Valuation-Informed Indexing #180
by Rob Bennett
During the time that I was working with Academic Researcher Wade Pfau on the research that we published together, he performed an important review of the investing research literature. His research journey began when, after becoming familiar with the Valuation-Informed Indexing concept, Wade observed in a post at the Bogleheads Forum discussion board that: “There is an extensive literature about the predictability of long-term stock returns. There is an extensive literature about short-term market timing. My question is about long-term market timing. The literature seems slim.”
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That turned out to be a massive understatement. When Wade, who holds a P/h.D. in Economics from Princeton, completed his investigations into the question, he concluded that in fact there is not even a single study anywhere in the literature suggesting that long-term timing might ever not work or might ever not be required. He was flabbergasted. Nothing in his studies at Princeton had ever led him to believe that the question of whether market timing works or not remains an open question. But in fact an important element of the question had never yet even been examined. “Nobody seemed to have provided a serious investigation of it. I just couldn’t understand why. And that bothered me.”
It bothered him enough that he went to the Bogleheads Forum to see if any of the thousands of Buy-and-Holders who congregate there knew of even a single study showing that long-term timing doesn’t work or isn’t required. Jack Bogle posts there. Bill Bernstein posts there. Larry Swedroe posts there. Rick Ferri posts there. No one at that board had ever heard of a single study supporting the key principle of the Buy-and-Hold strategy. The conclusion Wade reached after studying the literature himself was confirmed. There has never been a single piece of research produced suggesting either that long-term timing might not work or might not be required.
If you are a regular reader, you know what I think that means. I think it means that all stock investors MUST practice long-term timing (long-term timing is changing your stock allocation in response to big shifts in valuation levels with the understanding that you may not see benefits for doing so for as long as 10 years). Practicing long-term timing is exercising price discipline. It is a logical impossibility that practicing price discipline could ever be a bad thing.
Markets depend on price discipline to function. It is because the person buying a car is trying to push the sales price down while the person selling the car is trying to push the sales price up that the car market is able to do a good job at setting the prices of cars roughly where they should be. When large numbers of investors come to believe that Buy-and-Hold strategies can work, price discipline disappears from the stock market and the market becomes dysfunctional. Eventually, prices rise so far from where they would be if market participants were practicing price discipline that the only way the market can continue to function is for prices to crash.
That all follows, doesn’t it?
I believe that it is this failure to research long-term timing that explains why two people as smart as Eugene Fama and Robert Shiller could come to opposite conclusions on the question of how stock investing works. Fama concluded that the market is efficient before Shiller published his research showing that long-term timing always works. Fama has tuned out Shiller’s findings for 32 years now because in his mind timing is out of the question. Had Shiller published his findings first, Fama would have put his mental energies to the task of developing a model to explain how stock investing works with the thought that price discipline is essential firmly established. Because of a quirk of historical timing, he instead came to the project with an entirely inappropriate hostility to research-based showings of the importance of one form of market timing.
Many do not see it this way today.
When I tell Buy-and-Holders that there has never been a single study even suggesting any reason why long-term timing might not work, they respond that that doesn’t prove that long-term timing does work.
I think they are wrong.
Is there anyone alive who would say that it is not a good to check out Edmunds.com to learn the fair market value of a car before paying a visit to a dealer? We all check out Edmunds.com because we all want to exercise price discipline when buying cars. Why don’t we all check out the P/E10 value of stocks before setting our stock allocations? Isn’t that the same thing?
We spend more money on stocks over the course of a lifetime than we do on cars. Shouldn’t we have an equal to desire to exercise price discipline on the purchase re which we spend a relatively large percentage of our life savings as we do on the purchase re which we spend a relatively small percentage of our life savings?
But…. But…. But….
Buy-and-Holders don’t think like this. Their default position is that timing is a bad thing. They place the burden of proof on anyone trying to argue otherwise. They complain that they will be taking on added risk if they agree to practice any form of timing.
But if engaging in long-term timing is exercising price discipline, the risk shoe is on the other foot. It is failing to engage in timing that is the risky act. Price discipline is required. Long-term timing is required.
We thought otherwise for a time because we didn’t know everything. But as time goes on, we learn more and more.
Or so we hope.
Rob Bennett has recorded a podcast titled Does Robert Shiller Pull His Punches? His bio is here.