Valuation-Informed Indexing #195

by Rob Bennett

I am in the process of writing to the 30,000 professors listed at the Social Science Research Network (SSRN) site to let them know about the Valuation-Informed Indexing concept and the research that has been done over the past 33 years showing the superiority of the new model to the discredited but still dominant Buy-and-Hold Model. I have received lots of wonderful responses, some agreeing with my arguments and some taking issue with them. In almost every case in which I have received a response from the professor contacted, I have learned something important.

The most interesting responses of all have been the ones that referred to the concept of paradigm change as described in the famous book by Thomas Kuhn, The Structure of Scientific Revolutions. I think the comments that were made in those responses are precisely on point. The reason why it has been such a struggle to get Valuation-Informed Indexing to replace Buy-and-Hold is that the root idea (that it is investor emotions that are primarily responsible for stock price changes rather than economic or political developments) represent a challenge to a deeply engrained belief.

How many times have we all read one of those daily columns in the Wall Street Journal explaining why stock prices went up or down the day before? If Shiller is right, reading those columns is a big waste of time. If Shiller is right, the explanations put forward in those columns are a big bunch of silliness.

University of San Diego Law Professor Ted Sichelman wrote: “Unfortunately, many academics can become quite strident when their views are challenged, which is why I was counseled not to tread on treacherous ground prior to getting tenure. Like most other fields, academia is often subject to self-serving boas that obliterates ethical bounds.”

Jing Chen, Assistant Professor at the University of Northern British Columbia, wrote: “It is natural that powerful people will do what they can to protect their interest. It is the norm in the academic world and in the broader world. I am grateful that you write about it.”

Carol Osler, Program Director at the University of Northern British Columbia, wrote: “I certainly have seen the academic profession in action squelching unfashionable ideas and have often been on the wrong side of it. While there’s no magic solution, especially in the short run for individuals with jobs at stake, I sometimes find it calming to see that both philosophy and science are on our side about academics sometimes being profoundly unreasonable. For philosophy, Kuhn was a good start for me. He shows how most pathbreaking scientific ideas are rejected at first, usually for decades. Popper was also helpful. He has very harsh words for scientists who worship math, for example. For science, I am just now reading Jonathan Haist’s book on the psychological basis for morality, The Righteous Mind (2011). He shows, for example, why most ‘scientists’ behave like Kuhn documented, and support the group’s big ideas even in the face of strong evidence to the contrary.”

Former Financial Analysts Journal Editor Rob Arnott wrote: “I’ve had similar experiences to those you describe. My work has often triggered overt hostility from guardians of the status quo. I’ve had difficulties getting some of my controversial articles published. For instance, I’m having a dickens of a time getting any journal to publish my work with Harry Markowitz, Jason Hsu and Jun Lie, which shows that a modest amount of error in stock prices would create — and fully explain — the Fama-French size and value effects. Journals turning down a Nobel Laureate? Yep, it happens. And the journals that published some of my more controversial papers got hate mail. I also know of two young professors who wanted to do research on Fundamental Index and reported to me that their colleagues advised them that this line of research could derail their career prospects.”

25-Year CPA Lyn Graham wrote: “The cigarette and pharmaceutical industries funded research supporting their products by funding it. But this is big money supporting outcomes, not dissuading others.”

Law Lecturer Albert Sanchez Graells wrote: “The situation seems well below any professional and academic acceptable standards.”

Scott Burris, Director of the Center for Health Law, Policy and Practice, wrote: The fact that aggressive and short-term market timing was unproductive did not mean that there were never times when it would be wealth-maximizing to get out of the market.”

Harvard Law School Professor Alain Lempereur wrote: “It is not easy to work on this kind of topic. I can testify too.”

Brad Delong, Publisher of the Grasping Reality with Both Hands Blog, wrote: “Now Robert Shiller appears to be doing fine with his papers showing extraordinary degrees of mean reversion in yields.”

Michael Brennan, a Finance Professor at UCLA Anderson School of Management, wrote: “A lot of harm was done by misunderstanding the Efficient Market Hypothesis.”

Robert Savickas, Finance Professor at George Washington University, wrote: “All the things you say about Buy-and-Hold and about the importance of valuation levels for choosing your portfolio entry points is very intuitive, was always on my mind, and I am surprised that anyone in their right mind would argue with it. This should not generate controversy and I am surprised that it dies. You don’t need any financial education to intuitively understand these things…. This [Valuation-Informed Indexing] sounds like a real thing. If it is and I can thoroughly understand it, then it will end up in my classrooms (of course with reference to you and Wade)….It is great to have opposition. That means you are doing something right.”

Joachim Klement, CIO at Wellershoff & Partners, Inc., wrote: “I can confirm Wade Pfau’s experience. Whenever I send my papers to the Financial Analysts Journal or similar traditional journals, I get rejected….I am with you 100 percent. I still get frustrated with the slow pace of progress in economics and finance. As a fan of Thomas Kuhn’s The Structure of Scientific Revolutions, I know that what is typically needed is either a big crisis of the ascent of a new generation of scientists who did not build their careers on the old model.”

Rajiv Sethie, Economics Professor at Columbia University, wrote (at his blog): “Rob Bennett says that market timing based on aggregate P/E ratios can be a far more effective strategy. This claim is consistent with Shiller’s analysis and I can see how it might be so.”

Rob Bennett has recorded a podcast titled Why Stocks Let You Down and How to Make Sure It Never Happens Again. His bio is here.