by Rob Bennett
Buy-and-Hold is popular because of the catch phrases that are used to promote it. Like television commercials, they appeal to the emotions, not the intellect. Marketers know that, once they have won over our emotions, we will use our minds to develop rationalizations for sticking with the strategy to which we have become emotionally attached.
We are told that “You Can’t Beat the Market.”
Gates Capital Management's ECF Value Funds have a fantastic track record. The funds (full-name Excess Cash Flow Value Funds), which invest in an event-driven equity and credit strategy, have produced a 12.6% annualised return over the past 26 years. The funds added 7.7% overall in the second half of 2022, outperforming the 3.4% return for Read More
Why? There’s 30 years of academic research showing that valuations affect long-term returns. Lower your stock allocation when stocks are priced to fall hard and you are obviously going to do better than those who fail to do so. That’s beating the market, isn’t it?
My guess is that the marketing departments of the big mutual funds have done focus groups showing that middle-class investors are looking for humility in stock experts. They are sick of know-it-alls that pretend to insights they do not really possess. The catch-phrase “You Can’t Beat the Market” signals humility. It wins over the hearts of millions of middle-class investors rating straight shooters over smooth talkers.
The fuller reality is that the claim that “You Can’t Beat the Market” is not humble at all. It is arrogant as all get-out. It is arrogance dressed n humble clothing.
The key to understanding the trickery is identifying who it is that we are talking about when we say that a “market” cannot be beat. The impression we get when we are told that we cannot beat the market is that the market is comprised of big brains who know every angle and who we cannot hope to match in a game of wits. That’s a misimpression. The market is — Us!.
You are the market. I am the market. Millions of other middle-class people are the market. Rich people too. Smart people comprise a good percentage of the market. But then so do dumb people. The biggest percentage is no doubt reasonably smart people. Why? Because most of us are not super smart or super dumb but reasonably smart.
The market is us. When we say that it’s not possible to beat the market, we are saying that it is not possible to beat us. We are so gosh-darned smart that no one can ever think it possible to pull one over on us. We are the market and we are always right.
That’s a shocking and repulsive arrogance.
The reason why the catch phrase “You Can’t Beat the Market” is so popular is that it is an exercise in pure flattery. Telling a middle-class investor that he can’t beat the market is like telling a 50-year old guy with a paunch that all the sexy babes are going to fall for him is he buys the red sports car. It’s so absurd that no one could possibly fall for it unless he really, really, really wanted to fall for it.
And we do.
We all are at times tempted to believe that it might not be possible to beat the market. We want to believe that we are perfect beings. The only way that it could ever be the case that we could not beat the market would be if we had achieved perfection. If we set prices properly, the market would be unbeatable. We enjoy believing that it is not possible to beat the market because the unspoken premise of the claim is that we the market have attained perfect knowledge of how to invest in stocks.
You can beat the market.
How? By taking note of how the market has messed up and by setting your stock allocation accordingly.
The P/E10 value tells you how much we are messing up in our efforts to invest effectively at any given point in time. Pricing stocks too high is a mistake. Pricing stocks too low is a mistake. Whenever stocks are not priced at fair value, we the market have made a mistake. That’s not just a true statement. It is a true statement by definition. If either overvaluation or undervaluation exists, the market must be beatable.
We need to stop flattering ourselves. We need to restrain the arrogant spirit that tempts us to want to believe that it might not be possible to beat the market. The market is us. We are flawed creatures. Of course it is possible to beat us.
There’s a song titled “Trap Door” that explores this phenomenon. It argues that: “It’s when you are feeling proud that you really should feel ashamed.” It’s when large numbers of investors come to believe that the market cannot be beaten that the market is in the most trouble it has ever been in and is most subject to being beaten handily by any investor who has not permitted himself to get caught up in the mass outbreak of investor arrogance.
This one concludes with an Alfred Hitchcock twist.
What will happen when the losses we suffer from following Buy-and-Hold strategies have grown so large that our pride is broken and we come to realize how shameful it is to believe that we the market can never be beaten? Once we humble ourselves and acknowledge that of course we make mistakes and thus can be beaten, we will make the allocation adjustments needed to bring stock prices to fair value levels.
At that point, stocks will be properly priced. At that point, it really will not be possible to beat the market!
It is by being humble that we achieve the thing we assumed ourselves to have achieved without effort when we patted we the market on the back by claiming without justification that we are so perfect that we cannot possibly be beaten.
Rob Bennett believes that by studying the historical return data we can advance our understanding of how stock investing really works. His bio is here.