Valuation-Informed Indexing #290
by Rob Bennett
I believe that Buy-and-Hold is dangerous. I believe that, if valuations affect long-term returns (there is now 34 years of peer-reviewed research showing this to be so), then investors must be willing to change their stock allocations in response to big shifts in valuations; if they fail to do so, they permit their risk profiles to go wildly wrong. Buy-and-Hold posits that this is not required, that it is okay to “stay the course” re our stock allocations rather than re our risk profiles.
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Most investors do not agree with me. Many have expressed great interest in my ideas. But many others have voiced a burning hatred of me, a hate so intense that they have demanded that I be banned at over 20 investing discussion boards and blogs. Even those who like my stuff rarely stick up for me when faced with the attacks of the Buy-and-Holders. The usual scenario is that they make a few pleas for calm and then abandon the effort when the Buy-and-Holders return to the battle more determined in their rage than before.
Investing is emotional. That is what Shiller really was showing when he showed that valuations affect long-term returns. It is irrational not to price stocks properly. The P/E10 metric is telling us how emotional investors are at a given point in time. When investors get too emotional, they can pull the long-term return on stocks down to levels that were unimaginable in the days before we began learning the realities that have come to light in the past three decades. That’s what happened in 2000. A regression analysis of the historical return data shows that the most likely 10-year annualized return at the top of the bubble was a negative number. This from an asset class that on average supplies an annual return of 6.5 percent real. Yowsa!
It’s an either/or.
If the Buy-and-Holders are right that stock prices are determined by economic developments, the idea that valuation metrics could tell us anything about how the stock market works is silly. Mispricing is the product of emotion, not economics. If economic developments control, Shiller’s work product is a waste of time.
But, if Shiller is right about valuations, it is the work of the Buy-and-Holders that is a waste of time.
I ordinarily don’t say it that way. It sounds rude to state things so bluntly. The full reality is that the Buy-and-Holders generated many insights of great import. They laid the foundation on which Valuation-Informed Indexing was built. We wouldn’t be where we are today if not for the effort of our Buy-and-Hold friends. So it doesn’t seem right to say that their investing ideas are not just flawed but outright dangerous.
Still, Buy-and-Hold is a numbers-based strategy. It is imperative that numbers-based strategies get the numbers right. The numbers generated by advocates of numbers-based strategies speak in shorthand to the investors exposed to them. Many people invest large portions of their retirement savings in stocks because they have heard the Buy-and-Hold claim that stocks produce an average return of 6.5 percent real (which is true) as well as the Buy-and-Hold claim that it is not possible to know in advance when it is a bad time to buy stocks (which is false if Shiller is right that valuations affect long-term returns). And so they bought stocks even in 2000, locking in the negative long-term return offered by stocks at times when they are selling at such wildly inflated prices. If accurate numbers help us make sound investing decisions, inaccurate numbers trick us into making poor ones.
Are all the numbers produced by the Buy-and-Holders wrong? If Shiller is right, they are. Shiller doesn’t say this. At least not directly. He suggests it in all his writings. But he holds back from saying things in the blunt way that I am known to say them. Why? Shiller is obviously seeking to help us all become better investors. Why wouldn’t he warn us when stocks become a terrible long-term value proposition that that is indeed the case?
It upsets the Buy-and-Holders to hear such reports. That’s why. The Buy-and-Holders think they are right. They have their lives invested in that belief. Their retirement money is riding on it. And they have told their friends and neighbors and co-workers about their strategy. They did that to help those people out. They cannot bear to think that they were sending their friends and neighbors and co-workers down an unfortunate path.
Here’s my question to you —
Assume for the purposes of discussion that I am right that Buy-and-Hold is not just a flawed strategy but an outright dangerous one. I understand that you probably don’t agree with me. But please just for a moment entertain the idea that I am right. If I am right, how would you expect the Buy-and-Holders to react to my writings arguing the case?
They would probably react with great anger. No?
I have seen great anger directed at me from many Buy-and-Holders over the past 13 years. It wouldn’t be possible be exaggerate how strong the anger has been on the part of some and how reluctant those who did not themselves evidence great anger have been to step up and suggest the exercise of some restraint on the part of those evidencing great anger.
I don’t say that that in itself proves the case that Buy-and-Hold is dangerous. My view is that it is the wealth of research supporting Shiller’s core claim that proves the case. But I believe that the anger that I have seen from Buy-and-Holders when I have explored the strategic implications of Shiller’s claim is consistent with Shiller’s core claim. If he is right that it is investor emotion that is the primary determinant of stock prices rather than economic developments, you would expect to see anger on the part of Buy-and-Holders in response to articles exploring the implications of the claim. And that is indeed what I have seen. In spades.
This worries me. Many writers do not want to see anger directed at them. It could be that there are many who suspect that Buy-and-Hold is dangerous but who have been holding back from saying so in clear terms because they do not want to ignite the intense opposition of the millions of investors who today still possess confidence in their strategy but who are also beginning to experience doubts and who feel an intense desire to suppress those doubts.
Rob Bennett’s bio is here.