Which Is The Most Over-Valued Component?

[Reub]

I've read a lot of comments recently about this component of the PP or that component being over-valued. So which is the most over-valued in your opinion? Stocks, LTT's, gold, or cash?

[BearBones]

Not cash. LTTs were the vote a month or so ago. I tend to wonder if the 3 non-cash assets are all a bit overvalued; hence my concern that the PP may not perform in the short term going forward as it has in the past. Not a reason to abandon unless you feel confident and lucky (and in that case, you'd not be on this forum).

[MediumTex]

Stocks.

I think we are in the end stages of a fierce cyclical bull market in the midst of a longer term secular bear market for stocks.

[clacy]

Stocks.

I think we are in the end stages of a fierce cyclical bull market in the midst of a longer term secular bear market for stocks.

I tend to agree.  They can QE all they want, but you can't go straight up without some serious corrections and bear markets.  There will be a rough patch this year that may not be as brutal as 2008, but will certainly test people's confidence in stocks and the global economy.

[magneto]

If we look at the REAL yields presently available (for a UK investor) based on long term inflation rate of 3.1% :-

Stocks            3.4%
LT Bonds          0.3%
Gold                -3.1%
Cash              -0.6%

What do you think?

[Pointedstick]

If we look at the REAL yields presently available (for a UK investor):-

Stocks            3.4%
LT Bonds          0.3%
Gold                nil
Cash              -0.6%

What do you think?

I think I'm glad the PP holds these assets for their capital value and not their yield.

[gap]

I did a quick study in an attempt to see which component is relatively overvalued. I started 5 years ago with a 25% allocation to SPY, GLD, TLT and SHY. I rebalanced based on a 35/15 band. The CAGR was 7.4% and I had to re-balance only once on Aug 1, 2011.(I am checking data once a month to re-balance). Remarkably it got me to re-balance  GLD at 177. Today the %age of each component is as follows:
SPY -30%
GLD - 20.5%
TLT - 26.4%
SHY - 23.1%

Using this as a basis I would say SPY is the most overvalued today though it is not  time to re-balance yet if you are using a 35/15 band

[Stunt]

I did a quick study in an attempt to see which component is relatively overvalued. I started 5 years ago with a 25% allocation to SPY, GLD, TLT and SHY. I rebalanced based on a 35/15 band. The CAGR was 7.4% and I had to re-balance only once on Aug 1, 2011.(I am checking data once a month to re-balance). Remarkably it got me to re-balance  GLD at 177. Today the %age of each component is as follows:
SPY -30%
GLD - 20.5%
TLT - 26.4%
SHY - 23.1%

Using this as a basis I would say SPY is the most overvalued today though it is not  time to re-balance yet if you are using a 35/15 band

You are only looking at two data points for your conclusions.
Who's to say that stocks weren't under-valued at the time of your entry to PP?

I think the most overvalued is the long bonds component.
The credit worthiness of the US is at an all time low based on debt to GDP levels, deficit ratios and long term liabilities. Yields on debt should be much higher in my opinion but remains suppressed by government intervention. Anything subsidized by the government has to be the most over-valued.

Corporate balance sheets, profitability and growth due to overseas investment makes stocks still an attractive place. Especially since they have already had a big pull back and aren't even at all time highs (like the other assets - bonds, gold) with multiples more liquidity than just 6 years ago.

Gold is a function of inflation, monetary expansion and hedge against currency wars. It is consolidating and will continue to grow with eternal fed stimulus.

[Pointedstick]

I think the most overvalued is the long bonds component.
The credit worthiness of the US is at an all time low based on debt to GDP levels, deficit ratios and long term liabilities. Yields on debt should be much higher in my opinion but remains suppressed by government intervention. Anything subsidized by the government has to be the most over-valued.

That would be everything. Stocks, bonds, and gold have all benefited enormously from QE.

