Shiller Showed That Market Timing Is Price Discipline — That Changes Everything

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Shiller Showed That Market Timing Is Price Discipline — That Changes Everything

Book authors are told that they need an “elevator pitch,” a concise statement of the message of their book that will excite agents and publishers. My elevator pitch for Valuation Informed Indexing is — Shiller showed that market timing is price discipline and that changes everything.

The conventional line on Shiller is that he showed that valuations affect long-term returns. That’s just a non-provocative way of saying that market timing is price discipline. If valuations affect long-term returns, the risk of buying stocks is different at different valuation levels. If stock investing risk changes with changes in valuation levels, investors who want to keep their risk profile constant over time must adjust their stock allocation when valuations change. That’s market timing. If Shiller is right, market timing must work and market timing must benefit the investors who make use of it.

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If Shiller is right, practicing market timing is exercising price discipline. How could exercising price discipline ever be a bad thing?

If market timing is price discipline, the safe withdrawal rate is not always 4 percent but a number somewhere between 1.6 percent and 9.0 percent, depending on the valuation level that applies on the day the retirement begins.

If market timing is price discipline, stocks are not always the best investment choice. There is some price at which other investment classes (even super-safe investment classes like IBonds and Treasury Inflation-Protected Securities (TIPS) offer a stronger long-term value proposition than stocks.

If market timing is price discipline, stocks are not necessarily more risky than bonds. There are some price levels at which all of the long-term return possibilities for stocks are better than some of the long-term return possibilities for bonds.

If market timing is price discipline, stocks do not offer better returns than other asset classes solely because investors are being compensated for taking on more risk. In some cases, stock investors are being compensated because stocks are perceived as being risky even though the real risk of investing in stocks is small and in other cases stock investors are taking on large amounts of risk in exchange for a promise of only small returns.

If market timing is price discipline, investment advice that discourages market timing is going to hurt not only the investors to which it is directed but the entire economic system. A market in which price discipline is forsaken is a market that becomes dysfunctional and that eventually collapses. If market timing is price discipline, it is the heavy promotion of Buy-and-Hold strategies that causes price crashes.

If market timing is price discipline, it is the widespread belief in Buy-and-Hold (that is, in the idea that price discipline is not required when buying stocks) that causes economic crises. Trillions of dollars of consumer spending power disappear in price crashes. The economy obviously must contract dramatically when trillions of dollars of spending power disappear.

In short, if market timing is price discipline, investors are not entirely rational beings. If investors rationally pursued their self-interest, as the Buy-and-Holders believe, they would always practice price discipline. But Buy-and-Hold advocates not only fail to encourage investors to engage in market timing, they actively discourage the practice.

Shiller has described the intellectual leap from the finding that short-term price changes are unpredictable (University of Chicago Economics Professor Eugene Fama showed this in research published in the 1960s) to the Buy-and-Hold belief that the market sets prices properly as “one of the most remarkable errors in the history of economics.” I think that’s right. Market timing does not work in the short term because it is investor irrationality that causes both overpricing and underpricing and no one can say how long such irrationality will remain in place. But, for long-term market timing to not work, irrationality would need to be able to remain in place indefinitely. That’s a very different proposition. There has never in the history of the market been a time when mispricing remained in place indefinitely.

Which is another way of saying that there has never in the history of the market been a time when market timing (price discipline!) did not work. Price discipline/market timing is the key to long-term stock investing success.

Rob’s bio is here.

Updated on

Rob Bennett’s A Rich Life blog aims to put the “personal” back into “personal finance” - he focuses on the role played by emotion in saving and investing decisions. Rob developed the Passion Saving approach to money management; Passion Savers save not to finance their old-age retirements but to enjoy more freedom and opportunity in their 20s, 30s, 40s, and 50s - because they pursue saving goals over which they feel a more intense personal concern, they are more motivated to save effectively. He also developed the Valuation-Informed Indexing investing strategy, a strategy that combines the most powerful insights of Vanguard Founder John Bogle and Yale Professsor Robert Shiller in a simple approach offering higher returns at greatly diminished risk. Tom Gardner, co-founder of the Motley Fool web site, said of Rob’s work: “The elegant simplicty of his ideas warms the heart and startles the brain.”
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6 COMMENTS

  1. Wade gave a large number of credit on HIS paper. I have my name on many papers in the credit section, just like others. Getting credit doesn’t make you an author.

