Australian (ASX 200) stock market including the cyclically adjusted price earnings ratio (PE10 or CAPE) – May 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a cyclically adjusted PE ratio (known as the PE10 or CAPE) for the ASX 200 to attempt to value the Australian Stock Market. The method used is based on that developed by Yale Professor Robert Shiller for the S&P 500. I will call it the ASX 200 PE10 and it is the ratio of Real (ie after inflation) Monthly Prices and the 10 Year Real (ie after inflation) Average Earnings. For my Australian Equities I will use a nominal ASX 200 PE10 value of 16 to equate to when I hold 21% Australian Equities. On a linear scale I will target 30% less stocks when the ASX 200 PE10 = 26 and will own 30% more stocks when the ASX 200 PE10 = 6.

A History of Severe Real S&P 500 Stock Bear Markets – May 2010 Update

Looking at the first chart which shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market I have identified three historic severe stock bear markets. These I am defining as stock markets where from the stock market reaching a new high, they then proceeded to lose in excess of 60% of their real (inflation adjusted) value. These are best demonstrated by the second chart which shows each of these stock bear markets and the fall in percentage terms from the peak. So briefly what were these bear markets (full details here).

US (S&P 500) stock market including the cyclically adjusted price earnings ratio (PE10 or CAPE) – May 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on buy & hold and asset allocation I am using a Cyclically Adjusted Price / Average 10 Year Earnings (PE10 or CAPE) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller however I also incorporate earnings estimates up to the PE10 month of interest. Background information here.

Investing mistakes I’ve made – shorting the stock market

As I’ve travelled down my chosen road of taking full responsibility for my retirement investing strategy I’ve made plenty of mistakes that have cost me money (and I’m sure I’ll make plenty more). I’d therefore like to share some of these with you over the coming months. Previously I covered contango & exchange traded commodities (ETC’s) and today I’m going to cover shorting the stock market.

Bulls, bears and the 200 day moving average

A search online for the 200 day moving average or simple moving average (200 dma or 200 sma) will reveal many hits and a lot of different opinions. Firstly what is the 200 dma? In its simplest form it is the average of a markets closing price over a 200 day period. To construct the average you add the last 200 days closing prices and divide by 200. Another form is the 200 day exponential moving average (200 ema) which is a little more complex and provides more weight to young price data and less weight to old price data.

Minimising investment portfolio ‘fees and taxes’ not ‘fees or taxes’

One of the principles I followed when I first constructed (and in the ongoing maintenance of) my retirement investing low charge portfolio was to minimise fees and taxes. I do this as fees and taxes have a big effect on your final portfolio when investing over many years due to the compound interest effect as I demonstrated here.

Australian (ASX 200) stock market including the cyclically adjusted price earnings ratio (PE10 or CAPE) – April 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a cyclically adjusted PE ratio (known as the PE10 or CAPE) for the ASX 200 to attempt to value the Australian Stock Market. The method used is based on that developed by Yale Professor Robert Shiller for the S&P 500. I will call it the ASX 200 PE10 and it is the ratio of Real (ie after inflation) Monthly Prices and the 10 Year Real (ie after inflation) Average Earnings. For my Australian Equities I will use a nominal ASX 200 PE10 value of 16 to equate to when I hold 21% Australian Equities. On a linear scale I will target 30% less stocks when the ASX 200 PE10 = 26 and will own 30% more stocks when the ASX 200 PE10 = 6.

A History of Severe Real S&P 500 Stock Bear Markets – April 2010 Update

Looking at the first chart which shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market I have identified three historic severe stock bear markets. These I am defining as stock markets where from the stock market reaching a new high, they then proceeded to lose in excess of 60% of their real (inflation adjusted) value. These are best demonstrated by the second chart which shows each of these stock bear markets and the fall in percentage terms from the peak. So briefly what were these bear markets (full details here).

US (S&P 500) stock market including the cyclically adjusted price earnings ratio (PE10 or CAPE) – April 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on buy & hold and asset allocation I am using a Cyclically Adjusted Price / Average 10 Year Earnings (PE10 or CAPE) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller however I also incorporate earnings estimates up to the PE10 month of interest. Background information here.