I too am skeptical of long bonds' ability to go much higher, but your statement about the U.S. government's creditworthiness is inaccurate and doesn't have much to do with the performance of bonds. When the ratings agencies downgraded the government, bonds surged even higher! What to make of that? Is the normally very efficient bond market irrational only for government bonds? Or do they know something most people don't? Is it possible that the U.S. government will have no solvency of creditworthiness problems for the foreseeable future due to its massively powerful economy, issuing of the worlds reserve currency, and large, belligerent  military?

[Stunt]

I think the most overvalued is the long bonds component.
The credit worthiness of the US is at an all time low based on debt to GDP levels, deficit ratios and long term liabilities. Yields on debt should be much higher in my opinion but remains suppressed by government intervention. Anything subsidized by the government has to be the most over-valued.

That would be everything. Stocks, bonds, and gold have all benefited enormously from QE.

I too am skeptical of long bonds' ability to go much higher, but your statement about the U.S. government's creditworthiness is inaccurate and doesn't have much to do with the performance of bonds. When the ratings agencies downgraded the government, bonds surged even higher! What to make of that? Is the normally very efficient bond market irrational only for government bonds? Or do they know something most people don't? Is it possible that the U.S. government will have no solvency of creditworthiness problems for the foreseeable future due to its massively powerful economy, issuing of the worlds reserve currency, and large, belligerent  military?

I didn't say that the creditworthiness was worse relative to other countries, but that its at an all time low based on the ratios I mentioned. I think you would agree that the finances of the US were more stable 10 or so years ago.

If the world wasn't so interconnected these days, the downgrade would have resulted in a different situation. Higher debt levels, deficits and inability to legislate in any othe nation should cause borrowing rates to increase. I'm not saying rates have to go up, just that the reasons to push rates down (to have a big impact on long bonds) has been greatly diminished in today's climate.

[gap]

Yes, starting points do make a difference in the actual percentages and time of re-balance. So I decided go further back to the earliest date I could have actually bought  all these ETFs, which  is Nov 2004 when GLD was available.(others were available earlier).. I realize we could use other funds to replicate the PP even earlier. However, going back further, which caused two more re-balances,  did not change the highest %age component which is still SPY. I think the whole beauty of a fixed allocation and bands is the lack of need to forecast the unknown. The most expensive component pops out and encourages a re-balance when the allocation goes to extremes.
I am curious now to see if there is a starting point that will make  LT Bonds or any other asset the top one.

[Wonk]

Without a doubt it's equities with a Shiller PE of 23.40 (130yr mean of 16).  It can always get more overvalued (44 in 2000), but I wouldn't touch broad based equities with a 10ft pole right now.  I agree with MT and think we're at the end of a cyclical stock bull and won't see much upside for another 4-5 years.

[moda0306]

Wonk and other stock bears,

I'm not saying I disagree that the stock market has some adjusting to do, and the stock market can always escape yield zones that "make sense," but in the end these P/E ratios aren't in a vacuum... they're compared to bond yields and priced accordingly.  That PE of 23.4 is a yield of 4.3%... this isn't anything to go wild about, but when you compare this to yields elsewhere, it doesn't look so bad.

It'd be hard to convince me that the fact that bond yields suck right now isn't having a huge effect on stock prices.  If you could somehow make treasuries yield from 3-6% instead of 0-3%, you think stocks with that yield would stay the same?

[dragoncar]

Without a doubt it's equities with a Shiller PE of 23.40 (130yr mean of 16).  It can always get more overvalued (44 in 2000), but I wouldn't touch broad based equities with a 10ft pole right now.  I agree with MT and think we're at the end of a cyclical stock bull and won't see much upside for another 4-5 years.

Does this mean you do not implement the PP?  Or do you consider the PP to be a 20 ft pole?

[MachineGhost]

It'd be hard to convince me that the fact that bond yields suck right now isn't having a huge effect on stock prices.  If you could somehow make treasuries yield from 3-6% instead of 0-3%, you think stocks with that yield would stay the same?

