I often don’t like to predict the future… my crystal ball is perpetually in the shop. Let me rephrase that. I love to predict the future, but I’m not particularly good at it.
It’s easy to throw around predictions. (In fact, I’m going to throw out a prediction for this Sunday’s sporting event later on this week. Spoiler Oliver has MVP pedigree)
The stock market is the same way, right? You can’t know where it’s going?
These Two Tools Seem to Predict the Stock Market Extremely Well
I might have been a little over optimistic with the capital “KNOW” in the title, but I wanted to create separation from just any old prediction or guess. Let me introduce you to two friends of mine.
1. Shiller PE or CAPE
Back in 2012, I asked How Expensive Are Stocks Now? I wrote that Dow 13000 made things seem expensive. In short, I feel for an absolute number that didn’t really mean much (just like Dow 20,000). A reader pointed me to a historic graph of price/earnings and I learned how to use Shiller P/E as an indicator of relative value of the stock market.
At that time, both of those indicators actually showed that stocks were fairly cheap, because they had great earnings. In fact, my chart showed the Shiller PE 10 to be around 16.51, which very close to its mean. The higher the Shiller PE number, the higher the price/earnings ratio, which isn’t usually a good value. (Sometimes people call the Shiller PE, CAPE)
Today the Shiller PE sits at 28.16, which looks to be pretty close to the crash of 2008. The other times it was this high was the crash on Black Tuesday in the 1929 and the Dot-Com crash around 1999-2000. It’s not too hard to see a trend here, is it?
I’m not saying that we are headed for another crash (stock prices going down), but we could have a long period where stock prices don’t go up while earnings catch-up. Either one would bring the number in line with where it historically is.
2. Household Equity Percentage (HEP)
I hadn’t heard of HEP until recently when I read The Single Greatest Stock Market Predictor Is… What? which was highlighted in an article by Physician on Fire.
Here’s how HEP is explained there:
“HEP gives us a measure of what share of household finances are invested in equities. And that figure can be used to render some statistically solid conclusions about the long-term future of stock returns.
The figure is calculated by taking the dollars held by U.S. households in stocks and dividing by the quantity of household wealth held in stocks plus bonds plus cash.”
Financial Libre goes into extensive detail about why the measure should be less valuable flaming bag of crap, but then you see the chart and there’s a patented Keanu Reeves… WHOA? Then Financial Libre gives you details on why it appears to work despite all the flaws. It’s a cool enough read that I’ll link to it again for you.
The big takeaway is that there’s a second tool that seems to be great at predicting where the stock market is going to go.
Let’s Put Them Both Together!
Both the HEP and Shiller PE indicators make the United States look like a poor place to invest in the next decade. People who have been previously used to getting 7-8% returns might have to settle for 2-3% returns.
If you had $500,000 invested, you might (rule of 70) guess that you’d end the decade with a cool million. However, if we use the lower-end analysis, you might end the next ten years with around $610,000. That’s a big difference if you have a good amount of money involved.
So where do you go from here? That’s a great question. It might be time to explore some of those foreign stocks that have been under-performing for the last decade.
What do you think? Let me know in the comments.