Are we back to blowing asset bubbles already?

Last week saw Alan Greenspan interviewed as part of the Financial Crisis Inquiry Commission. The Times reported that during this interview “Mr Greenspan denied his policies encouraged the type of risky lending that spurred the financial crisis. The long-time Fed Chairman - whose reputation has been deeply undermined by the crisis - denied low interest rates and loose regulation had encouraged lenders and borrowers to take ever greater risks."

Australian Stock Market – March 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a cyclically adjusted PE ratio (known as the PE10 or CAPE) for the ASX 200 to attempt to value the Australian Stock Market. The method used is based on that developed by Yale Professor Robert Shiller for the S&P 500. I will call it the ASX 200 PE10 and it is the ratio of Real (ie after inflation) Monthly Prices and the 10 Year Real (ie after inflation) Average Earnings. For my Australian Equities I will use a nominal ASX 200 PE10 value of 16 to equate to when I hold 21% Australian Equities. On a linear scale I will target 30% less stocks when the ASX 200 PE10 = 26 and will own 30% more stocks when the ASX 200 PE10 = 6.

A History of Severe Real S&P 500 Stock Bear Markets – March Update

Looking at the first chart which shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market I have identified three historic severe stock bear markets. These I am defining as stock markets where from the stock market reaching a new high, they then proceeded to lose in excess of 60% of their real (inflation adjusted) value. These are best demonstrated by the second chart which shows each of these stock bear markets and the fall in percentage terms from the peak. So briefly what were these bear markets (full details here).

US (S&P 500) Stock Market – March 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on buy & hold and asset allocation I am using a Cyclically Adjusted Price / Average 10 Year Earnings (PE10 or CAPE) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller however I also incorporate earnings estimates up to the PE10 month of interest. Background information here.

Australian Stock Market – February 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a cyclically adjusted PE ratio for the ASX 200 to attempt to value the Australian Stock Market. The method used is based on that developed by Yale Professor Robert Shiller. I will call it the ASX 200 PE10 and it is the ratio of Real (ie after inflation) Monthly Prices and the 10 Year Real (ie after inflation) Average Earnings. For my Australian Equities I will use a nominal ASX 200 PE10 value of 16 to equate to when I hold 21% Australian Equities. On a linear scale I will target 30% less stocks when the ASX 200 PE10 average is ASX 200 PE10 average + 10 = 26 and will own 30% more stocks when the ASX 200 PE10 average is PE10 average -10 = 6.

Chart 1 plots the ASX 200 PE10. Key points this month are:

ASX 200 PE10 = 18.2 which is down from 18.8 last month. My target Australian Equities target is now 19.6% which is up from 19.2% last month.

ASX 200 PE10 Average = 22.8

ASX 200 PE10 20 Percentile = 17.3

ASX 200 PE10 80 Percentile = 27.7

ASX 200 PE10 Correlation with Real ASX 200 Price = 0.81

Chart 2 plots further reinforces why I am using this method. While the R^2 is low at 0.1433 there appears to be a trend suggesting that the return in the following year is dependent on the ASX 200 PE10 value. Using the trend line with a PE10 of 18.2 results in a 1 year expected real (after inflation) earnings projection of 13.3%. The correlation of the data in chart 2 is -0.38.

Chart 3 plots Real (after inflation) Earnings and Real Dividends. Dividends and Earnings both remain below the trend line. Earnings also remain very close to that of Dividends. What this means is that currently Australian companies are using nearly all their Earnings just to fund the Dividends. Yet the trend line suggests typically clear distance between the two with the trend lines running almost parallel. I ask the same question as last month. Where is the money for investments going to come from?

As always DYOR.

Assumptions include:
- All figures are taken from official data from the Reserve Bank of Australia.
- February price is the 17 February ’10 market close.
- February Earnings and Dividends are assumed to be the same as the January numbers
- Inflation data from January to February ’10 is estimated.