There's no correlation between bond yields and equivalent stock yields.  That isn't to say people are not buggered by the Fed artificially lowering interest rates, forcing them to take on higher and higher levels of risk just to achieve a modicum of a return.  But that is behavioral economics not rational economics.

[moda0306]

MG,

Yes there is a general correlation. Yields in the 70's and early '80s for both were generally higher than they are now. Yields on other options is going to put pressure on stock prices one way or another.

http://www.multpl.com/shiller-pe/

You can't tell me you don't see a broader longer term trend there that correlates with bond yields (if you flip the graph).  Obviously, short term movements aren't correlated to bond yield movements, but longer term movements seem to be.

[MachineGhost]

You can't tell me you don't see a broader longer term trend there that correlates with bond yields (if you flip the graph).  Obviously, short term movements aren't correlated to bond yield movements, but longer term movements seem to be.

No one uses the Shiller PE (which is inflation-adjusted) for the Fed Model.  And the Fed Model doesn't work before 1960.  So the correlation is rather a short term aberration, rather than a long term one.  Any correlation you are seeing is likely to be the direction of real interest rates, not the comparative worth of bonds vs stocks.  Correlation is not causation.

[Wonk]

Without a doubt it's equities with a Shiller PE of 23.40 (130yr mean of 16).  It can always get more overvalued (44 in 2000), but I wouldn't touch broad based equities with a 10ft pole right now.  I agree with MT and think we're at the end of a cyclical stock bull and won't see much upside for another 4-5 years.

Does this mean you do not implement the PP?  Or do you consider the PP to be a 20 ft pole?

The PP is 20% of my overall portfolio.  Since stocks constitute 5% of my portfolio, I guess you could say I'm touching broad based stocks with a 6" pole.  The other 80% is invested in gold/silver/miners and that hasn't changed in several years.  I don't see it changing either.

Moda,

I don't view it as a yield either/or scenario.  Secular markets typically take 16-20 years to change course and we're presently around year 13.  Central banks must continue to devalue in order to sustain high asset prices so I'm not a fan of most stocks or bonds at the moment.  I'll wait for better valuations.

[moda0306]

You can't tell me you don't see a broader longer term trend there that correlates with bond yields (if you flip the graph).  Obviously, short term movements aren't correlated to bond yield movements, but longer term movements seem to be.

No one uses the Shiller PE (which is inflation-adjusted) for the Fed Model.  And the Fed Model doesn't work before 1960.  So the correlation is rather a short term aberration, rather than a long term one.  Any correlation you are seeing is likely to be the direction of real interest rates, not the comparative worth of bonds vs stocks.  Correlation is not causation.

Plenty of people use Shiller PE as a gauge of a more stable view going forward of where earnings should be for pricing purposes, and what the fed may look at is irrelevent... the fed seeks rates based on inflation and unemployment, not the PE of the stock market.

I'm not saying one market causes the other, but the market IS going to look at bond yields when pricing stocks... maybe it's as simple as t-bills/bonds being a floor price on top of which progressively riskier and risker assets are priced, but there is some cause and affect there.  I'd never borrow money to a company for a lower rate than I'd borrow it to the US government.  I'd also never take an equity position in a company for an earnings share that I feel will yield me less than simply loaning that company money.

[systemskeptic]

Cash/Bonds/LTT are the most over-valued as a result of the global currency and economic landscape, and inflation in the US dollar is like a spring that has been wound up for 40 years and is waiting to release in the face of irrational markets.

Gold will continue to be a strong asset, Stocks in certain economic regions will probably have low returns, in other regions they will experience growth if the currency effects can be sufficiently isolated/mitigated. 

[MachineGhost]

Plenty of people use Shiller PE as a gauge of a more stable view going forward of where earnings should be for pricing purposes, and what the fed may look at is irrelevent... the fed seeks rates based on inflation and unemployment, not the PE of the stock market.

