Valuation-Informed Indexing #349
by Rob Bennett
Amid Predictions Revenue Could Tank 50%, Asset Managers Still Unprepared For Mifid II
I have learned a lot from my Buy-and-Hold friends over the years and I continue to do so until this day. I interact with Buy-and-Holders on an almost daily basis at my blog and on a weekly basis in the comments section to this column. A high percentage of the columns and blog entries that I write originate in discussions that I have with my Buy-and-Hold friends. The challenges that they put to me sharpen my thinking and push me towards consideration of ideas that I previously ignored and occasionally even cause me to come to understand that I have gotten something wrong and need to retrace my steps.
And of course I am always seeking to convert my Buy-and-Hold friends to Valuation-Informed Indexing. In fairness I sometimes wonder — Am I even open to the possibility of converting back to Buy-and-Hold?
I see it as a remote possibility at this point. I gave up on Buy-and-Hold on the evening of August 27, 2002. In the first few months following that date, I think it would have been entirely possible that I might have switched back. But as a belief is held for longer and longer time-periods, the belief becomes more solidly held. I like to think that my mind remains slightly open. But it would take a lot at this point for me to flip back to a belief in the Buy-and-Hold model for understanding how stock investing works.
When people ask me what it would take, the first thought that comes to mind is that the publication of peer-reviewed research supporting the Buy-and-Hold concept would do the trick. Buy-and-Holders believe that there already is research supporting their strategy and that there has been since the 1960s. I don’t think that’s right. Eugene Fama’s research purporting to show that market timing doesn’t work only examined short-term timing. Robert Shiller was the first researcher to examine long-term timing and he showed that long-term timing always works. So it is my belief that Fama’s research has been discredited and that the only research that still counts argues against Buy-and-Hold rather than for it.
However, if Fama’s research could be discredited, it is at least theoretically possible that Shiller’s research could be discredited as well. If that were to happen, I would have to reconsider my beliefs. The thing that won me over to Buy-and-Hold a good number of years back was the claim that the peer-reviewed research supports the strategy and it was my discovery that this is in fact not the case that caused me to lose confidence in it. Still, given that Shiller’s research has not been discredited in 36 years despite the great desire on the part of many Buy-and-Holders to undermine it indicates to me that Shiller’s research is legitimate.
One development that has shaken my confidence in Valuation-Informed Indexing to a small degree is the length of time that high valuations have remained in place. Stock prices reached insanely dangerous (from an historical perspective) levels in 1996 and have generally remained at such levels except for the first few months following the price crash of September 2008. Shiller predicted in 1996 that investors who stuck with their high stock allocations would live to regret it within 10 years and, while that prediction was partially borne out by the price crash of 2008, it was also partially not borne out by the big price increases that we have seen in the days since. Most Buy-and-Holders are somewhat disappointed with how stocks have performed from 2000 forward but few would say today that they regret sticking with their high stock allocations from 1996 forward.
We really are traveling through uncharted waters. Stocks have never before in U.S. history remained this high this long. This reality gives me pause. Could it be that the pattern that always applied in the past (that returns would be greatly reduced in times of high valuations) no longer applies and that, thus, it is now a mistake for investors to lower their stock allocations in response to price jumps evidencing irrational exuberance?
Perhaps. But I think that a better explanation of the long string of high-valuation years is that investors have been lulled into a false sense of security by the promotion of the Buy-and-Hold strategy. Most investors believe that there really is peer-reviewed research showing that there is no danger in failing to exercise price discipline when buying stocks. It makes sense to me to believe that a widespread belief that prices don’t matter would permit prices to remain high for a longer time that they have ever remained high before. But not permanently.
A third possibility is that some clever researcher could explore a new model that represents some sort of mix of the Buy-and-Hold and Valuation-Informed Indexing concepts. I am not able to imagine what that might be. But it is my sense that the Buy-and-Holders were not able to imagine Shiller’s findings in the days before they were published and indeed that many have not been able to integrate those findings into their own thinking on how stock investing works to this day. Unexpected things happen in this world. Perhaps something new will come along tomorrow that will replace Valuation-Informed Indexing in the way that I believe that Valuation-Informed Indexing replaced Buy-and-Hold back in 1981.
Rob’s bio is here.