Valuation-Informed Indexing #200
by Rob Bennett
Buy-and-Hold is about moving returns from a time-period in the future to one in the present. If we all reduced our stock allocations in response to big price increases, the P/E10 level would be stable and there would be no more bull markets.
Dan Loeb's Third Point returned 11% in its flagship Offshore Fund and 13.2% in its Ultra Fund for the first quarter. For April, the Offshore Fund was up 1.7%, while the Ultra Fund gained 2.3%. The S&P 500 was up 6.2% for the first quarter, while the MSCI World Index gained 5%. Q1 2021 hedge Read More
That would be no fun! People love bull markets and Buy-and-Hold because the alternative is deferred gratification, waiting until the economic growth needed to finance the returns obtained from investing in stocks has taken place before counting the returns as real.
Some say it doesn’t matter.
The phony bull market returns disappear in time anyway, they point out. All bull markets produce bear markets in which we see returns less than those justified by the economic realities to make up for the years in which we saw returns greater than those justified by the economic realities. So it all comes out in the wash in the end. No???I don’t think so.
Moving stock market returns from one time-period to another reduces economic productivity in seven different ways:
1) Bull Markets Cause People to Spend Money They Shouldn’t Spend
People complain all the time about our low savings rate. Bull markets contribute to that. Buy-and-Hold contributes to that.
People save when they are motivated to save. During a bull market, people look at the 30 percent gains they are seeing on their stock portfolios and determine that they don’t really need to buckle down just yet. It’s not irrational behavior. Stocks were priced at three times fair value in 2000. So an investor who had $200,000 of real value in his stock portfolio was led to believe that he had $600,000 of real value in his stock portfolio. It should shock no one that someone who thinks he is $400,000 farther along in his effort to finance his retirement would ease up on saving efforts for a time.
2) Bull Markets Cause Entrepreneurs to Start Businesses They Shouldn’t Start
Starting a business is a risk. Smart entrepreneurs hold off until they have a good bit of slack in their personal saving accounts before taking the plunge. The same $400,000 of funny money that would cause one investor to spend more than he should can case another investor to start a business that he would not dare to start if he knew the true value of his portfolio. Bulls make the free market less free. They introduce artificial stimulants into the mix of incentives and disincentives that we should all want to be steering people toward economically justified choices.
3) The Shift from Bull to Bear Causes Massive Unemployment
When investor psychology changes and the pretend gains of a bull market are wiped out, huge amounts of consumer spending disappear from the economy. Hundreds of thousands of businesses fold and millions of workers are left jobless. The loss of the labor of all those people represents a big economic loss. Our economy would function better if the bull/bear cycle were softened by our educating investors as to the dangers of investing heavily in stocks at times of insanely high prices.
4) Investor Overreactions Extend Economic Contractions
Stock prices never just return to fair-value levels following an out-of-control bull. They always drop to half of fair-value and remain there for years. It’s crazy for millions of investors to underprice their portfolios, even crazier than it is for them to overprice their portfolios. At least overpricing gives us the temporary good feeling of believing that we are richer than we really are. Underpricing extends the length of a recession or a depression. Still it’s a reality that has applied for 140 years. There’s a big economic price to be paid for moving stock returns into time-periods other than those in which they were earned.
5) Volatility Scares People Away From the Stock Market
When we try to enjoy stock returns before they have been earned, we increase the volatility of stock prices. There are lots of people who would invest in stocks if prices were less volatile who refrain from doing so because they don’t like the monkey business. We should want everyone who can afford to be invested in stocks to be invested in stocks. There is an economic cost associated with promoting investing strategies that make the stock market look more like a casino than like a way to participate in the gains of our free-market economic system.
6) Telescoping Stock Returns Makes Financial Planning More Difficult
Responsible people work the numbers of their retirement plans. There were millions of people during the late 1990s who used calculators to determine how much they needed to add to their Section 401(k) accounts each month to meet their financial goals. The calculators were telling them that they could count on return of 6.5 percent real for years to come. So those people were double-counting the gains that had been moved from later time-periods to the present. They were thinking that they could count the amounts in their portfolios as real and then enjoy annual returns of 6.5 percent real on a going-forward basis for a long time to come. The joke that was being played on these people was not a funny one.
7) Moving Forward the Recognition of Investing Returns Is Generational Theft
People who retired just prior to the beginning of the secular bear and who lowered their stock allocations when they retired had larger portfolios than they merited by way of the economic realities. They enjoyed the benefits of returns being pushed forward but did not experience the full effect of the downside of this “strategy.” There are of course just as many investors on the other side of the transaction. There are young people who will be behind on their retirement planning efforts for years or decades to come because they began earning enough money to invest in the market only after the secular bull market came to an end and the secular bear market began. People should be able to earn good returns in the stock market at all times. For that dream to become a reality, we all need to work to bring bull markets to an end before they gather so much steam as to become unstoppable.
Rob Bennett has recorded a podcast titled Irrational Exuberance Explains It All. His bio is here.