Valuation-Informed Indexing #229
by Rob Bennett
1) Valuations Either Mean Nothing at All or a Great Deal Indeed. A regression analysis of the historical return data shows that the most likely 10-year annualized return on stocks dropped from 15 percent real in 1982 to a negative 1 percent real in 2000 because of the increase in valuations. Few investors changed their stock allocations to the extent suggested by that change in the value proposition of owning stocks. Why not? Do we believe that valuations affect returns or not? If we believe that the market is efficient, overvaluation is a myth. Not too many of us believe anymore that the market is efficient. But what do we believe?
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2) Academic Researchers in This Field No Longer Have Confidence in Their Work. Rob Arnott once spoke at a conference of academic researchers in this field and asked how many still believed in the Efficient Market Theory. A tiny number of hands went up. He then asked a follow-up question: How many of the researchers would be using the Efficient Market Theory as the core assumption in the research that they would be doing when they got back to the office on Monday morning? Nearly every hand in the room shot up. Huh?
3) The Smartest People in This Field Are Afraid to Explore the Most Important Questions. I was working with an academic researcher a few years back and he submitted a research paper for peer review. One of the members of the committee that rejected the paper found the paper interesting but was concerned that its conclusions went very much against the conventional investing advice. He commented that (I am paraphrasing): “It would be great if we knew which theory was correct.” It would indeed! My thought is that we would be better able to determine which theory is correct if we published more papers examining what the data says about the conflicts between the two theories.
4) We No Longer Even Pretend That Economics Is a Science. Eugene Fama and Robert Shiller are both giants. They both deserved the Nobel Prizes in Economics they were awarded in late 2013. But many experts noted how odd it was that two leading researchers who have come to opposite conclusions about how stock investing works were awarded the prize at the same time. Shouldn’t the leaders in this field try to sort out who is right and who is wrong? The retirement hopes of millions depend on the answer to that question. And yet we have never had a national debate on it.
5) The Connection Between Economic Collapses and Stock-Market Price Crashes Is Poorly Understood. Something happened in 1929. There was a stock crash. And there was an economic depression. Did one cause the other? And, if so, which one caused which? We had another stock crash in 2008. And we had another economic collapse at that time too. We tell ourselves that we are on our way out of the recession. But there seem to be doubts residing underneath our surface confidence. Are we confident that we understand the true cause of the collapse. If we are not, can we be confident that we are on our way to overcoming it?
6) Many of Our Conventional Beliefs Just Don’t Add Up. I was taken aback when John Bogle said in early 2009 that he knew the drop in stock prices would not last long because it was preposterous to think that U.S. businesses had lost nearly $10 trillion in market value in so short a time. I understood the point he was making and I agreed with it. But it seemed to me that Bogle was saying that the market was not properly valuing stocks during those early months of 2009. Wasn’t he rejecting the core belief on which the entire Buy-and-Hold Model for understanding how stock investing works is built?
7) Investors Are Emotional. Visit a few investing discussion boards. You’ll see that what I am saying here is so. It is a troubling reality. It is investors that set stock prices. If investors are as intensely emotional as they show themselves to be everywhere on the internet where stock investing is discussed, can we count on them to set prices rationally and responsibly?
8) The Wall Street Journal Stated that Investing Experts “Leave Out Half the Story.” I commented on the article that said this here and elsewhere at the time it was published, a few years back. I think of it as one of those cases where the dog that doesn’t bark tells a tale by failing to do so. On the surface, it’s an amazing claim. If the experts are leaving out half the story, they are doing more harm than good. No? But other than me no one commented on the article. There should have been a nuclear explosion and there was nothing.
9) Discussion of How Shiller’s Findings Affect How We Should Set Our Stock Allocations Is Taboo. Behavioral Finance is important. Everyone acknowledges this. But important how? What most people want to know when they study the stock investing literature is — What should my stock allocation be? You won’t learn anything about that topic by reading Irrational Exuberance. That aspect of the question is ignored in the book. Why? What’s going on?
Rob Bennett has recorded a podcast titled Bogle on Minsky: We Have Met the Market and It Is Us. His bio is here.