Valuation-Informed Indexing #118
hy Rob Bennett
The song is here.
Carlson Capital's Black Diamond Arbitrage fund is up 5.77% for the first eight months of the year, including a 1.72% return for August. Last year, the fund returned 2.39% for the whole year. Q3 2021 hedge fund letters, conferences and more The fund consists of merger arbitrage mainly consisting of signed or "rate of return" Read More
Valuation-Informed Indexers believe that it is emotions, not human reasoning, that drives stock price changes. There are some unsettling implications that follow from that insight.
Stock price changes that are brought on by the logical analysis of economic developments are orderly. Things go up a little bit, things go down a little but. Things generally stay more or less the same. Wild price swings don’t evidence themselves in an efficient market.
‘They evidence themselves in the real-world market. That’s because the real-world market ain’t efficient. The real-world market, like the humans who buy and sell in it, is more than a little bit nutso.
Anything can happen in an emotions-driven market. Things can get out of hand. You don’t have to like it. If you want to understand the market, you have to come to terms with the reality. The only thing worse than how a market controlled by emotions behaves is how a market controlled by emotions that are denied behaves.
We loved stocks in the late 1990s. We loved them, loved them, loved them. We loved them like we have never loved them before. We loved them so much that we pushed the price of stocks up to three times what it would be if we hadn’t let out love for stocks get out of control.
That’s not good news for stocks.
A realistic love for stocks is a heathy thing. There are all sorts of reasons why we should love stocks. A realistic love is sustainable for the long term. An out-of-control love is not. An out-of-control love leads to bad places. An out-of-control love gets scary somewhere down the line.
When the police investigate a murder, the first person they question is the wife or husband of the person killed. Most people don’t hate anyone enough to kill him. The only ones most of us are ever capable of hating that much are the ones to which we have pinned all our hopes and dreams — the ones we love. A decision to love always carries with it the potential to create a temptation to hate the thing once loved.
This is a public policy issue. Too few pointed out the dangers of our love affair with stocks in the 1990s. Now that that love is in the process of turning into hate, we need to begin talking through the risks.
People hated stocks following the crash of the 1970s. There was the famous Business Week cover article on “The Death of Equities.” How could things ever reach a point where enough people hated stocks that it could profit a magazine to run a cover article arguing that the days of middle-class people buying stocks had come to a permanent stop? The love for stocks got too out of hand in the 1960s. The love turned to hate.
The hate for stocks felt in the 1930s was worse. That’s because the love felt for stocks in the 1920s was greater. We saw a P/E10 value of 25 in the 1960s. That sort of P/E10 value causes a lot of hate for stocks in the following years. In the 1920s, the P/E10 value reached 33. That was a lot worse. That P/E10 value created a stronger and longer lasting hate.
Do you remember the rule of thumb that advised that you should never buy stocks unless the dividend is higher than the return on bonds? The idea was that the certain return on stocks must be as higher than the return on bonds to justify the risk taken on because capital losses are as possible as capital gains. Most investors thought that made sense in the years following the last time stocks were loved nearly as much as they have been in recent years. Most people will think that rules tougher than that will make sense as stock prices continue to work their way downward.
I don’t think stocks should be loved OR hated. Investors lose by loving stocks because their love blinds them to the appeal of alternative asset classes. The likely long-term return for stocks was a negative number at the high point (or was it the low point?) of the recent bull while risk-free asset classes like Treasury Inflation-Protected Securities (TIPS) and IBonds were offering a return of 4 percent real. Love hurts.
But hating stocks can do just as much harm in the long run. Lots of people are developing fears of stocks today. By the time prices have risen enough to overcome their fears, it may be too late for these people to make up the shortfall in their retirement plans that comes from ignoring the most rewarding asset class. It’s the emotional extremes that cause all the trouble. People come to hate stocks only because for a time they went overboard in their love for stocks.
The Stock-Selling Industry pushes stocks too hard. The thought is that it is by selling stocks that the professionals in this field make the most money. The trouble is that overselling stocks at times of high prices causes such huge losses that millions avoid stocks for decades. We would be better off just teaching people the realities.
If stocks were not pushed so hard when they offer a poor long-term value proposition, people’s affection for stocks would be more stable and prices would be less volatile. A world in which stocks are neither loved nor hated would be a world in which we all invested far more effectively than we do today.
Rob Bennett thinks it is a big mistake to cheer on bull markets. His bio is here.