Valuation-Informed Indexing #221
by Rob Bennett
I’ve read Irrational Exuberance all the way through three times and I’ve read some sections four times.
Gates Capital Management's Excess Cash Flow (ECF) Value Funds have returned 14.5% net over the past 25 years, and in 2021, the fund manager continued to outperform. Due to an "absence of large mistakes" during the year, coupled with an "attractive environment for corporate events," the group's flagship ECF Value Fund, L.P returned 32.7% last Read More
I’ve picked up on many new and powerful insights each time.
A book presents an argument. The argument is laid out logically. You would think that the reader would either accept the logic of it or reject the logic of it and that would be the end of it. One careful read should be all that it takes to get what there is to get out of a book.
But that’s not at all the way it works. Especially when the book in question is as grounds-breaking a book as is Shiller’s masterpiece.
I believe that it would be possible to pick up on all the insights presented in a book that made the case for Buy-and-Hold investing. That’s because we are all familiar with the tenets of Buy-and-Hold today. So, if I were to read a new book Bogle, I could absorb most of the message in a single take.
However, I don’t think that that would have been true if I had read a book on Buy-and-Hold back in the early 1970s, when the strategy was being introduced to the world. It is the newness of the ideas in Irrational Exuberance that make them hard to absorb. Shiller is presenting an entirely new model for thinking about how stock investing works. There are over a dozen fresh concepts backing up the new paradigm. The reader’s mind is challenged in trying to keep up with them all as each new idea is explained.
On the first read, some new ideas click. But the reader passes over others because he can only take in so much at one time. When he returns to the book at a later date, he possesses the background needed to absorb the ideas ignored on the first reading and he finds himself enjoying a second exciting reading experience.
I remember the second time I read Irrational Exuberance. I was at the beach with my family. Shiller’s words were hitting with as much power as they did the first time I read the book several years earlier. I kept interrupting my wife’s reading of her own book to express my amazement over the experience. It was as if I had never read the book before. It was a strange experience.
I think this phenomenon points to an explanation of why Valuation-Informed Indexing has not become the dominant model for understanding how stock investing works in the 33 years since Shiller published his research showing that valuations affect long-term returns. That was all we needed to know to know that Buy-and-Hold can never work for a single long-term investor. If valuations affect long-term returns, stock investing risk is variable rather than fixed and investors must adjust their stock allocations in response to big valuation shifts to have any hope of keeping their risk profiles constant. But that implication of Shiller’s revolutionary finding does not register until a good number of other powerful insights related to it have been understood and have formed the foundation needed for the ultimate insight to be appreciated with the level of conviction needed for it to gain sufficient strength to overcome the influence of the long-accepted ideas it discredits.
Buy-and-Hold posits that changes in stock prices are caused by economic developments. Valuation-Informed Indexing posits that changes in stock prices are caused by shifts in investor emotions.
Buy-and-Hold posits that future stock prices are not at all predictable. Valuation-Informed Indexing posits that future stock prices are highly predictable.
Buy-and-Hold posits that neither short-term timing nor long-term timing can ever work. Valuation-Informed Indexing posits that short-term timing can never work but that long-term timing always works and in fact is always required for investors seeking to have some realistic hope of long-term investing success.
Buy-and-Hold posts that stocks are always the best investment choice for most investors. Valuation-Informed Indexing posits that stocks are sometimes the best choice and sometimes the worst choice.
Buy-and-Hold posits that stock investors are rewarded for taking on risk. Valuation-Informed Indexing posits that stocks are not necessarily a riskier asset class than certificates of deposit and that it is the investors who make an effort to reduce risk who do best in the long run.
Buy-and-Hold posits that investors acting in their self-interest exploit market inefficiencies and thereby eliminate them. Valuation-Informed Indexing posits that investors lie to themselves to serve the Get Rich Quick impulse that resides within all of us and thus ignore even the most obvious realities when making strategic choices.
Buy-and-Hold posts that it is always better to be committed to stocks for the long term. Valuation-Informed Indexers believe overpriced stocks are more dangerous the longer they are held.
Buy-and-Hold posits that young investors should go with high stock allocations and that retirees should go with low stock allocations. Valuation-Informed Indexing posits that young investors should go with low stock allocations when prices are high and that retirees should go with high stock allocations when prices are low.
Buy-and-Hold posits that price increases should be celebrated. Valuation-Informed Indexing posits that investors should cheer price drops because lower prices permit them to buy more stocks with less money.
Irrational Exuberance exposes its reader to so many new ideas that he cannot absorb them all in a single reading of the book. The book was published 14 years ago. But I believe that the investing public is still in the early stages of achieving an appreciation of its far-reaching message.
Rob Bennett has recorded a RobCast titled The Internet Changes Everything. His bio is here.