Valuation-Informed Indexing #315
by Rob Bennett
I know a lot of stuff. No more than most others, to be sure. But a lot, all the same. Even the slowest among us manages to pick up the stray bit of knowledge here and there. The years pass. And then one day we are compelled to acknowledge the strange truth that, starting from zero, we have over the course of a lifetime come to know a lot of stuff.
How does this magic happen?
I don’t believe that reading books is the key. I am addicted to reading. But as much as I love books, I have to acknowledge that, when I try to tell someone what i learned from a book that I read more than a year ago, I frequently struggle to provide much detail. Books are a critical part of the learning process. They present information in an organized way that permits the insights offered to stick in the brain. I don’t think that knowledge can be communicated without the aid of books or some other communications medium that serves the same general purpose. But I don’t think that books alone can get us to where we want to go. It takes more than reading words on paper or on computer screens to come to know things.
[drizzle]There are a small number of books that have had a big impact on me. What made them different? What element of the learning process is it that is missed in regard to most books that I read but enjoyed in regard to the small number of books that make a difference?
It’s talking over the ideas presented in a book that transforms the material from letters and words and paragraphs into a life-changing substance. Reading a book is potentially a big deal. It is by talking over the material presented in a book that we realize that potential. We come to know stuff by talking it over.
We learned in 1981 that the Buy-and-Hold investing strategy is rooted in error. The strategy was developed at a time when we believed that that market is efficient, that is, that the price assigned to stock makes sense, that it reflects all information available to the investors setting the price at that moment in time. Shiller showed in 1981 that it’s not so.
He published research showing that valuations affect long-term returns. If that’s so, it is not possible that prices change in response to unforeseen economic developments. If today’s valuation level tells us something important about the stock price that will apply in 10 years, there is something going into the calculation of that valuation level that predicts the future, a seemingly impossible task.
That something is investor emotion. Investor emotion (the Get Rich Quick impulse that resides within us all) causes us to willfully remain ignorant of information re how stocks should be priced that would pop our fantasy Get Rich Quick bubbles if we permitted our conscious minds access to it. When we collectively push stock prices too high (because our natural human greed prompts us to borrow from tomorrow’s profits), we “know” that we are doing harm to our future selves while at the same time we do not know this thing. We don’t want to know it. And our wills are stronger than our intellects. We block out of our brains the knowledge that we need to invest effectively because we want the thrill we obtain by “profiting” from bull markets.
The PE10 valuation metric quantifies all this. It tells us to what degree we are deceiving ourselves. It tells us whether stocks are worth buying relative to other available asset classes. It tells us what we need to know to greatly increase our long-term return while also greatly diminishing investing risk. What an amazing advance!
In the 35 years since Shiller achieved this “revolutionary” (his word) breakthrough for us, we have developed the idea in many important ways. There have been books published about it, some of which have become bestsellers. There have been calculators developed that report the numbers we use to plan our financial futures very differently than the calculators based on pre-1981 knowledge do. There have been all sort of things. In important respects, we have seen more of an increase in our knowledge of how stock investing works in the past 35 years than we saw in any previous 35-year time period.
But —
Valuations remain insanely high today. If we had truly absorbed the lesson, that couldn’t be. Smart investors assess the value proposition of stocks before putting money down on the table. Increasing prices diminish the value proposition. Which reduces demand for stocks. Which lowers the price. Which pulls the value proposition back to where it was before prices got out of hand. Bull markets are impossible in a world in which knowledge of Shiller’s findings is widespread. Overvaluation becomes a logical impossibility in a world in which most investors know that valuations affect long-term returns.
We know what Shiller revealed.
And we don’t know what Shiller revealed.
Both things are so.
What’s missing is the second part of the learning experience. We read words about what Shiller showed in his research. We make his books bestsellers. We praise him. We even award him Nobel prizes. But we don’t talk over what Shiller showed. I am the world expert re this one; I am banned at over 20 investing web sites. Most investors hate the idea of talking over what Shiller showed so much that they cannot tolerate the presence of posters who believe that he said something important and who explore the implications of his findings in the words that they put forward for the consideration of their fellow community members.
We don’t really know what Shiller taught us today. We kinda, sorta do. We can parrot back his words if prompted because we have read those words. But we haven’t yet learned much about what Shiller’s research brings to the table because we have not yet given ourselves permission to talk over the implications of what Shiller’s research brings to the table.
We are close.
The next price crash will get us to where we all deep in our hearts want to be.
Because the next price crash will do away with the fear that for decades now has been holding us back. Acknowledging what Shiller showed means acknowledging that our stock portfolios are not as big as the nominal numbers reported on our portfolio statements suggest. The next price crash will bring those numbers back to earth and thereby do away with the one thing holding us all back from achieving a major advance in our understanding.
You don’t really know something until you talk it through. Knowledge of Shiller’s research is today secret knowledge. There is a taboo that inhibits public discussion of it. We should be expecting that to change in the next year or two or three.
Rob’s bio is here.
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