Valuation-Informed Indexing #161
by Rob Bennett
You have probably noticed by now that I am no fan of the Buy-and-Hold investing philosophy. There’s lots about it that I love. I believe in investing for the long term and I disdain short-term timing and I think that investors should root their strategies in the findings of the academic research. My beef with Buy-and-Hold is that it discourages investors from changing their stock allocations in response to big valuation shifts, which causes their risk profiles to get wildly out of whack during out-of-control bull markets.
It’s hard to get Buy-and-Holders to admit that they are wrong. None of the humans enjoy acknowledging their mistakes. And these mistakes cause people to lose money. So the sense of embarrassment is stronger here than it is in other areas. So it’s been a tough road for me trying to open people up to consideration of the exciting implications of Yale Economics Professor Robert Shiller’s “revolutionary” (his word) findings.
It has been suggested on one or two occasions that I take my words to a bear site, where presumably they would be better received.
I don’t think that that is such a hot idea.
Contrary to a widely held misperception, I don’t have a drop of bear blood in me.
If anything, I view the Gloom and Doomers as representing a bigger problem than the Buy-and-Holders.
Buy-and-Holders are overly optimistic. They acknowledge that valuations matters. Their difference with me is that they don’t like to calculate how much valuations matter. They refrain from those calculations to keep their spirits up. They want to believe that stocks can offer strong long-term returns even starting from insanely high valuation levels. I say that we are going to see a price crash of 65 percent sometime over the next few years. The Buy-and-Holders believe (and they are sincere in this belief) that the recession is near an end and that things may be booming again before too much more sand makes its way through the hourglass.
I would characterize this as head-in-the-sand thinking. I don’t like it. I think it is dangerous. But I do relate to the optimistic spirit. We are living in troubled economic times. I think we all should be working together to bring those troubled economic times to a close. I don’t think the Buy-and-Holders are doing the right things. But at least they are taking what could be termed a positive approach. No problem was ever solved by excessive pessimism, in my assessment.
Doom-and-Gloomers are cynical, in my experience. They are much more willing than Buy-and-Holders to acknowledge the problems that follow from excessive stock valuations. I obviously approve of that part of their story. But why the long face, you know? People dislike “bears” for a number of reasons. One is that they are perceived as whiny and negative. The Doom-and-Gloomers play to the stereotype for no good purpose, in my view.
I do not think of myself as a bear. Not even a little bit. One of my pet peeves is that even Shiller’s book publisher thinks of him as a “permabear.” That word appears on the back cover of my copy of the man’s book. Shiller is NOT a bear! I don’t care if he says himself that that is what he is. If he says that (I have never heard Shiller himself use that word in reference to himself), I say he is wrong.
Shlller is a scientist.
A bear is someone who thinks stock prices are headed downward because he holds a negative outlook re our economic future. Shiller is just a fellow who has done research teaching us something we didn’t know about stocks in earlier days. He IS telling us that stock prices are headed downward. But not because he holds a negative outlook re our economic future.
Shiller and I believe that stock prices are headed downward because price changes are determined by investor emotions from years back. That’s not “bearishness.” It’s something different that in this particular case leads to a conclusion about where prices are headed that is similar to that held by the Doom-and-Gloomers (but for every different reasons).
This is not an academic discussion. We have an opportunity to change how the world thinks about stock investing following the next price crash. People will be open to new ideas then.
If we make a case that sounds dreary and pessimistic and bearish, there are millions of people who are going to close their ears to what we have to say. If we make a positive, research-based, forward-looking case, we will prevail.
Stock prices are going to crash again. The crash is going to wipe us out. The collective losses will be so great that there is a good chance that we will end up in the Second Great Depression.
That’s not bad news!
It’s good news!
The next crash is part of a process that we have to go through to make the transition from the old way of understanding how stock investing works to the new way of understanding how stock investing works. The new way of understanding how stock investing works is going to make our economy more productive than it has ever been before and is going to permit us all to earn far higher stock returns while taking on only greatly diminished risks.
There’s nothing gloomy, doomy about it. It’s good stuff. One of the reasons why it has been hard to convince people is that the case is often framed in a negative way. So I think we make a mistake to associate too closely with bears even though they agree with us that excessive valuations are a very bad thing.