Valuation-Informed Indexing #152
by Rob Bennett
For a long time I believed that the way to resolve all the friction that we have seen during the first 11 years of the debate over whether Buy-and-Hold or Valuation-Informed Indexing is the superior model was for people on both sides of the debate to show respect and affection for those on the other. My version of the famous question “Why can’t we all just get along?” became “Why can’t the two models for understanding how stock investing works thought to be supported by the academic research just co-exist?”
It would be great if that were possible.
We all learn more when we have available to us smart people who challenge our thinking. I would not be happy on a discussion board populated solely by Valuation-Informed Indexers. I of course like it when people say that the strategies that I advocate possess merit. But I learn more when I am challenged than I do when I am applauded. There have been several times during the 11 years of discussion in which I have solved some riddle that had long troubled me because a sharp Buy-and-Holder posed a challenge in such a way as to help me finally see through to the core of the dispute.
There are obviously lots of people who view Buy-and-Hold as the ideal strategy. We need to have those people’s opinions reflected in all discussions of stock investing. The normal thing in our society is to permit both sides to have their say. Democrats don’t need to acknowledge that Republicans are right to acknowledge that they have a right to speak up. And Republicans don’t need to acknowledge that Democrats are right to acknowledge that they have a right to speak up. We are a diverse nation. But we are united in a belief in free speech. So the ideal would be if Buy-and-Hold and Valuation-Informed Indexing could co-exist.
I no longer believe that is possible.
The analogy to Republicans and Democrats does not really hold.
Republicans and Democrats will be with us always because of the way in which these two political ideologies are defined. Democrats seek change. Republicans seek stability. There are good things and bad things associated with both change and stability. So there are always going to be arguments that can be made in favor of either position. The details of the political debate change over time — few argue today that the government should not be in the business of providing economic assistance to the elderly poor. But the question of whether that sort of assistance should be expanded or contracted of course remains a live issue.
That’s not the case in the debate between Buy-and-Hold and Valuation-Informed Indexing.
The debate there is the product of a mistake that, due to unusual circumstances, has remained uncorrected for three decades.
There never has been any true intellectual controversy over whether valuations affect long-term returns or not. All of the evidence points in the same direction — Valuations matter. The “controversy” has been over whether we should permit the implications of this reality to be discussed in public.
It’s the unusual circumstances that brought on the belief that exploration of Shiller’s revolutionary 1981 findings should be suppressed. The unusual circumstances that I am referring to are the huge bull market that began just about the time that Shiller made his huge discovery. Had it not been for the bull market, we of course would have gotten to work mining every insight that followed from Shiller’s work to its powerfully rewarding conclusion. The bull market rendered such exploration a dubious enterprise.
The problem has never been that Shiller’s work is not important enough to justify extensive exploration. It is just the opposite. Shiller’s work is too big, too good, to explore. Explore it and you turn the world’s understanding of how stock investing works on its head. You end up having to rewrite all the existing textbooks. All the people who have built careers rooted in a belief in the old model find themselves starting over again at zero. That obviously is not an appealing prospect to those with the greatest influence in this field. The people with the greatest influence in this field very much do not want to see our knowledge of how things work expand too quickly or too dramatically (I don’t intend that as a dig but merely as an explanation of some otherwise incomprehensible realities).
There will certainly be a brief time-period when the two models will co-exist. Valuation-Informed Indexing cannot overcome Buy-and-Hold in the space of 24 hours.
But I now believe that the time-period in which co-existence is the new reality will be short-lived. The reality here is that there never was any research supporting Buy-and-Hold. The entire thing was a mistake (the mistake was in assuming that, because short-term timing doesn’t work, long-term timing may not work either or at least is not required to achieve long-term success). The social taboo holding back discussion of Valuation-Informed Indexing will not be removed until economic circumstances become truly dire (my guess is that this will be the case following the next price crash, which will likely cause enough of a collective financial loss to bring on the Second Great Depression). Once the social taboo is gone, there will no longer be any reason for any expert in the field even to pretend to believe in Buy-and-Hold.
This is not to say that there will not be major debates about how stock investing works for many years to come. I am highly confident that such debates will continue for many, many years to come. What will change is that, after the next price crash, no one will be saying that there is no need for investors to take valuations into consideration when setting their stock allocations. The debates that will take place from that day forward will relate not to the question of whether long-term timing is required or not but to the question of how much long-term timing is required. There are entirely legitimate differences of opinion to be heard re that one.
Rob Bennett has recorded a podcast titled “When Stock Prices Fall, Where Does the Money Go?” His bio is here.