Valuation-Informed Indexing #177
by Rob Bennett
It shouldn’t have played out this way.
Warren Buffett’s 2018 Activist Investment
Most investors are aware of Warren Buffett's most high profile long-term investments. However, there is one long term investment that is often overlooked. Q2 2020 hedge fund letters, conferences and more This is building materials maker USG, which was owned by Berkshire Hathaway for more than 17 years before it was acquired in 2018. If Read More
Buy-and-Hold was an important advance.
Before Buy-and-Hold, there was little systematic study of how stock investing worked. Lots of people put forward their opinions. But stock investing was not the subject of much University study. So you never really knew whether the research you were looking at was the real thing or just the product of a marketing campaign.
Buy-and-Hold changed all that. Buy-and-Hold brought some standards to the investing advice field. You no longer could have four equally qualified experts advancing four conflicting ideas about how stock investing works. By rooting their strategies in what the peer-reviewed academic research says, the Buy-and-Holders insured that we would stop going around in circles and that knowledge would advance over time.
Then there was The Mistake.
There was never a study that showed that timing doesn’t work. Buy-and-Holders still say that to this day. But there never was even a tiny grain of truth to the claim. There were studies showing that short-term timing doesn’t work and the Buy-and-Holders jumped to the conclusion that neither short-term timing nor long-term timing works. The first person to test whether long-term timing works was Yale Economics Professor Robert Shiller in 1981. His research showed that long-term timing ALWAYS works. The Buy-and-Holders ignored that finding and continued advocating strategies rooted in their false belief that timing in general either doesn’t work or isn’t required for long-term success.
There are a number of things that should have happened following the publication of Shiller’s research. The Buy-and-Holders should have expressed great concern that their model might have been built on a shaky foundation and that they might be giving bad investing advice as a result. There should have been a call for lots of follow-up research aimed at determining whether the market is efficient or whether valuations affect long-term returns (it can’t be that both things are so!). There should have been lots of books written and lots of magazine articles published exploring the strategic implications of Shiller’s finding (which are breathtakingly far-reaching). There should have been a national debate on the question of how the Buy-and-Holders got it all so wrong and about what we need to do to insure that we are protected from mistakes with such frightening public policy implications in the future.
We played it precisely the opposite way.
We covered up The Mistake. Buy-and-Hold remained the dominant model for 32 years after it was discredited by the peer-reviewed academic research even though the findings of the peer-reviewed academic research are supposed to count for something in this field.
We have seen a change since the 2008 price crash. Today’s investors fear for their financial futures. Today’s investing analysts are abashed over the thunder they employed to power their dubious assurances that we could survive the out-of-control bull market of the late 1990s, that this might be the first bull in history that would not end badly. People are looking for a way out today.
But how do we turn this thing around at this point? In 1981, we could have said “oopsie!” and started over. That hardly flies three decades down the road. Millions of lives have been destroyed because of our reluctance to come clean re our mistakes for those 33 years. What would have been very easy to do in 1981 has become very, very, very hard to do in 2014.
So the cover-up continues. We tell ourselves that valuations might matter a little bit but not enough to destroy the retirement plans of those who follow the advice advanced by the Buy-and-Holders. We know of no research supporting this idea. But what alternative is there, given the 32-year delay in getting the errors in the dominant strategy fixed?
It’s not a happy story.
But I believe that it’s important that we look for an optimistic angle to give us some hope that we can set things right in coming years.
The good news is that lots of smart people who have been reluctant to speak out for years now have all the while been thinking over these matters in their own minds. Had the ordinary course of business applied, it probably would have taken 10 years for us to have completed the transition from Buy-and-Hold to Valuation-Informed Indexing. Shiller’s finding really was “revolutionary” (the word he uses to describe it). It was a shock and even in the best of circumstances a society cannot absorb a surprise of that magnitude in just a few months or even in just a few years.
So in ordinary circumstances Valuation-Informed Indexing would have become the dominant model in the late 1980s or the early 1990s. Given the 32-year delay, we are not now going to have to wait until the year 2024 to being reaping the benefits of the first true research-based strategy.
Given the 32 years of growing doubts re Buy-and-Hold that have been kept quiet, I believe that we will now be able to make the transition to the new model in six months or a year or at most two years.
That’s good news because it does not seem likely that we are going to have much time. Stock are priced for a price crash of 65 percent. The collective loss of consumer buying power will be in the trillions. We saw political friction from both the left (the Occupy Wall Street Movement) and the right (The Tea Party Movement) following the 2008 crash. The next one will hit a lot harder and will bring on a far more intense version of the story we saw in 2009 and 2010.
But the transition to Valuation-Informed Indexing should settle things. That next crash will permit us for the first time to tap into the benefits of the wonderful move led by the Buy-and-Hold Pioneers to general acceptance of research-based strategies.
We cannot afford to take 10 years to make the transition given the 32-year delay in our getting to work to make good things happen. Fortunately, it appears that there is good reason to believe that we won’t need to. A job that would have taken 10 years to complete had it been tackled promptly is probably not going to take more than a year or two to bring to completion when we finally are forced to get serious about it.
Rob Bennett has recorded a podcast titled Bogle and Valuations . His bio is here.