Valuation-Informed Indexing #405
By Rob Bennett
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
Say that Valuation-Informed Indexing is garbage. Say that Shiller is wrong. Say that valuations really do not affect long-term returns, that the market is efficient. Say that Buy-and-Hold is the ideal strategy.
If all of those things turn out to be so, I am going to look pretty darn foolish, aren’t I? I have devoted the last 16 years of my life to developing the strategy. I have been banned from numerous discussion boards and blogs and thereby separated from my friends. I followed the strategy in management of my own portfolio. If the strategy is a foolish one, I will have lost a lot of money as a result.
I am biased in what I say about how stock investing works. Very, very, very, very, very biased. You need to know that. Every word that I write about the subject of stock investing is drenched in bias. I do my best not to let my biases influence what I say. But of course it is impossible for me to be entirely successful in my efforts in that regard. My biases are so dear to my heart that I don’t see them doing their dirty work when they influence what I write. It is inevitable that there are times when my biases undermine my work despite my efforts to avoid having that happen.
Here’s the thing.
It’s not just me.
We are all biased when it comes to this subject.
We all invest our money to provide for our retirement. Once we do that, we become emotionally invested in the strategy we employ. We start out using it because we think it is a good strategy. But few of us are able to do as much research as we would like before we decide on a strategy. We lead busy lives. We cannot afford to put off investing until we figure it out. To fail to invest our money is to make a decision to choose the worst way to invest. So we go with what looks best at a particular moment in time, going on the limited amount of knowledge that we have been able to acquire about the subject of stock investing up to that moment of time.
We are aware of our lack of knowledge when we make the decision as to which investing strategy to employ. To ease our minds, we tell ourselves that we will no doubt learn more about the subject as time passes and that we can always change strategies if we see a need to do so. But the odds are stacked against us actually pulling that one off. Our bias grows stronger with each dollar that we invest pursuant to the strategy we follow. We might not have been too concerned about getting things right when we invested our first dollar. When hundreds of thousands of dollars have been added to the pile, it’s not easy to acknowledge that that initial choice was made in error.
Have you had the experience of doing the research involved in buying a car and then deciding on a model and purchasing that car and then seeing that car on the road everywhere you drive? Our minds are hit with lots of information bits during the course of a day. We see lots of cars and we do not possess the mental capacity to take note of each one we see. But once we develop an interest in a particular model, we see that model each time it crosses our path. The car was always there before our eyes. But it might as well have not been until we focused on it enough for it to be something that we noticed when it appeared.
It works that way with investing strategies. Stock prices fell hard in late 2008 and early 2009. Lots of people who generally do not pay much attention to stocks became highly interested in the subject at that time. They were worried that their retirement savings was going to be greatly diminished. They heard Buy-and-Holders advise them not to worry because money lost in price drops is always restored in not too long a time. Then they saw that happen. That made a big impression. Lots of those people became confirmed Buy-and-Holders as a result of that experience.
The pro-Buy-and-Hold story really did play out. Perhaps those people were right to be convinced by what they saw. But they saw only the scenario that they were watching for, not every scenario that has taken place in the market since its earliest days. I believe that they would gain a better understanding of how the market really works if they looked at all the scenarios, if they adhered to the disciplines that are required when peer-reviewed research is developed. I believe that, if they looked at all the scenarios, they would conclude that the Buy-and-Holders are wrong, that sometimes losses are recovered in a short time and sometimes they are not and that it is the valuation level that applies in a particular case that determine which it is. I believe that those people were looking for a particular model of car and saw it not because that is the only kind of car to see but because they had trained their eye to watch for that kind of car. I believe that they were looking at events with a biased perspective.
I believe that we all do that. Without intending to. Our minds are structured in such a way that there is always a risk that bias will influence what they perceive. And stock investing is a subject re which the bias problem is particularly strong because it is so important to get it right and yet most of the people who need to make decisions about stock investing do not possess expertise in the subject. The more important it is to get something right, the more likely we are to let our biases get the better of us. When something is important we don’t want to be wrong. And so we tune out information that might cause us to question beliefs on which we have a lot riding.
Rob’s bio is here.