10/08/2010
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Yale Professor Robert Shiller’s Cyclically Adjusted Price Earning Ratio (CAPE10) was reviewed October 2009. CAPE10 is defined as the ratio of price to the average of last 10 year trailing S&P 500 annual earnings. In his now famous book titled as “Irrational Exuberance”, Shiller popularized this ratio as a long term stock market valuation metric. MyPlanIQ has implemented a
strategy and maintains a live
portfolio.
The strategy characterizes the stock market valuation into the following five categories based on the ratio of the current CAPE10 to the long term average CAPE10 as follows:
· Significantly Overvalued (SO): such as if the ratio >= 150%
· Modestly Overvalued (MO): such as if 117% <= ratio < 150%
· Fairly Valued (FV): such as if 83% <= ratio < 117%
· Modestly Undervalued (MU): such as if 67% <= ratio < 83%
· Significantly Undervalued (SU): such as if ratio < 67%
At each rebalancing the CAPE index determines the shape of the portfolio:
· SO: 0% in stock, 100% in cash.
· MO: 25% in stock, 75% in cash.
· FV: 50% in stock, 50% in cash
· MU: 75% in stock, 25% in cash
· SU: 100% in stock, 0% in cash
The funds in the portfolio are (ETF alternatives):
· Wilshire 5000 total return index ^DWC (VTI, SPY, IWM)
Returns from 12/31/1970 to 10/23/2009
Schiller 6.9% standard deviation (std): 11.9%
^DWC 8.8% standard deviation (std): 19.5%
Over the very long haul, the Shiller portfolio has lower returns that the market with lower volatility. It is possible with some adjustment of the strategy, that the performance could be higher. A fuller discussion of the strategy is in the October 2009 review.
That was then, this is now. It is hard to imagine that an investor would have the patience that this approach demands to sit out of the market even if the market is overpriced. However, this is an interesting approach that we will compare against asset allocation strategies to see how they compare over a shorter time period.
We will review the performance of the portfolio against ^DWC and we will also compare it over five years with a 6 asset SIB with tactical and strategic asset allocation.
Table of 5 year and 1 year Returns for Shiller, ^DWC and SIBs
| Portfolio |
1 Year |
5 Years |
| Schiller |
10.3% std: 13.2% |
5.4% std: 7.8% |
| ^DWC |
-0.9% std: 25.0% |
-6.9% std: 22.0% |
| 6SIBSAA |
6.5% std: 15.3% |
8.9% std: 12.0% |
| 6SIBTAA |
13.2% std: 11.1% |
7.4% std: 14.3%
|
Comments on the results
· Although the market has outperformed the Shiller portfolio in the very long run, during the choppy markets of the last five years, Shiller has performed very well. In fact, same could be said over the last ten years.
· The 6SIB SAA has performed better than the market but not better than Shiller for the last five years although it has outperformed Shiller in the last year
· The 6SIB TAA shows the best longer term performance although the 6SIB SAA is the performance leader over the last year
· The market has delivered poor returns over the last five years with a high degree of volatility
On Friday Sept. 17, 2010, the current CAPE10 stood at 20.9, compared with 16.4 for the long term average of CAPE10, indicating it was 28% overvalued. Please refer to
MyPlanIQ indicators for more details,
Takeaways:· In the very long run, buying and holding the market delivers reasonable results if you have the patience
· For those with a shorter term horizon, having an asset allocation strategy is important
· The 6SIB SAA has good diversification and a simple buy and hold strategy
· The Shiller allocation strategy is interesting and can be tweaked to provide better results
· The 6SIB TAA has delivered the best performance
labels:investment,Symbols,VTI,SPY,IWM,BND,AGG,DBC,EEM,EFA,GSG,IYR,LQD,SHY,TLT,Bonds,Dollar/Currencies,Earnings,Economy,Hedge,Funds,
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