Valuation-Informed Indexing #320

by Rob Bennett

Most stock investors enjoy bull markets. I do not. My view is that the added returns that investors see in bull markets are borrowed from the returns that otherwise would come to them in future years — overvaluation is always a temporary phenomenon. So I hate bull markets.

And the irrationality that brings them on. And the bad investing advice that encourages the irrationality. Has there ever been a time when the widespread belief in Buy-and-Hold strategies did not end in tears? Not yet. Not in the 145 years of stock market history available for review by us today.

Bear markets are just as bad in a different sort of way. Irrational exuberance inevitably leads to irrational depression. The market never loses sight of its primary purpose — to get prices right. When investors become so enthralled with the Buy-and-Hold “idea” that they are unwilling to listen to the voice of common sense telling them to lighten up on stocks, it gets the job done by crashing prices. Millions of investors see trillions of dollars of consumer spending power disappear into thin air and cut back on spending. Hundreds of thousands of businesses fail. Millions of workers lose their jobs. Political stresses are felt. Not fun.

It all starts with the dumb idea that the stock market is the one place where we can truly get something for nothing. We are told that investors can vote themselves raises and no bad consequences will follow. “Experts” assure us that there is research supporting this odd claim but instructions as to where one might locate this research for the purpose of reviewing it carefully are left sketchy. Few ask challenging questions for so long as prices remain high.

It all gives me the willies. I like rationality. I like real research, the kind that exists in the physical realm and that can be reviewed and checked and questioned and challenged. I like real discussion, in which there is spirited but respectful back-and-forth between parties who are for the time coming at things from different perspectives but who want to hear the other fellow out as a check on their own possible biases. It’s been my experience that you don’t see too much of that sort of thing in the investing world at times when prices are high.

Or when they are low either. Bear markets are just the mirror image of bull markets. Investors who swore when stocks were overpriced that stocks are always best for the long run swear when stocks are underpriced that no middle-class person should ever consider purchases of this asset class; at those times recent experience makes the case that stocks are just “too risky.” That thought holds the day until stocks are popular and overpriced again.

These wild swings in emotion are not my particular cup of tea. Not when my retirement money is at stake. And especially not when I can see the human misery caused by all the Buy-and-Hold craziness reflected in the eyes of millions of middle-class people just trying to put aside enough money to finance a decent retirement and placing their trust in the experts (in marketing!) to steer them in the right direction.

These are all points that I have reflected on in the past. But it seems that there is no end to the misery that can be found following from bull markets once you put your mind to learning about it all. I learned a new one the other day — bull markets (and bear markets too) make financial planning itself impossible!

A small group of critics visits my web site most days to try to poke holes in whatever point I am making with that day’s blog entry. I was arguing not long ago that bull market gains are Pretend Money, cotton candy nothingness fated to be blown away in the wind as fair-value prices reassert themselves. One of my critics asked if this means that the numbers on his portfolio statement are “lies.” Of course it means that, I assured him. “Overvalued” means “mispriced.” When stocks are priced at two times fair value, we all need to divide the numbers on our portfolio statements by two to know the real and lasting value of our holdings.

You can probably see now why I have been banned at so many places. This is not the way to win popularity points at a time when most of us are worried that we have not saved enough to finance our retirements.

This fellow shot back with a query as to whether the car and house and consumer goods he was able to buy as a result of his many years of good stock returns were all “lies” as well. That one slowed me down. The things we buy with bull market gains are real. Shiller showed that stock valuations return to fair-value levels in time. But nothing requires you to return the car you purchased with a portion of those gains. Those who cash in their gains before prices crash get to keep them. Andrew Smithers once remarked that: “He who panics first panics best.”

But then it hit me.

No, you don’t have to give back the things you bought with phony bull market gains. But you wouldn’t have bought most of those things at the prices offered had you known that you were not going to be able to retain all of your bull market gains. So you made bad purchasing decisions and bad financial planning decisions. How can anyone plan effectively without knowing the true numbers that apply? And you cannot go back in time and take those choices over once the price crash teaches you the realities. So bull markets do hurt even those who cash in their gains.

And of course bear markets do too. In bear markets, the fear that things will never be normal again, that our powerful economy will never function properly again, causes us all to pass up opportunities that we would grasp if we were thinking clearly. That’s why things get so dark and hopeless in bear markets. The insane idea that stocks can never be a bad choice becomes transformed into the equally insane idea that stocks can never be a good choice. Someone needs to tell the Buy-and-Holders that moderation is a virtue.

Bull markets are no fun. No fun at all.

Rob’s bio is here.