Valuation-Informed Indexing #282
by Rob Bennett
Claim #8: “If over some interval in the first decade or so of the 21st Century the U.S. market is going to follow an uneven course down, as well it might — back, let us say, to its levels in the mid-1990s or even lower…the real losses could be comparable to the total destruction of all the schools in the country, or all the farms in the country, or possibly even all the homes in the country.” (Page 213)
Baupost's investment process involves "never-ending" gleaning of facts to help support investment ideas Seth Klarman writes in his end-of-year letter to investors. In the letter, a copy of which ValueWalk has been able to review, the value investor describes the Baupost Group's process to identify ideas and answer the most critical questions about its potential Read More
The economic crisis brought on by the out-of-control bull market of the 1990s (which in turn was brought on by the relentless promotion of Buy-and-Hold strategies) has caused the formation of radical political movements on both the right (The Tea Party Movement) and the left (The Occupy Wall Street Movement). People are losing confidence in our political system because of the economic damage caused by the continued promotion of the old model for understanding how stock investing works. Yet the matter is never discussed in political debates!
Claim #9: The loss will not be borne equally. Some who rode the market up to new prosperity will have lightened up on their stock holdings and will keep their gains; others will have recently entered the market and will take only the losses. Thus a substantial fall in the market would leave some people really poor while leaving others very rich…. People who have put away only a modest amount in the stock market for their children’s education may find that their savings are inadequate, that the real value of the portfolio has fallen far short of the increased cost of a college education…. Others, a little older, may find that their careers or ambitions are thwarted.” (Page 214)
There is of course always some luck involved in achieving success in life. But the extent to which luck plays a role is greatly increased when stocks offer an amazing value proposition at some times (when prices are low) and a poor value proposition at other times (when prices are high) and when most investors are not aware of this critically important reality because it has become taboo to mention it. The more we make success in life a product of luck, the less equitable and the less stable a society we create for ourselves.
Claim #10: “The optimism represented by the high stock market has coincided with a much lower personal savings rate in the United States — in fact a personal savings rate of around zero…. It is reasonable to suppose that the stock market in the first decade of the 21st Century will decline in value by an amount on the order of one year’s national income…. If we are to offset by additional saving such a decline in ten years’ time… we will have to be saving on the order of an additional 10 percent of our pretax incomes each year.” (Page 216)
People need to know the true value of their accumulated assets to engage in effective financial planning. It is perfectly understandable why people would save less during a bull market; the Pretend Gains reported on their portfolio statements tell them that they are closer to achieving their saving goals than is the reality. The bigger a bull market, the greater the human suffering that follows it as wealth evaporates in the return to proper valuation levels. All in the industry have a huge incentive to pretend that bull-market gains are real. But how do they answer to the millions who have seen their lives destroyed or damaged as a result of the widely and frequently repeated deceptions?
Claim #11: “Once, just before going on national television, the anchor looked me squarely in the eye and told me that what I said could conceivably have an impact on the market, and that people can get upset if they perceive prognosticators as disrupting the market…. If I were not so involved with research on speculative behavior, I might well have responded to the subtle pressure to conform and soft-peddled by pessimistic views. As it is, however, I can only tell the truth as I see it.” (Page 240)
A poster at a discussion board once told me that everything that I say about how stock investing works made perfect sense to her. Still, she did not intend to move away from her Buy-and-Hold strategy because the success of her retirement plan was at stake and the “experts” were not saying anything close to what I was saying. This poster had never been informed of the phenomenon that Shiller points to here, that those expressing views that support Buy-and-Hold are rewarded in their careers and that those who express views that support Valuation-Informed Indexing are penalized. The deck is stacked, at least for so long as prices remain high.
Claim #12: “One investment manager for a pension plan spoke to me about how difficult it was for him to suggest in his public statements that people should perhaps be concerned about the overpricing of the stock market. Despite his considerable reputation and apparent sympathy with the views expressed in my book, he seemed to be saying that it was not within his authority to make bold and unprovable statements contrary to conventional wisdom. He seemed to view his charge as interpreting received doctrine, and that it would be considered a dereliction of duty to voice contrary opinions that came only from his own judgment.” (Page 240)
The healthy way for a society to move from a belief in one model for understanding how stock investing works to another is through a gradual process in which those who believe in both models express their views just as strongly as they believe them. The problem in the stock investing field is that the hundreds of questions that get raised when someone questions whether Buy-and-Hold is a fundamentally wrong model are such painfully sensitive ones. The theoretical reality is that there is more need for open and full debate over matters that are of such great import. But the practical reality is that people who have built their careers around a mistake that is likely to ruin the lives of millions will remain highly reluctant to acknowledge this until they are left with no other option. An academic told me that she believes that we will see the transition from Buy-and-Hold to Valuation-Informed Indexing take place only after we experience an economic crisis bigger than the one we experienced in late 2008.
Rob Bennett’s bio is here.