“The Prospector Would Still Be At That Same Spot Still Digging With His Even-More-Callused Fingers”

Today’s blog entry is a guest post by Arty, one of the best contributors to the Retire Early and Indexing discussion-board communities in recent years. I’ve read hundreds of articles about our economic crisis. Few have made the key point about the cause of the crash as clearly and succinctly as the words below. 

Arty put forward the words as a comment to the blog entry entitled “This Month’s Permanent Portfolio,” where he also offered dozens of other comments also worth checking out.

Rob,

Was listening to your podcast on “attitude”. And how investors can remain emotionally “invested” in doing the wrong thing. Reminded me of a story I kept (written I think, by Arthur Jones, who pioneered a far more rational approach to strength training than had existed in the mainstream–and, sadly, still exists as the dominant model, though people are slowly learning:

Imagine you are on a hiking trip through some rugged desert terrain. You see a figure in the distance. It’s an old man, bearded and half-naked, on hands and knees, with his fingers clawing at the hard, sandy earth.

“You ask, ‘What are you doing?’

” ‘I’m digging for gold.’

” ‘How long have you been at it?’

” ‘Weeks — months maybe. It’s painfully slow work.’

“You notice the old man’s bloody fingers, his raw and callused knuckles. You say, ‘But listen, man! Digging with your bare hands is a pretty inefficient way to prospect for gold. That hole’s only a couple of feet deep. Let me loan you my shovel.’

“You reach into your backpack, pull out a lightweight, tempered-edge spade, and drive it into the ground. Then, you show the man how he can break and scoop the hard sand much more efficiently. In less than five minutes you have demonstrated to the old fellow that he can make more progress in a few moments than he could in a month of using his bare hands.

“Then, an amazing thing happens,”. “That old man’s eyes fill with hate and his face flushes angrily. He charges at you and grabs the shovel from your hands. He’s now preparing to throw the shovel, or perhaps even try to beat you with it.

“You quickly retreat, and get the hell out of the old man’s range, as the shovel comes crashing down behind you on the hard sand.”

That’s not the end of the story.

“If you return to that rugged location in the desert a year later, what would you expect to see that old man doing? Would he be using the shovel properly and have holes as big as school buses spread over the immediate and adjacent surroundings?

“No, absolutely not! Instead, the prospector would be at that same spot — with a somewhat bigger hole — still digging with his even-more-callused fingers. And there, in plain sight, only a few yards away . . . would be the unused, and now rusty, shovel.”

Arty

Comments

  1. Evidence Based Investing says

    The prospector’s approach seems to be catastrophically unproductive.

  2. Arty says

    Rob,

    Some questions and thoughts.

    When you make a valuations assessment based on P/E 10, you are weighing some allocation percentage into stocks vs. an allocation in comparatively riskless T-Bills or TIPS (held to maturity) say. Is that correct?

    Even though the valuation level for Value stocks was high at 2000 (it was the tech “growth” bubble that truly exploded) you are really looking mainly at the S&P 500 as your “equities”, and not the small, or value classes, which, can and have, had their own valuations cycles? (Though, granted, at many times all classes get crushed in crises, like in *this* bear.) But your focus remains on broad market (TSM) equities and valuations, not really anything else, yes?

    Are there any other tools you’ve seen, other than P/E 10 that hold some predictive power? Must P/E 10 be used alone or can it be used in conjunction with other valid measures? If, for example you have high equity valuations and high TIPS yields (4%, say), well, it is then a good idea to move much of your equity position into TIPS. But what if the TIPS yield at that time is 1%? This is just an example, but I’m wondering if there are other signals that are useful too, in conjunction with P/E 10.


    More on studies… In logic and persuasion, there is a fallacy we may call, context switching. The use (misuse) of the market timing studies employs this well. Here, a portion of “the truth” is embraced (short-term timing does not work, or the brief period covered shows it does not work) and made to seem the one, absolute and all applying ‘truth” (market timing does not work).
    —-

    While on studies, I would like to see your work submitted to a journal, using whatever tools you developed as the subject of the work. I don’t view this as just another valuations article. With the tool, it might be much more than that and can build directly on the work of Shiller et al. You have a good writing and numbers team (between you and John_, to make such a submission. I think that sort of science could only help the state of affairs. And, the timing can not be better within the next year or so.
    —-

    One more thought on the Harry Browne portfolio. You mentioned lack of income as a concern. But it does have the cash (ST bond component) and the LT Bonds (20-30 years). That and good returns overall in various economic environments. Just a thought…

    Arty

  3. Rob says

    But your focus remains on broad market (TSM) equities and valuations, not really anything else, yes?

