Pardon if this was already posted.
In yesterdays NYT, Shiller wonders aloud about whether there is any basis for the CAPE ratio being so high.
http://www.nytimes.com/2014/08/17/upshot/the-mystery-of-lofty-elevations.html?_r=0&abt=0002&abg=1

@Scott, I was thinking the same thing.
Does this mean I should be careful about DoubleLIne Shiller CAPE fund? It is based on another Nobel laureate, Robert Shiller's CAPE index...

May the demise of this brilliant fund serve as downlifting inspiration to the many other zombie funds staggering around the landscape. (Psst--- just let go, you'll feel so much better when you do, as will your investors, so much better).

Item 2) Some say I have way too many funds … perhaps so, perhaps not! In comparing my portfolio’s performance to Morningstars Moderate Target Risk as a benchmark … well I have handily bettered the benchmark.
Old_Skeet

Congratulations Old_Skeet. You've done a great job, and most importantly, you've done it 'your way.' You've navigated the investment landscape and come up with a system that works for you.

Good piece, backing up the clear tendency of market-cap indexes to be great on the way up and very un-great on the way down. It's amazing how something as simple as the clearly documented record of those indexes in up- and down-markets escapes the cognition of the 'indexes are all you need, now and forever' commenters.
I'd been thinking the reason there's been so much of that sentiment flying around the finance sphere is that many of those making said comments must be thinking only in terms of the standard return periods, and any of those from 1-5 years show market-cap indexes as brilliant choices because the last 5y neatly coincides with the latest bull market - clearly the sweet spot of a market cap index.
One of the best analyses of an optimal stake in stock indexes in a long-term portfolio came from, believe it or not, Gus Sauter, former bigwig at Vanguard (sorry, no link, haven't been able to find it recently), which took into account many years of data and concluded that something like 30%, but no more, of a stock portfolio in index funds made an optimal contribution to long-term returns.

FYI: Vanguard spokesman John Woerth in a statement says the company denies wrongdoing, affirms the legality of its practices and says it will defend against the suit vigorously.
Regards,
Ted
Read more at http://www.philly.com/philly/blogs/inq-phillydeals/Has-Vanguard-Group-underpaid-its-income-taxes.html#ogqZ3XlQifG3jzFh.99

@Charles: thanks for your take on this with individual stocks.
For someone not purchasing individual stocks, but taking an approach with stock index funds or exchange traded funds, how would you let the Shiller CAPE ratio influence your investing decisions?
One approach some take is to let the Shiller P/E influence their asset allocation, backing off on equities when the Shiller P/E is elevated. Based on this (Shiller P/E way above long term historic levels of 16.5), some only have 50% or so of their normal allocation to equities right now. Another possible approach is choosing funds that have lower P/E ratios, such as GVAL, the DoubleLine DSENX, the exchange traded note CAPE, investing in the 4 U.S. stock sectors with the lowest Shiller P/Es, and choosing a traditional value fund (based on low P/E and low price/book ratios)

@rjb112.
Yes sir. Meb fan I am.

How then do you think investors should use the Shiller P/E in their investing decisions?

Every now and then, I fear Mr. Faber does sound a little like a Cape Crusader. But I think I most align with his preference to find the intersection of value and momentum.
Aloca AA comes to mind this past year. BAC last couple years.
If I jump-in on low valuation only, even if I really like the company, I'll have it on a short leash. There is just so much unknown. Always.
But once the stock gets some altitude, thanks to momentum (be it due to earnings or group think), I'll try to use 200 day or 10 mo SMA. If it dips below that, I'll look to exit.
If momentum turns a 1 bagger to a 2 bagger to a...10 bagger. I will try to stay with it regardless of valuation and use only momentum to determine whether to remain or exit.
So, I guess the short answer is: I seem to be most comfortable entering a position when it has both value and momentum, but once established, momentum is the driver.
That's what seems to be working for me these days. FWIW.
Hope all is well.
c

Yes, the current P/E ratio and/or the CAPE ratio are currently a tad (that’s a scientific measure) on the high side relative to long term averages. But these signals, which according to a Vanguard study do provide a 20-30% explanation of market price movements, are not sufficiently above the norm to likely generate negative equity returns for the upcoming decade.
They are not in the worrisome zone yet, but warrant some watching.
Based on current values and historical average data, I expect stock dividends to yield 2% annually, productivity gains to yield a 2% gain, demographics to enhance returns by 1% annually........
Adding these factors together projects an expected 10-year positive 7% annual equity reward.

