Valuation-Informed Indexing #115
by Rob Bennett
I was greatly disappointed by the response we saw from leading figures in the investing field to the stock-market price crash of 2008. I have been writing about the dangers of Buy-and-Hold investing for 10 years now and I have seen how difficult it is to get people to open their minds to new investing ideas once they have become emotionally addicted to strategies that for the length of a bull market seemed to be paying off. The months immediately following the crash were the big exception. We had an opportunity then to change minds. We blew it.
A number of well-respected figures (including John Bogle, Burton Malkiel and Warren Buffett) stepped forward to advise investors not to panic. This is of course in itself a 100 percent appropriate response. We were at risk of falling into a Second Great Depression at the time and millions of people very much needed to hear reassurances that the sky was not falling. So there was some good done with the statements that were made. Still, I think there were important mistakes made and that the leading figures need to learn from those mistakes and be sure not to repeat them following the next crash.
The core message put forward by Bogle, Malkiel and Buffett was that following the crash stocks were “on sale,” that prices would inevitably rise again and that it was a mistake to flee the market. It is certainly true that stocks offered a better long-term value proposition following the crash than they did before the crash. So the message in part was a positive one. However, there were three big problems.
One, it was not true that stocks were on sale following the crash. The P/E10 value at the lowest point was 13. That’s only a wee bit lower than the fair-value P/E10 value of 15. We should have been telling people that it had been a long time since stocks had been selling at anything close to fair-value price levels and that this represented a significant buying opportunity. We should not have been telling people that stocks were on sale. This set up false expectations. Stock prices need to fall a long ways from where they stand today for stocks to be on sale. Many do not realize this and part of the reason why they do not realize it is that they were in the wake of the crash comforted by the idea that prices had fallen far below fair-value levels.
Another big mistake was the failure of the leading figures in the field to let people know that stocks would likely be performing poorly for a good number of years to come. We have never recovered from a bull market by living through a single price crash. The P/E10 value has in the wake of every earlier secular bull market fallen to 7 or 8, a 65 percent price drop from where we stand today. How many of today’s investors know this?
I of course understand that the primary goal in the minds of those who were speaking out was to avoid panic. I presume that their motivation in presenting a rosy picture of the future was to offer reassurance. I don’t think that is at all a smart idea to overdo the reassuring words, however. To tell investors in 2008 that the worst of the bear market was over was akin to a doctor telling a patient with a cancer that has not been cured that the future is bright. That’s the message that the patient wants to hear and that’s the message that the doctor wants to tell but that’s not at all the right message to send. Truth matters.
It matters a lot. Why? Because people don’t seek reassurance only one time in a secular bear market (there are always multiple price crashes in secular bears). People are going to need to hear soothing words when prices crash again. And it is going to be harder to get them to believe the soothing words offered when they recall that the soothing words offered in 2008 did not prove out.
I am not suggesting that we should have filled people’s minds with visions of doom and gloom. The aim should be the opposite of that. The aim should be to build within people a real confidence in the future. That can be achieved with words that are 100 percent true. Yes, we are likely to see another crash. But the long-term value proposition of stocks really did improve dramatically with the 2008 crash. And the long-term value proposition of stocks will soar in the wake of the next crash. We could have told investors what to expect and reassured them in a lasting and real way.
The third big mistake was not to reveal to investors the true cause of the crash. People who are worried want to know why the thing that is worrying them came to cause such trouble. The 2008 crash presented a great opportunity to let people know that we made a mistake as a society by permitting the bull market of the 1990s to get so out of control. We need to face the issue sooner or later. There is never going to be a time when it is going to be the easy thing to do. People were looking for leadership in late 2008 and talking straight on the primary cause of today’s troubles would have been a good way of winning their confidence and respect.
The next crash is going to be scary. People had surplus assets in 2008. The crash scared them but most believed that they could make it through to the other side. The next crash will hit a society that has been feeling battered financially for years. The sense of panic and hopelessness will be far greater. It is critical that respected figures say the right thing to restore confidence quickly.
More happy talk will not do the job. We need to tell people that bull markets are a deception. We need to tell people that the funny money that they thought they had earned in the 1990s was all part of a game of Let’s Pretend and that that money is never coming back.
It’s by taking in the disheartening news that people’s hearts will be opened to hearing about all of the exciting discoveries about how stock investing works that we have learned about in recent decades and have been keeping secret out of a concern than telling the true story will make the Buy-and-Hold advocates look bad.