    The calculator was built using the history of the S&P 500. In a direct sense, it only makes “predictions” of where the S&P will be in 10 years.

    Knowing where the S&P will be gives you a general idea of where all sorts of other things will be. But only a general idea. The farther away you move from an S&P portfolio, the less accuracy you are going to get from a calculator based on the history of the S&P.

    John Walter Russell has done research on a number of market segments (value, small cap, etc.). His site is http://www.Early-Retirement-Planning-Insights.com. If you use the search box, you should be able to find that research. It generally shows that the various segments perform in ways largely similar to the broader S&P index.

    I do not say that any of the findings we have come to in the first seven years are definitive or anything close to it. My aim is to get thousands and thousands and thousands of people talking about these issues. When that happens, there will be hundreds of calculators like The Stock-Return Predictor available on the internet. People will be studying these questions from every possible angle and our understanding of how stock investing works will grow and grow and grow.

    The sad thing is that we cannot get this process moving forward until we get some of the big-name experts to say those magic words “I” and “Was” and “Wrong.” The promotion of the Passive Investing concept (the idea that valuations do not matter AT ALL) has taken 70 percent of the questions that we need to have answered to understand how stock investing works off the table.

    The state of knowledge of investing is primitive today not because we lack I.Q. points. It is because most of us are devoting all of our mental energies to NOT knowing how investing works instead of to knowing how it works. We need to give up our belief in Passive Investing. In a world in which The Passive Investing Monster has been conquered, all sorts of wonderful things are possible.

    The creation of The Stock-Return Predictor is a baby step forward. It is not intended to answer all the questions. The intent is to give people a taste of what is possible when we get to the other side of the mountain. Every person concerned about seeing out economy go into a depression and about the world war that will likely result from this should be working today to open up the internet to honest posting on the grave flaws of the Passive Investing model, in my view. I am not able to think of any issue of greater importance to our entire society at this point in time.

    It’s a bold statement. But that is my sincere take re this matter.

    We need a functioning economy. We cannot have a functioning economy in a world in which no one knows the true value of his or her stock portfolio. No one can know the true value of his or her stock portfolio in a world in which most of us pretend that overvaluation and undervaluation do not have an effect. We’ve been telling millions of lies to each other for 30 years now and we need to stop doing this.

    Rob

  4. Rob says

    Are there any other tools you’ve seen, other than P/E 10 that hold some predictive power? Must P/E 10 be used alone or can it be used in conjunction with other valid measures?

    P/E10 does not possess God-like powers, Arty. It is a tool to help people understand the realities. Nothing more and nothing less. There are scores of other tools that could be put to profitable use. For example, there’s something called Tobin’s Q. Some valuation-informed investors use that in preference to P/E10.

    P/E10 should NEVER be used alone. It should ALWAYS be used in conjunction with other things.

    I’ll offer one illustration of the point. We are today at a P/E10 value of 12. That’s a wonderful P/E10 value. Going by the numbers, you should have an 80 percent stock allocation.

    I don’t recommend that. I say that the typical middle-class investor might want to go with 50 percent or 60 percent if he was not investing passively before the crash and at 0 percent or 30 percent if he was. Why do I say these things?

    We went to more insane price levels in the 1990s than we ever did before in history. So the payback is likely going to be greater than it has ever been before. The numbers we use to generate the calculator results are numbers that came from times in history in which the belief in Passive Investing was not as strong as it was in the 1990s. So you can’t count on those results playing out in this environment. We may be seeing some very bad stuff before things turn around.

    Stocks offer a good deal today. But we don’t know precisely how much pain you are going to need to suffer to see the good stuff. We are at a place at which we have never been before because of the reckless advice we have been hearing from the “experts” for 30 years now. The calculator helps you know how to proceed. It does NOT answer all the questions.

    The reason why I say that those who have been investing passively should not even go to 50 percent is that they have suffered a huge hit ALREADY. The price of those big returns promised by the calculator is that you need to be able to withstand a 50 percent price drop from today’s price levels. I think that’s possible for Rationals. I don’t see it as being even a tiny bit possible for Passives, who have already seen losses of 50 percent or more since 2000. Passives need to be spending the next year or two learning the ABCs of investing and THEN should think about dipping a toe into the water.

