Valuation-Informed Indexing #272
by Rob Bennett
I have spent the last 13 years of my life exploring in depth the implications of Robert Shiller’s “revolutionary” (Shiller’s word) 1981 finding that valuations affect long-term returns. A lot of people have a hard time accepting that we are as a nation working our way through a paradigm change in our understanding of how stock investing works because paradigm change is always hard to recognize until it has come to completion.
I was recently diagnosed with diabetes (please see last week’s column for an examination of the self-delusion that kept me from seeking a doctor for two years and of how that self-delusion compares to the self-delusion of the Buy-and-Holders who still believe today that it is not necessary for investors to change their stock allocations in response to big price shifts) and have been doing lots of research into the question of how best to cope with the disease. I’ve learned about a revolution that has taken place re this question that mirrors in many ways the revolution taking place in the investing realm and which perhaps can help us all to understand a bit better why the Shiller revolution is proceeding as it is.
In 1970, the medical community believed that the consumption of fats was dangerous. The consumption of carbohydrates was encouraged as a means of keeping fats consumption low. The reality proved by Richard Bernstein in the years since is that it is carbohydrates that are the real killer in the American diet and that fats are harmless in comparison. The Bernstein revolution (an approach to the treatment of diabetes in which a super-low carbohydrate diet is encouraged) was slowed because the “experts” in the field had fallen in love with an idea (that carbohydrates were okay and that fats were bad) that at one time was given some support in the literature but that had never been sufficiently proven to justify its status as dogma.
The parallel is that, prior to 1981, the investing advice community believed that market timing was always a bad idea. The reality proved by Shiller is that, while short-term timing never works, long-term timing always works and is always required for investors seeking to keep their risk profiles roughly constant. Again, the experts have had a hard time acknowledging the error. Experts don’t like to acknowledge their human fallibility. So they have an inclination to go into denial when new research is done showing that their too-hasty conclusions re the meaning of earlier research need to be reconsidered.
The story of how Bernstein has showed that the Low-Fat/High Carb Diabetes-Treatment Emperor is wearing no clothes is an inspiring one. Bernstein was an engineer in 1970 suffering from Type 1 diabetes. He was a young man but his organ damage had grown serious enough that insurance tables showed that he possessed a life expectancy of only five years. He was desperate enough to find answers that, when he saw an advertisement in a product brochure for a blood-glucose testing machine costing $60,000 in today’s dollars, he put the money down. He was told that the machine could only be sold to doctors. Fortunately for those of us suffering from the disease today, he happened to be married to one. So Bernstein was able to make that $60,000 purchase of a machine that did the job that is done today by machines costing about $20.
Engineers enjoy solving problems. He tested himself at different times of day and noted what foods caused him problems. He learned that it was carbs doing the damage. So he stopped eating carbs. His symptoms disappeared.
He wrote up a paper explaining what really works in the treatment of diabetes. His paper was rejected because he did not hold a medical degree. Being a can-do guy, he didn’t have to think long to figure out how to solve this new problem. He applied to medical school! Today millions of diabetics follow the Bernstein approach to coping with diabetes and obtain results that most experts in this field viewed as impossible only a few decades ago.
Robert Shiller has the credentials needed to be perceived as an investing expert. But he is married to a psychologist. Things he heard from his wife about how humans operate in this world told him that the core premise of the Buy-and-Hold project — that investors pursue their self-interest in rational ways — was false. He went about the business of finding a “machine” that does the job that needs to be done in the investing realm as much as the job of measuring blood-glucose levels needs to be done in the diabetes realm. Shiller showed that it controlling investor emotion that is the key to curing investor irrationality. His P/E10 tool measures investor emotion and thereby helps us to gain control of our long-time investing “disease,” the disease responsible for 70 percent of the risk of stock investing.
Bernstein’s approach has become popular despite the opposition of the experts in the medical realm because people who suffer from diabetes have been able to share with each other news of what really works on internet blogs and discussion boards. I believe that it is through the magical internet communications medium that we are going to work around the “experts” in this field who continue to push Buy-and-Hold strategies to this day. There are too many people who need to know the realities of stock investing to hold back the dissemination of what we we have learned over the past 34 years much longer.
Every now and again a revolution can be a very good thing!
Rob Bennett’s bio is here.