1. What is your thinking regarding expecting "demographics to enhance returns by 1% annually....."? One of the biggest demographic issues in the U.S. is "The Graying of America", the aging of America. Substantial numbers of baby boomers retire every day, reducing the overall GDP and productivity, which in and of itself as a factor decreases the profits of corporations. What are the demographic trends you think will add to stock returns going forward?
2. Re: "according to a Vanguard study do provide a 20-30% explanation of market price movements.
Do you have a reference to this study, or link/URL? I'm not doubting what you are saying, but would like to read it
3. Re: 'the current P/E ratio and/or CAPE ratio a tad on the high side relative to long term averages....not in the worrisome zone yet'
James Montier is a key member on Jeremy Grantham's GMO team, who write their monthly stock market 7-year forecast. The Shiller CAPE is a significant factor they consider.
James Montier does not agree that the Shiller P/E is a tad high. He says it is exceedingly high.
In this interview from May 15, 2014: http://money.cnn.com/2014/05/01/pf/stocks-overpriced.moneymag/index.html?iid=SF_M_River
he is asked:
Interviewer: "Are stocks overpriced?"
James Montier: "There is no doubt that the U.S. stock market is exceedingly overvalued."
Interviewer: "What makes you so sure?"
James Montier: "The simplest sensible benchmark is the Shiller P/E. Right now we're looking at a broad index like the Standard & Poor's 500 trading at something like 26, 27 times the Shiller P/E. Fair value would be 16 or 17 times historical earnings."

Hi Guys,
I’m in davidrmoran’s and Charles’ corner on this issue.
Yes, the current P/E ratio and/or the CAPE ratio are currently a tad (that’s a scientific measure) on the high side relative to long term averages. But these signals, which according to a Vanguard study do provide a 20-30% explanation of market price movements, are not sufficiently above the norm to likely generate negative equity returns for the upcoming decade.
They are not in the worrisome zone yet, but warrant some watching.
Here’s why. I’ll be using the methodology formulated in Chapter 2, On the Nature of Returns, of John Bogle’s classic “Common Sense on Mutual Funds” book.
Based on current values and historical average data, I expect stock dividends to yield 2% annually, productivity gains to yield a 2% gain, demographics to enhance returns by 1% annually, inflation to contribute about 3%, and since the P/E ratio is nearing a tipping point, I expect a modest regression-to-the-mean to subtract maybe 1% annually.
Adding these factors together projects an expected 10-year positive 7% annual equity reward. That’s roughly 3% below the long-term returns because of a little muted GDP growth rate (which impacts productivity profits) and a likely slight regression-to-the-mean of the present P/E status.
Well, that’s my guesstimate. It directly reflects the Bogle long-term returns model, historical data sets, and current parameter valuations. Given the depressed character of current bond performance, stocks still don’t appear to be a bad deal, but also don’t expect the historical average of equity returns. Too bad, but not really too bad.
Well, that’s my hat in the forecasting ring. Forecasting the next 10-year return is actually easier and more reliably made than projecting next year’s return. I hope this helps.
Best Regards.

@Charles, I know you are a big Meb Faber fan, who in his book Global Value places a great deal of importance on the Shiller CAPE. Meb Faber obviously thinks the Shiller CAPE should play a big role in our investing decisions. The referenced chart shows the Shiller P/E to have averaged 25.1 for the past 25 years. How then do you think investors should use the Shiller P/E in their investing decisions?

This is extremely interesting to me since Shiller CAPE has become such a meme:
>> If you avoided equities while they were above their historical CAPE measurement, you just missed 24 years of equity gains.

Hear, hear.

This is extremely interesting to me since Shiller CAPE has become such a meme:
>> If you avoided equities while they were above their historical CAPE measurement, you just missed 24 years of equity gains.

