Q: What do 1930, 1965 and 2011 have in common?

[Wonk]

A: They all have a P/E10 north of 22 to start the year, which is frothy. 

http://www.multpl.com/

Now, this thread is in the VP section for a reason.  Don't go changing a perfectly good PP because of this--it's just something to consider if you are feeling cheeky about equities.  Back to your regularly scheduled programming...

We all know what happened in 1930.  Wasn't pretty until PE10 dropped below 10 in 1932.  Nothing crazy happened in 1965.  In fact, it rose a bit by Jan 1966...then it dropped and inflation ate away at the real value of equities for the next 18 years.

Have there been other times when PE10 has been above 22?  Yes.  They've either been on the way up to an even bigger bubble (eg 1996-2000), or on the way back down after the bubble started to pop (eg 2000-2003).  The 100 year median is a shade under 16, so this market is definitely overvalued.  The only question now is whether inflation will begin to turn this market sideways until earnings catch up or if deflation will cut the legs out from under it. 

This secular bear in equities is not hibernating yet.  He's sharpening his teeth.  Markets don't give us guarantees, only probabilities.  I'd hazard a guess we'll see PE10 at or below 10 at some point in the next 5-10 years.  Look for it...it'll be time to back up the truck and buy.  In the meantime, speculate in your VP as you see fit.  I, for one, can't wait until we get some cheap prices for companies.  We've been waiting 25 years for it!

Enjoy the weekend!

[Wonk]

Further reading on PE 10 can be found in Robert Shiller's paper:

http://www.econ.yale.edu/~shiller/data/peratio.html

Ironically, it was released in 1996--when the PE 10 was 24.  The S&P continued to rally for another 3 years until the pop, so todays PE 10 is not a guarantee of the top.  Doesn't mean it's not overvalued though.  Dodd & Graham were the first to popularize PE 10.

[moda0306]

The idea that a stock portfolio would have had no growth between 1966 and 1982, while simultaneously experiencing some serious inflation during that same period, is amazing to me.  I think some people, myself included, spent way too much of their lives experiencing the mid-80's through the 90's and just feel like that's the norm.

I'm very glad I stumbled upon the PP so early in life.

[Wonk]

I think some people, myself included, spent way too much of their lives experiencing the mid-80's through the 90's and just feel like that's the norm.

That's one of the reasons why I believe secular market cycles exist and will continue to exist.  I agree that it's great to be a PP investor in the 00's and 10's.

[moda0306]

Regardless of whether it was a cycle, or just a coincidental sequence of events, it's unbelievable the purchasing power you would have lost during that period by owning stocks alone.

[Lone Wolf]

Regardless of whether it was a cycle, or just a coincidental sequence of events, it's unbelievable the purchasing power you would have lost during that period by owning stocks alone.

You're right.  Many people call stocks their "inflation protection" but this has never seemed like a good idea to me.  During all this inflation (when cash is generally not a pleasant place to be) it would have still been better to simply hunker down in cash such as treasury bills, CD ladders, or a savings account.

Sure, you'd have gotten your purchasing power raided with either investment but I hadn't realized that stocks were this much worse than just cash.  It definitely shows that relying on stocks to save you from inflation is not a good strategy.

[moda0306]

When inflation comes as a result of foreign wars & oil shocks, as opposed to bread & butter fed easing, you aren't going to see stocks do well.  I was stupid to ever think that.  Ironically, you're right... cash tends to keep up with inflation much more accurately/safely than stocks.  Gold, on the otherhand, has the canary effect of skyrocketing when the problems are just beginning.

[Lone Wolf]

Stocks (ON AVERAGE) often seen as providing inflation + 4% real gains (for 4% 'safe' withdrawal rates) which ON AVERAGE is implied as reasonable from the above (IN PRACTICE HOWEVER MANY INVESTORS DON'T ACHIEVE THE AVERAGE (see below)).

Exactly... the "on average" bit that you're mentioning is what really trips people up.  Looking at the very long term, stocks do indeed come out ahead of inflation thanks to the sheer fact that they have such awesome long-term growth rates.

Unfortunately, this observation can lead to some bad conclusions.  This average performance does not mean that stocks are guaranteed to weather specific bouts of inflation well at all.  The period of time that moda points out shows that a 100% stock portfolio would have had to weather a couple decades of net lost purchasing power in order to "catch up" much later.

I think this shows that if you are building inflation protection into your diversified portfolio, stocks simply cannot play that role.

[moda0306]

That's one reason the PP is so appealing... it forces you into a non-stomach churning buy-low/sell-high mechanical process that makes the PP greater than a sum of its parts, in terms of both low volatility and higher return.  It's like looking at 2 items... one is a pile of metal, leather, fluids, plastic & rubber, and the other is a finely engineered Porsche.  Looking at one pile, you'd never guess that when put together the right way you could get the second.

Clive... yes, averages mean little when spread far beyond the reasonable needs of a human being.  On average, we all die, so why don't we all just give up? 

[moda0306]

The thing is, often it's the same people going heavy into stocks that also depend on the same prosperity that makes their stocks do well to help them pay their mortgage, pay off their loans, buy cars, tv's, etc, and live a better life.

So basically what WAY too many people do is the equivalent to going all in in hold-em with pocket sevens.

Then you get the old lady with more money than God, and she won't invest in anything but ST munis or money market cash.  I see this all the time.

[MediumTex]

Then you get the old lady with more money than God, and she won't invest in anything but ST munis or money market cash.  I see this all the time.

That's probably how she got all the money in the first place--not making foolish speculations.

[moda0306]

She probably got it through either her or her late husband taking risks at some point.  I doubt too many people become as wealthy as some of these old women do by shopping at Costco and investing in ST munis.

[Jan Van]

The old lady?

http://www.youtube.com/watch?v=qG4IaHgqH00

Did somebody here post that link? Can't remember where I found it...
PS. Yes, that's shot in my native country 
PS2. This isn't off-topic, is it?