I believe that. And I am certainly not alone. Millions of people believe it. I sometimes get the impression that just about everyone believes it.
But we certainly are not putting that belief into action. The fair-value CAPE is 17. Today’s CAPE is 38. Today’s stock market is priced at two times its real and lasting value. We are investing as if we don’t believe that valuations matter at all.
The problem is the thoughts that the relentless promotion of the Buy-and-Hold strategy has put into our heads. The core premise of the Buy-and-Hold strategy is that market timing is a bad idea. It’s true that trying to guess when price shifts will take place rarely works. But that’s not the only possible form of timing. If you change your stock allocation in response to valuation shifts because you want to keep your risk profile constant over time, that’s market timing. You don’t know when the allocation change will pay off (the evidence is strong that it is not possible to know this) but you can have confidence that keeping your risk profile constant will pay off in the long run. For one thing, this is common sense. For another, there is peer-reviewed research showing that it is so.
So we have a battle for the mind of the U.S. stock investor going on. Common sense and the peer-reviewed research tells us that timing always works and is always required. But the Buy-and-Holders say otherwise. The Buy-and-Holders have a lot of influence. Buy-and-Hold is the dominant investment strategy today. Lot of people repeat Buy-and-Hold dogmas without ever personally checking them out. The more often other investors hear these dogmas repeated, the more credibility they acquire. Lots of us today believe in a way of investing in stocks that doesn’t really make sense.
I believe that those of us who believe that valuations matter need to begin challenging the Buy-and-Holders more directly and more frequently. I was a Buy-and-Holder myself once upon a time. I happened to question one dogma (the claim that the safe withdrawal rate is always 4 percent). The reaction that I received to my questioning (effusive support from some, an intense, emotional opposition from others) led me to question more of the dogmas. The more questions I asked, the more dogmas I was able to identify that do not stand up to scrutiny. Today I would describe Buy-and-Hold as “dangerous.” That’s a big change. I got there step by step.
Probably my favorite Buy-and-Hold claim is the claim that investors should seek to “Stay the Course.” That sounds like a responsible, long-term approach to investing. It’s what I am looking for when deciding on ways to invest my retirement money. When I consider the phrase, I understand why I was once drawn to Buy-and-Hold and why so many millions remain enamored of the strategy today.
The trouble, I have come to realize, is in the implementation of the injunction. To Buy-and-Holders, staying the course means sticking with the same stock allocation at all times. That made some sense when the Buy-and-Hold strategy was being developed back in the 1960s. At that time, the Efficient Market Theory was a popular academic construct. If the market were efficient, investors would be engaged in the rational pursuit of their self-interest. They would never misprice stocks. So of course there would be no benefit to be had by changing one’s stock allocation in response to price shifts for the purpose of keeping one’s risk profile constant.
Robert Shiller put the Efficient Market concept to bed with his Nobel-prize-winning research showing that valuations affect long-term returns. If overvaluation and undervaluation are meaningful concepts, stocks offer a different value proposition at different price levels and market timing makes all the sense in the world. Investors really should be Staying the Course but the thing that they should want to keep constant is their risk profile, not their stock allocation. Staying the Course in a meaningful way not only doesn’t require being disdainful of market timing, it requires making use of it.
Another dangerous Buy-and-Hold dogma is the one that says that investors who lower their stock allocation for a time during which stock prices continue to rise are “missing out” on gains they would have obtained had they stuck to their initial allocation. Shiller’s book title suggests the flaw in this line of thinking. It’s obviously true that the nominal value of a portfolio increases during a time of risking prices and that investors who switched to a lower stock allocation will not fully participate in those “gains.” But, if the gains are merely the product of irrational exuberance, is it even proper to think of them as gains? Irrational exuberance gains are nothing like gains backed by economic growth. Irrational exuberance gains are backed by nothing more than a passing investor emotionalism. Investors who treat such gains as real often find themselves suffering setbacks in the long run as the consequence of failing to distinguish between the two very different types of stock gains.
How about the idea that investors needn’t worry too much about losses suffered in the price crashes that inevitably follow times of high stock prices? The claim here is that the market always eventually recovers and indeed someday reaches higher highs. There’s a technical sense in which that really is so. The stock market certainly is always headed upward over time. The rub is that, starting from times when prices are super high, it can take a very long time for prices to recover. Investors who lose less in price crashes can often invest in other asset classes offering better returns until the stock market regains the allure it possesses when prices are reasonable.
The reason why so many place their confidence in Buy-and-Hold is not that it stands up to scrutiny. It is that too few of us challenge the claims of the Buy-and-Holders when they are advanced. I have learned that the case for Buy-and-Hold is surprisingly weak. Those of us who believe that valuations matter should be aggressively challenging it whenever opportunities to do so present themselves.