A History of Severe Real S&P 500 Stock Bear Markets – February Update

Looking at the first chart which shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market I have identified three historic severe stock bear markets. These I am defining as stock markets where from the stock market reaching a new high, they then proceeded to lose in excess of 60% of their real (inflation adjusted) value. These are best demonstrated by the second chart which shows each of these stock bear markets and the fall in percentage terms from the peak. So briefly what were these bear markets (full details here).

The first severe stock bear (marked in purple on the chart) market started with a new real high being reached in September 1906 and incorporated the 1907 Bankers Panic. From the high it took until January 1920 for the stock market to reach a real loss of 60.9% and then until December 1920 to reach its real low of -70.0%. That’s a period of 14 years and 3 months.

The second severe stock bear (marked in blue on the chart) market started with a new real high being reached in September 1929 and is obviously the period of the Great Depression. The markets passed through -60% on a number of occasions. In June 1932 the market reached its real low of -80.6%. That’s only a relatively short period of time however it really wasn’t over then as the market never really recovered and kept dipping back below -60% in real terms. 20 years later the market was still below the real -60% mark.

The third severe stock bear (marked in olive on the chart) market started with a new real high being reached in December 1968, incorporated the stock market crash of 1973 to 1974 and the 1973 Oil Crisis. From the market high it took until March 1982 for the stock market to reach a real loss of -60.9% and then until July 1982 to reach its real low of -62.6%. That’s a period of 13 years and 7 months.

So that brings me, as always, to the last line on the chart marked in red which shows the real bear market that we are currently in. This period began in August 2000 with the Dot Com Crash however we were unable to reach a new real high before the Global Financial Crisis took hold. In this real bear stock market we have been unable to break through -60% ‘only’ reaching -58.6% in March 2009. That is a period of only 8 years and 7 months.

As the second chart clearly shows we have now dipped back below the -40% line to be at -41.9% from -39.4% last month. We are now 9 years and 6 months into this severe bear market which is a relatively short period of time compared with the other severe bears shown. The previous bears all went below -60% in the years to come and at this point were:
- in 1916 at -25.4% and over the next year heading to -33.8%.
- in 1939 at -50.7% and over the next year pretty much standing still in real terms to reach -52.0%.
- in 1978 at -50.1% and over the next year heading to -53.1%.

I’m going to keep watching this comparison as I think it could be just starting to get interesting. Governments around the world are fast running out of borrowing capacity as Greece has aptly demonstrated. Closer to home the Bank of England has stated that more quantitative easing (QE) could be just around the corner. What will that do to inflation? The best growth that can be ‘created’ in the UK even with QE, bank bailouts and “cash for clunkers” is a miserly 0.1%. Finally, despite the big bonuses, I don’t see any evidence that the banking sector has repaired itself. I don’t see other developed economies being a whole lot better. Could we yet see that real -60% bear? History suggests there is still plenty of time for it to occur.

Assumptions include:
- Inflation data from the Bureau of Labor Statistics. January and February ‘10 inflation is extrapolated.
- Prices are month averages except February ‘10 which is the 12 February ’10 S&P 500 stock market close.
- Historic data provided from Professor Shiller website.

US (S&P 500) Stock Market – February 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a Cyclically Adjusted Price / Average 10 Year Earnings (PE10 or CAPE) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller. Background information here.

Chart 1 plots the Shiller PE10. Key points this month are:

Shiller PE10 = 19.9 which is down from 20.6 last month. My UK Equities target asset allocation therefore increases from 18.6% to 18.8%. Additionally my International Equities target asset allocation increases from 13.3% to 13.4%.

Shiller PE10 Average (1881 to Present) = 16.4. This means we are currently still 21% higher than the long run average since 1881.

Shiller PE10 20 Percentile (1881 to Present) = 11.0

Shiller PE10 80 Percentile (1881 to Present) = 20.6. The Shiller PE10 has now fallen back through the 80 Percentile.

Shiller PE10 Correlation with Real (ie after inflation) S&P 500 Price = 0.78

Chart 2 further reinforces why I am using this method. While the R^2 is low there appears to be a trend suggesting that the return in the following year is dependent on the Shiller PE10 value. Using the trend line with a PE10 of 19.9 results in a 1 year expected real (after inflation) earnings projection of 5.2%.