    The calculator performs a valuable service. It does NOT answer all possible questions. Not by a long, long, long shot. It’s not even close.

    Rob

  5. Rob says

    In logic and persuasion, there is a fallacy we may call, context switching. The use (misuse) of the market timing studies employs this well. Here, a portion of “the truth” is embraced (short-term timing does not work, or the brief period covered shows it does not work) and made to seem the one, absolute and all applying ‘truth” (market timing does not work).

    That’s it, Arty.

    That’s your entire economic crisis right there.

    We made one mistake. But it was a doozy.

    There has of course never been a sliver of evidence that long-term timing does not work. The idea that any evidence showing this could ever be produced is of course preposterous. Expecting to see such evidence is like expecting to see evidence of a working perpetual motion machine.

    Rob

  6. Rob says

    I would like to see your work submitted to a journal

    If someone wants to submit it, I certainly have no objection.

    My primary concern is with my fellow community members in the Retire Early and Indexing discussion-board communities, thousands of good and fine people who have suffered devastating life setbacks as a result of the ban on honest posting at our boards.

    I built the Motley Fool board for a purpose. I wanted to have a place where people interested in achieving financial freedom early in life could get together and trade ideas. The idea has worked beyond my wildest expectations. All of the insights set forward at this site are the work product of community interactions. I am proud of all the work we have done together both on the saving side and on the investing side and I believe that, once the ban on honest posting is lifted, our potential is unlimited. I care about our community a whole big bunch more than I care about seeing any peer-reviewed studies published in any Hot Shot Journals.

    I have nothing against Hot Shot Journals. I have learned from things published in Hot Shot Journals. I am glad that they are around. I wish the people involved in producing them well. It’s just not my particular cup of tea, you know?

    I am a community guy, Arty. I believe in this new communications medium. I think it would be fair to say that the Retire Early and Indexing communities have done a whole big bunch more to help people understand the realities of stock investing over the past seven years than any Hot Shot Journals have in 50 years.

    I understand your feelings re this matter. I know you are sincere and I know that your intent is good. But I’ll continue to dance with the one who brung me. My heart is with my fellow community members. I don’t need the approval of any Hot Shot Journals to assure me that the work we have done together (our community includes you, to be sure!) is of tremendous value.

    If the Hot Shot Journals were so great, we never would have gotten into this mess in the first place. If the community rules had been followed, we would have been letting people know the accurate SWR numbers seven years ago. What does that tell you about which of the two mediums truly has more power to do a little bit of good in this world?

    Rob

  7. Rob says

    One more thought on the Harry Browne portfolio. You mentioned lack of income as a concern. But it does have the cash (ST bond component) and the LT Bonds (20-30 years). That and good returns overall in various economic environments. Just a thought…

    You point is perfectly well taken.

    I don’t say that Valuation-Informed Indexing works better than the Harry Browne portfolio. My gut told me that it was a better choice for me. But I believe that lots of others should be studying lots of other things before any of us come to any definitive conclusions.

    Valuation-Informed Indexing is far superior to Passive Indexing. Of that I am 100 percent certain. I can state that one strongly because it is not possible for the human mind to imagine a scenario in which Rational Investing would not beat Passive Investing on a risk-adjusted basis over the long term.

    I cannot make the same sort of statement re the Harry Browne approach (or re lots of other possible approaches). I look forward to seeing lots of smart people examine thousands of such questions in days to come. That’s what it’s all about. The point of all this is to get a national debate on how stock investing really works initiated. Once the debate gets started, there’s no stopping us, in my assessment.

    Rob

  8. Arty says

    “But I’ll continue to dance with the one who brung me. My heart is with my fellow community members. I don’t need the approval of any Hot Shot Journals to assure me that the work we have done together (our community includes you, to be sure!) is of tremendous value.”

    I don’t see your getting published and serving your community as mutually exclusive notions. I think publication reinforces the concept and brings it to a wider community who can also benefit. The peer-review publication process may also ask questions about your work, which, in turn, may result in your improving it. That’s a win-win.

    “If the Hot Shot Journals were so great, we never would have gotten into this mess in the first place.”