I guess you didn't read the Wikipedia entry.  The so-called Fed Model has nothing to do with monetary policy, but what you (or others) are advocating as a stock valuation scheme.  My point is comparing equivalent stock yields to bond yields isn't supported by the long-term data.  Lots of things that make intuitive sense in investing don't hold up upon further scrutiny.  This should be no surprise to you.

But, I will risk being stood corrected by declaring that perhaps asset class relationships have changed under a fiat monetary system.  The 1960's were certainly a new era of rampant government social spending and 1969-1971 popped the cork out of the bottle thanks to Nixon.

I digress here, but it never ceases to amaze me how much evil can be traced back to Republican "Tricky Dick" Nixon.  The latest I've learned was that Nixon was responsible for fostering the for-profit HMO abomination onto America -- non-profits were intentionally banned -- in a classic case of crony capitalism due to Kaiser-Permanente's influence which was, and still is, run like a corporate mining town with a bit of Scientology-like flair.  I would run in the opposite direction before ever accepting health insurance from KP due the horror stories I've both read and heard.

[Pointedstick]

I would run in the opposite direction before ever accepting health insurance from KP due the horror stories I've both read and heard.

Funny you should mention this. My wife, son and I have coverage with Kaiser and couldn't be happier. My wife delivered our son at one of their facilities and received outstanding service throughout the pregnancy, delivery, and post-natal period.

Anecdotes are no evidence of a trend, of course, but I just wanted to share my experience and say that they're not all bad for everyone. What stories have you heard?

[moda0306]

MG,

I see what you mean.  I really think the switch to fiat would have something to do with it, but I'm simply saying that I think the floor on yields set by treasury bonds is going to create a situation where, while the stock market yield might far exceed it at times, there is far, far more likely chances of a PE of 8 (yield of 12.5%) when t-bills have a high yield than when they have a low yield.

Obviously this is some crude technical analysis, but I use it less as a timing tool than as a concept to realize why the stock market might not, or maybe even likely won't, reach the PE ratios stock bears would like to see based on what we saw in 1981.

I will just refer back to my rule about treasury vs corporate bond yields (I think everybody can agree on this one), and then build in the fact that nobody would take an equity stake in a company for less share of earnings than what a bond with them would represent... now this one's more complex, but PE (upside down), whether PE10, PE1, or some other measure, without adjusting for changes in earnings, is a pretty good place to start.  Obviously, then you have to build in expectations about the rate of positive rate of change in earnings, but this is usually built on current profits.

Maybe the market doesn't think it out quite this much, but it seems to me that this is due to, at its core, a miscalculation on the rate of change of corporate earnings over the next X number of years.  I mean if we knew earnings would stay the same until the end of time, we'd have something much easier to compare to bonds.

I think my theory pretty easily explains why the market could get to a PE of 8 in 1981, but in the worst financial crisis since the great depression we bottomed out at 15.

[MachineGhost]

Anecdotes are no evidence of a trend, of course, but I just wanted to share my experience and say that they're not all bad for everyone. What stories have you heard?

Mostly stories about the incompetence (physicians) and the profit motive (hospitals) playing a major role against prevention and treatment of diseases found out later to be terminal, too late.  If you look up news stories about KP, you will get an idea of the malfeaseance they have engaged in.  Also, KP is extremely popular in the liberal San Francisco-Oakland (hometown) area so there's a favoritism bias that needs to be discounted.

Also, I don't think you'll like find too much shenigans in maternal care compared to degenerative or terminal care.  American society sort of accepts neglect of the latter more or less as an open secret compared to "protecting the children".

[Pointedstick]

Also, I don't think you'll like find too much shenigans in maternal care compared to degenerative or terminal care.  Society sort of accepts neglect of the latter more or less as an open secret compared to "protecting the children".

It's true. But my sense--and correct me if I'm wrong--is that terminal care is a disaster everywhere. If there's a medical sector I constantly hear horror stories about, it's end-of-life issues and the astronomical associated costs, and it seems to be a problem with every company.