Valuation-Informed Indexing #124
by Rob Bennett
I wrote last week about Yale Economics Professor Robert Shiller’s chilling words re the limits to the tolerated discussion of investing realities. Shiller says in his lecture on behavioral economics that he was a “total outcast” when he first raised doubts about the legitimacy of the Buy-and-Hold Model. By noting that “we have a system that allows it to happen,” he suggested that our freedom to speak freely re these matters does not come without a price. And he has hinted at the price that is paid by those who do speak frankly in several interviews in which he has explained that he has never told us all he knows about how stock investing works because he knows that he would be branded “unprofessional” if he were to do so.
It would obviously be a good thing if we knew as much about how stock investing works as it is possible to know and if we shared that knowledge with as many of our friends and neighbors and co-workers as possible. So why have we made a decision as a society to impose a Social Taboo on those who are too blunt in their criticisms of Buy-and-Hold or too enthusiastic in their support of Valuation-Informed Indexing (the model rooted in a belief in Shiller’s research, which shows that investors must change their stock allocations in response to big valuation shifts to have any hope whatsoever of keeping their risk profiles roughly constant)?
There are 10 reasons.
1. Those in the Stock-Selling Industry earn bigger commissions if large numbers of investors believe that stocks offer a strong value proposition regardless of the price at which they are selling.
2. Shiller’s research showing that valuations affect long-term returns has only been available to us for 30 years. That sounds like a long time. In relative terms, it isn’t. There were hundreds of years in which people did not know of the need to change their stock allocations in response to big valuation shifts. Beliefs on such fundamental questions change only gradually.
3. At the time of Shiller’s discovery, it made no practical difference. In 1981, stock prices were at rock-bottom lows. So there was no immediate harm done by telling investors that staying at the same stock allocation at all times was an acceptable strategy.
4. The huge bull market of the 1980s and 1990s rewarded Buy-and-Holders and punished those who did not buy in to the idea that there is no need to time the market.
5. Buy-and-Hold was the first strategy that was supported by academic research. This greatly impressed the millions of middle-class people who need to invest in stocks to finance their retirements but who are not well-informed about investing and are frightened to do so. Academics get things wrong all the time. This is especially the case when they are doing work in a field that has only recently come to be a subject of academic study. But the endorsement that Buy-and-Hold won from the academics persuaded millions who would have maintained a healthier skepticism had it only been Wall Street touts pushing the idea.
6. Shiller’s findings are counter-intuitive. Shiller’s work confirms the earlier finding that short-term timing does not work while showing that long-term timing always works and in fact is required for long-term investing success. It strikes us as odd that it is impossible to predict short-term price changes but that looking at a single metric (P/E10) reveals where prices are headed in the long term.
7. The $12 trillion in Pretend Gains generated during the wild bull bought the silence of many voices that otherwise would have expressed skepticism. Magazines don’t want to tell their readers that they are farther behind in their retirement planning than they have come to believe they are. Nor do policymakers want to talk about these important but unpopular truths. Those employed in The Stock-Selling Industry certainly do not want to do so.
8. Shiiler’s findings are dramatically at odds with the findings of University of Chicago Economics Professor Eugene Fama, which served as the foundation stone of the Buy-and-Hold Model. Had Shiller advanced the ball in some small way, the Buy-and-Holders would have happily incorporated his contribution into their model. He didn’t. He overturned it entirely. If Fama is right, Buy-and-Hold is ideal. If Shiller is right, Buy-and-Hold is dangerous. It’s more important to acknowledge big mistakes but it is harder to do so.
9. Those possessing the personality type that draw people to investing analysis do not tend to be comfortable discussing the role of human emotion in the investing project. This is a numbers-based field. People who are drawn to it place their confidence in the hard stuff, not the soft stuff of human emotions. P/E10 is a number but it is a number that tells us important things about human psychology. Many in this field would prefer not to have to come to terms with such things.
10. The threat of lawsuits hangs over all in this field who become aware of mistakes they have made. Shiller showed the Efficient Market Theory to be mistaken. But the mistake that was made caused huge dollar losses for millions. In our litigious society, that spells “Lawsuits.” The industry has naturally if unfortunately been more inclined to circle the wagons than to come clean.