Cliff Asness had a great interview with Steve Forbes back in April (a copy is here) that highlights the dilemma facing investors today: stocks and bonds are overpriced, so what do you do?On April 22 the closing yield on the 10-year was 2.73%, today we're at 2.509%.
Forbes:
…Looking at stocks and bonds, are they both overpriced?Asness on market valuations:
Yeah, they are…if you’re going to say, “what are the next 10 years going to look like?”…value has some power to forecast the next decade…right now my favorite measure of value…is Bob Shiller’s PE. It’s gotten very popular. I’ve been looking at it since the late 90s. And that’s about the 85th percentile expensive back to 1926, so only 15 percent of the time has it been more expensive. It’s occasionally been way more expensive, so percentiles…people can use them to be tricky. Statisticians have all kinds of tricks…We’re at 25 on the Shiller PE. The 100th percentile, hit in early 2000, was 45…I would not call this a bubble, I would just call this an expensive market.Asness on real yields:
The real bond yield…that’s just the 10-year bond minus our best guess of what economists are forecasting for inflation. I say “our best guess,” because we have their actual guess for 20, 30 years, [but] databases don’t exist and we have to guess at what they were guessing before that, but that’s also about the 85th percentile. The difference between them is relatively normal. People focus on bonds because it feels much more measurable. And yields are [low]…[this is] not a commercial for bonds…85th isn’t so good.
Both [stocks and bonds] are very similar [at the 85th percentile]…For truly long term investors, I would not use this to time the market…I still think returns will be positive. So if you’re out of the market for the next 10 years, that’s not going to help, and I don’t think you’re going to get the exact timing right. But I would lower my expectations. Whether you’re a pension plan, or an individual with a sheet of paper trying to figure out, “how much do I need to retire?” if we are right that these higher than normal prices, [and] lower than normal yields, are going to lead to positive, but lower than normal returns, well, you have to use those.
We think a 60/40 portfolio of U.S. stocks and bonds has averaged about 5% over inflation historically. We think, even if valuations stay high -- and it could be worse if valuations fall, right? Regression to the mean. If those PEs come down, it could be worse -- but even if they stay high we think they…offer 2 to 3 percent over inflation...MORE
Today the S^P 500 looks to open at 1977.25 vs. 1,879.55 three months ago.