FYI: Copy & Paste 7/4/14: Amy Feldnan: Barron's:
I will ask some same question that I have several times in the past, do you own a health care fund ? If you don't you should.
Regards,
Ted
It has been 11 years since the human genome was first mapped, at a cost of $2.7 billion. Since then, the cost of DNA sequencing has dropped to about $1,000, and our understanding of the nature of disease has expanded exponentially. This has created a land rush for biotechnology companies, which use living organisms to develop medical treatments. For the past three years, biotech stocks have risen spectacularly, though this year things have been bumpier.
Eddie Yoon, manager of the $6.3 billion Fidelity Select Health Care Portfolio (ticker: FSPHX) and leader of Fidelity's 12-person health team, compares the innovations in biotech -- and the new companies being created -- to the explosion in technology and digital businesses that happened after Netscape's 1995 initial public offering. "The price point of sequencing the human genome has fallen so fast, and the early-stage pipeline for biotech is exploding right now," Yoon says. "That's what is driving innovation.
There are many ways to invest in that innovation, and the pros take very different views in terms of assessing value and risk. New drugs are altering the way we live, and areas like immuno-oncology hold enormous promise, but getting drugs to market is expensive, time-consuming, and far from a sure thing. With risks high, and valuations no longer cheap, minefields abound.
The best of the health-care funds (and funds with large stakes in health care) all have investments in biotech, but their strategies differ. At one end of the spectrum, Vanguard Health Care (VGHCX), the granddaddy of health funds with $37.7 billion in assets, takes a more conservative approach: It has just 12% in biotech -- a smidge less than the MSCI ACWI health-care index -- while its No. 1 holding is Merck (MRK), the global drug company with a strong pipeline. The fund rarely leads during market rallies, though it suffers less on the downside.
By contrast, the $2 billion Janus Global Life Sciences (JFNAX) has 32% in biotech, including three of its top five holdings: Gilead Sciences (GILD), a leader in HIV drugs, which has recently launched the hepatitis C blockbuster Sovaldi; Celgene (CELG), whose flagship product, Revlimid, fights blood cancers; and Biogen Idec (BIIB), which specializes in drugs for neurological disorders, autoimmune disorders, and hemophilia. Says Janus Global Life Sciences' manager Andy Acker: "We've seen an acceleration of innovation. More drugs are getting approved more rapidly at lower cost." In fact, he adds, since 1999, biotech-drug sales have soared from $5 billion to more than $100 billion, and the number of blockbuster biotech drugs has risen tenfold, from three to more than 30, a level of innovation that he expects will continue.
Matt Kamm, lead health analyst at Artisan and co-manager of the $1.1 billion Artisan Global Opportunities (ARTRX), which has 19% of its assets in health care, sees similar opportunities. He points to Regeneron Pharmaceuticals (REGN), whose drug Eylea treats macular degeneration, and which is the fund's No. 3 holding. As the lines blur between biotech and big pharma, Regeneron has set up a partnership with Sanofi (SAN.France), the Paris-based drug giant, also a holding. "It has allowed Regeneron to act like it has a giant balance sheet and build a pipeline, and it gives Sanofi growth and products for the future," Kamm says. In addition to Eylea, Regeneron (which trades at 26 times next year's earnings) has three drugs in Phase 2 and 3 trials, for cholesterol, rheumatoid arthritis, and atopic dermatitis, and another 11 in development. That diversified drug pipeline appeals to Kamm: "This is a risky business, even for the best companies, so it's important that companies make good, risk-adjusted decisions about research-and-development spending and have multiple shots on goal."
For similar reasons, Kamm likes Biogen Idec, which trades at 23 times next year's earnings. It has a new oral medication for multiple sclerosis, Tecfidera; a new product launching for hemophilia; and other treatments in the pipeline for MS, spinal muscular atrophy, and Alzheimer's -- all squarely part of the firm's focus on neurological disorders. "They're all high-risk as stand-alone opportunities," Kamm says. "But we think it's a broad enough pipeline."
WHAT OF THE WAVE of biotech IPOs earlier this year? Those are riskier. Janus' Acker, who invests in small-company biotech, keeps the holdings to small pieces of the portfolio. "Some of these are pretty early stage," he says. "We saw some frothiness in the market." Artisan's Kamm is steering clear completely. "They're coin tosses or lottery tickets," he says.
The Best Defense Is a Good Offense
With health-care funds returning 37% in the past year, the sector's no longer a defensive strategy. Below are five good options.
Assets Total Return*
Fund/Ticker Manager (bil) 1-Year 5-Year Top 3 Holdings**
Fidelity Select Health Care Portfolio/FSPHX Eddie Yoon $6.3 50.3% 27.6% Actavis, Biogen Idec, McKesson
Janus Global Life Sciences/JFNAX Andy Acker 2.0 45.0 25.7 Gilead Sciences, Aetna, Celgene
Prudential Jennison Health Sciences/PHLAX David Chan 2.5 36.6 28.4 Alexion, Biomarin, Vertex
T. Rowe Price Health Sciences/PRHSX Taymour Tamaddon 9.1 39.8 29.1 Aetna, Agilent Tech, Alexion
Vanguard Health Care/VGHCX Jean Hynes 37.7 37.9 22.4 Merck, UnitedHealth, Forest Labs
*Returns are annualized as of 07/02
**As of 05/31 Sources: Morningstar; fund companies
Fidelity's Yoon trimmed his fund's exposure to small biotech stocks early this year when he saw stretched valuations and decreasing quality. His fund now tilts its biotech holdings toward larger companies with stable free cash flows and encouraging pipelines. Plus, he has been diversifying holdings to areas such as medical devices, specialty pharmaceuticals, and life sciences. Where Gilead was once Fidelity Select Health Care's top holding, for instance, now it's Actavis (ACT), a global drug company with a huge business in generics. It may not be a sexy business, but Yoon argues that its global footprint in more than 100 countries, and its ability to leverage its sales force across multiple categories, gives it advantages. The shares, recently at $222, trade at 13 times next year's earnings estimates. "They are an innovator; they are a consolidator; and they are accessing the global market," Yoon says.
Regardless of the broader economy, Yoon argues, the rising demands of an aging population and an emerging middle class worldwide will continue to drive health care. "Just because the health-care space is up a lot," he says, "doesn't mean there aren't a lot of good opportunities in this business."

