I REMAIN A CAPE CRUSADER!

As you know, I rely on  Professor Shiller's CAPE ratio to determine when I rebalance my family's financial assets.  Yesterday it reached 33.5--roughly the high of the bull market that ended in 1929, before the stock market crash in October of that year. The only other time the CAPE was above this level was during the bull market that ended in March, 2000, when the CAPE reached 44.  (In a post called "WAITING FOR GODOT" written December 2, 2016,  I explained why I think the CAPE won't reach that lofty level this time.)

CAPE detractors are numerous and tend to become vehement at major market tops.  Why?   Professor Shiller recognized that business cycles exist, resulting in  profit margin cycles.  Wall Street practitioners in general have a bullish bias.  They tend to apply mean P/E ratios to peak earnings to determine fair value,  rather than the more reasonable approach -- applying them to mean earnings.  Thus, to them the market appears still cheap at market tops.  Shiller's CAPE concept "curbs the enthusiasm" of the bulls.

Recently CAPE logic seems even more under siege.

As I mentioned in my last post of October 23, 2016, the denominator of the CAPE ratio is the ten-year average annual earnings of the Standard and Poor's 500 Index ("the Index")  adjusted for inflation.  Because of this moving average construct, during the next two years the depressed earnings of the Great Recession will be dropped, and earnings during 2018 and 2019 will be added.  Hypothetically, even if actual earnings during the next two years were flat, the CAPE ratio,with the Index still at 2751, will have declined to the high twenties just because the ten-year average earnings would have increased.   This argument is valid, but it relies on a vagary in how the CAPE is calculated.  Once the U.S.  economy experiences the next recession, this effect will be reversed!

Also recently, one of the money managers I most respect hinted that recent elevated profit margins may be the "new normal" -- or  at least that these profit margins will be extended many years going forward.  He might be right. But to me he has uttered the most dangerous phrase in a money manager's lexicon, "This time it's different!".

Yesterday, the CAPE ratio reached 100% overvaluation.  As a CAPE crusader, I rebalanced. The sale proceeds remain in cash equivalents.

So long as the yield on the ten-year U.S. Treasury note remains under 3% (it is now at 2.58%) and earnings increase, the Index will have an upward bias. Once 3% is breached, a bear market should quickly ensue. As the Index becomes more overvalued, I shall continue to rebalance--next stop 110%.