It's all SIMPLE
Robert Shiller, of Yale University, wrote a book before the early 2000 bubble reached its peak. In "Irrational Exuberance", Shiller warned and documented the case that stocks were overvalued, and the bubble was ready to burst. He decided that in order to make some sense out of studying all the data, you had to have some constant to measure value, and he decided to use the PE ratio and the dividend yield. Contrary to some "new economy" nitwits today, who only are used car salesmen in disguise, the PE and dividend have always and WILL always matter. His highly-detailed data showed that the average historical P/E ratio for the S & P from 1895-1995 was 14.6 times earnings. A P/E of 14 roughly equals a simple annual return of about 7%. It just so happens that the long-term historical return for the stock market averages near 7%. It all makes sense.
His data also showed that the average dividend yield for the stock markets was 4.6% from 1895-1995.
Using this logic, if the P/E ratios are around 14, they are fairly-valued, neither a buy nor a sell. If they are cut in half -- 7 times earnings -- they are a buy and stocks are cheap. If they are 50% higher than fair-value -- at 21 times earnings -- they are expensive and indicate they should be sold. If they get to twice fair-value -- 28 times earnings -- it shows a speculative bubble. Stocks (remember we're talking averages now) should be sold quickly during a bubble environment.
You can apply the same type formula to dividend yields. They have an inverse relationship to P/E ratios, so high dividend yields show stocks are undervalued and should be bought. Of course there are specific examples where companies debt ratings, etc. are poor and this is not a reliable indicator on a specific basis, but we are talking averages. Low dividend yields relate to overvaluation and should be sold historically.
Shiller's message was simple. If you buy stocks (averages) when they are very undervalued -- a P/E near 7 -- chances are you will have a great return on your investments over time. If, however, you buy stocks when they are overvalued -- a P/E above 21 - the chances are great you will lose money or have no gains at all over a long period of time -- perhaps even a 20 year period.
In the early 1920's stocks had very low PE's (under 5) and very good yields (about 7.5%). By the late 1920's, a bubble had developed. In the 1940's this opportunity came again with stocks peaking in the mid 1960's. In the early 1980's, this low PE presented itself again with a bubble developing and peaking in early 2000.
So you have about a 10-year period after 1929 for the bubble to unwind and valuations to get cheap again. From the 1960's peak you have about a 20-year period for valuations to get historically low again. Now, we are near the 3rd year mark in waiting for stocks on average to get historically low in valuation again so the next long-term buy and hold period will begin.
Where is the PE on average for the S & P now? Estimates seem to range from 25-30. We are not near a level that should be bought by long-term investors. Slider speaks of "low-risk/high-return" situations as all that interests him. PATIENCE is the key here. Everyone will suffer the volatility UNTIL we get to another historical low valuation period which should be bought. They will also set themselves up for ZERO return by buying now. Even if they buy more at the lows, their averages will be net zero over a long period of time. No one will find the exact bottom, but I'd say a good plan is to pull all your money out of the markets and make it safe -- even if it's only earning 1.5%. WAIT until the averages at least get to fair-value (PE of 14), and then begin dollar-cost-averaging back in.
Sure, there are always "trades" that can be made during ANY given time period -- just look at QCOM the past 10 days. But you have to have volatility, risk, and great ability to profit much. For the average person, it is much more profitable to only have your money at work in the stock market when the low-valuation opportunities exists.
This rally may go a little more, but if you look at the historical perspective, you can see where it is going to end up before the next long, bull run. And that is somewhere between 40-80% lower. The average person who is within 10 years of retirement and is fully invested because they ar buying the garbage being sent to them from totally-biased people (TV, brokers, bankers, analysts) will be severely hurt before this is over. Many will have to work another 10 years for which they did not plan.
Wait for Slider's "low risk/high return" opportunity if you only want your money in the stock market. I could go on about why gold investments should prosper extremely well during the time the stock markets eventually reach this "once in 20 year buying opportunity level", but this old man is tired. Back to pain killers.
I remain,
SOROS
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