I just bought this fund and have high hopes for it. One source of good information on the Doubleline Funds is to listen to the online replays and webcasts they produce. There is a replay on this Shiller Enhanced Cape fund that you can download dated May 20th. There is another one coming up on October 21st. The commentator is Jeffrey Sherman on both.
I usually listen to Doubleline replays and find them very informative.
Jeffrey Gundlach and Jeffrey Sherman are co-managers.
http://www.doublelinefunds.com/funds/shiller/overview.html (Barron's webcast)
http://www.doublelinefunds.com/pdf/DSEEX_Fact_Sheet.pdf
http://www.doublelinefunds.com/webcasts.html

jlev, just these:
http://www.doubleline.com/shiller-enhanced-cape-overview.php
http://www.doublelinefunds.com/pdf/DSEEX_Fact_Sheet.pdf
http://www.doublelinefunds.com/pdf/DSEEX_q114_letter.pdf
Thanks much for causing me to go study the PLUS series; have been rocking with PDI for many months, at least until recently :)

@MJG: appreciate your post. Yes, I try to look at the P/E given and make sure I know if it is a trailing twelve months P/E, a forward P/E [using the projected/estimated earnings going forward], what company came up with the earnings estimates, and all the details. Often those details are not given sufficiently. As I just replied to someone else, I find it unfortunate that M* just seems to report the forward P/E on the portfolios of individual mutual funds, as well as exchange traded funds and even index funds. I wish it would become standard to report both TTM P/E and forward P/E, and give relevant details such as you bring up.
I'm sure forward P/E ratios given in 2007 turned out to be way, way off base, since earnings must have collapsed during the great recession. Then the actual P/E goes thru the roof, since the denominator shrinks.....then the P shrinks and after a while we are in a bear market! So I agree with you wrt distrusting earnings forecasts, or any other forecast for that matter.
I think Buffett said something to the effect of, 'market forecasters make fortune tellers look good.'
You mentioned "Nobel laureate Robert Shiller recently introduced the 10-year average of real (inflation-adjusted) earnings as the Earnings denominator". I tried to look up when he introduced that, but so far haven't found it. I thought it was quite some time ago, at least people talk about it as if was a long time ago. Certainly has become a very hot topic. I think the current Shiller P/E is 26. Shiller's very good buddy Jeremy Siegel has a number of criticisms about using the Shiller P/E, or CAPE 10, to judge valuation. Especially now, since Siegel doesn't like that it includes the great recession.
I happen to like Robert Shiller a lot. He had a nice interview with Consuelo Mack on WealthTrack this year.
You can google it. It's on You Tube. I just posted it, but, "surprise", the URL from You Tube ended up posting the video graphic itself embedded [like when Ted posts a video with an arrow to view it!], and all I wanted to do is post the URL. The WealthTrack show was 2/21/2014
Cheers

