Adjusting for that embedded profit margin – which, again, produces a historically more reliable indication of actual subsequent S&P 500 total returns – the Shiller CAPE would presently be over 32. John Hussman Ph.D.

Allocation Stocks/ Bonds

% Allocation Formula

7-3-14

% Allocation = 100 – [100 x (Current PE10 – Avg. PE10 / 2)]  /  (Avg.PE10 x 2 – Avg. PE10 / 2)

Current PE10.....26.63

Avg. PE10.........16.54

% Stock Allocation is 26% 4%

The Delusion of Perpetual Motion 
John P. Hussman, Ph.D.

On a historical basis, the CAPE of over 26 is already quite enough to expect more than a decade of negative real total returns for the S&P 500. Aside from the crashes that followed the 1929, 2000 and 2007 peaks, a very long period of negative real returns also followed the other historical peak in the CAPE near 24 in the mid-1960’s. As noted above, one adjustment to the CAPE that significantly improves its relationship with actual subsequent market returns – as it does for numerous other measures – is to correct for the implied profit margin embedded into the multiple. This is true even though the denominator of the CAPE is based on 10-year averaging. At present, the margin embedded in the Shiller CAPE is more than 20% above the historical average. Adjusting for that embedded profit margin – which, again, produces a historically more reliable indication of actual subsequent S&P 500 total returns – the Shiller CAPE would presently be over 32. That level might make even Professor Shiller question whether stocks should be a material component of portfolios (at least for investors with horizons much shorter than the 50-year average duration of S&P 500 stocks). In any event, even the phrase “lighten up” is problematic for the market if more than a few investors heed that advice.

DYI Comment: Using Shiller PE10 of 32 moves down significantly the stock allocation to 4%!  This is an over blown market that is devoid of value for the long term investor.  The return for stocks is NOT bake in the cake but is a function of the price that you pay and today you are paying through the nose.

Estimated 10yr return on Stocks

Using 5.4% as the historical growth rate of dividends and 4.0% as the ending yield.

Starting Yield*---------return**
1.0%-----------------------(-5.7%)
1.5%-----------------------(-1.7%)

 
2.0%------------------------1.3%---YOU ARE HERE!

2.5%------------------------3.8%

3.0%------------------------5.9%
3.5%------------------------7.8%
4.0%------------------------9.4%
4.5%-----------------------10.9%

5.0%-----------------------12.3%
5.5%-----------------------13.6%
6.0%-----------------------14.8%
6.5%-----------------------15.9%

7.0%-----------------------17.0%
7.5%-----------------------18.0%
8.0%-----------------------19.0%

*Starting dividend yield of the S&P500-**10yr estimated average annual rate of return.

THE GREAT WAIT CONTINUES!
DYI