mostly this is the difference between 2015 being "surprising" in this regard versus it being "predictable", but I don't think it impacts your thesis or takeaways more broadly.<br /><br />Also, I'll +1 to the question above from John Wang -- "for the price/ cash return ratio, should an adjustment be made for stock issuance?"Anonymoushttps://www.blogger.com/profile/00916399091921587674noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-89635402079812385692016-08-25T05:13:35.091-04:002016-08-25T05:13:35.091-04:00Hi Aswath, great article.
One question, why did ...Hi Aswath, great article. <br /><br />One question, why did you use 1927 as your starting point for the $100 invested?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-49703298909318784982016-08-24T19:23:08.663-04:002016-08-24T19:23:08.663-04:00Hi professor aswath, a couple of questions on the ...Hi professor aswath, a couple of questions on the post. Do you have the payout % of dividend and buyback vs. the FCFE? Cos earnings is not really the available cash to equity holders. <br />Also, for the price/ cash return ratio, should an adjustment be made for stock issuance?Anonymoushttps://www.blogger.com/profile/04432757188810974270noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-80146281290823239452016-08-24T18:05:26.187-04:002016-08-24T18:05:26.187-04:00Easy question first. I am not a market timer and I...Easy question first. I am not a market timer and I behave consistently. I don't use any ratios to predict the market because I am convinced that none of them work. I will try to do the 10-year forecast but let's assume that it does much better. What exactly are we to do with that forecast? Stay out of the market for the next 10 years? The costs of staying out of the market increase with your market timing horizon. So, you would need almost perfect market timing for a 10-year forecast to work.Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-59150334954175062312016-08-24T17:32:57.486-04:002016-08-24T17:32:57.486-04:00Great post! I also watched Batman V Superman on a ...Great post! I also watched Batman V Superman on a plane recently and was not a fan. I distracted myself by writing down all of my complaints to share with my friends. Possibly not as productive a use of time as your response.<br /><br />https://www.facebook.com/michael.sterling/posts/870789523842?pnref=storyMichaelhttps://www.blogger.com/profile/17538861929992242643noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-61029095673938862632016-08-24T15:49:39.180-04:002016-08-24T15:49:39.180-04:00Would you really use P/(Div+buybacks) as a good ex...Would you really use P/(Div+buybacks) as a good example to predict the market though? Looking at your data, the ratio was at a low in 2007/2008 and I should have invested? Can you clarify if/when using that metric is actually useful? <br />Thank you!Mikenoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-23867956192204991012016-08-24T15:46:35.090-04:002016-08-24T15:46:35.090-04:00A very Bill Gross-ian intro...A very Bill Gross-ian intro...Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-58190493512041385462016-08-24T15:16:06.734-04:002016-08-24T15:16:06.734-04:00AMAZING post! This is the most rational critique o...AMAZING post! This is the most rational critique of the CAPE I have read.<br /><br />One question: how much does the CAPE improve at predicting future returns if you look a full 10 years out as opposed to just 1 and 5 years out? Based on Hussman's work, it seems that CAPE does correlate better to 10 year returns.<br /><br />Obviously, CAPE doesn't help much with investment decision-making even if the above holds true.Jake M.noreply@blogger.com