Hi rjb112,
Definitions matter every bit as much as costs matter when making investment decisions.
I appreciate that you are a careful researcher, so this observation is likely to be totally unnecessary. However, when consulting any financial article, be sure to understand the precise definition of whatever statistic is being quoted.
The Price to Earnings ratio is one such statistic that has plenty of special definitions that could be misleading or misinterpreted if not properly recognized. Is the Price component based on current closing price or the monthly average? Is the Earnings component based on current level or is it a trailing 12 month average? Most importantly, are those Earnings the historical values or are they future projections?
I say most importantly because an estimate of future earnings is simply a forecast prone to error. My position on forecasts has been consistent: I am basically skeptical of most financial forecasts and generally distrust them. As you correctly inferred in your post, the likely explanation for the disparity in P/Es reported is that they were generated from the various sources that you cited.
When using the P/E ratio as part of the investment decision, it is hazardous to use future estimates. These estimates are often based on optimistic guesstimates, false assumptions, and/or behavioral biases. I believe it is a far safer approach to use the historical P/E ratio.
Nobel laureate Robert Shiller recently introduced the 10-year average of real (inflation-adjusted) earnings as the Earnings denominator. That’s his Cyclically Adjusted Price to Earnings Ratio (CAPE) formulation. That smoothing operation helps to tame the wild oscillations caused by point data anomalies. That too is a good concept.
Again historically, the current levels, like those exhibited by the S&P 500 Index, are a bit on the high side of the long-term trendline, but the trendline itself has been slowly increasing over time. Nothing is constant; the constituent makeup of the S&P 500 units slowly morphs.
As always, you alone get to interpret these data in your investment decision making.
I would caution you not to get too upset about rather small disparities in reported financial statistics. Given the dynamic nature of the marketplace, these are all subject to rapid changes anyway. As other MFOers have offered, don’t be frozen into paralysis by hyper analyses.
Good luck and Best Wishes.

FWIW, here the newest GMO 7 year forecast has U.S. Quality @ 2.3%, U.S. large cap @ -1.5%, and U.S. Small Cap @ -4.5% annual after inflation.
I'm also dubious of M*'s Vanguard figures because they only update by the quarter. IJS, which is updated daily lists a P/E of 18.75 vs. ITOT which has a P/E of 17.33.
Take with whatever grains of salt you like.

@mrdarcy or anyone else who knows: Can we get a clear, unambiguous definition of what GMO means by "U.S. Quality"? What mutual funds and exchange traded funds are there that focus on what GMO calls "U.S. Quality"? Note from above that U.S. Quality is not the same as U.S. large cap.
Also, I think GMO may be using the Shiller CAPE 10 price to earnings ratio to determine these expected 7-year returns. There are exchange traded funds and one mutual fund that specifically choose low Shiller CAPE 10 ratios. For example, Barclays ETN+ Shiller CAPE ETN CAPE ; also the exchange traded fund GVAL specifically chooses only countries that have low Shiller P/E ratios, and currently the portfolio has a P/E of 11.5 per Morningstar. Also DoubleLine Shiller Enhanced CAPE N DSENX

