Valuation-Informed Indexing #268
by Rob Bennett
There was a play in Saturday night’s playoff game between the Dodgers and the Mets that generated a lot of controversy. Chase Utley broke up a double play that was arguably a bit late and arguably a bit away from the base and broke a player’s leg doing it. Some say that Utley was playing good old-fashioned hard-nosed baseball. Some say that the slide was dirty and that a rules change is need to prevent something like this from happening again.
I was telling my boys about the play and the reaction to it when something came out of my mouth that reminded me of where things stand today in our gradually improving understanding of how stock investing works. I grew up in Philadelphia and so I know Utley from his time with the Phillies. I read about the play at a Phillies site (TheGoodPhight.com). There were comments on the thread discussing the play that offered intelligent comments on both sides of the controversy. That’s what I found exciting about it. But the comment that I made to my boys was: “If you said that Utley’s slide was dirty on that thread, you would have gotten banned from the site.”
The site is run for the benefit of Phillies fans. Phillies fans love Utley. So you are not permitted to say that the slide was dirty. I don’t think that that is a good policy. People are saying at other sites that Utley’s slide was dirty. I am certain that there are some Phillies fans who believe that to be the case. But they keep their mouths shut at that site. There is no rule that says that you cannot criticize Chase Utley at that site. But there is an unwritten rule. And people follow it. Or else.
Please understand that the site does permit different opinions to be expressed re the controversial slide. There were many comments offered that questioned the slide and nothing bad happened to the community members who offered those comments. My point is not that there is no range of opinion evident. My point is that that range is improperly limited. Site owners have to draw lines as to what is permitted and what is not. I think that Phillies fans would learn more about their team if a greater range of opinion was permitted at that site.
I have seen the same general phenomenon play out at lots of investing sites.
Buy-and-Hold is today the dominant model for understanding how stock investing works. A core belief of Buy-and-Holders is that it is not possible to time the market. Yale University Economics Professor Robert Shiller showed in 1981 that today’s valuation level effectively predicts the price of a broad index that applies 10 years or 15 years or 20 years in the future. It follows that long-term timing (changing your stock allocation in response to a big shift in valuations with an understanding that you may not see benefits for doing so for 10 years or longer) always works. Long-term timing is price discipline. A market cannot work without price discipline. One form of market timing not only works but is always required for investors who hope to keep their risk profiles roughly constant.
Or at least so it seems to Rob Bennett.
There are lots of good and smart people who strongly disagree.
That’s what makes a ballgame!
We are not seeing a vigorous discussion of the implications of Shiller’s findings at any large investing discussion board or blog today. The implications of Shiller’s findings are far-reaching indeed. If Shiller is right (and there is a mountain of evidence showing that he is — the man was awarded a Nobel prize for his work in this area), stock investing risk is not static but variable. That changes everything. In fact, I spent 16 months working with Wade Pfau on research that has been published in a peer-reviewed journal that shows that investors can reduce risk by nearly 70 percent by being wiling to engage in long-term timing. That’s amazing. That’s something that we should be discussing every day on every blog on the internet.
People do discuss Shiller, to be sure. But they discuss Shiller in the manner in which Phillies fans discuss Utley’s slide. They advance criticism of the Buy-and-Hold Model only in the most tentative and gentle ways. It’s common to hear someone say “valuations matter.” It is not at all common to hear someone say “it was the promotion of Buy-and-Hold strategies that was the primary cause of the economic crisis” (because we are in the process of paying back the $12 trillion that we borrowed from our future selves when we pushed stock prices up to insanely dangerous levels in the late 1990s). In fact, I am the only person that I have ever heard make that claim.
I make lots of claims that I have never heard anyone else make. I once described Buy-and-Hold as “a Get Rich Quick scheme” in the comments section of a blog and a fellow put up a comment saying that he had never heard anyone say that before. Is it really so outlandish a claim? If valuations affect long-term returns, the nominal price quoted as the market price is not real; the extent to which the nominal price exceeds the fair-value price is cotton-candy nothingness fated to get blown away in the wind in days to come. Is that not so?
Say that there is a range of opinion on how stock investing works that extends from “1” (which signifies that Buy-and-Hold is perfect in every way) to “10” (which signifies that Buy-and-Hold is truly dangerous because it makes it impossible for investors to keep their risk profiles constant). If we permitted a full range of opinions to be discussed and explored, most investors would probably end up holding opinions in the middle of the range. Most investors would see merit in Buy-and-Hold but would also maintain a healthy skepticism re its most extreme claims and would feel the same way about Valuation-Informed Indexing. That’s how I think things should be done.
That’s not how things are done today. Today, those holding opinions that range from “1” to “3” are welcomed at all boards and blogs and warmly invited to share their thoughts in great depth. “4”s are permitted. “5”s are tolerated, but just barely. Those holding opinions ranging from the “6” level to the “10” level are warned that they must censor themselves, and, if they fail to do so, they are banned.
We don’t know what we are missing when we don’t hear from the “6”s and the “7”s and the “8”s and the “9”s and the “10”s. Because we never hear them.
There’s nothing dirty about Shiller’s research findings. I believe that these findings will in future days be taking us to some wonderful places. We need to begin encouraging a wide range of discussions re what it means to say that “valuations matter.”
Rob Bennett’s bio is here.