Chart 3 plots Real (after inflation) Earnings and Real Dividends for the S&P 500. Real Dividends are still falling however they are still above their long term trend. Real Earnings have a roller coaster ride continually, particularly since about 1990. If the Standard and Poors forecast earnings are to be believed however we continue to be above the long term earnings trend and climbing.

Assumptions include:
- Q4 ’09 & Q1 ’10 earnings are estimates from Standard & Poors.
- Inflation data from the Bureau of Labor Statistics. January & February ‘10 inflation is extrapolated.
- January & February ‘10 dividends are estimated as December ‘09 dividend.
- Prices are month averages except February ‘10 which is the 11 February ’10 S&P 500 stock market at 1430.
- Historic data provided from Professor Shiller website.

As always DYOR.

My allocation to emerging market equities

Tim Hale in his book ‘Smarter Investing : Simpler Decisions For Better Results’ provides some tips for investing in emerging markets. These are:
“
- do so in moderation;
- Own a diversified pool of markets, rather than putting all your eggs in one basket, such as China, despite what the Sunday papers may say;
- be prepared for the times when returns diverge substantially from UK and developed markets on the downside;
- don’t be overly optimistic about the degree to which a free lunch is on offer
“

Additionally he suggests that the correlation between emerging markets and developed markets is 0.6 although he also states that this could be generous. I have also considered that “from 1987 to 2004 emerging market equities only beat US equities by 1 percent ... but with around twice the level of volatility...”

With all this in mind plus knowing that I want to minimise fees and taxes I have positioned my retirement investing emerging markets equities as follows:

- Investing in moderation with a desired allocation of only 5%.

- The ETF owns a diversified pool of markets which I detail below.

- I am prepared for times when returns diverge substantially which should help me to buy low and sell high as I have described in previous posts.

- I am not being overly optimistic about the free lunch.

- I am buying the ETF’s within my ISA. I have done this as picking up on the high volatility point means that I may have to buy and sell often which is in my opinion best done in a tax wrapper to prevent capital gains tax ever becoming payable.

- I have minimised fees by buying an emerging markets exchange traded fund (ETF)

My Emerging Markets Equity ETF asset allocation is as follows:
- 16.9% China
- 15.7% Brazil
- 12.2% South Korea
- 11.0% Taiwan
- 8.7% India
- 6.9% South Africa
- 6.6% Russia
- 4.3% Mexico
- 2.7% Malaysia
- 14.9% Other

As always DYOR.

Free Asset Allocator Website

I am running my entire retirement investing strategy including expected annual returns and projected retirement dates from an excel spreadsheet. Today though, I stumbled upon a nice little tool that looks to be written by Morningstar which provides a quick way of mixing up simple asset allocations to project expected returns. Additionally if you enter the portfolio value, annual investments, desired years to retirement or similar and your total financial goal it provides a probability of reaching the goal. Link here.

The website states “Asset Allocator helps you assess the likelihood of meeting your financial goals based on your current financial situation. If you find that you are not on track to meet your goals you can adjust certain criteria and immediately see the effect of your portfolio's growth potential.”

I entered my retirement investing strategy into the site which included a Portfolio Value which is currently at 40% of my Financial Goal. My Annual Investments were based on me investing around 60% of my gross annual earnings and I entered my time to retirement (Years) as 7 years. Asset Mix was entered as my Desired Low Charge Portfolio as I describe regularly on the site including here.

The Expected Return was provided as 8.99% with a 3 year standard deviation of 13.18. An Expected Return of 8.99% seems a little bullish for my tastes. Using my models I have a current expected annual return after inflation of 4.2%. The UK arithmetic mean of the retail prices index (RPI) since 1987 is 3.5%. Totally these would give an expected return of around 7.7% before inflation which is a variation of 1.29%.

What is also provided by the website is a Probability of [reaching my] Goal. In my case this was provided as 91%. I’ll take those odds...

As always DYOR.

