Category: Investing

The Truth About the Shiller PE

Is now a good time to invest in stocks?NYSE floor Old - Crop

Like the weather, the market outlook is a topic that can always be discussed, whatever the circumstances, and generally without much in the way of a definitive conclusion. It is often reduced to a question of whether or not the market is expensive or cheap just now.

Lately, the most popular measure of market valuation appears to be the current market price divided by the last ten years average earnings. This is variously known as PE10, the cyclically adjusted PE (CAPE), or Shiller’s PE, in honor of the Yale economist Robert Shiller who has popularized it. (But would never claim to have invented it. He calls it CAPE and so shall I.)

In just the past week, CAPE was sagely mentioned in both The New York Times and The Wall Street Journal. The Times called it “a conservative method” and used it to make the case that stocks are not particularly cheap at the moment. The Journal used it to make the argument that the market can be effectively timed, but left it to the reader to draw his own short-term conclusions.

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Exciting New Research in Finance

Time to review the latest cutting-edge academic research, as discussed in our country’s leading business newspaper. A report in the Wall Street Journal from Monday brings us two items that expand our understanding of that mysterious beast known as the stock market.

NYSE-floor The first item is a recently released report from the Investment Company Institute (the trade group for mutual fund companies) which revealed that the average mutual fund investor’s willingness to take risk is lower now than it was two years ago before the market experienced its well publicized unpleasantness.

It is a report that is just chock full of enlightening insights. A person only needs to skim the chart captions to learn a lot. Turns out, “Tax-Deferred Accounts Are A Popular Way to Hold Mutual Funds.” And “Fund Performance Is the Most Important Factor Shaping Opinions of the Fund Industry.” Further, “Mutual Fund Industry Favorability Rises and Falls with Stock Market Performance.”

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The Importance of Correlation

Earlier this week The Wall Street Journal ran a piece on, of all things, the importance of the correlation coefficients between the returns of investments. I have mixed feelings about it.

Blackboard Lecturing Crop On the one hand, correlation between asset returns is a neglected subject of great importance. The mid-Twentieth Century realization of its central role was the start of modern financial theory as we now know it. A professional level understanding of risk begins and ends with correlations, so it would make some sense for amateur investors to know at least the basics.

On the other hand, the article serves as a good reminder of why they know so little. Despite being called Why the Math of Correlation Matters, it contains no math. This might be because the author worried that her readers would find the math scary and hard, but I fear it is because the author herself finds it scary and hard.

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Mythical Money Myths

Chicklet-currency My job as critic of personal finance advice is made a lot easier if other writers concisely summarize their points of view in easy to digest and refute bullet points. It gets even better if the other writer is argumentative, taking a neatly delineated position on a question which I can contradict.

So when I saw that Free Money Finance yesterday posted a list of Money Myths, my heart leapt. And I was not disappointed. There were eight myths listed, with bullet point explanations and links to fuller arguments from previous posts. What could be easier?

By my scoring, one of the myths really is untrue, two are so subjective that it could go either way based on interpretation, and five are not myths.

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Loopy Academic Research as Explained by the Times

Today I am going to write about The New York Times again.

I know. I know. I shouldn’t. I promised to stop taking the Times seriously a while back. But I just can’t stay away. Including the Thursday re-run I wrote about it twice last week. I just can’t help it. Moths and flames.Grads Kit

On Wednesday last the Times published Looking Ahead to the Spend-Down Years. I am honestly not sure how to characterize the topic of the article, other than to say it had to do with retirement and money and cited the work of several clueless academics with evidently too much time on their hands.

The piece was illustrated with creepy but eye-catching computer generated images of a man’s head as he aged. This was explained in the first few paragraphs.

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