    It’s not their fault how published work gets used by others. And “hot shot” is just a way of denigrating them all, and the scientific process, which is unfair. It is mostly how the science is used, or misused, by other “experts” that is the problem, not science per se. Published works have also helped. Short-term timing studies help us understand what does not work. Published work on TIPS (a comparatively new vehicle in the U.S.) have helped many understand and benefit from them. There is tons of work that you would likely say has helped our understanding of investing.

    At day’s end you don’t want to publish and that is fine.

    “The point of all this is to get a national debate on how stock investing really works initiated. Once the debate gets started, there’s no stopping us, in my assessment.”

    I agree entirely with this sentiment, which is why I think publishing is a useful auxiliary to that aim. Like it or not, it also adds a useful imprimatur of validity. You may not feel that is helpful or desirable. It’s your hard work and you have every right to do with it what you wish.

    Arty

  9. Rob says

    It’s not their fault how published work gets used by others.

    They have no responsibilities to speak up when they see their work being misused? I don’t buy it.

    And “hot shot” is just a way of denigrating them all, and the scientific process, which is unfair.

    I see it just the other way, Arty. I hear denigration of the discussion-board medium in the suggestion that the work we have done doesn’t “count” until we get it published in a journal.

    Again, I understand that your intent is good. But I do sense that you feel that journals are more important than discussion boards. I don’t feel that way. Like everyone else, I direct my time to the stuff that I think is most important. I see the internet discussion-board medium as the more important medium.

    You’re right that the two are not mutually exclusive. But there are only so many hours in the day and there are hundreds of articles that I would like to be writing and hundreds of podcasts that I would like to be recording and new calculators that I would like to be developing and more blogs that I would like to be posting guest entries at and all that sort of thing. If I were to devote time to getting published in a journal, it would take time away from other stuff that I view as being more valuable.

    Rob

  10. Rob says

    It is mostly how the science is used, or misused, by other “experts” that is the problem, not science per se.

    We agree that it is not science itself that is at fault. Science is the answer, not the problem.

    But I say that a lot of the people being published in the journals are contributing to the problem.

    Rob Arnott asked for a show of hands at a conference of academic researchers in this field how many believed in the Efficient Market Theory. Not one researcher raised his or her hand.

    Then he asked a follow-up. He asked how many would be making use of the Efficient Market Theory as the starting premise of the work they would be doing when they got back to the office on Monday. Nearly every hand went up.

    Is this not part of the problem?

    Rob

  11. Rob says

    Short-term timing studies help us understand what does not work.

    Absolutely.

    We agree 100 percent re this one.

    Ideas mined by the people who have been promoting Passive Investing for 30 years provide the foundation for the Rational Investing model.

    Rational Investing would not be possible today if Passive Investing had not come before it.

    We owe all these people our gratitude. They have revolutionized middle-class investing.

    Rob

  12. Rob says

    I think publishing is a useful auxiliary to that aim. Like it or not, it also adds a useful imprimatur of validity.

    I believe that the reason we are coming at this from different directions is that you feel that our task is an intellectual one. You are thinking that we need to persuade people.

    I feel that we need to change people’s hearts. The intellectual persuasion part of the job can be done in 10 minutes. But it adds up to nothing for so long as people feel all the shame and guilt and embarrassment over what they done by promoting Passive Investing for 30 years.

    At some point, the pain will get so great that these people will break down and say the three magic words. When that happens, all the boards will be opened to honest posting. AND all the journals will begin running articles rooted in the Rational Investing model rather than the Passive Investing model.

    We need to change hearts, not minds. The minds will follow easily once the hearts are changed.

    How do you change hearts? I try to do it through words. I wish that worked.

    The only thing that we have seen make a big difference is the pain suffered as a result of the huge price crash. I cannot bring myself to say that only by suffering great pain can we move forward. However, I cannot deny that the evidence in the record could be reasonably interpreted as suggesting that this is so.

    Rob

  13. Rob says

    It’s your hard work and you have every right to do with it what you wish.

    I’m grateful to you for making the suggestion, Arty.

    I am not God. I do not get them all right.

    I learn by hearing what other people interested in the topic tell me when they take the time out of their day to try to help me (and others) out. It might be that you are right and that I am wrong.

    Rob

  14. Arty says

    “I believe that the reason we are coming at this from different directions is that you feel that our task is an intellectual one. You are thinking that we need to persuade people.”

