Valuation-Informed Indexing #123
by Rob Bennett
Buy-and-Hold is the dominant investing strategy of today. It has not been proven correct. My personal view is that there is a mountain of evidence showing that it can never work for a single long-term investor. But it is certainly popular. We hear it promoted on numerous web sites, television shows and magazine articles.
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Can we question it?
Yes and no.
There are a good number of people who in recent years have expressed doubts about the merit of Buy-and-Hold strategies. That said, I think it can also fairly be said that there are limits to the sorts of challenges that the Buy-and-Holders will tolerate.
I strongly approve of 90 percent of what the Buy-and-Holders say. I strongly disapprove of one critical claim — the claim that it is not necessary for investors to adjust their stock allocations in response to big shifts in valuation levels. My take is that investors should aim to keep their risk profiles roughly stable over the years. Stocks are obviously far more risky when they are high-priced than they are when prices are at moderate or low levels. So I believe that investors hoping to have a realistic chance of enjoying long-term success MUST remain open to changing their stock allocations in response to big valuation shifts.
It is Yale University Economics Professor Robert Shiller’s research that shows this to be so. Prior to 1981, many found the research of University of Chicago Economics Professor Eugene Fama showing the market to be efficient persuasive. Shiller’s work discredited the earlier belief. An efficient market takes all relevant factors into consideration when setting the price. An efficient market can never become highly overpriced because overpricing diminishes the long-term value proposition and that causes sales and the sales lower the price until it reaches fair-value levels again.
So it’s settled. The market is not efficient. Investors must take valuations into consideration when setting their allocations to have any realistic hope of long-term investing success.
Except it is most definitely NOT settled. Buy-and-Hold remains popular today. Many smart and good people question my claim that long-term timing always works and in fact is required for long-term investing success.
Why? Why haven’t views changed in a dramatic way during the 30 years since Shiller’s publication of his “revolutionary” (his word) findings?
It’s because we don’t talk about the implications of those findings. None of us do. Even Shiller does not do this. Shiller’s book (Irrational Exuberance) does a wonderful job of explaining the theory behind the Valuation-Informed Indexing model. But never does it devote even a paragraph of discussion to the critically important question of what investors should do now that we know that the market is not efficient.
Shiller tells us why in this video of his lecture on behavioral finance. You’ll have to listen carefully. He doesn’t state the matter plainly or boldly. But if, life me, you have wondered for years why his revolutionary findings have not yet launched a national debate on how stock investing really works, I think you will be able to read between the lines and obtain the answer by listening to his words.
Shiller says early in his lecture that he was a “total outcast” when he first began exploring his new investing model. He notes that: “I had tenure, so I could do it.” But, still, “you don’t want to do anything that is too out of fashion.” Fortunately, “we have a system that allows it to happen and I’s very glad to have that.”
The statement is chilling when you consider the impulse behind it.
No one says “Iran does not have the ability to launch nuclear weapons” unless doubts are beginning to form about the matter. It may well be a true statement, and, if it is a true statement, it is certainly a positive statement according to a literal analysis of its content. But there is a negative implication raised by utterance of the statement. To say that “Iran does not have the ability to launch nuclear weapons” is to suggest that there is some reason to think otherwise or at least some reason to think that in future days the reality may become otherwise. The full truth of the matter is that the statement “Iran does not have the ability to launch nuclear weapons” is scary.
So it is with Shiller’s statement that our political system permits challenges to the dominant beliefs about how stock investing works. It must be a true statement or else Shiller could not have done his research or have published his book or have given his university lectures. But why does the man feel a need to say these words? Is there some sort of question as to whether discussion of alternative beliefs about how stock investing works is permitted or not? Why was he ever made to feel that he is was an outcast? Why does he worry about the consequences of being too out of fashion in his thinking about stock investing? Why does he even raise the issue of whether our political system permits challenges to Buy-and-Hold?
There are disturbing questions.
Shiller has said elsewhere that he has never told us all that he knows about how stock investing works because he knows that he would be widely branded “unprofessional” if he were to do so. That’s not good. This fellow is an economics professor at Yale. If he has something to tell us about stock investing that we do not know, we should be encouraging him to spill the beans. He obviously doesn’t feel comfortable spilling the beans.
We have as a society somewhere down the line done things to make Robert Shiller feel uncomfortable about telling us all he knows about how stock investing works. We have as a society somewhere along the line gotten on a very, very wrong track re our tolerance of a full and complete and vigorous discussion of the investing realities.
Rob Bennett created The Stock-Return Predictor, a calculator that performs a regression analysis of the historical return data to reveal the most likely annualized ten-year return starting from any possible starting-point P/E10 level. His bio is here.