My allocation to international equities

Tim Hale in his book ‘Smarter Investing : Simpler Decisions For Better Results’ states that ‘investing in a range of developed equity markets such as those in North America, the European Union, Japan and Australasia, provides the potential to deliver comparable returns, given similar levels of risk, long term rates of economic growth and reasonably comparable levels of governance, law, political stability and capitalist economics...’

However, he also mentions that investing in developed international equity markets can expose you to economic cycles / pressures that are out of sync and currency exchange rates. These types of effects can be clearly seen by looking at the chart above which has been prepared using the Yahoo Finance website. The period used is December 1989 to the present day with the red line being the S&P 500 (USA), the blue line being the FTSE 100 (United Kingdom) and the green line being the Nikkei 225 (Japan).

It is these types of effects that I am looking to take advantage of in my retirement investing strategy by regularly balancing back to my desired regional allocation within my international equities allocation. This is exactly the same principle I am using with my total low charge portfolio allowing me to buy when the market is low and sell when the market is high.

When choosing what regions to invest in I wanted to also ensure that my allocations were large enough to make a difference within my total low charge portfolio. For example my nominal allocation (before allowing for corrections in line with PE10 ratios) to international equities is 15%. If within my international equities I have an allocation to a region at 20% then this will affect 3% of the total portfolio which matters. If I went down as low as 5% then the total affect would be only 0.75%. A 10% swing in stock market prices in this region would then only make a difference of 0.075% to the total portfolio which in my opinion is insignificant.

So what regions am I allocating to my international equities asset allocation? I’ve kept it really simple with desired allocations of:
- 40% United States
- 40% Developed Europe (France, Germany, Italy, Spain, Netherlands, Switzerland etc)
- 20% Japan

My current asset allocation is:
- 38% United States
- 38% Developed Europe
- 21% Japan
- 3% Other

Others include South & Central America, Emerging Europe, Middle East & Africa and Developed Asia. These other regions have not been deliberately chosen but are merely the by product of buying low cost funds that cover a little more than the regions I am interested in.
Sectors within these regions include energy, materials, industrials, consumer discretionary, consumer staples, health care, financials and information technology.

As always DYOR.

Australian Stock Market – January 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a cyclically adjusted PE ratio for the ASX 200 to attempt to value the Australian Stock Market. The method used is based on that developed by Yale Professor Robert Shiller. I will call it the ASX 200 PE10 and it is the ratio of Real (ie after inflation) Monthly Prices and the 10 Year Real (ie after inflation) Average Earnings. For my Australian Equities I will use a nominal ASX 200 PE10 value of 16 to equate to when I hold 21% Australian Equities. On a linear scale I will target 30% less stocks when the ASX 200 PE10 average is ASX 200 PE10 average + 10 = 26 and will own 30% more stocks when the ASX 200 PE10 average is PE10 average -10 = 6.

Chart 1 plots the ASX 200 PE10. Key points this month are:
ASX 200 PE10 = 18.8 which is up from 18.7 last month. My target Australian Equities target is now 19.2% which is down from 19.3% last month.
ASX 200 PE10 Average = 22.9
ASX 200 PE10 20 Percentile = 17.3
ASX 200 PE10 80 Percentile = 27.7
ASX 200 PE10 Correlation with Real ASX 200 Price = 0.82

Chart 2 plots further reinforces why I am using this method. While the R^2 is low at 0.1358 there appears to be a trend suggesting that the return in the following year is dependent on the ASX 200 PE10 value. Using the trend line with a PE10 of 18.8 results in a 1 year expected real (after inflation) earnings projection of 12.5%. The correlation of the data in chart 2 is -0.37.

Chart 3 plots Real (after inflation) Earnings and Real Dividends. Dividends and Earnings are below the trend line. In fact Earnings are now very close to that of Dividends. What this means is that currently Australian companies are using nearly all their Earnings just to fund the Dividends. Yet the trend line suggests typically clear distance between the two with the trend lines running almost parallel. Where is the money for investments going to come from?

As always DYOR.

Assumptions include:
- All figures are taken from official data from the Reserve Bank of Australia.
- January price is the 21 January ’10 market close.
- January Earnings and Dividends are assumed to be the same as the December numbers
- Inflation data from October ’09 to January ’10 is estimated.