Hi rjb112,
What works on Wall Street is not constant. That’s why the super quants who currently run the most successful Hedge funds are so secretive about their methods and must use the highest speed computers to find and to exploit the market inefficiencies.
Folks have been learning this investment lesson forever. Jesse Livermore never revealed his secrets and continuously revised them based on present conditions.
In 1996, James O’Shaughnessy wrote a book titled “What Works on Wall Street” after much research. It was celebrated as the most influential investment book over decades. When O’Shaughnessy initiated a mutual fund to put his findings into practice, it failed miserably. He sold the fund, and the methods he discovered generated excess returns for a period thereafter. Investment strategies come and go and often return. These things are highly transient.
Risk and reward are tied at the hip, but with a bungee cord so that departures in time and space are variable and unpredictable. But the cord does exist. It is captured in the Wall Street rule of a regression-to-the-mean.
Each investor gets to choose his own risk level. As Ben Franklin said: “He that would catch fish, must venture his bait”. More recently, Nassim Taleb observed: “Risk taking is necessary for large success – but it is also necessary for failure”. You get to pick where on the risk spectrum your portfolio is positioned.
There are no free lunches. The marketplace is not a perfect measuring machine and is never in equilibrium. Markets move in that ideal direction, but never quite get there. Some exogenous event disrupts the process. Physically, it’s like an agitated coiled spring that is slowing down to an equilibrium, but gets an unexpected push. Opportunities present themselves but are extremely transient. Hard work is the price to identifying opportunities.
Two themes that run throughout Scott Patterson’s excellent book “The Quants” are the secret, competitive nature of its participants, and the need for hypersonic speed. The market pricing dislocations don’t persist. For these wiz-kids, The Truth is an elusive target. Emotions are high and disaster is always near, especially when excessive leverage is deployed to magnify small percentage profits into outsized wealth.
Many long-term players say investing is conceptually easy, but difficult to execute. When David Swensen was writing “Unconventional Success”, he changed the entire format of his book to advocate an Index approach when he realized that the average investor had neither the time, knowledge, or resources needed to execute the strategies deployed by successful professionals.
In the business world size does matter.
A reasonable analogy is the human lifecycle. A vibrant adult (a mature business) is better equipped to endure and survive “the slings and arrows of outrageous (mis)fortune” than a baby (an upstart business).
Again, historically investment asset classes do have a pecking order in terms of expected returns with anticipated risk factors. Typically, but not always since the marketplace can be wild and illogical for excruciatingly long periods, Small Cap rewards are expected to outdistance Large Cap returns. The historical data generally supports this proposition.
Although Small Caps are often expected to deliver about 2 % incremental returns over their Large Cap brethren, current investor perceptions that are both factually and emotionally driven do distort these projections. Why?
Small size often makes the company more vulnerable to unexpected perturbations. Typically their product line is more focused and not as diverse as a Large firm. Another risk factor is that growing businesses are often not geography dispersed. Their marketing is regional, not international, so localized disturbances more directly impact their sales.
The accessible funding line for these smaller outfits is more fragile with lower reserves and less access to loans and at higher interest rates when they can be secured. Large companies have survived their growing phase and are more stable; smaller firms are more subject to business model failures and exogenous disruptions (a new competitor or invention) with bankruptcy a higher probability.
The bottom-line is that the old investment saw of “Diversification, diversification, diversification” is operative with respect to business sizes. Smart large businesses have the resources to do it, small businesses do not.
The equity marketplace recognizes these small organization frailties in the risk-reward tradeoffs. Standard deviation is one incomplete measure of risk that is easily available for all stocks.
An example of the market’s pricing sensitivities is to compare the Vanguard S&P 500 Index (VFINX) with the Vanguard Small Cap Value Index (VISVX) funds. My comparison dates to 1998 which is the first year of operation for the Small Cap Value fund. Here is a Link to that data set:
http://quotes.morningstar.com/fund/visvx/f?rbtnTicker=Ticker&t=VISVX&x=0&y=0&SC=Q&pageno=0&TLC=
Since VISVX inception, it has cumulatively outperformed the S&P 500 Index. From the Morningstar’s chart, VISVX has turned an initial $10K investment into $39.6K while the large cap S&P 500 produced $23.6K.
Given the wild rides of the marketplace, this ordering of outcome will not persist for all specific timeframes. One thing is certain; change will happen.
Once again historically, the marketplace belonged to Mom and Pop investors. Now, professional players dominate the landscape. Indexing was nearly nonexistent early-on. Now it is 30% of the investment funds (about half professional and half Mom and Pop). Vanguard now controls more money than does Fidelity. Sea changes are not uncommon in the investment world, so an individual investor must always be alert.
Investment opportunities quickly fade. The speed needed to take advantage of these opportunities almost always takes the individual investor out of the ballgame. Even Hedge funds suffer this fate. But some general principles remain like diversification and reversion-to-the-mean.
I hope this helps. Enough pontificating. Thanks for giving me the chance to do so.
Best Wishes.