Mean

Inversion

DYI:  How low can we go?  Stocks on a valuation basis historically have oscillated from extreme highs – a trip that requires years in the making – all the way back to extreme lows – again a trip that requires years to accomplish.

Secular bull markets historically end above 23 times Shiller PE¹⁰ and secular bear markets end and a new secular bull market is born with the Shiller PE¹⁰ at 5 to 7.  So….What is our historical average annual return from now at PE¹⁰ at 29.23 to 7 times PE¹⁰ over the next 12 years?  Go to moneychimp.com and drum roll please…..negative 4.89% with dividends reinvested.

DYI’s percentage allocation page for stocks and bonds are now at a scant 17%.  Valuations are now at extremes. 

 %

Allocation Formula

3-1-17
Updated Monthly

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

Current PE10.....29.12

Avg. PE10.........16.73

% Stock Allocation 17% 

Logic behind this approach:

--As the stock market becomes more expensive, a conservative investor's stock allocation should go down. The rationale recognizes the reduced expected future returns for stocks, and the increasing risk. 

--The formula acknowledges the increased likelihood of the market falling from current levels based on historical valuation levels and regression to the median, rather than from volatility. Many agree this is the key to value investing.  

Please note there is controversy regarding the divisor (Avg. PE10).  The average since 1881 as reported by Multpl.com is 16.70.  However, Larry Swedroe and others believe that using a revised Shiller P/E mean of 19.6 , the number since 1960 ( a 53-year period), reflects more modern accounting procedures.

DYI adheres to the long view where over time the legacy (prior 1959) values will be absorbed into the average.  Also it can be said with just as much vigor the last 20 years corporate America has been noted for accounting irregularities.  So....If you use the higher or lower number, or average them, you'll be within the guide posts of value. 

  DYI