March 23, 2009 Letters to the Editor

Updated: April 13, 2009.

Two-Level Switching in a P/E10 = 14 Market

I received this letter from Rob Bennett.

I found your article "Two-Level Switching in a P/E10 = 14 Market" fascinating. Thanks for helping us all out yet again.

It's easy to understand why 100 percent stocks would work best when the P/E10 level is below 9. And it's easy to understand why 20 percent stocks would work best when the P/E10 level is above 21. However, it's hard (at least for me) to understand why 40 percent stocks works best when the P/E10 level is between 9 and 21.

Intuitively, I expect that middle number to be 60 percent or more. It could be that my intuition is entirely wrong. Or it could be that there is some factor that I am not grasping. Or I suppose there is at least a theoretical possibility that there is some quirk in the numbers causing that middle percentage to be lower than what might be expected, given how strong a long-term value proposition stocks generally offer at those price points.

Do you see the "conflict" here that I see? Or do you think I am imagining things?

Are you able to offer thoughts as to why the middle number would be so low? Are the numbers telling us that, in a bear market, the risk of big price drops remains high even when prices drop to fair-value levels? It seems to me that the risk of big price drops needs to remain high for the best allocation to be only 40 percent. I understand that there's a chance of another 50 percent price drop. But it seems to me that price drops beyond those we have already experienced are not likely to remain in place for long (and thus will not ultimately have much effect on long-term returns). So I am not today able to grasp why the numbers show 40 percent to be the best stock allocation at today's P/E10 level.

I'd be grateful to hear any further thoughts that you or others can offer re these points.

Highly interesting stuff in any event.


Thank you for an excellent letter. You have made an important observation.

The key assumption is that we are still in a long lasting (secular) Bear Market. If we have already reached a turning point, the thresholds and allocations are wrong. Even the optimization criterion is centered on the issue of turning points.

I focused on Year 10, not Year 30.

Keep in mind that the three level baseline uses a 50% allocation for P/E10 levels between 10 and 18. It has thresholds of 8-10-18 and allocations of 100-80-50-20%. I came up with that by looking at Year 30.

We have a conflict based on short term timing assumptions.

Interestingly, these latest results are consistent with the Invest Early conclusion: we should dollar cost average over the next 4 to 7 years. It is also consistent with my own preference for gradual allocation shifts as opposed to abrupt changes.

DVY just announced its dividend...

I received this letter from Michael.

DVY just announced its dividend...$.438/share, down from $.556 or about 21%...would be curious how this compares with your expectations....


Thank you. That is quite a haircut.

To be more precise: the new dividend amount is 0.43768 per share, down from a peak of 0.67784 per share from March 25, 2008, a drop of 35.4%. DVY’s drop is more than the S&P500 has dropped since 1950. The earlier worst case S&P500 drop was just under 25%.

The difference is the financial services sector. DVY’s financial services holdings are down from 40% to 20%. Other areas of the stock market are holding up well.

The Government has decimated financial services. It is protecting bonds and preferred shares to the maximum extent possible since they qualify as bank reserves for making loans. Common shareholders are left with a pittance.

This unbalanced treatment has favored the other component of my Retirement Practice portfolio, PFF, an exchange traded index fund of preferred stock. It is holding up in spite of being 80% in financial services.

According to Dr. John Hussman’s commentaries, the accounting of toxic holdings is being applied unfairly. Instead of separating the tranches of mortgage derivatives, healthy banks are penalized for losses that will never apply to them.

The Federal Reserve is afraid of deflation. It is pulling out all stops to inflate the economy as much as it can. That is the only way that it can CONTROL the economy. The Federal Reserve has no tools when prices fall.


I received this letter from Larry.

Where do I find that number now and again, where would I find it in the future?


Thank you. That is an often asked question.

I have added a P/E10 button with the answer. [You use the Stock Returns Predictor.]

DVY Distribution Rate

I received this letter from Michael.

Hi John...I would love if someone (you??) could reconcile the different DVY yields quoted...I see the site quoting 8.16% but then I see (the site I go to the most for ETF information) quoting 5.31% (which seems to be the latest .4377 div * 4 quarters / 33 share price) you have a view which is more correct?


Thank you. You are correct about the yields. Yahoo Finance refers to the latest twelve months. ETF Connect is providing an extrapolation from the most recent distribution.

I prefer to use ETF Connect data since they present a full distribution history. I do not always prefer to use their stated yield, which for DVY equals 4*the most recent quarterly amount/the most recent closing price. They call this the “Current Distribution Rate.”

Given that DVY’s drop in the dividend amount is due to problems with financial services, I recommend using ETF Connect’s “Current Distribution Rate” in this instance.

With PFF, the total of the most recent twelve months of returns is $2.7596 with a recent closing price of $23.64. This translates to an 11.67% yield. In contrast, the Current Distribution Rate is 12.69%. I prefer to use the full year’s dividend amount for PFF since the distributions are monthly and they fluctuate a lot.

Yahoo Finance reports its yield at a specific date, in this case 31 January 2009. It was 14.27% on that day, but not today.

Here is the impact of such numbers.

I used 5.31% for DVY and 11.67% for PFF and assumed equal dollar amounts for the Something Simple portfolio. The withdrawal rate dropped to 7.8% with 3% per year adjustments for inflation. This is much lower than the 10% that I reported in “A Ten Percent Withdrawal Rate.”

Different asset classes...

I received this letter from Michael.

John - Like you and increasingly others, I accept the PE10 as one of the best metrics in terms of long term equity valuations (and their predictive value). I was curious if you know of any work that has been done on other asset classes? E.g., is there an intellectually supportable "PE10" equivalent for say real estate? commodities? Are there "accepted" metrics that you think are bunk and have you heard any alternatives?


Thank you.

P/E10 works well even with individual slices of Large and Small Capitalization and Value and Growth. Refer to the Gummy Slices articles in my early Notes.

Notes [actually, Notes through November 29, 2005.]

I suspect that Jeremy Grantham calculates the individual slice equivalent of P/E10 when he projects Year 7 returns. His actual process, however, is proprietary.

Jeremy Grantham’s GMO Web Site

I do not know of an equivalent for real estate and commodities. As for real estate, the Case-Shiller index is new. There is no long history for validating an approach.

Other useful measures of the overall market include Tobin’s q and dividend equivalents (P/D5 and P/D10) of P/E10. I think that Dr. John Hussman’s Price to Peak Earnings approach is a good one. I also like Ed Easterling’s method of smoothing single year P/E data.

John Hussman’s Web Site
Ed Easterling’s Web Site

My own preference remains P/E10 because it is easily available.

Additional Remarks

I recommend caution when using the Price to Book ratio. It is a good value indicator. But once it misled investors for as long as a decade. Just as the market alternates between favoring value and growth, the market sometimes favors tangible holdings and, at other times, it favors intellectual holdings.

Use a combination of measures to assess a company’s value. The traditional measures are price to earnings, price to book, price to free cash flow, price to sales and dividend yield.

Current P/E10

I received this letter from MaRico.

How do I continue to get the current P/E10. Do you have subscription or something?


Thank you. No.

I keep P/E10 up to date at no charge.

Just follow the instructions after pressing the P/E10 button on your left. You will need to know the current value of the S&P500 index. It is freely available from many sources.

I scale P/E10 from the most current complete reading from Professor Robert Shiller’s Online Data [S&P500 Excel file]. I use the formula: (current P/E10) = (reference P/E10)*(current S&P500 value)/(reference S&P500 value).

Professor Robert Shiller’s Web Site

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