Valuation-Informed Indexing #254
by Rob Bennett
I write about Valuation-Informed Indexing, the model for understanding how stock investing works rooted in the research of Yale Economics Professor Robert Shiller. In contrast to Buy-and-Hold, Valuation-Informed Indexing posits that investors must adjust their stock allocations in response to big changes in valuations to keep their risk profiles roughly constant over time.
David Einhorn Buys Three New Stocks: These Are The Names And Theses (Q3 Letter)
David Einhorn's Greenlight Capital funds returned 5.9% in the third quarter of 2020, compared to a gain of 8.9% for the S&P 500 in the same period. This year has been particularly challenging for value investors. Growth stocks have surged as value has struggled. For Greenlight, one of Wall Street's most established value-focused investment funds, Read More
It’s strange that there has not been more discussion of the implications of Shiller’s finding that valuations affect long-term returns in the 34 years since his peer-reviewed research showing this was published. Shiller’s finding changes everything. It means that long-term stock returns are highly predictable. It means that stocks are not nearly as risky as we have long believed them to be. It means that the economic crises that have always followed in the wake of bull markets (because the pretend gains generated by overvaluation disappear in time) can be avoided.
Why hasn’t there been a national debate about the implications of these findings? Why have we remained in this Twilight Zone where Buy-and-Hold has been discredited but remains popular for over three decades now?
Discussion of these issues has been discouraged but not entirely prohibited.
I am banned at 20 different investing sites. I have of course never engaged in behavior that would justify a ban. So those of us who aim to get the much-needed national debate launched pay a price for our efforts.
But the full reality is that, even at sites that support Buy-and-Hold strongly, you will occasionally see discussion of Shiller’s findings. It is fair to say that discussion of the implications of Shiller’s findings is censored. But it is a soft censorship. Engaging in in-depth discussion of Shiller’s ideas will get you banned. But surface discussions of his ideas are considered acceptable pretty much everywhere.
When I first started writing about these ideas, I worked under the belief that I was not at risk of being banned at any site unless I violated one of the published rules of the site. I was naive. It doesn’t work that way at all, not in regards to this particular issue.
There have been several sites where there was extensive discussion of whether I should be banned or not. I listen closely to those discussions, trying to figure out what it is in the minds of the Buy-and-Holders that most upsets them in explorations of Shiller’s ideas.
There has never been a case in which anyone advocating a ban pointed to a particular statement that I made that violated a site rule. It’s always one of two claims that are used to support bannings: (1) that I post too frequently; or (2) that my posts are too long.
My posts tend to generate lots of questions. People have heard about the principles of Buy-and-Hold at many different places and at many different times. So, when someone says that “timing doesn’t work” or that “you can’t beat the market,” most people understand where they are coming from. You will often see people agree with those sentiments. But it is rare for people to express a need for them to be explained. We all get what Buy-and-Hold is about at this point.
But when I say that investors need to lower their stock allocations in response to big valuation increases, that confuses people. The idea makes perfect sense. Cars offer a poorer value proposition when they are priced at two times fair value and it seems to follow that the same would be so of stocks. But that is rarely said. So when it is said, the claim generates questions. People want to know how this new way of thinking about stock investing works and why they haven’t heard about it before.
For Valuation-Informed Indexing to take over the world, it is not enough that people be permitted to mention Shiller’s findings. We need to be able to explore their implications in great depth. And we need to be able to make reference to those implications over and over again, on a daily basis. We need to be able to refer to Shiller’s findings every time a Buy-and-Hold principle is advanced as a means of countering that principle. For Valuation-Informed Indexing to become more popular, people need to come to see that Buy-and-Hold is gravely flawed. That comes with repetition of the core point — that stocks are a less appealing asset class when they are overpriced and that they become less and less appealing as the overpricing grows larger and larger.
There was one woman who explained her desire that I be banned by saying: “Rob is one of the sweetest and most polite posters that I have encountered on the internet — and he irritates me to no end!”
I do that deliberately.
It’s not that I want to irritate people. Obviously I do not want to do that.
It’s that most Buy-and-Holders want to believe in Buy-and-Hold and I want to make that impossible.
If I were to say one time that valuations matter and then shut up about the matter, I would not be banned at a single site. Buy-and-Holders can deal with that. They tell themselves that it is a shame that I am so deluded as not to recognize the merit of the Buy-and-Hold strategy but that such is life. If I make the case only one time, people can ignore the message and go on with their lives.
The trouble from my point of view is that people have been going on with their lives for 34 years and Valuation-Informed Indexing has not taken off. For it to take off, people need to be come to terms with what the last 34 years of peer-reviewed research says. They need to hear the message frequently, so frequently that they are no longer able to ignore it.
We overrate the power of logic. Logic is important but it is often the repetition of a point rather than its soundness that persuades people of its merit. The people who produce television commercials get this. They pay to get their message heard over and over and over again. Why? Because that is what gets the job done. That’s what works.
Shiller revolutionized the world of investing analysis. We all have heard about his ideas. We think we know what he has discovered. But we haven’t. Not really. We won’t truly come to understand Shiller’s ideas until we hear them voiced as often as we hear the ideas in which the Buy-and-Hold Model is rooted voiced. We need to hear about the effect of valuations on long-term returns every day and in every discussion of stock investing in which we participate.
Rob Bennett’s bio is here.