    Your constant lying just hurts your credibility.

  2. A

    number of people were listed in the credits. You were not a co-author.

    Your timing scheme failed. You even documented your own failure. Repeating lies won’t help.

  3. Me and Wade worked together on that paper for 16 months. Wade gave me credit for the work that I did with him on many occasions. We exchanged scores of e-mail during the time that we were working on it and I have posted the texts of those e-mails at my web site. Wade’s conclusion at the end of our research was: “Yes, Virginia, Valuation-Informed Indexing works!” That says it.

    The research that I did with Wade shows that an investor who failed to practice long-term timing (price discipline!) always increases his long-term return while reducing his risk. That’s working, in my book. Buy-and-Holders urge investors NOT to practice long-term timing (price discipline). Since practicing timing reduces risk and increase return, failing to practice timing does the opposite. So Buy-and-Hold has never worked.

    Is it a good thing to practice market timing or not? That’s the question. If the market were efficient, as was believed to be the case when Buy-and-Hold was developed, market timing would be a good thing. But Shiller showed in 1981 that the market is NOT efficient, that in fact valuations affect long-term returns. If valuations affect long-term returns, the stock investing risk is not stable but variable. If risk is variable, then investors who want to keep their risk profile stable over time MUST practice market timing to do so. So how could market timing ever be a bad thing?

    This issue is not controversial because it is hard to understand or because the research is not clear. This issue is controversial because, if it is true that valuations affect long-term returns, then we need to adjust our portfolio numbers for the effect of valuations to know the true and lasting value of our stock holdings. The adjustment today would be to divide by two. It hurts to know that your stock holding are only worth one-half of what you were led to believe they were worth. Of course, the other side of the story is that it is impossible to engage in effective financial planning if you don’t know the true and lasting value of your holdings.

    Those are my sincere thoughts re these matters, in any event, Sammy.

    Rob

  4. No, you did not co-author a paper with Wade. Of course, you use that line repeatedly, despite being proven otherwise. You have yet to show one single person with a successful track record when utilizing VII and you have also failed to show even one person that has failed while implementing buy, hold and rebalance. When confronted with data, you ignore it.

    With all that said, you are still avoiding the question I continue to ask as follows: Given your failed plan utilizing VII, why should anyone listen to you?

  5. I co-authored (with Wade Pfau) peer-reviewed research that shows that Valuation-Informed Indexing has been far superior to Buy-and-Hold for as far back as we have good records of stock prices. Engaging in market timing always dramatically reduces risk while also dramatically increasing return. That’s results, Sammy. That’s what an investment strategy should be aiming to do.

    It’s true that it can take a long time for market timing to work. Usually 10 years is enough. But even that is a long time. In the current bull/bear cycle, we have been at very high prices for 23 years. That’s a very long time. Still, in the event that Shiller is right that overvaluation is the product of irrational exuberance rather than of rational investor assessments of economic realities, the Valuation-Informed Indexers will end up on top when the price crash finally comes.

    It all comes down to whether stock price changes are caused by rational assessment of economic realities (the Buy-and-Hold belief) or by shifts in investor emotion (the Valuation-Informed Indexing belief. I obviously believe the latter. What I believe really, really strongly, though, is that we all should be exploring these questions at every site on the internet. This is super important stuff. We all should be doing all that we can to figure it out.

    That’s my sincere take, in any event, Sammy. I naturally wish you all good things.

    Rob

  6. Do you think if you keep repeating something, people will finally believe it? What matters to people are results. As we all know, your VII strategy failed. Based on your own posts, we can calculate that you have spent down most, if not all of your nest egg. If a buy and holder went 17 years without a market recovery, you would be telling him that his planned failed. Imagine that same buy and hold person telling you “we will all have to wait to see how it all plays out”. That would be ridiculous.

    It is results, Rob that matters. That is what pays the bills. That is why I keep asking you to show us just one successful outcome from a VII investor.

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