    Again, I do not think these are mutually exclusive concepts. “Persuasion” can exist in multiple pathways.

    “The intellectual persuasion part of the job can be done in 10 minutes.”

    I disagree because there may be valid objections to aspects of the argument, or with the tools used, and you might agree with them in continued dialogue. I can’t say what those would be. I can only say they *may* exist and good discussion might modify your current views. If true, I’d see that as a good thing.

    “But it adds up to nothing for so long as people feel all the shame and guilt and embarrassment over what they done by promoting Passive Investing for 30 years.”

    I think that is a powerful insight. I do not doubt the psychological underpinnings of your views on this. I share them.

    “We need to change hearts, not minds. The minds will follow easily once the hearts are changed.”

    Well, you and JWR have spent a ton of time on the technical (mind) component in all this! For me that is what “valuation matters” means when I read Shiller, or when your work develops with a statistical tool. So you have appealed powerfully to the “mind” portion heavily (the “rational”). But again, the behavioral (irrational?) underpinnings also exist, i.e., why change does not occur, say, even if a method has been shown to be inferior.

    So again, I don’t see the work as mutually exclusive. I say strengthen the technical argument as much as you can (vis peer-reviewed science). *And* also discuss the behavioral to your heart’s content.

    But if you want to spend your time differently, that’s another matter entirely.

    Arty

  15. Rob says

    I disagree because there may be valid objections to aspects of the argument, or with the tools used, and you might agree with them in continued dialogue.

    Once you accept that valuations affect long-term returns, there is zero possibility that Passive could be the way to go, right?

    I have been at this for seven years and I have never heard one person make one argument that valuations do not affect long-term returns.

    So what are these “valid objections” you are referring to? There are no valid objections possible.

    On the details, sure. There are thousands of valid questions about the details. You get no argument from me.

    But there is zero case that can be made that Passive makes sense.

    So why are there still people advocating Passive?

    It’s 100 percent emotion. Zero reasoning.

    Rob

  16. Rob says

    you and JWR have spent a ton of time on the technical (mind) component in all this!

    Yes. But the work product we produce can never match the work product that will be produced when there are thousands and thousands of people participating in the discussions, including all those who advocate Passive today.

    The leverage in getting those thousands involved in a constructive way is huge.

    Not one soul benefits from believing in Passive. There is zero rational reason why we should lose the benefits of even one investor’s work product. Making the shift to Rational is a win/win/win/win. No downside whatsoever. Not for one person on the entire planet.

    Saying that you see a benefit in Passive is like saying that you see a benefit in cancer.

    That’s an intentionally strongly worded statement. Is it not so? Is there any benefit that anyone can imagine to have people continuing to believe in Passive? My poor little mind is sure not able to think of any.

    Rob

  17. Rob says

    So you have appealed powerfully to the “mind” portion heavily (the “rational”).

    Rational Investing is NOT the more mind-oriented approach. That’s Passive Investing.

    Passives look only at logic chains. This is the huge mistake. Most investors are humans. Humans are not influenced only by logic chains.

    Logic chains are about 30 percent of what affects investing results. Passives get that 30 percent perfect. They get the other 70 percent all wrong (because they refuse to look at it on grounds that it is not logical) and that destroys them.

    When dealing with humans, the Rational thing to do is to look at BOTH logic AND emotion. Why? Because humans act according to both logic and emotion. You cannot get any of the numbers right unless you look at both.

    Overvaluation and undervaluation are not the product of logic. They are the product of emotion. Rational Investors take valuations into account. Passive Investors do not. That’s the entire difference between the two models.

    It’s the difference between a model that works and a model that cannot work.

    Which is the Rational thing to do when dealing with humans? To ignore emotion or to acknowledge its influence?

    That’s the question on the table.

    Rob

  18. Rob says

    But if you want to spend your time differently, that’s another matter entirely.

    If we can persuade people to act in their own self interests, there will be so much good stuff coming in from so many directions that you won’t be able to keep track of it.

    If we cannot persuade people to act in their own self interests, the economy is probably going to go over a cliff and we are all doomed, Rationals and Passives alike. There probably won’t be any journals left to publish in under that scenario.

    I focus on the emotional side because I believe that that’s where the real action is.

    Rob

Trackbacks

Leave a Reply

Your email address will not be published.

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

Comments links could be nofollow free.