Valuation-Informed Indexing #138
by Rob Bennett
I say that we have another stock crash coming. I say this because there has never yet in U.S. history been a secular bear market that did not eventually take us down to a P/E10 level of 7 or 8. That’s a 65 percent price drop from where we stand today.
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
Most people think I am delusional.
What if I turn out to be right? Would it be okay for me to say “I told you so?”
I raise this question because of a conversation I had with a fellow who posted under the name “Uncle Mick” at the Safe Withdrawal Rate Research Group board a number of years back. Mick agreed with me on many but not all points. At one point he expressed concern that, if the stock crash I was predicting (this conversation took place prior to the 2008 crash) took place, it would serve no purpose for people who had predicted it to say “I told you so.”
I of course agree that it is in bad taste to say those precise words. A crash is going to hurt people. It serves no constructive purpose to make them feel even more pain. To put forward words suggesting that they could have known in advance what was coming would make them feel more pain. So literally advancing “I told you so” arguments is out.
I won’t say “I told you so.” I promise!
But there are points that come close to the message conveyed by an “I told you so” message that really must be conveyed.
Yale Economics Professor Robert Shiller predicted the 2008 economic crisis in his book, which was published in 2000. I certainly don’t want Shiller to be so graceless as to step forward and say “I told you so.” But I do think Shiller should be getting a lot more credit for that prediction that I have heard given to him thus far.
Predictions are a way of testing the merit of competing theories. Shiller’s theory permitted him to predict events that actually did play out. The Buy-and-Holders did not predict the crisis. To the contrary, they were shocked and amazed and stunned by the crisis. That should tell us something about the merit of their model for understanding the markets. It does not by itself tell us they are wrong in all that they say. But the fact that they failed so spectacularly re this one issue suggests that we should evidence greater skepticism toward other ideas being put forward by people from that school of thought.
Even more importantly, a full discussion of the research findings behind Shiller’s prediction would go a long way toward helping us overcome the crisis. The first thing that a doctor does when trying to cure an ailment is to form a diagnosis. Get the diagnosis wrong and you are likely to get the treatment wrong. Have we gotten the diagnosis for our economic troubles wrong? It sure seems so to me.
Once we acknowledge that it was high stock prices that caused the crisis, we can get about the business of insuring that we never see prices reach such levels again. Shiller’s research findings and the practical investing implications that follow from them point the way to achieving greater economic stability. Unfortunately, we have as a society not yet completed the first step in this multi-step process of properly identifying the primary cause of the crisis. Any “I told you so” statements that led us in that direction would be big positives.
The phrase “Buy-and-Hold” is new. But the core idea of the Buy-and-Holders — that there is no need for investors to consider price when setting their stock allocations — has been around since the first day that a stock market opened up for business. Following the first three times that the Buy-and-Hold idea caused huge losses for all who followed it (losses collectively large enough to bring on an economic crisis for the society that tolerated widespread promotion of the concept), Buy-and-Hold became unpopular for a time but then caught on again after the passage of enough years to help those burned by the strategy to forget what they had lived through.
We will see the unfortunate pattern repeat yet again if blame for the losses is not assigned. Price crashes don’t just happen. Economic crises don’t just happen. Economic crises and price crashes are the natural and inevitable result of strategies telling investors that it is not necessary for them to consider price when setting their allocations becoming popular. It hurts investors to hear this message today because many have been hurt by losses already suffered and cannot bear the thought of falling further behind in their efforts to finance their old-age retirements.
This won’t be an issue following the next price crash. At that point, stock valuations will be below fair-value levels. Thus, telling investors what the last 30 years of academic research shows will be telling them that the real value of their portfolios is greater than the nominal value rather than less. That hasn’t been so for many years now and the change will present an exciting opportunity. This will be the first time since Shiller published his revolutionary research that we will have a chance to explain the realities to investors without making them feel that we are taking money out of their pockets by doing so.
We want to take advantage of that opportunity! If we must engage in a little bit of “I told you so” talk to pull it off, then so be it.
The “I told you so” message can he advanced for two very different motives. If the idea is to crow, it really is a counter-productive business. To the extent that that is the message, we all should resist any urge to say the words “I told you so.”
But accountability is important. We do want to identify the strategies that work and the strategies that fail. So we do want to declare winners and losers. If stocks crash yes again, I think we all will feel comfortable saying that Buy-and-Hold is a loser strategy and that Valuation-Informed Indexing is a winner strategy. We shouldn’t hold back. We need to say just that if we want to help our Buy-and-Hold friends advance in their understanding of what really works in stock investing.
Rob Bennett has recorded a podcast titled “I Know More About Investing Than John Bogle (And You Can Too).” His bio is here.