Recent blog entries have reported on my correspondence with www.IndexUniverse.com in an effort to have an article on Valuation-Informed Indexing published at the site. Set forth below is the text of an e-mail that I sent to Matt Hougan on February 5, 2008, and his response, sent the following day.
Thanks for your response.
This particular article was intended as an introduction to the Valuation-Informed Indexing concept, not as a complete and total proof that it is the way to go. It would take a book-length manuscript to pull that one off!
My thought was that I would start with an introduction to the concept and then follow with articles addressing various other aspects of the question. Some of these would indeed address the statistical work supporting this approach, others would address emotional aspects of the question (I view these as most important), others would address what “experts” say, and still others would engage in a common-sense reasoning process (I would place the “Staying the Course” article in this category).
If you want to begin with a numbers-focused article, I suggest that I begin with a description of The Stock-Return Predictor. This is a calculator available free at my site that uses a regression analysis of the historical stock-return data to reveal the most likely 10-year annualized real return of the S&P index, presuming that stocks perform in the future somewhat as they always have in the past. The statistical work is all done by John Walter Russell (owner of the Early-Retirement-Planning-Insight.com site). I am not able to do that sort of work.
I think the best way to proceed is for you to take a look at the calculator and the write-up that describes it. If an article describing the calculator has appeal, it will not be much trouble to write one up that would be suitable for your site. With that, readers will have background on the tool used to execute the “Staying the Course” strategy described in the article you have already seen.
Does that make sense from your perspective?
Here is a link to the calculator:
The issue is that you are, to be frank, a lightening rod of controversy. I don’t really know why (nor, really, do I care). But that means that anything you publish on our site has to be extra-well-documented and fully supported by hard facts and research. I’m not trying to be hard on you, just to be a good editor.
So, going back to your first article, here would be my critique. The article makes intuitive sense. The insight – buy less when the market is high, buy more when the market is low – is not especially controversial nor particularly revolutionary.
What would make the article interesting, then, is hard data. Reading the article, I’m left wondering: Is the opportunity cost of reducing your equity exposure worth the risk reduction? What are the impacts on returns of following this strategy on a historical basis, and what are the exact details of implementation (and how were those details decided?)
Ultra-long-term studies of the market show that fluctuations in P/E account for a tiny fraction of long-term equity returns. The bulk are accounted for by reinvested dividends and to a lesser extent corporate earnings growth. That would suggest to me that ultra-long-term investors would do worse under your framework. The data may show otherwise … which is why I need the data.
I read the link on the returns calculator, but I’m left at the same point of wanting to see the details of the implementation and details of historical performance, complete with annualized returns, min/mix annual drawdowns and Sharpe ratios.