Valuation-Informed Indexing #220
by Rob Bennett
Ezra Klein recently posted an article at the Vox.com site that has important things to teach us about why we have been so slow to incorporate Yale University Economics Professor Robert Shiller’s finding that valuations affect long-term returns into our understanding of how stock investing works. The article is titled: “Gamergate and the Politicization of Absolutely Everything.”
Klein writes: “One thing that comes clear when you spend much time reading inside the Gamergate community is the feeling of being misunderstood — and, for that matter, smeared — is very, very real. If you’re reading about Gamergate on the left, virtually all you’re reading about is the intense, horrifying harassment against women that’s happening under Gamergate’s banner. If you’re reading about Gamergate from inside Gamergate, virtually all you’re reading about is how the media is smearing Gamergate by equating it with harassers who don’t represent the movement’s real tactics or goals (some Gamergaters even believe the trolls are part of a false flag operation meant to discredit Gamergate). Gamergaters are furious that the media focuses on all the bullying happening under Gamergate rather than all the money Gamergaters are raising for anti-bullying efforts….Gamergate happens to be about video games but it could be about anything. Video games are the excuse for this fight, not the cause of it.”
He’s saying that people often do not try to settle differences through the use of reason. They choose up sides and then duke it out. All sorts of points are debated. But the points that are being discussed do not matter much to those doing battle. All that matters to them is what side they are on and what side is winning. Once we choose sides, we are not trying to learn, we are trying to win.
Academic Researcher Wade Pfau once made this point when he was advocating Valuation-Informed Indexing at the Bogleheads Forum. Wade was getting a hostile reaction from some of the Buy-and-Hold dogmatics at that board. At one point, he said (I am paraphrasing): “You see those who advocate market timing as snake-oil salesmen. I do not want you to see me that way.”
Valuation-Informed Indexers advocate market timing. Not the form that doesn’t work, the form that the Buy-and-Holders have with good reason come to hate with a burning passion. We are as much opposed to short-term timing (changing your stock allocation because of a belief as to where stock prices are headed over the next year or so) as the Buy-and-Holders. We advocate long-term timing (changing your stock allocation in response to a big shift in valuations with an understanding that you may not see a benefit for doing so for as long as 10 years), the form of timing that always works and is always 100 percent required for investors hoping to keep their risk profiles roughly constant in the face of big valuation shifts.
The Buy-and-Holders should go for that. Vanguard Founder John Bogle often tells investors that the most important rule of all is to “Stay the Course.” It’s obviously not possible for investors to Stay the Course if they don’t keep their risk profiles constant. And of course the entire 140 years of return data available to us shows that long-term timing is of critical importance. So there shouldn’t be any controversy over this matter at all.
But there is.
Buy-and-Holders hate hearing that long-term timing always works and is always required. They don’t just dislike this reality. They hate it with a burning hate. I know whereof I speak.
It’s because of the phenomenon that Klein writes about in the article linked to above.
The question of whether timing works or is required is not a strategic question for Buy-and-Holders. It is an identifier question. For Buy-and-Holders, the good types of investment advisors are the ones who disdain market timing and the bad types of investing advisors are the ones who advocate market timing. Buy-and-Holders really do believe in looking at research for guidance. But not re this matter. They don’t want to know about the mountain of research showing that long-term timing always works and is always required. To even acknowledge the possibility that such research might exist makes a Buy-and-Holder feel that he is considering becoming a heretic.
The religious analogy used to come up all the time in my days of posting at the Bogleheads Forum. Posters who could see some merit in both positions would observe that the Buy-and-Hold dogmatics wanted to burn me at the stake. It wasn’t that the arguments for Valuation-Informed Indexing weren’t strong. It was that those arguments were outside the bounds of acceptable discussion. Never in 12 years has a Buy-and-Holder found any errors in claims that I make for the Shiller-rooted strategy. What I hear on a daily basis is some version of the argument that: “Everyone knows that market timing cannot work.” What everyone knows need not be proven. It is known.
So Valuation-Informed Indexers and Buy-and-Holders talk past each other. It is only when the Buy-and-Holders become interested in learning something new that it will become possible to achieve forward movement.
I believe that that day is approaching. Shiller’s work shows us that stocks are priced today for a 65 percent crash sometime within the next year or two. Losses of that size suffered on top of the losses that investors have already experienced in recent years are going to hit with devastating impact. People are going to open their minds to new ideas. We are going to enjoy 33 years worth of insights in a time-period of about six months. It is going to be a trip.
People are rational creatures. But we flatter ourselves to think that we are only or purely that. We get caught up in our emotions all the time. The Buy-and-Holders were responsible for some hugely important insights. Their showing that short-term timing never works was a big one and they are rightly proud of it. I mean no challenge to that insight when I make the case for long-term timing. But the Buy-and-Holders hear a challenge even when one is not intended. The insight is so important to them that they cannot bear even the thought of cutting it back a bit in the one way in which the research has shown it does not apply.
This will change. But we always need to keep in mind that it is humans whom we are trying to persuade and not robot thinking machines. The Buy-and-Holders are hurting. They shouldn’t be. They should be proud of building the foundation on which the recent advances were built. But in their minds the recent advances represent an attack on an old belief that has become very important to them over the years.