Valuation-Informed Indexing #271
by Rob Bennett
I don’t believe that Buy-and-Hold can work. Buy-and-Holders don’t consider valuations when setting their stock allocations. That makes no sense. It is essential to consider price when buying something. There is no reason to believe that stocks are the sole exception to that otherwise universal rule.
I face one big problem in making my case.
The Buy-and-Holders are smart. I’ve spoken to thousands of Buy-and-Holders over the past 13 years and I’ve never yet encountered a dumb one. And the Buy-and-Holders don’t buy what I say. They say that investors can be assumed to act in their self-interest and that that insures that stock prices will never stray too far from where they should be. To argue that stocks were priced at three times fair value at the top of the bubble, as valuation metrics show to have been the case, is crazy. Rational investors could never let prices get so out of hand, according to my Buy-and-Hold friends.
My response is that humans greatly underestimate their capacity for self-deception. I have a story from my own life to present to you that in my view reveals this capacity for self-deception in a powerfully compelling way.
I was recently diagnosed with diabetes. It’s a serious disease. It can cause loss of vision. It can cause gangrene, requiring the diabetic to have his legs cut off.
I knew a long time ago.
I experienced my first symptom two years ago. I had dry mouth, especially when I ate something sweet. I looked up the symptom on the internet. I was informed that dry mouth is a common early symptom of diabetes. So I knew.
Treated early (primarily by a change in diet), diabetes can be held in check. So it is important to see a doctor on the first sign of symptoms. I didn’t go to a doctor when I experienced dry mouth. I didn’t want to change my diet. So I didn’t want to acknowledge that I had diabetes. So I lied to myself. I told myself that maybe I didn’t have diabetes.
Did I believe this obvious lie?
Kind of. Sort of.
And on another level of consciousness I saw through the lie. I am one of the humans. That’s how we humans operate. We can know something and not know it at the same time if we are too smart not to know and too determined not to know to accept the realities.
The dry mouth went away in a few weeks. Some months later a second symptom appeared. I felt a tingling in my feet. That’s another classic symptom of diabetes.
I told myself three different lies about the tingling in my feet. First I told myself that I was imagining things. The tingling was slight in the early days. So I was able to get away with that one for a time. Then the tingling got a big stronger. Now I told myself that I needed new running shoes. That one didn’t work anymore once I broke down and got new running shoes. Then I told myself that the tingling wasn’t so bad. That was the most pathetic lie. I wasn’t even making up a story anymore; I was just making an excuse for not doing anything about the problem.
This past Summer a third symptom appeared. I lost a lot of weight. I went from 260 pounds to 220 pounds. Diabetics often lose weight because their cells are not able to absorb sugar and the sugar leaves their body through their urine rather than being stored as fat (please understand that damage is being done to the organs when this is happening — getting diabetes is not a smart approach to taking off those extra pounds!). I never acknowledged that I was losing weight. I knew that I was eating like a pig and so I dismissed the evidence that this was happening. There were several occasions on which friends that I had not seen for some time remarked that I looked “trim” and I rejected their observations out of hand as flattery. I never got on a scale. I didn’t want to see that the number had gone higher than 260 as a result of my poor eating habits. I kept myself in the dark as to what was going on.
Things got crazy. I say that now because there’s no cause for me to lie to myself about it anymore. But I made up stories in earlier days and pretended to believe them. It’s hard to deceive one’s self about the loss of 40 pounds of weight. When I was getting ready for bed and I would take off my belt, my pants would drop to the floor without me removing them. I was wearing pants with a size 40 waist when I should have been wearing pants with a size 36 waist. I was acting in a stupid and crazy manner. No? I don’t think that I am generally a stupid and crazy person. But I cannot deny the stupid and crazy behavior that I evidenced for those two years. This all happened.
What was I thinking?
I even have a particular reason for taking diabetes seriously. I had an uncle who had to have his legs cut off because he failed to change his diet after being diagnosed. I remember thinking as a teenager how horrible this was. It’s bad enough to lose one’s legs. But to lose them because you didn’t take an action that you knew was needed to prevent the loss — that’s doubly horrible. My uncle — one of the self-deluded humans — did that. Knowing what happened to him as a result of his delusions, I walked a good ways down that same path over the past two years. I’m a mess!
We all are.
That’s the point of Shiller’s “revolutionary” (his word) finding of 1981 that valuations affect long-term returns. If Shiller is right (there is now a mountain of evidence showing that he is), the mis-pricing of stocks is a real phenomenon. When stock prices rise to the levels that they rose to in the late 1990s, we are borrowing from our future selves and we have to pay the money back in years to come.
Rob Bennett’s bio is here.